The A-B Living Trusts was initially conceived to address Federal Estate Tax (FET). When I began practicing Estate Planning in California the exemption from FET was $600,000 and real property values were high. Most everyone with a home in San Diego could potentially owe FET in their estate. As a result, almost everyone had A-B provisions included in their Living Trust.
How do they work? Are they no longer needed? How do they benefit you? Do they cost extra fees? Should they be deleted from the Trust? How are they administered on the death of a spouse?
A-B Trusts are for spouses as they have no application for single people. The A-B provisions come into active existence when a spouse dies. The Survivor's Trust A is commonly remembered by the fact that the Surviving Spouse is Above ground, Trust A. The deceased spouse is Below ground hence, Trust B. The Trust estate is then split between the two Trusts by a formula. Practically speaking, each Trust receives one-half of the Community Property owned by the Living Trust and the Separate Property owned by each spouse. The formula limits funding Trust B up to the maximum of the FET exemption. As a result, the B Trust insures that the exemption amount for the decedent spouse is retained. Otherwise it would be lost on the death of the first spouse.
Okay, for those of you who are starting to doze off grab a cup of Joe or get some sugar in your system because we've got some important information that YOU NEED TO KNOW.
I hope I don't have to raise this issue again.
Now, here's the deal. The exemption from FET is now $5 Million per person. How many couples do you know have $10 Million plus. That should tell you something. Most couples don't need A-B Living Trusts, right? Wrong, the answer is maybe. Let's see why.
What if there is a blended family, i.e., children from prior marriages. Example: Biff and Bunny each have children by previous marriages who wish that such children inherit their respective shares of the estate. Biff and Bunny each have separate property and have accumulated additional community property, including the home, during their twelve year marriage. Absent an A-B Trust, all of the estate will be left to the surviving spouse on the death of the first spouse. Is that the real intentions of spouses? Because of the absence of the B Trust, the surviving spouse is normally free to direct the distribution of the remainder of the Trust estate to whoever he/she wishes. After, the death of the first spouse it is very common for his/her children to distance themselves from the step-parent. When this results, which children, do you think will benefit from the distribution of the Trust estate on the death of the surviving spouse.
To avoid this catastrophe, blended families must have an A-B Living Trusts to assure one-half of the Trust estate is distributed to the children of the first deceased spouse.
Okay, now what about some asset protection concerns. Let's assume there is a special asset, like a vacation home, that clients may want to protect from the potential negligence of the surviving spouse which could create damages to the Trust estate. If this is the case, we could consider using Trust B which is irrevocable and typically, unamendable, as the recepient of such asset. Since the surviving spouse does not own any of the Trust B assets personally, we could arguably protect such assets from judgement creditors. Again, Trust B can be a benefit to the family by including it in the Family Living Trust.
Let's look at an interesting strategy, regarding property taxes.
Hypothetical: Jack and Jill own a home valued at $800,000 and several rental properties valued at $2.2 Million. There total estate is significantly under the $5 Million exemption for one person, so a Simple Living Trust would normally be considered for their family. However, if we implement an A-B Living Trusts, look at the result property tax-wise.
If we have a Simple Living Trust, the entire Trust estate is left to the surviving spouse. On his/her death, the children will inherit the home and rental properties valued at a total of $3 Million. We want to utilize every tax benefit possible in the transfer of the estate to the children. The real property reassessment rules limit the Parent-child exclusion to the home, unlimited value, and $1 Million of other real property. Under this fact situation, the home and $1 Million in rental property would be excluded from reassessment.
Okay, pretty good result. But take a gander at the strategy if including an A-B Trust. On the death of the first spouse, we fund Trust A with the home and $1 Million of rental property. We place the remainder of the rental property in Trust B. On the death of the surviving spouse, Trust A becomes irrevocable and distributes the home and $1 Million to the children, all excluded from reassessment based on the Parent-Child exclusion of the surviving spouse. Trust B distributes the remainder of the rental property to the children with another exclusion of $1 Million based on the Parent-Child exclusion of the first deceased parent. Wow! What a strategic technique. By implementing the A-B Living Trusts you have just saved your children, or possibly grandchildren, thousands and thousands of potential real property taxes.
In summary, if you have a blended family; have a concern regarding asset protection; or have valuable real properties, you must consider an A-B Living Trusts for your family.