Do we need an A/B or an A/B/C Trust?

If you are a couple and if you have a revocable living trust, now is a good time to review your trust because of recent changes in the law.

There are two common estate plans for married people or registered domestic partners in California: the all-to-each-other trust or the A/B or A/B/C Trust.

The all-to-each-other trust leaves the entire trust estate to the surviving spouse or to the Survivor’s Trust on the death of the first spouse. On the death of the surviving spouse, the trust estate is distributed as most recently provided by the surviving spouse. The surviving spouse’s estate tax exemption applies to protect that amount from estate tax on the death of the surviving spouse.

On the other hand, the so-called A/B or A/B/C Trust states that on the death of the first spouse, the trust estate is divided into two or three subtrusts: 1) an A Trust, also called a Survivor’s Trust, 2) a B Trust, also called a Bypass Trust, Credit Shelter Trust, or Exemption Trust, and possibly 3) a C Trust, also called a Marital Trust or QTIP Trust. The A Trust is revocable and amendable by the surviving spouse, whereas the B and C Trusts are not. The surviving spouse typically has the use of the income and principal from the B and C Trusts, but the use is limited by an ascertainable standard (frequently for the health, education, support and maintenance of the surviving spouse), and the B and C Trusts will be distributed as provided by the deceased spouse unless the surviving spouse was given a limited power to change the distribution. The deceased spouse’s estate tax exemption applies to the B Trust, thus protecting it from estate tax on the surviving spouse’s death. The A Trust and C Trust, if any, are subject to estate tax on the surviving spouse’s death, and the surviving spouse’s estate tax exemption applies to those.

For many years, the estate tax exemption was $1,000,000 or less. Even though an A/B or A/B/C Trust is not attractive to many couples, the relatively low estate tax exemption forced many couples into adopting this type of trust to take advantage of both spouse’s exemptions. With the all-to-each-other trust, property passes from the deceased spouse to the surviving spouse’s trust without using the deceased spouse’s exemption, because of the marital deduction. Thus, when the surviving spouse died, only the surviving spouse’s exemption could be used to protect property from estate tax. With the A/B or A/B/C Trust, the deceased spouse’s exemption was used to protect the B Trust, and the surviving spouse’s exemption was applied to the survivor’s estate. Thus, the exemption amount was effectively doubled. This reality forced many couples into deciding whether to use the all-to-each-other trust but forego the deceased spouse’s exemption, or adopt the A/B or A/B/C Trust with the resulting administrative burden, fiduciary duty and loss of control.

In recent years, the estate tax exemption has gone up dramatically; it is now above $5,000,000 per person and is indexed for inflation. In addition, couples are entitled to use “portability” to transfer the deceased spouse’s unused estate tax to the surviving spouse so long as the surviving spouse timely files an estate tax return for the deceased spouse’s estate and other conditions are met. Naturally, the law may change, the exemption may drop, portability may disappear, but at the moment, estate tax is not a driving force behind estate planning for most people because of these changes in the law.

Nonetheless, you may want an A/B or an A/B/C split. As alluded to above, the surviving spouse will not have complete control over how the B Trust and C Trust assets are spent during the surviving spouse’s lifetime, because the surviving spouse will be limited to some kind of ascertainable standard for use of the income and assets. Also, the surviving spouse will have little or no control over how the assets are distributed on the surviving spouse’s death; rather, the trust as it existed on the deceased spouse’s death will dictate how the assets are distributed. In this way, the deceased spouse can maintain control (from the grave) over the disposition of his or her share of the trust estate.

This may be a desirable thing. For example, you and your spouse may have a mixed family and you each may want to be sure that your share of the estate goes where you want it to go. Or, you may be concerned that your spouse might remarry, and you want to prevent your assets from going to the new spouse. Or, you may be concerned that your spouse might become subject to undue influence as he or she ages, from which the B/C Trusts might offer some protection.

Other factors come into play in determining which plan is right for you. For example, if you have an A/B or A/B/C Trust, there will be some trust administration to slog through on the death of the first spouse. The trustee will be responsible for managing the trust for the benefit of the surviving spouse and the remainder beneficiaries, which can lead to some conflict between those two groups. The B and C Trusts will have their own tax returns to file. An A/B Trust can be awkward to deal with if your main asset is your house or if you have encumbered real property. Also, the assets in the B Trust will likely not receive a new income tax basis on the death of the surviving spouse.

In short, there is no one right answer. You should talk to your estate planning attorney to review all relevant factors before deciding.