An AB trust is a legal device that has become much less commonly utilized than it was in the past. In order to understand the value of an AB trust, you need to digest some background information about the estate tax. There is a federal estate tax that carries a hefty 40 percent maximum rate. This levy can significantly reduce your legacy, but most people are not exposed to it, because there is a rather large exclusion.
At the time of this writing in 2019, the federal estate tax exclusion is $11.4 million. As a result, the first $11.4 million can be transferred free of taxation, and the estate tax would be imposed on transfers that exceed this amount. This exclusion is the highest that it has ever been since the estate tax was enacted.
Since we are talking about AB trusts here, the sequential changes are quite relevant. Back in 2001, the estate tax exclusion was just $675,000. By 2009, it was $3.5 million, and there was a total repeal of the estate tax in 2010. This was part of the Bush era tax cut package.
In 2011, the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act included provisions that applied to the estate tax. Under the previous arrangement that included the repeal, the estate tax was going to return in 2011 with a $1 million exclusion. This act provided tax relief for wealthy families, because it set the exclusion at $5 million.
This was the base exclusion for the next several years, and there were annual adjustments to account for inflation. In 2017, the estate tax exclusion was $5.49 million. During that year, there was a new round of tax cuts, and the estate tax was profoundly impacted. In 2018, the exclusion was set at $11.18 million. An inflation adjustment has brought the figure up to the $11.4 million for 2019 as we stated previously.
Now that you have the requisite information, we can move on to the traditional value of AB trusts. When the estate tax exclusion was in the $675,000 to $3.5 million range, a significant number of families faced estate tax exposure. As a result, they had to implement estate planning strategies that provided estate tax efficiency.
At this point, it is important to note that there is an estate tax marital deduction that allows you to transfer unlimited assets to your spouse free of the estate tax.
If you were to establish an AB trust, after your passing, a portion of your estate that is equal to the amount of the exclusion would be conveyed into a bypass or “B” trust. The rest would go into another trust (the A trust) that benefits your surviving spouse.
Assets in the B trust would not be subject to taxation because of your exclusion. The transfer to your surviving spouse would be tax-free as well via the unlimited marital deduction.
Your exclusion would be exhausted, but your spouse would still be entitled to an exclusion. After the passing of your surviving spouse, his or her exclusion would be applied when assets are transferred to the final beneficiaries.
Estate Tax Portability
Prior to the tax law that was enacted in 2012 the estate tax was not portable between spouses. This means that a surviving spouse would not be able to use the exclusion that was allotted to his or her spouse.
In other words, when you died, your exclusion died with you. AB trusts allowed wealthy individuals to use their exclusions to fund B trusts, and the survivors would still have exclusions to utilize.
The laws were changed in 2011, and the estate tax exclusion was made portable. This more or less eliminated the need for AB trusts for estate tax purposes. In addition to this, as we have stated, the exclusion went up to $5 million that year, and this was a factor as well. Fewer families were exposed to the estate tax.
Now that it has reached $11.4 million, and the estate tax exclusion is portable, a couple could transfer $22.8 million free of federal transfer taxes. Because of this, a tiny percentage of people are exposed to the estate tax.
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