LAWYER FOR Life
K i r s t e n H o w e , At t or n e y At L aw
July 2014
Keeping Your Family Healthy, Wealthy & Wise
What Should Be Done
About A-B Trusts?
In This Issue
• What Should Be Done
About A-B Trusts?
...................... Page 1
•A Personal Note From
Kirsten Howe
...................... Page 4
In the old days (meaning way back
any time before 2013) we estate
planners routinely created what are
commonly known as “A-B trusts” for
our married clients. The goal was
to minimize and defer estate tax by
creating both a survivor’s trust (the
“A trust”) and a bypass trust (the “B
trust”) when the first spouse dies.
This would allow us to use up all
of the estate tax exemption of the
deceased spouse while still allowing
the surviving spouse access to the
entire estate if necessary, and it also
allows the estate tax to be deferred
until after both spouses have died.
The estate tax was as high as 55% in
2001 (historically it has been higher,
but that was before my time), and the
estate tax exemption was all over the
map changing from year to year, but
sometimes as low as $1,000,000. So
we erred on the side of complexity
by creating the A-B structure for our
surviving spouses in order to make
sure nobody got caught flat-footed
and had to pay estate tax.
(cont.)
Kirsten Howe
Attorney at Law
1615 Bonanza Street, Suite 324
Walnut Creek, California 94596
Ph: 925-943-2740
www.kirstenesq.com
What Should Be Done About A-B Trusts? (cont.)
On January 2, 2013, President Obama signed the
American Taxpayer Relief Act (ATRA) into law.
Among many other things, this law established a
permanent estate tax
regime that included
very high exemptions
from estate and gift tax
($5,340,000 for 2014,
indexed to inflation)
a flat estate tax rate
of 40% and spousal
portability of unused
estate tax exemption.
The law also increased
the tax on long-term
capital gains to its
highest rate since
1997. When combined
with the new 3.8% net
investment income tax
that took effect last year as a part of ObamaCare, the
top federal rate on long-term capital gains is now
23.8%, up from 15% in 2012 and the top California
long-term capital gains tax rate is 13.3%.
The long and short of all of this is that for the vast
majority of Americans, estate taxes are no longer a
concern and we as planners may need to be more
focused on income taxes when our clients look to
us to help them plan and administer their estates.
There are a couple of pretty easy fixes for these old
A-B style trusts.
Married Couples Can Amend Their Trusts
In the case of married couples doing estate planning,
when there is no chance that the joint estate will
exceed the combined estate tax exemption amount,
which for a married couple is $10,680,000 this
year, there is simply no longer any tax reason to
create a bypass trust. This past year we amended
and restated more trusts than we ever have, and the
reason in most cases
was to eliminate the
A-B structure.
If
the couple has been
married for many
years and there are
no step-children, it is
much simpler for the
deceased spouse to
leave his or her entire
estate to the surviving
spouse. Having just
one revocable trust
instead of two trusts
(an irrevocable B trust
and a revocable A
trust) is simpler. It may
be prudent for the surviving spouse to file an estate
tax return in order to claim the deceased spouse’s
unused exemption amount, but that is much easier
than filing an income tax return for the B trust
every year. Believe me, surviving spouses do not like
bypass trusts.
In addition, the tax result from not creating a B or
bypass trust will be better for the children in the
end. Assets in the bypass trust do not get a new,
stepped-up tax basis when the surviving spouse
dies. Assets owned by the surviving spouse do get
that new stepped-up basis. That new basis means
that when the kids inherit the assets, there is no
built-in capital gain, and hence no capital gains tax
to be paid if the children decide to sell the assets. By
creating a trust that does not require the creation of
a bypass trust, we are able to minimize capital gains
taxes paid by the children.
(cont.)
What Should Be Done About A-B Trusts? (cont.)
Of course, this approach will not work for every
family. In an intact family we are usually not worried
that one spouse will disinherit the children after the
other spouse dies. However, blended families often
desire to preserve assets in an irrevocable trust for
the children of the first spouse to die so that the
surviving spouse cannot disinherit them. However, it
is important to note that because of portability and
the very high estate tax exemptions, this irrevocable
trust does not have to be a bypass trust, it can be a
marital deduction trust. Huh? What is the difference
you ask? An example will be helpful.
If Husband dies in a blended family, we would leave
his estate in a marital deduction trust, which you may
have heard called a QTIP trust or “C trust”. This is
a trust that the IRS considers to be owned by Wife
but which is actually an irrevocable trust controlled
by Husband’s wishes, meaning Wife can’t disinherit
Husband’s kids. From an income tax perspective,
because the IRS considers this C trust to be Wife’s,
when Wife dies the assets that it holds will get a new
stepped-up tax basis. The C trust is still an irrevocable
trust, so Wife will still have to file a tax return for it
every year, but it allows Husband to make sure his
kids are not disinherited by Wife and also to get those
kids the best income tax result.
Widowed Clients Can Modify Trusts
What can we do to help a widowed client who has an
A-B trust but, because of the tax law changes discussed
above, really does not need that complex structure?
Oftentimes it is appropriate and possible to modify the
trust after the first spouse dies. Remember, with an A-B
structure, the bypass trust becomes irrevocable once
the first spouse dies. This means that the surviving
spouse cannot simply go to his attorney and draft
an amendment to the trust. Instead he will have to
do a modification to the trust, which requires court
approval. This is not a difficult process. It requires that
we file a petition with the probate court and get the
consent of all of the children. It may also require the
consent of grandchildren, depending on the terms of
the trust. If the petition is granted, the trust will remain
revocable until the surviving spouse dies.
Recommendation: If you have an A-B trust, consider
restating it to eliminate the required A-B structure or
to replace it with an A-C structure while both spouses
are alive or modifying the trust if one spouse has died.
Kirsten Howe
Attorney at Law
1615 Bonanza Street, Suite 324
Walnut Creek, California 94596
Ph: 925-943-2740
www.kirstenesq.com
A Personal Note From Kirsten Howe
Dear Clients and Other Friends,
If you are a recent widow or a married couple who has not reviewed your trust in the last few years, I hope
you will read my article about A-B trusts and take your own trust out to see if the strategies in the article
apply to you. Because the estate tax laws have changed in the recent past, an amendment or modification
of your trust might dramatically simplify your life.
I hope you have a fun summer planned for yourself. We have our annual camping trip to Yosemite coming
up as well as a camping trip to our new national park, Pinnacles. I’ve never been there and am really looking
forward to it.
Take care and stay cool!
Kirsten Howe
Kirsten Howe, Attorney at Law