Most living trusts created prior to 2009 contain a mandatory requirement to divide the trust into two or more sub-trusts upon the death of a spouse.  These trusts were commonly utilized to reduce or eliminate estate taxes, by taking advantage of the estate tax exemption.  This is the value of assets which can pass to your heirs free of estate tax.  Any assets over the estate tax exemption are taxed at 40% or more. 

Since the estate tax exemption prior to 2009 was much less than now, these types of trusts (hereinafter referred to as “AB trusts”) made sense for many middle income families to legally reduce or eliminate estate taxes on their assets.  If you have a living trust created between 1977 and 2009, it is likely an AB trust.

The new tax law, effective 2018, increases the federal estate tax exemption to $11.2 million for individuals and up to $22.4 million for married couples.  As a result, the AB living trust has become obsolete for most families whose assets total well under the $22.4 million exemption. For this reason, those families should strongly consider converting their living trust to a non-AB trust.

Specifically, an AB living trust may actually hurt families whose assets are less than the $22.4 million exemption:

  1. Significant legal and accounting fees are required to implement the mandatory AB trust split.  And once the sub-trust division has occurred, the surviving spouse will generally be burdened with filing a separate tax return for the B sub-trust, in addition to their own personal tax return.
  2. The surviving spouse’s control over the B sub-trust assets is limited.
  3. Although the assets allocated to the B sub-trust will receive a step-up in tax basis upon the death of the first spouse, those B sub-trust assets will not receive another step-up in tax basis upon the death of the second spouse.

In some circumstances, if estate assets are over the $22.4 million exemption, it may be   advantageous to implement the mandatory AB trust split to reduce or eliminate estate taxes. Whether or not a family should utilize an AB living trust (requiring mandatory split) is a decision that should be made with the advice of your estate planning attorney.  Utilizing good legal counsel, many clients are converting their AB trust to a non-AB trust.

It’s worth mentioning there are other reasons why a trust which splits into two or more sub-trusts upon death of first spouse may be favored.  For example, if spouses have children from a previous relationship (blended family), and wish to limit a surviving spouse’s ability to change the trust beneficiaries, a trust which splits into two or more sub-trusts upon death of first spouse may be desirable.  Although inconvenient for the surviving spouse, the restrictions and associated administration costs may well be worth the peace of mind knowing that children will receive an inheritance, even if a surviving spouse remarries.  And this type of trust can be drafted to avoid the pitfalls of an AB trust.

In conclusion, the recommended approach for most families whose assets are under $11.2 million is to create a non-AB living trust, or amend their current AB living trust to a non-AB format.  This ultimately can save considerable time, money, and headaches.  Even if the family estate is worth between $11.2 million and $22.4 million, amending a current AB living trust to a non-mandatory AB format (such as a disclaimer trust where the AB sub-trust split is optional instead of mandatory), may be strongly desired and quite beneficial.

Finally, note that all living trusts, regardless of the type or format, should contain guardian provisions for any minor children, as well as testamentary trust provisions to allow the successor trustee to use the trust assets for young children’s health, education, maintenance, and support until they have reached the age you have designated for them to receive their inheritance outright.

 
Michael K. Elson is a prominent estate and trust attorney located in Encino and Valencia and provides estate, business and asset protection planning, including trusts, LLCs, corporations, probate, and trust administration.  Mr. Elson provides estate planning for income property owners and has been writing articles for the AOA magazine for nearly 15 years.  He may be reached at (818) 763-8831 or by visiting www.living-trust-attorney.com.  This article is a broad overview of some estate planning options.  Since each person’s circumstances are unique, and there are many intricate exceptions and periodic changes in the law, the mere reading of the material herein does not create an attorney/client relationship between the author and the reader.