To B or not to B

13 May, 2018//Posted by : admin//Category : Uncategorized

In the early 1970s, when I first became acquainted with the issues of death taxes, there was both a California state inheritance tax and the Federal Estate and Gift Tax. Of course, these created financial issues for estate planners, and for the trustees and executors of estates after death.

The California electorate were presented with an up or down vote on whether to keep the California inheritance tax in 1982. Not surprisingly, the voters decided that a no vote was the way to go on that proposition. If the nation were given the choice, federal death taxes would most likely suffer the same fate. However, the decisions on federal taxes rests with our duly elected representatives in Congress.
There is good news for the taxpayers on that front, however, since the tax now only affects the most wealthy among us.

I recall that in 1975, when I passed the bar, the individual exemption from the federal estate tax was only $60,000.00. That’s right, a 60 followed by three (3) zeros. Of course, even allowing for inflation and the value of a dollar over 40 years ago, that 60k did not let too many Californians off the hook for federal taxes, or at least filing a 706 return, if they owned their home or at least one real property.

The most common estate tax avoidance plan that was created by savvy accountants and lawyers was the A-B or survivor and exemption trusts. This became a standard approach with husband-wife living trusts. What that plan entails is a division and allocation of marital assets into two (and sometimes more) trusts upon the death of the first spouse. The “A” trust (sometimes referred to as the “Above-ground”) trust was designated as the surviving spouse’s trust, to be funded with that spouse’s share of community property and their separate property, if any. The “B” trust (“Below ground”) trust was allocated the Decedent Trustor’s separate and community property. The B trust was assigned a new taxpayer ID number from the survivor’s SSN, and the separate entities went on until death of said surviving spouse. This is an over simplification, but in this manner, the individual exemptions of both spouses were utilized. In 1975 dollars, that meant that $120,000 could be shielded from estate tax.

As time has gone on, the individual exemption amount has steadily gone up, in stages. There has even been some discussion in Congress at times about eliminating the Federal Estate Tax altogether. In any event the exemption now stands at $11,000,000. That is an 11 followed by six (6) zeros. Obviously, most members of the middle class are not faced with the same tax exposure as in 1975.

Since most estates no longer face a severe risk of taxation, the issue arises as to what the surviving spouse should do with that A-B allocation built into their trust. Some, if not most, of the trusts drafted in previous decades provide that the Trustee (usually the surviving spouse) “shall” make that division and allocation into separate trusts. The pattern seems to be that, if given a choice between dividing up their property between fictional entities, filing separate tax returns for each, and doing the fiduciary duties required of a trustee with named beneficiaries (usually children), most surviving spouses either ignore the “mandatory” language in the old trusts, or it is never even reviewed until the survivor’s successors review it with an estate attorney. In most cases, the failure to allocate to separate trusts causes no problems. Since there is no tax due anyway on less than multi millionaire estates anyway, these trusts are just administered as if that A-B language is not there. That is, it is divided up and distributed among surviving issue, as the plan usually goes. Problems can occur when the surviving spouse has gone completely off the plan and amended the trust to provide for a different distribution: either to a new spouse, new children, stepchildren or charity. Or, he or she decides to disinherit one or more of the kids for any number of reasons. These changes can and do expose the estate and/or trustee to litigation by the aggrieved or disinherited.

The lesson to be learned is that a surviving spouse and/or their trustees and beneficiary/children are well advised to seek legal counsel upon death of the first spouse. A cautious review of the intentions and language of the existing estate plan will avoid contentious problems down the line. Also, married couples with living trusts are well advised to seek tax and legal counsel on whether they need to provide for federal estate tax, or how best to do that in present times.