Many affluent married couples, who fear that their estates might someday be subject to estate tax, set up what are called bypass or AB trusts. These trusts are much more complicated than simple revocable living trusts, which are designed only to avoid probate.
Now that the federal estate tax exemption is so high ($5.45 million per person for deaths in 2016, $10.9 million for married couples to share however they wish), however, fewer people need to use tax-avoidance tactics like bypass trusts. Still, thousands of bypass trusts are in existence, even if the people who made them may no longer need to worry about estate tax.
If your spouse has passed away and you are faced with taking over as sole trustee of an AB trust, you’ve got a lot of work in front of you. You’ll need expert help from a lawyer who has experience in administering this kind of trust, and possibly also from a CPA with expertise in tax planning.
When the first spouse dies, the trust must be split into two trusts, called the survivor’s trust and the bypass trust. The survivor’s trust is usually referred to as the A trust; the bypass trust is called the B trust.
The bypass trust. Property in the bypass trust doesn’t belong to the surviving spouse, but he or she has the right to use it, and receive income from it, for life. As long as the value of the assets in this trust is below the federal estate tax exemption (currently $5 million), no federal estate tax will be due. (It may still be subject to state estate tax, depending on where you live.)
The survivor’s trust. Everything else goes into the revocable survivor’s trust. As surviving spouse, you have total control over it and can spend it, give it away, or leave it to the beneficiaries you choose. No estate tax is due on this property, either, because everything left to a surviving spouse is free from federal (and state) estate tax.
The tax savings will come at the second spouse’s death. Then, the property in the bypass trust will go—tax-free—to the couple’s “final beneficiaries,” commonly their children.
When one spouse dies, the survivor is the sole trustee. It’s the trustee’s job to split the trust assets into the survivor’s trust and the bypass trust. Generally, the surviving spouse then serves as trustee of both trusts—which is a wholly different job from serving as a trustee of the original trust. Now, you’ve got legal responsibilities to the beneficiaries who will eventually inherit the trust assets.