Updated: Sep 17, 2019
To “B” or not to “B”, that is the question.
Is your Living Trust Broken?
5 Trust Tips You Need to Know
1. Is your Living Trust up to date?
This play on the famous Shakespearian quote concerns estate plans that have an “A-B” Living Trust. This letter is being provided to you as recent changes to the law makes it is a good idea for you to review whether your “A-B” Living Trust still meets your needs as the tax law has now made them far less desirable.
While the idea of couples holding their assets in a trust is still quite advantageous to avoid the expensive, time-consuming probate court process, Congress has simplified the planning field by allowing a simpler to administer Disclaimer Trust instead, that avoids many hassles and costs.
2. Do you understand how your trust works?
We want our clients to understand how their trust works, so we start our review with some tips to check if an “amendment” to your “A-B” Living Trust makes sense for you to change it to a Disclaimer Trust, as the vast majority of all attorneys’ clients are currently doing nationwide.
Here are some tips to begin a check-up of your trust, which is periodically necessary for you to do, as estate tax laws may occasionally have a major change.
Remember the old saying the only thing certain in life is death and taxes? Well, the Estate Tax is where the IRS taxes the value of one’s assets at death. Years ago, the best way to avoid any estate (“death taxes”) was to prepare an “A-B” Living Trust. “A-B” was easily thought of as “A” meaning above ground and “B” meaning below ground. In other words, the first spouse to die is below ground so that spouse’s own assets and share of community property goes into the “B” trust and the surviving spouse who is still alive/above ground has his/her share “owned” by the “A” trust.
3. Understanding how the Federal Estate Tax Works?
Remember the French Revolution? Marie Antoinette? Lavish spending by the Monarch and the wealthy nobles while to lower class starved?
In 1910 Theodore Roosevelt believed that the wealth of our nation should not be held in the hands of a few.
“We grudge no man a fortune in civil life if it is honorably obtained and
well used. It is not even enough that it should have been gained without
doing damage to the community. We should permit it to be gained only so
long as the gaining represents benefit to the community … The really big
fortune, the swollen fortune, by the mere fact of its size, acquires qualities
which differentiate it in kind as well as in degree from what is possessed
by men of relatively small means. Therefore, I believe in a graduated income
tax on big fortunes, and … a graduated inheritance tax on big fortunes, properly safeguarded against evasion, and increasing rapidly in amount with the size of
Theodore Roosevelt, December 15, 2010.
Shortly thereafter, the Estate Tax was enacted in 1916. A goal of the estate Tax was to break up “swollen fortunes” but allow citizens of smaller means to transfer their estates to their children without an Estate Tax. To do this Congress injected an “exemption” credit (or exclusion amount) to allow most families, farmers and blue-collar workers to hand down their small estates without a tax. The Estate Tax credit was $50,000 in 1916. This means that in 1916 a married couple could transfer $100,000 to their children without paying any Estate Tax.
Fast forward to 1987 - 1997. The Estate Tax exemption had risen to $600,000 per person and $1,200,000 for a married couple. The problem was that the $600,000 Estate Tax exemption amount did not keep pace with realty. Many families had amassed wealth far more than $1,200,000.
Enter stage left - the tax attorneys and estate planners.
A picture is worth a thousand words. Meet Bob and Amy. They live in California, have been married for 20 years, have two children and all their property is California Community Property. (California community property law says that all property acquired during marriage is community property (“CP”) Here is a diagram of Amy and Bob’s A-B trust plan used for a California married couple in the 1980s and 1990s:
The reason estate planners created A-B trusts was to fully utilize the Deceased Spouse’s Estate Tax exemption amount. If Bob had gifted his $600,000 to Amy, she would then own $1,200,000 but could only shelter $600,000 with her exemption. With a 55% Estate Tax the heirs would pay $330,000 in Estate Tax! A device was need to utilize Bob’s $600,000 exemption. By creating and funding the B trust with the Bob’s exemption amount of $600,000 his exemption was fully used. Upon Amy’s death, she could shelter her $600,000 from Federal Estate tax.
Although the B trust would have to get a Taxpayer Identification Number, perform an annual accounting, file an IRS Form 1041 Fiduciary Tax return each year, and pay the trustee to manage the trust, it was more than well worth it to dodge the bullet on $330,000 of estate tax.
The result of this marvelous planning? The children paid no estate tax!
4. So, what’s the problem?
The 2019 exemption amount is now $11,400,000.00 per person and $22,800,000 per couple. Nowadays, the A-B trust set-up is only necessary for less than one-half of 1% of the U.S. population as death taxes do not kick in until a person’s assets exceed $11,400,000 million, double for married couples, and few couples die worth nearly $22,800,000 in assets. Thus, the extra paperwork, tax returns and cost administration of the “A & B” trusts at the passing of the first spouse is wholly unnecessary.
5. Why do we recommend an “amendment” to your old A-B trust?
First, it is expensive and burdensome to administer the “B” trust. It requires a federal Employer Identification Number, a trustee to manage the trust, an accounting, and an annual Fiduciary 1041 Tax Return, which, in turn, creates more potential for an audit. It makes abundant sense to spare the Surviving Spouse trustee the hassle, accounting and legal expenses involved administering the B trust.
Additionally, it is often a real problem to “fund” the “B” trust with the deceased spouse’s share of assets: In many cases the family’s largest asset is their home. With our family example above, assume an $800,000 home and $400,000 in financial assets. To fund the “B” trust, the Surviving Spouse would have to “deed” one-half of the house to the “B” trust (a $400,000 value) and transfer another $200,000 (one-half of the remaining financial assets) to fully fund the “B” trust with $600,000 in assets, which equals the maximum amount exempt from estate taxes. This creates a problem as we always try to keep the home in the “A” trust for IRS section 121 tax and practical reasons.
Another significant tax reason is the home, a typically appreciating asset here in San Diego, will get a full “step-up in basis” to its market value upon the death of the Surviving Spouse. If one-half of the home is conveyed to the “B” trust, then heirs who inherit the home when both spouses are gone, will pay a significant “capital gains” tax rate on the gain half transferred to the “B” trust. The B trust takes the deceased spouses date of death basis.
Moreover, the practical reason is the Surviving Spouse probably does not want the heirs meddling into her management of the home. Furthermore, it may be more difficult to refinance the home if one-half is owned by a trust rather than the Surviving Spouse outright.
6. How do I know if I have an A-B trust?
Typically, within the first few pages of your trust you can look for the following, or similar, language:
DISTRIBUTION ON FIRST DEATH
On the death of whichever of us is the first to die (the “Deceased Settlor”), the property of the survivor of us (the “Surviving Settlor”) shall be distributed to the Trustee of the Survivor’s Trust described in the next Article and the property of the Deceased Settlor shall be allocated and distributed in accordance with the wishes of the Deceased Settlor, as follows:
A. Surviving Settlor’s Property. The Trustee shall distribute to the Trustee of the “Survivor’s Trust” the Surviving Settlor's separate property, one-half interest in community property, and any share of the separate property of the Deceased Settlor that the Surviving Settlor would be entitled to receive under the laws of the Deceased Settlor’s domicile at death, including, if applicable, any share of quasi-community property or other forced share.
B. Decedent’s Property. The Trustee shall distribute the Deceased Settlor’s property as follows:
1. To the Trustee of the Survivor's Trust (the “A” trust): All furniture, furnishings, clothing, personal effects, private papers, jewelry, motor vehicles, boats, airplanes, collectibles, recreation equipment, country club memberships and other tangible articles of a personal nature, or the Trust's interest in any such property, together with insurance on said property shall be transferred to the Survivor’s Trust.
2. To the Trustee of the Bypass Trust (the “B” trust): The residue of the Deceased Settlor’s property.
Just as it is a good idea to periodically see a doctor for a checkup, your estate plan needs a checkup, too. Your trust and estate plan periodically need review for compliance with the ever changing tax laws and California trust law. Our office offers a free consultation to review your estate plan. We will quickly tell you if you have an unwanted A-B trust.
R. Anthony Bauman
A Professional Law Corporation
12526 High Bluff Drive, Suite 300
San Diego, CA 92130