Will Your A-B Trust Leave Your Family Paying More In Capital Gain Tax?
An A-B Trust, also known as a Credit Shelter Trust or Bypass Trust, is a very popular type of trust that can be drafted in a number of different ways. The goal of this type of trust is to “shelter” a particular share of the first-to-die spouse’s assets in order to maximize the available estate tax exemption amount to both spouses.
However, given that tax law changes in 2013 introduced the “portability election” (allowing a surviving spouse to use the unused federal estate tax exemption of the deceased spouse without the need for a trust), the ratcheting up of the estate tax exemption for married couples ($24.12 million in 2022, although set to sunset back to approximately $12 million at the end of 2025), and with Ohio’s elimination of the state’s estate tax in 2013, the estate tax is no longer a serious concern for many married couples; however, an existing A-B Trust that is no longer necessary to avoid estate taxes may instead cause the unintended loss of a capital gain tax benefit known as the “step-up” in basis.
A-B Trust Arrangements and Drawbacks
The Internal Revenue Code provides that assets included in a decedent’s estate will receive a “step up” in tax basis to the date-of-death fair market value. If the first-to-die spouse leaves all of his or her assets to the surviving spouse, those assets get a step-up in tax basis at that time, and, when the surviving spouse dies, those assets will again get an updated step-up in tax basis.
With an A-B Trust in place, a married couple’s assets are split into two separate trusts upon the first spouse’s death, where the assets in the “A” Trust will be treated as having passed to the surviving spouse. The assets in the “A” Trust will receive a step-up in tax basis upon the first spouse’s death and a second step-up in tax basis when the surviving spouse dies. The assets passing to the “B” Trust will get the step-up in tax basis when the first spouse dies, but will not receive the “second” basis adjustment when the surviving spouse dies because those assets were not included in the surviving spouse’s estate.
As a result, when the surviving spouse dies and the beneficiaries of the A-B Trust sell the “B” trust assets, the tax basis will be based on the first-to-die spouse’s time of death. If an extended period of time has passed between the spouses’ deaths and the “B” trust assets have appreciated in value during that time, the capital gain tax liability for the beneficiaries could be much higher than it would have been without the A-B Trust arrangement.
There are numerous reasons for having a trust in place that may or may not involve the estate tax, but saving capital gain taxes should now be an important consideration. Not all A-B Trusts are drafted the same, and the capital gain tax issue described herein may be less of a concern depending on the formula used for funding the “B” trust.
Find Help With Estate Planning
There are several strategies your estate planning attorney can use to help you balance estate tax considerations with capital gain tax issues. If you are interested in a trust or if you have any questions regarding your existing trust, please contact one of the Estate Planning attorneys at FGKS Law.
