What is an A-B Trust and how does it work?

The A-B trust is a trust that has two portions - the A trust and the B trust. It is an estate planning tool that helps married couples avoid heavy taxes. The A-B trust splits into two portions when any one of the spouses dies. In A-B trust, both of the spouses put assets and name a final beneficiary who is anyone other than the spouses. In an A-B trust, the A trust is known as the survivor's trust, while the B trust is known as descendants trust of a bypass trust.

How does A-B Trust Work?

In an A-B trust, each spouse keeps an equal amount of assets. When the first spouse dies, the trust splits into two. In the case of the death of the first spouse, the first $ 5.43 million is funded to the B trust. The remaining amount is kept in A trust. It saves the payment of taxes as no estate tax has to be paid according to the unlimited marital deduction rule.

On the death of surviving spouse, the A trust's amount remains tax-free. Additionally, the B trust is also subjected to tax exemption equal to the balancing amount the first spouse may have. It saves an enormous amount of tax as the total tax levied is the amount obtained from only B trust which already gets enough tax exemption. The beneficiary gets the final amount after total tax deductions if any.

Advantages of A-B Trust

By including the terms in the A-B trust, the B trust owner can have access to A trust. It allowed the B trust owner to generate an income through A trust's assets too. Therefore, it is a great help to the other spouse who may be in the need of funds or assets for financial burdens.

As the unused amount of tax exemption of any trust can be added to the taxes levied to the other trust, an enormous amount of tax is avoided. The final beneficiary thus gets a greater amount of funds when both the spouses die.

There is no double taxation in the case of A-B trust. Each trust is considered part of one trust and hence no two taxes are applicable to an A-B trust. Once the tax is collected from one spouse's account, the other is left untouched and hence double taxation does not occur.

Federal Gift taxes and estate tax exemptions being already levied, most households do not need an A-B tax for tax exemptions. Only couples having assets worth or more than $ 11.7 million need to pay the taxes.

Disadvantages of A-B Trust.

  • There is usually a maintenance cost associated with A-B trust. After the death of the first spouse, the second needs to compile income tax returns which costs the surviving spouse a good amount.

  • Keeping track of two trust accounts is complicated than managing one account.

  • Although there are tax exemptions, the spouses may be subject to capital gains taxes which may be large enough.

Points to Note

  • The A-B trust splits into two trusts after the death of the first spouse.

  • The total amount in A trust remains tax-free after the first spouse's death.