Save Taxes by Updating your Estate Plan
If you have an old A-B Trust in place, you may be unaware that recent tax law changes have transformed your A-B Trust from an estate tax shelter into an income tax burden for your loved ones. An A-B Trust, also known as a Credit Shelter Trust or Bypass Trust, typically provides that on the death of the first spouse, a particular share of the married couple’s assets are transferred into an irrevocable sub-trust (the “B” trust), rather than to the surviving spouse directly. Traditionally, using an A-B Trust was an estate planning strategy to preserve the deceased spouse’s estate tax exemption to be used upon the death of the surviving spouse. Without sheltering the first spouse’s unused exemption in the “B” trust, any assets in excess of the survivor’s exemption amount would be exposed to very high federal estate taxes.
However, tax law changes in 2013 made permanent an individual federal estate lifetime tax exemption of $5 million (adjusted annually for inflation – 2017 is $5.49 million). If you and your spouse won’t surpass the combined $11 million threshold, your A-B Trust may need to be changed from an estate tax planning perspective. Married couples whose combined assets including life insurance proceeds are less than $5.49 million clearly need to review whether their A-B Trust structure needs to be changed. BEWARE – if you keep your old A-B Trust in place, you might actually be creating a negative income tax consequence because of a specific tax basis rule.
The Internal Revenue Code provides that the tax basis in inherited property gets “stepped up” to its date-of-death fair market value when it is included in a decedent’s estate. When the first spouse dies and the couple has an A-B Trust in place, the assets passing to the “B” Trust get this “stepped up” tax basis. However, when the surviving spouse dies and there are assets remaining in the “B” trust, those assets will not receive the same basis adjustment since those assets are not included in the surviving spouse’s estate. As a result, when the surviving spouse dies and the beneficiaries of the A-B Trust sell the “B” trust assets, the beneficiaries will be responsible for paying any capital gains taxes associated with those assets. If a long amount of time has passed between the spouses’ deaths and the “B” trust assets are valuable, the income tax liability for the beneficiaries could be significant.
While the non-tax reasons for having a trust in place may ultimately drive your estate plan, saving income taxes should now be an important consideration. There are several strategies your estate planning attorney can use to help you maximize income tax savings, and each strategy has its own advantages and disadvantages. Your estate planning lawyer can give you peace of mind by identifying and implementing strategies to help your family save income taxes when you pass away. If you have an old A-B Trust in place, contact your estate planning lawyer today to review your estate plan.
Bill Hesch is a CPA, PFS (Personal Financial Specialist), and attorney licensed in Ohio and Kentucky who helps clients with their financial and estate planning. He also practices elder law, corporate law, Medicaid planning, tax law, and probate in the Greater Cincinnati and Northern Kentucky areas. His practice area includes Hamilton County, Butler County, Warren County, and Clermont County in Ohio, and Campbell County, Kenton County, and Boone County in Kentucky.