Timo​thy Follett, Attorney at Law

SANTA BARBARA ESTATE PLANNER

(805) 669-7009

​tim@timfollettlaw.com

A well-crafted estate plan should prevent any anticipated conflicts between your beneficiaries, however, an unhappy beneficiary can always challenge the trust after your death.


A common example occurs when family members do not agree on the financial decisions being made by the trustee.  When the family home, a major asset of the estate, is appraised and sold at market value after the parent’s death, a beneficiary may be unsatisfied with the proposed sale of the home (wanting it to stay in the family), or even with the sale price itself.  The unhappy beneficiary may challenge the trust, which can cause a long and costly delay in the distribution of assets and incur legal fees that reduce the size of the estate.


An ideal way to head off this conflict is to communicate your wishes about the distribution of your assets with your children in advance.  We understand that this is a difficult subject to discuss, but the chances of a beneficiary challenging the trust after the death of a loved one can be significantly reduced when all parties to the trust are aware of the parent’s intentions.


To help ease the discomfort of discussing financial arrangements, you should consider inviting your estate planning attorney to meet with you and your heirs when you choose to have that discussion.  Timothy Follett, Attorney at Law, is more than happy to discuss your goals and concerns with your children.


We believe an open discussion allows everyone to voice their thoughts, understand how the trust affects them as a beneficiary, and potential disagreements can be tackled and resolved upfront.  This is a difficult conversation to have, but everyone benefits by avoiding conflicts, court challenges, and delays when the trustee is administering and distributing the assets.  More importantly, you may find that the family comes together after they find out that you have thought of everything and everyone!


Let us know how we can help you. Call our office to schedule an appointment to talk to Timothy about how we may guide you in talking to your heirs, or to schedule an appointment to bring everyone together. 
 


How Does an AB Trust Work?

In general, upon the death of the first spouse in an AB Trust, two subtrusts are created: Trust A (the Survivor’s Trust, holding the surviving spouse’s property); and Trust B (the Bypass Trust, holding the deceased spouse’s property). The deceased spouse’s Federal Estate Tax Exemption is used to fund Trust B, the Bypass Trust.  The reason Trust B had to be created to hold the deceased spouse’s property was because the Federal Estate Tax Exemption was like a use-it-or-lose-it coupon.  The coupon had to be used at the time of death or it could not be used at all.  As a result, the AB Trust used the first deceased spouse’s Federal Estate Tax Exemption when the first spouse died, and the surviving spouse’s Estate Tax Exemption was used later when the surviving spouse died.

What Changed?

In 2012, a major change in the law now allows a surviving spouse to claim the deceased spouse’s Estate Tax Exemption (referred to as portability).  Now, the tax coupon is not a use-it-or-lose-it coupon.  The surviving spouse can now use his or her coupon and their Deceased Spouse’s Unused Exemption (“DSUE”).  This change in the law makes Bypass Trusts optional because the surviving spouse can use both of couple’s the Federal Estate Tax Exemptions.

Why Does This Change Matter?

The change in the law can help couples avoid passing capital gains taxes onto their beneficiaries. Inclusion of an asset in a decedent’s estate allows for a step up in the basis of that asset.  The step up in basis can eliminate or reduce the beneficiary’s capital gains taxes.  This example is specific to California, a community property state with no estate taxes:

When Husband dies, his share of the community property and his separate property are passed to Wife.  As a result, all of Husband’s and all of Wife’s community property get a step up in basis to the current fair market value.  Husband’s separate property given to Wife also receives a step up in basis to the current fair market value.  When Wife dies, all of Husband’s property is included in her taxable estate, so all of the property gets a second step up to the current fair market value before it is passed to the beneficiaries.

The beneficiaries can avoid paying capital gains taxes when they sell the property, and Wife can avoid Federal Estate Taxes by using her Federal Estate Tax Exemption and her Deceased Spouse’s Unused Exemption.

How is the AB Trust Unable to Avoid Capital Gains Taxes?

The AB Trust uses the first deceased spouse’s Estate Tax Exemption to fund the Bypass Trust.  The assets that are placed into the Bypass Trust are not included in the surviving spouse’s taxable estate. As a result of the non-inclusion of the assets in the surviving spouse’s taxable estate, the assets in the Bypass Trust only get one step up in basis when the first spouse dies.  When the assets come out of the Bypass Trust upon the death of the surviving spouse, the beneficiaries may pay a capital gains tax on the growth in value of the assets during the period of time that they were in the Bypass Trust.  If the Bypass Trust is not funded carefully and if the spouses die many years apart, the assets in the Bypass Trust could grow significantly and create a large capital gains tax that the beneficiaries would be responsible to pay.  

So, Should I get rid of my AB Trust?

It depends, talk to an attorney.  An AB Trust has its benefits and drawbacks and there are still many good reasons to have an AB Trust.  In addition, capital gains taxes are just a possible product of an AB Trust, not a certainty.  An alternative to an AB Trust can eliminate capital gains taxes, but the alternative has its benefits and drawbacks as well.  As a result, the decision to keep or get rid of an AB Trust is highly personal and fact dependent.  The best way to determine if an AB Trust is still the best option for you is to meet with your estate planner.

If you are unable to meet with your estate planner, Timothy Follett, Attorney at Law will review your existing estate plan and counsel you on your options so you can make an informed decision about the future of your AB Trust.  The review of your existing estate plan and counseling session is a complimentary service offered by our firm.    

Timothy Follett Copyright

We Finished Our Estate Plan, What Do We Tell Our Adult Children?

Do I Still Need an AB Trust?

It depends. . .

This article is for educational purposes only. Your attorney should help you decide whether you need an AB Trust.  The decision on whether to keep or replace an AB Trust is highly fact specific and subject to your personal goals and risk tolerance.

AB Trusts are very common estate plans, because prior to 2012, the only sure way for a married couple to both use their Federal Estate Tax Exemptions, through a trust, was by the use of an AB Trust.  However, a major change in the Federal Estate Tax Law in 2012 gave married couples more options for their estate plan.  Estate plans that have an AB Trust should be reviewed by an estate planner to determine if an AB Trust is still the best option.