By Steven J. Gibbs, Esq.
Business and investment strategies are designed to take advantage of the existing legal framework. So, for example, if the U.S. tax code includes a credit incentivizing business investment in a certain area, a strategy that makes maximum use of that credit might make sense. Estate planning, of course, is no different. If your goal is to reduce or eliminate estate taxes, you’ll want to develop a strategy that makes the best use of available exemptions and exclusions. Here’s the thing, though: the legal framework that governs estate planning sometimes changes. In fact, it changes pretty regularly. And when that happens, you need to be ready to adapt your strategy to reflect the new reality. This scenario recently played out in relation to a fairly well-known estate-planning tool called an “A-B trust” (or “bypass trust”). Not too long ago, AB Trusts in Florida (and elsewhere) were a common, sophisticated way for married couples to reduce their overall estate tax liability. But when the tax code changed in 2011, they all the sudden became less useful. That’s not to say A-B trusts are completely obsolete—they can still serve some important purposes. They’re just relevant to fewer taxpayers than they once were.
And this raises an important question if you already have an AB trust in Florida built into your estate plan: Do you leave the Florida AB trust in place or adapt to the new situation? The answer won’t be the same for everyone. And to make the right decision, you need to know how AB trusts in Florida work, what they can do, and why they’re not quite as useful as the once were.
The motivation behind an AB trust, as it relates to an AB Trust in Florida where there is no federal inheritance tax, is to eliminate or reduce a married couple’s eventual combined estate tax liability by maximizing the benefits of the unlimited spousal estate tax exemption and the lifetime exemptions of both spouses. Under the unlimited marital deduction, a decedent spouse can transfer some or all of his or her wealth to the surviving spouse without incurring one iota of estate tax. It doesn’t matter how large the estate is, if the transfer goes to a surviving spouse, it’s tax free.
The snag—at least under the old version of the tax code—was that, upon the death of the surviving spouse, his or her estate would be taxed on all wealth that exceeded the surviving spouse’s lifetime exemption. So, if the first spouse simply transferred everything to the second, the first spouse’s exemption was essentially wasted. A-B trusts are intended to make full use of both spouses’ exemptions, thereby reducing their combined tax liability.
How AB Trusts in Florida Work Today
Practically speaking, an “A-B trust” actually consists of a pair of complementary trusts created through a Florida last will or a separate Florida revocable living trust. When the first spouse (“Decedent”) dies, all assets in his or her estate over the amount of the lifetime exemption are transferred to the “marital trust” (or “A trust”). The surviving spouse (“Survivor”) is the beneficiary of the marital trust and has control over its assets, so no federal estate tax in Florida is owed on assets in the marital trust due to the unlimited spousal exemption.
Also upon Decedent’s death, the other trust (“bypass trust” or “B trust”) is funded with assets valued at the amount of Decedent’s exemption. Importantly, the bypass trust is an irrevocable trust, and Survivor cannot have any control over assets in the trust. The bypass trust can be used for Survivor’s support to a degree, but for the most part Survivor will be relying on the marital trust.
When Survivor dies, the assets held in both trusts are distributed to the ultimate beneficiaries named in each trust (often the couple’s children or grandchildren) and this is the basis for many dynasty trusts in Florida, often used for high net worth estate planning in Florida. The final beneficiaries of the two trusts can be the same or they can be different (the latter works well when the spouses have children from prior marriages). The marital trust is now subject to federal estate taxes as part of Survivor’s estate, but only to the extent its value exceeds Survivor’s lifetime exemption. The bypass trust, though, is not included within Survivor’s estate, having already passed through Decedent’s. That’s why it’s called the “bypass” trust—because it bypasses the second spouse’s estate.
For the strategy to be effective, the couple’s assets in Florida (and elsewhere) must be titled appropriately—allocated fairly evenly between the two spouses—before the death of the first spouse. If all assets are held jointly, and the surviving spouse therefore automatically receives the full interests upon death, they won’t be able to use the bypass trust to cash in on the first spouse’s exemption.
Changes to the Tax Code and AB Trusts in Florida
Starting in 2011, A-B trusts became less useful due to a tax-code amendment that made estate tax exemptions “portable” between spouses in Florida and elsewhere. That is, a surviving spouse can now claim any unused portion of his or her decedent spouse’s exemption. So, if the first spouse simply leaves everything to the surviving spouse—and the survivor files the requisite paperwork with the IRS—the couple can take advantage of both of their entire exemptions without the need for an A-B Trust. In effect, the surviving spouse’s exemption is enlarged and ends up equaling the regular exemption plus whatever exemption the decedent spouse did not use.
Another change to the tax code that has limited the utility of A-B trusts is the substantial estate tax exemption increases enacted by Congress. In 2001, the estate tax exemption was $675,000, which means any estate valued at more than $675,000 was subject to the tax. But, starting in 2002, the exemption amount has repeatedly increased so that, in 2019, in stands at $11.4 million—or just shy of seventeen times higher than the 2001 amount. Obviously, far fewer estates are qualifying for the tax now compared to 2001. And, when you also consider the portability of exemptions between spouses, the number of married couples to whom A-B trusts are relevant has very significantly decreased.
When to Consider Consolidating an AB Trust
Given the changes to the tax code, an A-B trust that served a valuable purpose in an estate plan developed in 2001, or even in 2010, might have become superfluous. After all, why use two trusts when one might be sufficient? If your only reason for creating an A-B trust was to mitigate estate taxes, it may now be unnecessarily complicating an estate plan and limiting the options of the surviving spouse.
Portability is a simpler way of accessing both spouses’ exemptions. And one of the drawbacks of an AB trust in Florida and elsewhere is that it limits the survivor’s access to and control over assets held in the bypass trust. If for some reason—be it long-term nursing home care, medical expenses, or just an exceptionally long lifespan—the wealth in the marital trust ends up being insufficient to meet all the survivor’s needs, having substantial wealth tied up in the bypass trust and not easily tapped could become a serious problem. If you instead move that wealth into a single trust accessible by a surviving spouse, this potential scenario is eliminated.
If the first spouse has valuable assets he or she wants to pass on to someone else (such as children from a prior marriage), that can still be accomplished by directly bequeathing those assets through a will or through a living trust. The first spouse can claim the exemption up to the value of wealth left to children, leave the rest to the surviving spouse, and the survivor can still use through portability whatever unused exemption is remaining.
If you end up deciding to rely on portability, it is vital that the first spouse’s estate file the form necessary for the second spouse to claim the remaining exemption—even if it doesn’t look at the time of death like the combined estate will qualify for estate tax. If, for instance, a surviving spouse outlives the other by two or three decades, an estate that didn’t look like it would owe any estate taxes might have appreciated to the point that the survivor’s exemption alone is insufficient to cover everything.
It’s also worth mentioning that every time an appreciating asset passes through an estate, it receives a step-up in basis, which means the tax basis converts to the asset’s value at the time of inheritance rather than the amount of the investment. Getting two step-ups (one for each spouses’ estate) for securities that have dramatically increased in value since the time of purchase can result in big income tax savings.
When an AB Trust Can Still be Useful
The principle purpose served by AB trusts in Florida and elsewhere is to ensure a couple takes advantage of both spouses’ federal estate tax exemptions. But that’s not the only purpose. About a dozen or so states have their own versions of the estate tax, and, of those, only Hawaii and Maryland allow portability of exemptions. Estate-tax exemptions at the state level are often considerably lower than the federal exemption, too.
Florida residents don’t need to worry about paying any estate taxes to Tallahassee. But if a surviving spouse might move to a state that does have the tax (New York, for example), an AB Trust in Florida to take advantage of the state exemptions might be a good idea.
The portability that has diminished the utility of AB trusts also extends to the gift tax exemption in Florida because the two exemptions are linked. However, generation-skipping tax (“GST”) exemptions in Florida an elsewhere are not portable. So, a couple who intends to skip over a generation and leave wealth directly to their grandchildren might be best served by using an A-B trust to make the most of their GST exemptions.
Setting aside transfer taxes, there are still situations in which an A-B trust could prove useful. For instance, an AB trust in Florida can be set up to comfortably provide for a surviving spouse for life but make sure that, when the survivor dies, the heirs to whom the decedent spouse wanted to leave wealth get what was intended. The trust can prevent an unfortunate situation where a surviving spouse disinherits the decedent’s children from a prior marriage; or loses a sizeable portion of the legacy to creditor attachment; or spends irresponsibly and leaves little for the decedent’s heirs.
It’s true that AB trusts in Florida and elsewhere often aren’t the only instrument that can serve these purposes. A spousal support trust established through a will could just as easily take care of the surviving spouse before ensuring that the first spouse’s children benefit from the estate. But, if a workable Florida AB trust is already in place, it might not be necessary to get rid of one in favor of the other.
Sometimes, it’s better to get wealth past the estate tax earlier, without relying on portability. When a surviving spouse claims a leftover exemption, it isn’t indexed for inflation. If there’s only a couple years between their deaths, that probably won’t make much difference. But if the survivor hangs on for a few decades longer than the decedent, assets that would have been placed in a bypass trust might have gained markedly in value. If you opt for portability, all that appreciation will be tacked on to the surviving spouse’s taxable estate, and the leftover exemption might no longer cover the entire value. But, with an AB trust in Florida, those appreciated assets aren’t included in the survivor’s estate because they were already exempted as part of the first spouse’s estate when transferred to the bypass trust.
You also need to remember that Congress changed the tax code and made AB trusts across the country less widely applicable. You can’t be sure that estate tax laws won’t change again. If the currently massive exemption is reduced to be more consistent with 20th Century levels—or if portability is taken off the table—an AB trust that looks like an unnecessary complexity now could end up being a bigtime tax saver in the future.
Like most things in Florida estate planning, the utility of an AB trust in Florida depends not just on the current state of the law, but also on your individual circumstances and goals. An experienced estate-planning attorney can help you decide if an AB in Florida trust would be beneficial in your situation or if you’re better off consolidating an existing AB trust strategy into another planning instrument.
Steven J. Gibbs is a trust and estate planning attorney who provides complete Estate Planning, Trust Planning, Business Planning, Asset Protection, Elder and Medicaid Planning, Real Estate, Probate and Trust Administration legal services in Florida and California. Steve’s main offices are located in Fort Myers, Florida, and San Juan Capistrano, California. Estate planning legal services are provided statewide in these locations.
The Gibbs Law Office was founded by Steven Gibbs in January 2009 upon the commitment to provide client-centered legal services.
239.415.7495 | www.gibbslawfl.com