When you find yourself the sole trustee of an estate-tax-avoidance AB trust, your first job is to split the trust into two separate trusts: the bypass trust and your own survivor's trust. This is the first step toward saving on estate tax.
Learn more about how AB trusts save on taxes.
Splitting the trust is a complicated exercise; you'll need professional help to sort out the long-term financial and tax consequences. There are four main issues to address, each discussed below.
Before the splitting can be done, you need to know what the trust owns. Unfortunately, it's not uncommon for people to set up a trust and make lists of the property it's to hold—and then never get around to actually moving the property into the trust. Transferring legal title to the property is called "funding" the trust, and it's often overlooked, totally or partially.
So start with the lists attached to the trust document (usually called property schedules), and then check to make sure that the assets are actually held in the name of the trust. For example, for real estate, there must be a deed showing ownership in the name of you and your spouse in your capacity as trustees of the AB trust. Similarly, any accounts or vehicles must have title documents that show them held in trust.
The trust document may direct you to put, say, $1 million worth of assets in the bypass trust. But obviously, you can't do that unless you know what the assets are worth. That's why you need a date-of-death valuation of the trust property.
You may need written appraisals, from a professional, for some assets—a family home or valuable painting, for example. With financial accounts, you won't need an appraiser, but you'll need to document the value as of the death of your spouse.
Another reason you may need to know how much trust assets are worth: If the total amount of property left by your late spouse exceeds the estate tax exemption amount ($12.06 million for deaths in 2022), then you'll need to file a federal estate tax return. If your state imposes its own estate tax, you may need to file even if the estate's value is significantly lower.
Before the estate tax exemption amount was so high, many people created "formula trusts," which directed that the bypass trust be funded with property equal in value to the amount of the federal estate tax exemption at the time of the first spouse's death. For example, in 2001, when the exempt amount was $1 million, the surviving spouse would have put $1 million of assets in the bypass trust and the rest in his or her revocable trust. That way, the tax savings were maximized: no tax was due on the property in the bypass trust, because it didn't exceed the exempt amount, and no tax was due on the property in the survivor's trust, because property left to the surviving spouse passes tax-free.
Now that the federal estate tax exemption is over $12 million, however, formula trusts don't work well for most people. Very few couples have so much money that they want $12 million of it tied up in an irrevocable trust, where the surviving spouse gets only the income generated by the assets. So the trust document may specify that a smaller amount go into Trust A, the bypass trust.
Deciding which property should go into which trust is a complicated process. Your financial needs and preferences, as well as the tax consequences, must be taken into account. You'll need to think about what assets you might want to sell, which are likely to appreciate in value, and so on. Definitely consult a probate lawyer who can clearly explain the ramifications of various ways of divvying up the property.