As I mentioned in July's "Ask The Lawyer", J.S., in Hewlett, New York, had inquired about the following situation:

Her sister had Living Trusts drawn up for herself and her husband. She had referred to something called an "A-B Trust". J.S. wanted to know more about the "A-B Trust".

Dear J.S.:

An "A-B Trust" is actually more than one trust, generally set-up to take effect upon the death of the first spouse. This means they are testamentary trusts and, as such, are irrevocable (the Grantor is deceased).

The "A" trust is for the spouse who is A-live and the "B" trust is for estate tax purposes of the spouse who is B-uried. Another way to remember these trusts is that the "A" trusts' assets generally pass to the A-bove ground spouse. The "B" trusts' assets stay in the taxable estate of the B-elow ground spouse. Let's look at the estate tax consequences for the "B" trust.

This trust is sometimes referred to as a Family Bypass Trust or a Credit Shelter Trust, because it "bypasses" the surviving spouse's taxable estate. The credit is what you hear called the "$600,000 Credit Equivalent", which is simply that total amount, $600,000, that can be (currently) transferred, by gift or through an estate, to anyone other than the surviving spouse, without incurring a Federal gift or estate tax (an estate is usually entitled to an unlimited marital deduction, so any assets transferred to the surviving spouse would not incur taxes). In other words, the IRS will not collect any Federal gift or estate tax until a transfer of more than $600,000 to other than a spouse. This means that by creating a "B" trust upon the first spouse's death, that estate can avoid Federal estate tax on assets up to $600,000. In our example, your sister and brother-in-Law can therefor transfer up to $1.2 million to their children, or other beneficiaries, free of Federal estate taxes, upon the surviving spouse's death (that spouse also being entitled to transfer $600,000 estate tax free).

The "B" trust generally lasts until the surviving spouse's death. At that time, even if its principal has grown to greater than $600,000, its assets will pass to the beneficiaries free of trust and free of estate taxes.

There are many benefits to the "B" trust. One is that it's income is usually for the benefit of the surviving spouse. This means the trust can be funded with income producing assets and the surviving spouse will not lose the benefit of any current interest, dividends, etc. However, this trust is many times funded with growth investments (i.e., growth stocks) which appreciate in value and don't generate current income. Remember, upon the surviving spouses death, the "B" trusts' principal may have multiplied many times in value, but upon its transfer no estate taxes will be due.

Another benefit is that the surviving spouse may be granted the right to demand principal from the trust, in each year of the trust, in the greater amount of $5,000 or five (5%) percent of the fair market value of trust principal. This is the "5 & 5 Power".

A further benefit is that the trustee may be given the right to use principal of the trust for the surviving spouse's health, education, maintenance, or support.

The "B" trust requires an independent trustee. Also, a separate Federal EIN (like a social security number) must be obtained and a Fiduciary's income tax return will need to be filed. A Living Trust generally does not need a separate Federal EIN or tax return because it is revocable and the Grantor is a Trustee.

An Estate Planner uses the "B" Trust to save estate taxes and still provide benefits to the surviving spouse, all while retaining control of the ultimate beneficiaries. In New York, this trusts' proper use may save a $1 million joint spousal estate more than $134,000 (13.4%) in estate taxes and a $1.2 million estate almost $210,000 (17.4%). It's a great way to care for your loved ones' financial needs.