A-B Trust: Definition, Function, and Tax Benefits in Estate Planning

A-B Trust: Definition, Function, and Tax Benefits in Estate Planning
Posted on 31-05-2023

"A-B Trust: Definition, Function, and Tax Benefits in Estate Planning"

An A-B trust, also known as a bypass trust or a credit shelter trust, is a type of trust arrangement commonly used in estate planning to maximize tax benefits for married couples. It is designed to take advantage of the estate tax exemption by allowing both spouses to fully utilize their individual exemptions, thereby reducing or eliminating potential estate tax liability upon the death of the surviving spouse.

Here's a breakdown of the A-B trust, including its definition, how it works, and the tax benefits it offers:

Definition: An A-B trust is a trust arrangement that divides a married couple's assets into two separate trusts: the "A" trust (also known as the "marital trust" or "survivor's trust") and the "B" trust (also known as the "bypass trust" or "credit shelter trust"). Upon the death of the first spouse, the couple's assets are split between these two trusts according to the terms outlined in their estate planning documents.

How It Works:

  1. Establishment: The A-B trust is typically established through a revocable living trust or as a testamentary trust within the couple's wills.
  2. Division of Assets: The couple's assets are divided into the A trust and the B trust. The A trust contains the surviving spouse's share of the assets, while the B trust holds the deceased spouse's share.
  3. Surviving Spouse's Rights: The surviving spouse has certain rights and access to the assets in the A trust, including the ability to use income generated by the trust and sometimes even the principal.
  4. Bypass Trust Restrictions: The assets in the B trust are typically restricted from the surviving spouse's control, with limited access to income and principal. This separation ensures that the assets in the B trust will not be subject to estate tax upon the surviving spouse's death.
  5. Distribution of Assets: Upon the surviving spouse's death, the assets in the A trust pass according to the designated beneficiaries or instructions outlined in the trust document. The assets in the B trust are distributed to the designated beneficiaries, often children or other family members.

Tax Benefits: The A-B trust provides several tax benefits, including:

  1. Utilization of Estate Tax Exemption: By dividing assets between the A and B trusts, each spouse can fully utilize their individual estate tax exemptions. This approach effectively doubles the exemption amount and helps reduce or eliminate potential estate tax liability.
  2. Preservation of Portability: In the United States, the concept of portability allows the surviving spouse to utilize the deceased spouse's unused estate tax exemption. With an A-B trust, any unused exemption of the deceased spouse can be preserved in the B trust and used by the surviving spouse, maximizing the overall exemption available to the couple.
  3. Reduction of Future Estate Tax: The assets in the B trust are shielded from estate tax upon the surviving spouse's death since they are not included in the surviving spouse's estate. This can help reduce or eliminate estate tax liability for the combined estate of the couple.

It's important to note that estate tax laws and regulations can vary between jurisdictions, so it's advisable to consult with a qualified estate planning attorney or tax professional to ensure that an A-B trust is appropriate for your specific circumstances and to stay updated on any changes in tax laws that may impact the effectiveness of this strategy.

Additionally, while an A-B trust can provide tax benefits, it may also come with certain complexities and considerations, such as administrative costs, potential loss of step-up in cost basis for assets held in the B trust, and restrictions on the surviving spouse's control over the B trust assets. Therefore, careful planning and professional guidance are essential to determine if an A-B trust aligns with your estate planning goals.


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