A/B Trust Information: Estate Planning At Its Finest

Two different parts of your estate are exempt from estate (inheritance) taxes. The first $1.5 million (the 2004 estate tax exemption) of your estate is not taxed. And anything inherited by your spouse is not taxed. Estate planning can help you to reduce or eliminate estate taxes using both of these exemptions.

Your spouse will inherit your estate tax-free when you die. But your spouse's heirs will eventually pay taxes on the entire estate. Giving your assets to your husband or wife simply postpones the payment of estate taxes; it does not avoid them.

You and your spouse are each entitled to your own estate tax exemption. By passing on part of your estate to someone other than your spouse when you die, you can use your estate tax exemption to reduce your estate taxes. Then, when your husband or wife dies, his or her estate tax exemption can be used to avoid more estate taxes.

If you'd like to avoid estate taxes using your estate tax exemption, but don't want to leave your spouse without support or deprive her or him of your share of the estate, you need an A/B trust. An A/B trust is a living trust that lets your spouse continue to use your share of the estate, while protecting it from further taxation when your spouse dies.

When you die, your portion of the estate is moved into the B, or "bypass," portion of the trust. Assets in the bypass trust will not be taxed again; they have already been taxed, and your estate tax exemption has protected them from inheritance taxes. When your spouse dies, only the remainder of the estate is taxed, and is protected by your spouse's estate tax exemption. Your part of the estate, in the bypass trust, is inherited tax-free as it was already taxed upon your death.

If you and your husband or wife have a combined estate that is greater than the exemption, you can reduce or eliminate your estate taxes using an A/B trust. However, the A/B trust cannot be changed after the death of either partner in the marriage. If you and your spouse are young, you may not want to tie up your estate in this way. The survivor of the marriage will have many years to find other ways to reduce inheritance tax that will not have the restrictions of an A/B trust.