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An AB trust is a trust created by married couples to maximize their federal estate tax exemptions. Recently the law has changed as to the estate tax exemption and people are finding out that the AB trust is no longer in their best financial interest. Here are the reasons why.
At the time when most people created their trusts, the tax laws were quite different than they are today. Years back, the estate tax exemption was only $675,000 per person, and the first spouse’s exemption dies with them unless the couple had signed a trust directing the deceased spouse’s share of assets into a ByPass sub-trust. The Bypass sub-trust was designed to preserve the first spouse’s exemption so that – at the survivor’s later death – their two exemptions could be combined, thereby doubling the assets that the couple could pass to their children or other beneficiaries free of estate tax.
However, these AB Trusts come with a price. The survivor no longer has unrestricted use of the deceased spouse’s share of marital assets, the surviving spouse is required to keep separate accounts and is obligated to file fiduciary income tax returns each year for the ByPass Trust.
With the new tax law, the individual exemption has been increased to $5,250,000 per person (in 2013), so now the surviving spouse does not need to elect to preserve the unused portion for later use if their combined estate is not worth more than $5,250,000. Moreover, the trust split sometime interferes with Medi-Cal planning if nursing care is needed. Thus, these older trusts are no longer necessary for most couples. The problem is that many couples still have these outdated trusts in place and only learns of the trust split requirement upon the death of their spouse, when the terms of the trust can no longer be changed by an amendment.
Once one of the spouses dies, the terms of the trust cannot be changed by the surviving spouse alone. There is a way to fix this problem. A petition can be filed in Probate Court for an order reforming the trust to eliminate this restrictive trust split requirement. The court petition would be based upon “changed circumstances” that were not known or anticipated at the time when the original trust was created. Since most of these trusts were created years ago for tax savings purposes, the change in tax law dramatically increasing the exemption usually qualifies as the requisite “changed circumstances”.
Most courts have been receptive to this analysis and have issued orders reforming these older trusts to eliminate the sub trust requirement, so as to permit all assets to go to the surviving spouse. The key is to petition the court before you take steps to split assets and/or file tax returns. It would be advisable to review these AB Trusts in light of the new change in the federal tax exemption because the long term savings can far exceed the attorney fee to review these AB trusts.
The purpose of this column is to provide general information on the law, which is subject to change. It is not legal advice. Consult a lawyer if you have a specific legal problem.
Published: Jan. 9, 2014 – Volume 12 – Issue 39