AB Trusts

Tax saving trusts
Working Principle of a Tax Saving Trust
The Effect of a Tax Saving AB Trust

Tax saving trusts

Some trust are specifically designed to boost tax savings. The most common kind is the so called AB Trust (sometimes “bypass trust”, “Exemption trust”, “family trust” or “credit shelter trust”). AB Trusts are prevalent even as their tax saving effect applies to married couples only. Those trusts have an two-sided focus. They still avoid costly probate and can additionally provide significant estate tax savings on large estates.

Working Principle of a Tax Saving Trust

An AB Trust uses the personal estate tax exemption of each spouse to maximize tax savings on the combined estate for the heirs of the couple (in most cases their children). The construction utilizes an ordinary shared living trust for both spouses and two additional trusts for each spouse, Trust A and Trust B. If one of the spouses dies, all his designated property of the shared trust goes into a new Trust A, which becomes irrevocable and gives the surviving spouse a lifelong interest in the trust assets. No trust assets are transferred upon the death of the first spouse to the other spouse. They remain in the now irrevocable Trust A. The designated property of the surviving spouse goes into Trust B, which stays revocable. The children of the couple are usually nominated as second beneficiary of those two trust. Therefore they receive the trust assets of Trust A and Trust B (as long as the surviving spouse has not changed Trust B) according to the terms of the trusts.

In terms of estate tax the first transfer from the shared trust to Trust A is taxable, because  the marital deduction does not apply here. However there is still the personal threshold that reduces or nullifies estate taxes. When the children finally become beneficiaries of Trust A there is no more estate tax to pay. Estate Tax is then applied on the assets of Trust B (the trust of the surviving spouse). However now the personal estate tax threshold of the second spouse reduces or nullifies the Estate Tax of this transaction.

The Effect of a Tax Saving AB Trust

As a result the personal tax exemption amount of both spouses can be used for passing property to the children, thus the tax exemption amount of both spouses is combined. In contrary if the ownership of the first spouse’s property was transferred to the surviving spouse first and again transferred to the children upon the second spouse’s death, the tax exemption amount could only be used once. Given the tax exemption threshold would be $ 3.5 million (like in 2009) this construction allows couples to pass up to $ 7 million in property free of estate tax.

The tax saving effect has to be considered as soon as you and your spouse own property that is worth more than $ 3.5 million. However it is not always easy to determine the exact value of your property. Therefore when drafting a tax saving living trust construction, not only the complexity of the law has to be taken into consideration but also, accounting skills are required in order to do a proper evaluation of your estate assets. But there is no need to become desperate. The lawyers of Rinne Legal in San Francisco are looking forward to consult you and to provide the necessary estate planning assistance.