Questions About An A-B Trust

[Thank_You]

What is the name of your state? New York

Checking my understanding on this...

John and Lisa are spouses, grantors and trustees of an A-B revocable living trust. The only assets the trust holds are all of their separate financial assets and the house they live in.

John dies and Lisa survives him.

When John dies the total of his separate financial assets is less than the exclusion amount for both state and federal estate taxes. (Note that even if the house is included in John’s assets, the total value of the assets is still below both the state and federal exclusion amount.)

Assumptions:

1. The “A” trust is the “Marital Deduction” trust and the “B” trust is the “Credit Shelter” trust.

2. Assume current law (which is always a shaky assumption since things can change on a dime these days… so much for predictability, stability and continuity).

Questions:

1. Since John’s separate assets upon his death are below both the state and federal estate tax exclusion amount, all of John’s assets would go into the “B” trust and there will be no “A” trust. Is this correct?

2. The B trust is irrevocable. Correct?

3. The B trust specifies that the income earned in the trust is to be paid out at least annually to Lisa. The B Trust will have to have its own TIN and file its own tax returns. Correct?

4. If the B trust has to file tax returns, I assume the returns show that the income was passed through and the trust only has to pay pay taxes on any income (income for tax purposes) that is retained in the trust. Correct?

5. Do Lisa’s assets stay where they are in the original trust, no changes?

6. Lisa has a greater amount of separate financial assets in the original trust than John had, but her assets are still under the current state and federal estate tax exclusion even if the house is included in her assets. Is it advisable to keep the house in Lisa’s trust, or transfer it to the B trust? What are the factors to consider in this decision, or is it usually clear that one or the other is the best place to keep the home?

 

[TrustUser]

not correct about the distribution. it really all depends on how the trust is worded. since the exclusion is so high today, it wont affect many people.

the concept of the ab trust though, is not simply to avoid taxes.

another big concept is the ability for each grantor to specify who they want their assets to go. so very often, the worth of the assets is split right down the middle. cuz with the marital or survivor trust (as i refer to it) is owned free and clear by the survivor. and can do anything they want with it.

MOSTLY. again, it all depends on how it is written. it is conceivable that the language would place caveats on what the survivor can and can not do. it could place a caveat that the survivor trust has the same beneficiaries as the shelter trust, for example.

the shelter trust is irrevocable, and does have its own tin

 

[Taxing Matters]

What is the name of your state? New York

Checking my understanding on this...

The term "A-B trust" generally refers to the use of two trusts in estate planning and there are several ways that two trusts might be used. You are referring specifically to a credit shelter trust arrangement, however, the goal of which is to maximize the estate tax credit for both spouses, thus ensuring the kids (or whomever the other beneficiaries are) get the most assets possible when the second spouse dies by limiting the federal tax bite.

The way the credit shelter trust system works is that when the first spouse dies, his/her estate is split into two trusts: one is a trust for the kids (or whomever the non-spouse beneficiaries are). That trust gets the estate assets that will use up the decedent's estate tax credit. The surviving spouse may get a right to income or limited right to assets from that trust as a safeguard against the second spouse not having enough to live on. But the access has to be very limited because if the spouse has the right to it then trust might qualify for the marital deduction and not use up the estate tax credit The second trust is the marital trust, and is actually optional (but often used when one spouse wants to control how the other spouse uses the assets) and is where the assets that suriving spouse gets. That gift does not use up any of the estate tax credit. The surviving spouse could get his/her share outright and the arrangement would work just as well. Turning then to your questions:

1. How much goes to the credit shelter trust depends on how the trust is written. There are several different ways to work this and which way you go depends on the assets that you expect the couple to have at death and what their goals are. But if you truly want to fully max out the estate tax credit then in your hypothetical all the assets would indeed to to the credit shelter (the B trust) and the marital trust gets nothing. That's fine if the surviving spouse has enough of his/her own assets on which to live for the rest of his/her life, but might not be so great otherwise.

2. Yes, the credit shelter trust is irrevocable.

3. It is common for the credit shelter trust to provide that the surviving spouse does get the income from the trust. The trust would indeed file its own income tax returns. For federal income tax, that is the Form 1041. And to do that the trust must, of course, have its own TIN.

4. The rule is that the trust pays tax on the income of the trust except to the extent the trust makes distributions to beneficiaries during the year. Where the trust has made distributions to beneficiaries during the tax year, some or all of the taxable income of the trust may flow through to the beneficiary and the beneficiary pays the tax on it instead of the trust. Thus generally the suriving spouse ends up paying tax on income associated with the distributions he/she receives. A full discussion of this topic is beyond the scope of an internet message board.

5. I'm not clear what you are asking here. If Lisa is the surviving spouse then her assets are not involved in this. This is about dealing with the assets of her decedent spouse. What do you mean by the orginal trust? If you mean that they started out with a joint revocable living trust and that the assets of the decedent spouse are then transferred to the credit shelter trust and the revocable living trust continues with Lisa's assets in it then the issue of what happens the house depends on who own the house when her husband dies. It would be adviseable here to arrange the ownerships of assets before death between the spouses to make the best use of the estate tax credit, again assuming that it will not adversely affect the surviving spouse's ability to live his/her life comfortably until he or she dies.

But note something very important here. Credit shelter trusts are virtually extinct now if the goal for the trusts is simply to make the best use of the federal estate tax credit. That's because Congress finally, after many decades, realized it was stupid to force couples to go through these kinds of hoops to achieve something that could be done much better, and easier, another way. As a result, Congress passed a law about ten years ago that now allows the estate of the first spouse to die to elect to effectively transfer his/her estate tax credit to the estate of his/her surviving spouse. With that election, the credit shelter trust is not needed. The first spouse can simply transfer his/her assets to the surviving spouse who then gets the benefit of those assets during his/her remaining lifetime. Then when the second spouse dies, that spouse gets to use the combined estate tax credit that he or she has plus the estate tax credit that his/her deceased spouse had. That provides the same tax result, is much easier to do, and allows the suriving spouse much more use of all the assets, if needed. Perhaps in a state with its own estate tax these credit shelter trust arrangements might still be useful, but none of the states in which I practice has an estate tax any longer.

 

[Thank_You]

Hi Taxing Matters and thank you for your very cogent response! It's clear you are a professional in this area and I am fortunate to have access to you. I am pleased that you confirmed my understanding on these things as that gives me a sense of confidence that John and Lisa are on the right track.

Here are some comments on a couple of things.

Credit shelter trusts are virtually extinct now if the goal for the trusts is simply to make the best use of the federal estate tax credit. That's because Congress finally, after many decades, realized it was stupid to force couples to go through these kinds of hoops to achieve something that could be done much better, and easier, another way. As a result, Congress passed a law about ten years ago that now allows the estate of the first spouse to die to elect to effectively transfer his/her estate tax credit to the estate of his/her surviving spouse. With that election, the credit shelter trust is not needed.

I assume you are talking about portability, so yes, this makes sense at the federal level. However, you may not be aware that under New York's draconian death tax law, there is no portability provision. Furthermore there is a so-called "cliff" at about $5.5 million. If the taxable estate exceeds this cliff amount, the entire amount of the estate is taxed from the very first dollar! If the taxable estate is below $5.5 million, then the cliff is avoided. Since John and Lisa's combined estate is likely to exceed $5.5 million they still need some mechanism to shield them from the oppressive New York state tax cliff and lack of portability. My understanding is that a credit shelter trust of the type we are talking about is one of the effective ways to do that. So in the case of John and Lisa, if my understanding is correct, I think this is still a good choice.

QUESTION #1: Do you concur with the above?

It would be nice if this wasn't necessary since who needs the complications and expense of an additional trust. But it may be the best way to avoid the NY state tax.

5. I'm not clear what you are asking here. If Lisa is the surviving spouse then her assets are not involved in this. This is about dealing with the assets of her decedent spouse. What do you mean by the orginal trust?

Here is what I mean by the "original trust." John and Lisa's assets are now in a revocable living trust account. When one of them dies, the separate assets of the decedent will be transferred to an irrevocable credit shelter trust (trust B)... (and the overflow, if any, maybe to another trust (trust A) the marital trust). Let's say John passes first. Lisa's assets were already in a trust, the revocable living trust. That is the trust I am calling "the original trust," because it is a separate trust from the credit shelter trust.

So my questions are:

QUESTION #2: After John's death, do Lisa's assets stay exactly where they were before John's death? In the "original" revocable living trust?

QUESTION #3: So with the A-B trust that John and Lisa have, after John's death there would be either 2 trusts (original and B) or 3 trusts (original, B and A)?

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I think the question of whether or not John and Lisa's house should remain in the "original" revocable trust after the first of them dies or be moved to the "B" trust is an important one. But in order to understand what else to ask I will have to ask this preliminary question. The house is now titled in the name of John and Lisa's "original" trust. Is there an additional aspect to this that needs to be known?

What I am referring to is this. All of the other assets in their trust can be identified as either John's separate assets or Lisa's separate assets. But I am not clear on how the house is legally allocated. Is it John's separate asset? Lisa's separate asset? A joint asset? Something else?

QUESTION #4: If the house is titled in the name of the original trust, and there is no agreement specifying what part is allocated to John and what part to Lisa, how is this determined?

Before I can ask any further questions on this important point, I think I need to understand that?

Thank you again for any help!

 

[Taxing Matters]

You'd need to ask a NY tax attorney about the NY state aspects of this and what would work to manage the NY estate tax. Thankfully every jurisdiction in which I practice has eliminated their estate and inheritance taxes. I tell people I know living in NY, PA, and other states with significant death taxes to consider relocating out of those states when they retire, if not earlier, to avoid those taxes. That's what I did, and living in a state with no death taxes and lower overall tax burden is a change I'm quite happy with.

 

[Thank_You]

You are so right. If relocation was an option for John and Lisa they would be out of NY in a flash. Unfortunately it's not.

Since John and Lisa's A-B trust was written and fairly recently updated by a NY attorney, I will have to assume that the A-B trust is appropriate. And I further assume it was created as such for the reasons I gave... to minimize NY state estate tax. That explanation makes sense to me so I'm pretty confident it's right.

I am still stumped on the part about the house though and will need to have clarity around that. Maybe someone else here knows something that will shed some light on this.

Thank you again for your help Taxing Matters, I appreciate it. And congratulations on escaping the tyranny of these confiscatory states! How John and Lisa envy you.

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[Thank_You]

Taxing Matters.... Are you able to address questions 2 and 3 above, not about any specific case, but with regard to a typical A-B trust and how it typically works? I should think this part is pretty straightforward. I just want to confirm that what is described there is generally how it typically works (questions 2 and 3 only).