If the last time you and your spouse updated your estate plan was more than a decade ago, your estate plan may contain what is sometimes referred to as AB trust planning, which, until 2011, was the a primary way married couples could ensure that both were taking advantage of their federal estate tax exemptions.
An AB trust structure helps married couples reduce estate taxes and control the distribution of the property and accounts owned by the first spouse to die. When the first spouse dies, their assets are split into two subtrusts. Trust A – for the alive spouse (sometimes called a marital or QTIP trust) holds property for the surviving spouse and avoids estate taxes by using the unlimited marital deduction. Trust B – for the buried spouse (sometimes called a bypass, family, or credit shelter trust) holds the deceased spouse’s assets for spouse beneficiaries, nonspouse beneficiaries, or some combination of the two, while minimizing estate taxes by using their estate tax exemption. In 2025, the estate tax exemption is $13.99 million. This setup helps keep money safe and ensures that it goes to the right people.
Before 2011, if you did not use the federal estate tax exclusion amount for the first spouse to die, at their death, it was lost forever. This changed in 2011 when portability of the estate tax exemption between spouses was introduced. Portability allows a surviving spouse to inherit the unused portion of their deceased spouse’s federal estate tax exemption. If the first spouse’s taxable estate at the time of death is below the exemption limit or passes entirely to the surviving spouse under the marital deduction, the unused exemption can be transferred (or ported) to the surviving spouse, provided that an estate tax return is timely filed upon the first spouse’s death. As a result, the surviving spouse can use their own federal estate tax exemption amount plus the amount ported from the deceased spouse to minimize or avoid estate taxes upon the survivor’s passing. The good news is that portability has been made a permanent part of the federal estate tax laws. The bad news is that the AB trust planning in your old estate plan may now do more harm than good.
Take, for example, a hypothetical couple, Harry and Carrie. They have been married for 40 years. If Harry dies in 2025 and none of his $13.99 million estate tax exemption is used, Carrie can add Harry’s $13.99 million exemption to her own by filing a timely estate tax return exemption. If Carrie subsequently dies in 2027 and the federal estate tax exclusion amount has been reduced to $7.5 million, she will have $21.49 million (Harry’s $13.99 million plus her $7.5 million) worth of federal estate tax exemption. Also, all accounts and property passing outright to Carrie from Harry’s estate or revocable trust, or by right of survivorship, will receive a full basis adjustment to their fair market values as of Harry’s date of death. (Usually, the basis adjustment is a step-up in basis because property generally increases in value over time.)
But what if Harry and Carrie have a typical 1990s estate plan that uses an AB trust structure to ensure full use of both spouses’ federal estate tax exemptions? If they neglected to update their 1990s estate plan and Harry dies in 2025, then not only will Carrie be stuck with two subtrusts that were drafted using decades-old planning priorities, but their beneficiaries will also receive no step-up in income tax basis for the accounts and property remaining in the B trust when Carrie dies. Instead, the beneficiaries will inherit the B trust’s accounts and property with the basis calculated as of Harry’s 2025 date of death. As a result, if Carrie lives for a long time, there could very well be a large capital gains tax bill when the beneficiaries decide to sell the inherited accounts or property many years down the road.
Harry and Carrie’s story is only one example. It shows the downside of an old estate plan that uses AB trust planning. On the other hand, there are still many good reasons for married couples to keep AB trust planning in their updated estate plans. A two-subtrust structure allows you to provide for your surviving spouse under one subtrust in a tax-efficient way by using the unlimited marital deduction while allowing different beneficiaries under the other subtrust to benefit from accounts and property held in that subtrust immediately upon your death instead of waiting for your surviving spouse to pass away.
Let Us Help
If you are married and your estate plan is more than a few years old, schedule time with us so that together we can determine whether an AB trust plan still makes sense for you and your family. It is possible that your existing estate plan can be revised to take advantage of the favorable features of AB trust planning while also maximizing the benefits of current estate tax exemption rates and laws such as portability and basis adjustment planning.
