An AB trust is a legal arrangement for married couples that can minimize estate taxes by splitting assets between two separate trusts when one spouse dies. While a federal provision that went into effect in 2011 rendered AB trusts unnecessary for most married couples, they can still be valuable estate planning tools for the wealthy, especially those who live in states that levy their own estate taxes. A financial advisor can help you decide whether an AB trust is right for you and create an estate plan to give you peace of mind.
What Is an AB trust?
An AB trust, also known as a bypass trust, divides a married couple’s estate into two separate legal entities (trust A and trust B) when the first of the two people dies. Trust B receives assets equal to the state or federal estate tax exemption limit, while the remaining assets in the couple’s estate are transferred to a marital trust for the surviving spouse.
The surviving spouse does not control trust B, which is irrevocable, but they may be able to receive income from that trust or live in a property owned by the trust. When the surviving spouse dies, only trust A will be subject to estate taxes.
How much money is potentially owed in estate taxes when a person dies primarily depends on the size of the estate and where the couple lived. Taxes are not owed on assets that fall below the federal gift and estate tax limit ($11.7 million in 2021), but 12 states and Washington D.C. levy their own estate taxes. These states have exemption limits well below the federal threshold, leading some couples to think carefully about how their estate is handled after their deaths.
A provision known as the unlimited marital deduction allows married couples to transfer an unlimited amount of assets to their spouses tax free. Even if an estate exceeds the federal and state tax exemption limits, the surviving spouse won’t have to worry about a tax bill. But those same assets may be subject to estate taxes when the surviving spouse eventually dies.
However, under a law that went into effect in January 2011, surviving spouses can claim the unused portion of their deceased spouse’s federal tax exemption. This “portability” of the federal estate tax exemption effectively allows a married couple to ultimately transfer up to $23.4 million without paying tax.
As a result, a married couple with an estate smaller than $23.4 million may not need an AB Trust. Instead, they can simply take advantage of the unlimited marital deduction and portability rule.
Reasons to Create an AB Trust
Of course, wealthy couples living in states with estate taxes may still benefit from establishing an AB trust.
For example, Frank and Linda live in Illinois and have a $9 million estate. While their combined assets are exempt from federal estate tax, Illinois levies its own estate tax on assets exceeding $4 million. Without an AB trust, $5 million would be subject to Illinois estate tax upon the death of the second spouse.
But with an AB trust, the death of the first spouse (Linda) would trigger the split of the estate into separate trusts. Four million dollars (the state exemption limit) would be transferred to trust B, while the remaining $5 million would be transferred to trust A for the surviving spouse, Frank. By using an AB trust, only $1 million from trust A would be subject to Illinois estate tax at the time of Frank’s death, saving money for his beneficiaries.
The table below breaks down 12 states and Washington D.C., which levy their own estate taxes with exemption limits:
States With Estate Taxes
|New York||$5.93 million|
|Rhode Island||$1.595 million|
|Washington D.C.||$4 million|
While the marital exemption and the portability rule has rendered AB trusts less useful, they can still help minimize estate taxes that are owed when assets are transferred. The viability of AB trust will depend on the size of a couple’s estate and where they live. While the federal government allows couples to potentially protect $23.4 million from estate taxes, 12 states and Washington D.C. all levy their own estate taxes and have lower exemption limits.
Tips for Estate Planning
- SmartAsset has compiled an estate planning guide to help you navigate this important process. Our guide includes estate tax rates and inheritance laws by state, tips on who needs an estate plan and more.
- It helps to have an expert in your corner, especially when it comes to estate planning. SmartAsset can help you find a financial advisor in your area who offers estate planning services. Our matching tool can pair you with three local advisors in minutes. If you’re ready to find an expert, get started now.
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