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Estate planning often involves protecting assets from taxes, such as the federal estate tax in the US. A trust can help avoid inheritance taxes, and an AB trust allows spouses to combine exemptions and reduce tax liability. State-level inheritance taxes vary, but some can be paid through a will.
When people begin the estate planning process, one topic often of primary concern is the protection of estate assets from taxes, particularly if the estate is large. In the United States, the federal estate tax is considered by many to be an estate tax, and there is a cap on the value of the property above which a hefty tax is levied when the owner of the property dies. An estate can pass from one spouse to the other without taxation as long as the spouse is a US citizen, but the heirs of the surviving spouse will have to pay the tax on the death of the second spouse. It is possible, however, to avoid inheritance taxes, at least to a significant extent, by setting up a trust.
Inheritance and probate taxes are what large estates most often seek relief from. While the two terms are often used interchangeably, the difference between them is basically that inheritance taxes are paid by the deceased’s estate, whereas inheritance taxes are paid by those who inherit the deceased’s wealth. There are estate tax laws at the federal level and probate and probate tax laws at the state level, where there is some variability.
The US Tax Relief Act of 2010 increased the value of the federal property tax ceiling to $5 million United States Dollars (USD), with an effective tax rate of 35%. That means anything in an estate over the $5 million dollar limit would be taxed at 35 percent unless it goes to a spouse. It is this over-the-cap amount that those with large estates wish to protect from estate tax with a trust.
Avoiding estate tax with a trust effectively transfers estate funds to heirs without subjecting them to estate tax. For tax years 2011 and 2012, married individuals in the United States will be able to combine their gift tax exemptions of $5 million to pass on up to $10 million to their heirs, tax-free. Those exemptions can change, however, so those planning their estates can look to protect their assets and reduce inheritance tax with a trust known as an AB trust.
The “A” part of an AB trust is commonly referred to as the “marital” part of the trust; the “B” part is known as the “bypass” or “family” part. These trusts can be established through a will or a revocable trust. This type of trust allows the two spouses’ exemptions to be combined and, in the event of the death of one of the spouses, allows the surviving spouse to use the trust money for living expenses. When the second spouse dies, the high amount of the exemption means that, on all but the largest estate, the heirs will pay no or very little estate tax.
Inheritance taxes, levied by individual states, are a different matter. As of 2011, seven U.S. states levied an estate tax, which ranged from about 1 percent to 20 percent of the property’s value. All seven states exempt spouses from this tax, and four exempt children and grandchildren as well. It is usually not possible to avoid paying this estate tax with a trust, so some people put text in a will directing the estate to pay any estate taxes for which the heirs may be liable.
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