What is an AB Trust?

Tax Planning for Married Couples

Married couples can maximize the use of both of their federal exemptions from estate tax by using AB Trusts as part of their estate plan. The AB Trust system can be set up under the couples' Last Will and Testaments or Revocable Living Trusts. The "A Trust" is also commonly referred to as the "Marital Trust," "QTIP Trust," or "Marital Deduction Trust." The "B Trust" is also commonly referred to as the "Bypass Trust," "Credit Shelter Trust," or "Family Trust."

Here's how the AB Trust system works to maximize the use of both spouses' estate tax exemptions:

1. The couple includes the appropriate AB Trust language in their Last Will and Testaments or Revocable Living Trusts. Note that this should not be attempted without the assistance of a qualified estate planning attorney.
   
   
2. The couple divides their assets so that each spouse has about the same value of assets in his or her individual name or in his or her Revocable Living Trust. This is an important step and must be done in order for the AB Trust system to work. Many times couples leave their assets in joint accounts and this completely voids the use of the AB Trust system since the joint assets will pass outright to the surviving spouse instead of through the deceased spouse's Last Will or Revocable Living Trust.
   
   
3. When the first spouse dies, the first $3,500,000 of his or her assets are funded into the B Trust. This effectively uses the first spouse's $3,500,000 federal exemption from estate taxes. The B Trust can be relatively flexible and used for the benefit of the surviving spouse and descendants or other beneficiaries.
   
   
4. If the deceased spouse's assets exceed $3,500,000, then the excess is funded into the A Trust. This will defer the payment of estate taxes on the assets above the deceased spouse's $3,500,000 exemption until after the surviving spouse's death. Because of this estate tax deferment, the A Trust is less flexible and can only be used for the benefit of the surviving spouse. In addition, the surviving spouse is required to receive all of the income from the A Trust.
   
   
5. When the surviving spouse later dies, he or she still has his or her own $3,500,000 exemption. The first $3,500,000 of the surviving spouse's separate assets will pass estate tax free to the final beneficiaries. Anything over $3,500,000 will be taxed.
   
   
6. The assets remaining in the B Trust pass estate tax free to the final beneficiaries. This is because the B Trust used up the $3,500,000 exemption of the first spouse to die, so anything left in the B Trust will pass estate tax free. This can provide a significant windfall to the final beneficiaries if the surviving spouse doesn't need to use the assets from the B Trust.
   
   
7. The assets remaining in the A Trust are taxed as part of the surviving spouse's estate. As mentioned above, the estate tax on the A Trust is effectively deferred until after the surviving spouse dies.
   
   
8. The balance of the A Trust that remains after the estate tax bill is paid passes to the final beneficiaries. Note that the beneficiaries of the A and B Trusts can be different.

As illustrated above, effective use of the AB Trust system will allow married couples to pass on $7,000,000 to their final beneficiaries, free from any federal estate taxes. This is by far the most common technique used by married couples to reduce, or even eliminate, the federal estate tax bill.