Play the Video: Reforming an AB Trust After the Death of the First Spouse

If you are a surviving spouse, family, or a professional advisor to a surviving spouse with an AB trust, it is vitally important to watch the above video or listen to (or read) the below presentation regarding the major problems and disadvantages of the now outdated AB Trust and how it has gone from a potential tax advantage to a potentially huge tax disadvantage. Most importantly we discuss how you can obtain a court order relieving you from the AB trust.

Listen to the Audio by clicking above or read about it below!

Why Most No Longer Need or Want an AB Trust and Why the Failure to Reform Your Trust Will Likely Trigger Heavy Taxes and Hassles for Your Loved Ones  

If you established a joint married trust prior to 2011, it is very likely the trust was structured in an AB trust format. In short, for U.S. Citizens, the AB trust format no longer offers any estate tax advantage and is now an outdated tax concept.

• Instead of saving taxes, the AB trust will likely result in a much higher capital gain tax burden for your loved ones.
• From a tax standpoint, the AB trust format will uselessly burden the surviving spouse with significant restrictions, tax filings, irrevocability, accountability, and other legal responsibilities for life, and all this in addition to potentially triggering high capital gain taxes for your loved ones after your death.

That is why, if you are a surviving spouse, family of a surviving spouse, or a professional advisor to a surviving spouse it is vitally important to check every trust for this issue. If you see words like Marital Trust, Exemption Trust, credit shelter trust, ByPass Trust, etc this means you probably have an AB trust and should strongly consider initiating a trust reformation process seeking a court order giving surviving spouse’s and their families relief from the AB trust! Otherwise, the survivor will remain stuck  with burdensome restrictions and everyone may ultimately pay more in unnecessary taxes!

No one can speak better to the headaches of an AB trust than the countless surviving spouses we have met with over the years who seem to universally dislike, and regret, being saddled with the requirements of the AB trust format.

We’ve Helped Many Clients Achieve Reformation
The good news is that our law firm has successfully helped numerous clients achieve this equitable relief often without requiring a court appearance especially when the children and beneficiaries cooperate. In truth, children should usually be eager to cooperate especially since they often stand to benefit the most in the form of a stepped-up basis (discussed below).

We Offer a Free Consultation
Free of charge at our law office, we are happy to sit down with anyone to analyze and discuss the applicability and appropriateness of an AB reformation to your particular circumstances. We help families with this all the time and we look forward to helping any family achieve this equitable relief.

Read Below for More Details On Why an AB Trust is Now an Outdated Tax Concept and Generally a Useless Headache

New Portability Law Simplifies Planning Between Spouses:
Prior to 2011 only the issue of estate taxes – more specifically the possible need to utilize both spouses’ estate tax exemptions introduced complications to the otherwise straightforward wish of most married couples for the surviving spouse to inherit all assets at the first spouse’s death. In other words most couples only agreed to the AB structure as an advised tax strategy and otherwise had no desire to burden and restrict the surviving spouse. Hopefully the need for such complications is now a thing of the past because current law now allows portability of the exemption between spouses (as long as the surviving spouse is U.S Citizen). Under portability the surviving spouse is now allowed the straightforward use of both (husband’s and wife’s) exemptions without the need for any special (AB) sub-trust planning and its accompanying red tape. With portability spouses can safely do what most of them have been telling us they want to do for years: leave their estates outright to each other (which is not what the AB trust does as you’ll learn!)

Current Exemption is Now $11+ Million per Person ($22+ Million for a Surviving Spouse):
The current estate tax exemption has been raised to 11+ Million. All by itself, even without Portability, this higher rate would nullify any need for the hassles of an exemption sub-trust for most (less than 1% of households are worth over $11 Million in 2011) — yet when available, portability is what fully eliminates any need for an exemption sub-trust from a tax standpoint. With portability, under current law a surviving spouse will be allowed to pass up to $22+ Million estate tax-free – no AB, or exemption sub-trust necessary. With portability, an AB, (or even exercising a Disclaimer) will not buy you one extra dime in exemption. As long as portability remains law (and we think it will), from a tax standpoint there is simply no reason to have or continue with an AB or ABC trust and every reason not to if you wish matters to be as flexible, simple, and straightforward for your spouse as possible.

(Note: Before the end of 2026 lawmakers must vote to make the higher exemption permanent of the exemption amount will drop back to the pre-2018 levels of approximately $6 Million per person and $12 Million for a surviving spouse with portability).

Lost Income Tax Advantages of an AB Trust
The truly irony is that instead of fulfilling the promise to save on taxes, AB trusts now regularly result in more taxes — often hundreds of thousands, even millions of dollars in unnecessary taxes. As discussed below, anyone with an AB trust should also clearly understand there is no step-up in basis for the B trust assets at the surviving spouse’s death or capital gain exclusion for a residence allocated to the B or C trust. Many times this can ultimately end up being a very costly lost income tax benefit and now it is completely needless from a tax standpoint with portability.

Lost Capital Gains Exclusion
Most of you should be familiar with the $250,000 tax break when you sell your residence. Problem is, that nice tax break doesn’t apply to any part of the residence allocated to the B trust. In California, this alone could cost the surviving spouse up to $90,000 in additional taxes when the surviving spouse sells the residence.

Lost Stepped-Up Basis (Often the MOST EXPENSIVE CONSEQUENCE of the AB Trust)

Normally, when you inherit an asset you get the benefit of something called a stepped-up-income tax basis. Stated at its most basic level, the stepped-up basis means the IRS ignores all appreciation that occurred before you inherited the asset. Simply put, this allows you to either sell the asset income tax free upon inheritance or if you sell it later you will only pay taxes on the appreciation that occurred after it was inherited.

Many regard the stepped-up income tax basis is one of the most generous benefits in the tax code and it isn’t hard to understand why given that it allows you to sell the inherited asset while paying little or no income tax. Problem is, this benefit does not apply to assets inherited from a B trust. Again – assets inherited from a B trust DO NOT receive the benefit of a stepped-up basis and this is often THE most expensive consequence of the AB trust!

In California for example, it’s not uncommon for B trust assets such as real estate or stocks to appreciate $1M during the surviving spouse’s life. If these assets are inherited from the B trust, then sold, it will eventually cost the heirs as much as $400,000 in additional income taxes. In stark contrast, without the AB trust, there would be no additional income taxes due on the million dollars of appreciation.

To summarize, the same asset inherited from the B trust will eventually cost the heirs as much as $400,000 in income taxes yet without the AB trust there would be no income taxes due on the million dollars of appreciation.

Whatever numbers you choose for your own estimates, the rule remains the same. B trust assets do not receive a stepped-up income tax basis and it is just another way that the B trust regularly results in more taxes.

Responsibilities & Burdens of an AB Trust on the Surviving Spouse: 
1) The B trust becomes irrevocable and non-amendable upon the first spouse’s death (the surviving spouse cannot alter those trusts, or add, change, or remove beneficiaries or gifts from those trusts).  2) The surviving spouse’s use of the assets in the B trust must be limited to an ascertainable standard.  3) As the successor trustee the surviving spouse is responsible and answerable to the future “inheritors” of the B trust for appropriately using the assets and must render accountings as well as provide a copy of the trust to the heirs and future beneficiaries.  4) The surviving spouse must properly allocate, title assets in, obtain tax ID numbers for, and maintain the B trust after the first spouse’s death. 5) During the surviving spouse’s entire remaining lifetime they must continue to accurately track and keep records of the assets and transactions of each trust and complete separate tax filings for the A & B trusts each year.

Remember, an AB Trust Requires Adherence to Its Terms No Matter Portability, What Your Net Worth Is or What The Exemption Is at the time of death.
The existence of higher exemptions or portability does not and will not relieve the surviving spouse from the AB trust requirements. Using or keeping an A/B trust still means you will force the surviving spouse to live with the aforementioned lifetime restrictions and legal responsibilities. An A/B trust doesn’t care about the exemption amount or portability, it still legally requires the surviving spouse to comply with its strictures — unless you update your trust. Worse yet, it can actually become a tax negative, exposing the surviving spouse and heirs to needlessly lost income tax advantages.

An AB Trust Gives Children the Power to Make The Survivors Life Very Difficult & Expensive:
Using the AB trust terms as the legal leverage, we have seen more than one case where the surviving spouse has been harassed and taken to court by their very own children. Despite having essentially done nothing inappropriate these surviving spouses were nonetheless forced to respond to their children’s lawyers, demand-letters and lawsuits. That’s because the AB trust gave their children legal standing to demand accountings and justification for the expenditures and management of the trust assets.  Since our court system generally lets everything play out, the surviving spouse is forced to respond, make court appearances and spend thousands or tens of thousands of dollars in legal fees. There is no time to fully chronicle these sad stories but just understand these spouses suffer from a great deal of regret for having ever signed up for an AB(C) trust! These are some of the dark sides of an AB trust that often are not emphasized at the time someone was telling you “how great they are” and why.

It Is No Surprise Surviving Spouses Dislike Living with the AB Trust (and Never Forget That Could Be You!):
It isn’t hard to see, that even under circumstances where it turned out to make tax-sense, why we never encountered a surviving spouse who liked having to live with an AB (or ABC) trust. We found that somehow they never seemed to share a lawyer’s or accountant’s opinion that “administering an AB, ABC, or any exemption trust is no big deal”. A word to the wise: In considering whether you wish the surviving spouse to live with the restrictions and burdens of an AB or ABC ask yourself how much you would like it!

The (Flawed) Assumptions of the AB & ABC Trust Approaches:
It is important to reiterate that throughout the 80’s, 90’s, and beyond the AB trust was most often the default choice. Because of the then lower estate-tax exemptions, almost all law offices universally encouraged these approaches from a perspective of assumed need. Yet that assumed need, it has turned out, often ended up being wrong. That’s because the exemption amounts began rising dramatically in the year 2000 and from a tax standpoint (with the increased exemptions) many couples didn’t end up being worth enough to justify the complications of an AB trust (totally unnecessary to pass the combined estate tax free). Even before Portability and and the ability for a married couple to now pass $22+ million tax-free, this essentially made the AB trust a completely useless albatross for those who otherwise just wanted to leave everything outright to their spouse. Understanding this is important as a matter of perspective because sadly it seems many stay stuck in the past.