If you have an AB Trust, you would likely benefit from modifying it
Updated: Jun 11
What is an AB Trust and how do I know if I have one?
An AB Trust is a trust created by a married couple and upon the death of the first spouse, is split into two trusts called the “A Trust” and the “B Trust.” Sometimes the “B Trust” is referred to as a “bypass trust” or an “exemption trust.” Whatever the trust is called, it usually operates the same way: the “B Trust” becomes irrevocable upon the death of the first spouse, meaning the surviving spouse is not allowed to make changes to it.
Chances are, if you made a trust with your spouse prior to 2011, you have an AB Trust. However, the most certain way to determine whether or not you have an AB Trust is to take it to an attorney for review.
Why would anyone make an AB Trust?
The reason for creating an AB Trust is to keep your estate under the federal tax exemption limit and, thus, avoid estate taxes at your death. By making one trust irrevocable on the death of the first spouse, and funding it up to the amount of the federal estate tax exemption, a couple can effectively double the federal estate tax exemption for their estate, thus, avoiding twice the taxes.
For example, when the federal estate tax exemption was around $400,000 and you had an estate worth $600,000, you would pay federal estate taxes on $200,000 of your estate if you did not have an AB Trust. By creating an AB trust:
$400,000 would be put into Trust A and
$200,000 would be put into the Trust B upon the death of the first spouse.
Upon the death of the second spouse, both trusts have $400,000 or less in them so neither would trigger the federal estate tax.
So what’s the problem?
The federal estate tax exemption used to be much lower than it is today. It was drastically raised in recent years and is now over $11 million. As such, there is no reason to have an AB trust for the average family.
The problem with having an AB trust is that property put into the “B Trust” will not benefit from a stepped up tax basis from the date of death of the first spouse to the date of death of the second spouse. This means future beneficiaries will have to pay capital gains taxes any increase in value in the “B Trust” assets. Now that the federal estate tax exemption is so high, there is no reason why your beneficiaries should have to pay capital gains taxes on the “B Trust.”
Using previous example:
Trust B has $200,000 in it at the death of the first spouse.
Lets say by the time the second spouse dies, the assets have appreciated to $300,000.
The beneficiaries would have to pay capital gains taxes on the $100,000 of appreciation.
If the AB Trust in the example is amended properly before the second spouse dies, the beneficiaries might not have to pay any capital gains taxes at all.
Chances are, by modifying your AB Trust, you will save your family the cost of paying capital gains taxes.
How can I change it?
If your spouse is still alive, you can change your AB trust by making a trust amendment. There are specific legal formalities that must be followed for the amendment to be valid, so seeing an attorney to make the amendment is recommended.
If your spouse has passed away, even though the “B Trust” is irrevocable there are ways to amend the trust so your beneficiaries can enjoy the stepped up tax basis between the time of your spouse’s passing and yours. However, the process is a bit more complex, and you will have to petition the court to allow you to modify the trust. There are a few legal authorities that you can petition under.
One way to modify is under Cal. Prob. Code §15403, which allows for modification of an irrevocable trust where all beneficiaries consent, and the clause is not necessary to carry out a material purpose of the trust. Another way is under Cal. Prob. Code §15409, which allows for modification of an irrevocable trust if, due to an unforeseen circumstance, continuance of the trust would defeat or substantially impair the accomplishment of the purpose of the trust.
As always, every person’s situation is different, and the information in this blog is intended only as general information. The information should not be relied upon as a substitute for specific legal advice concerning your particular situation.
For advice specific to your situation, or if you think you might have an AB Trust, contact us for an appointment.
About the Koons & Riswold Auburn Law Office
Koons & Riswold maintains its main office in Auburn, California to provide clients with legal services in Auburn, as well as the greater Placer County region. Our Auburn lawyers provide legal services well suited to the Auburn area, which include: Living Trust and Estate Planning services, Probate, Real Estate legal issues, and Business Law matters. All our lawyers have deep roots in the Auburn area, having strong familial, community, and professional ties to the region. Koons & Riswold has recently opened a satellite office in Rocklin, California for the purpose of providing Living Trust and Estate Planning services there.