These days very few families need a complicated tax avoidance trust also known as an A-B Trust. Many trusts were set up over the years to help protect wealth from death taxes. The old A-B Trust allowed you to double the tax savings by creating 2 trusts. However, the federal death tax exemption has risen steadily in recent years from $600,000 to $11,400,000 for 2019 (or to over $22,000,000 for couples). Congress has made the death tax exemption permanent until 2026 and indexed it for inflation. As a result very few people need estate tax planning, and many A-B Trusts that were created years ago are no longer necessary.
But what if you set up an A-B trust years ago? You may want to act now to get rid of it and avoid unnecessary expense and hassle for your family. The current laws make A-B trusts less desirable than they have been in the past when the exemption amount was $600,000.
How does an A-B trust work? When one spouse dies the trust is split into two (2) trusts, Trust A for the surviving spouse, and Trust B for the deceased spouse. Trust B is irrevocable, the surviving spouse cannot change its terms. When one spouse dies the survivor must hire a lawyer or an accountant to determine how to best divide the couple's assets between the deceased spouse's irrevocable trust and the surviving spouse's revocable trust. This decision can have important tax consequences.
The irrevocable “B” Trust is a separate tax paying entity. The surviving spouse must get an employer identification number issued by the IRS for the trust, and file annual trust tax returns (both a 1041 and a 541). These returns are in addition to the 1040 and 540 returns required for Trust A. Therefore the surviving spouse will need to file four (4) separate income tax returns for the rest of her life! The surviving spouse must keep separate records for the irrevocable trust property.
The surviving spouse would need two bank accounts: one for Trust A and another separate bank account for Trust B. The A-B trust becomes complicated after the death of the first spouse, and most surviving spouses are upset about these complications. The children are upset with the A-B Trust because the assets in the B trust are subject to income taxes that could have been avoided if their parents had busted the A-B Trust.
As long as both spouses are alive you can revoke your old A-B Trust and avoid the expense and hassle that will come after one spouse dies. To do it correctly, you should restate your old A-B Trust and update it to a simple probate avoidance trust with disclaimer provisions. You will also want to update your wills, health care directives, and powers of attorney for property. The title and date originally used for the trust will stay the same, so you don't have to worry about changing title to any of your assets.
Marc has 36 years in financial services and 6 years in teaching.
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