What Is an A/B Trust and Do I Need One?

Under current law, spouses can leave each other an unlimited amount when they die, with no estate tax, because of an IRS tax exemption provision called the unlimited marital deduction. The marital deduction allows the first spouse to die to leave his or her entire half of the estate to the surviving spouse tax-free.  However, when the surviving spouse dies and passes the combined estate to his or her heirs, the estate will only benefit from the surviving spouse’s tax exemption.  Therefore, the exemption of the first spouse was wasted.

To preserve the exemption of the first spouse to die, many couples use an A/B trust (the B trust is also called a “bypass” or “exemption” trust).  When the first spouse dies, any amount up to $3.5 million dollars, as of January 1, 2009, is placed into the A/B trust.  This trust is not taxed at that time nor at the later death of the surviving spouse.

A tax planning provision in the A/B trust splits a couple’s estate into two trusts on the death of the first to die.  For example, John and Jane have a combined estate of $7 million.  If John dies first, his trust uses his $3.5 million exemption.  When Jane dies, her trust uses her $3.5 million exemption.  This reduces their taxable estate to $0, so the full $7 million can go to their loved ones transfer tax free.

There are other advantages to the A/B Trust as well.  The surviving spouse has access to the income from the trust for life and can use the principal if necessary for his or her health, education, support and maintenance.

Another advantage of the A/B Trust is the ability to include different provisions for the surviving spouse should he or she remarry. A remarriage provision helps to insure that the ultimate beneficiaries of the deceased spouse’s estate will be that person’s children.  If a surviving spouse remarried, that spouse could be limited in the amount of the principal of the deceased spouse’s trust that could be withdrawn. 

With the scheduled decrease of the estate tax exemption from $3.5 million to $1 million in 2011 these A/B trusts will become even more important.