Navigating the Estate Tax: A/B Trusts
For married couples in Oregon, A/B trust planning is probably the most important and effective estate planning tool. It reduces a couple’s overall tax liability and, when combined with the unlimited marital deduction, excludes any property passing to the surviving spouse from tax at the death of the first spouse (the “deceased spouse”). This combination of tax reduction and deferral is achieved by separating the couple’s original Living Trust into “A” and “B” shares after the death of the first spouse through a process called trust administration. The deceased spouse’s estate typically funds the B Trust (also known as the “Family Trust”) up to the Oregon exclusion amount, currently $1 million. This protects the first $1 million from estate tax since taxes are only applied to amounts over the $1 million exclusion. Any remainder after funding the Family Trust is then used to fund the A Trust (also known as the Survivor’s Trust), and depending on the size of the estate, sometimes a marital trust as well.
If done properly, the surviving spouse is protected from having to pay any immediate tax and the couple’s overall tax liability is lower. The Survivor’s Trust and any marital deduction property, although not taxable to the deceased spouse’s estate, is subject to estate tax at the surviving spouse’s death. So, how does it all work?
Suppose that a couple has a combined estate worth $2 million and a simple will, trust, or no estate plan. At the death of the first spouse, if each names the other as the primary beneficiary, the surviving spouse would receive all of the couple’s assets, either through probate, trust administration, or by operation of law. The deceased spouse’s estate would owe no tax because his or her $1 million share of the combined estate is equal to the Oregon exclusion amount, but the surviving spouse would owe $101,250 (approximately 10% of the amount over the Oregon exclusion, see Table 1 – Oregon Estate Tax Rates) because he or she died owning the entire $2 million combined estate.)
Now suppose that the couple’s estate plan features an A/B trust. At the death of the first spouse the Family Trust will be funded up to the $1 million Oregon exclusion amount. The deceased spouse’s estate would still owe no tax, but unlike in the previous example, assets in the Family Trust would not be included in the surviving spouse’s estate because the Family Trust is irrevocable. Note that even though the Family Trust is irrevocable, the surviving spouse does not lose half of his or her assets. The surviving spouse may continue to access income and principle from the Family Trust for his or her health, education, maintenance, and support (the “HEMS” standard). An irrevocable trust subject to the HEMS standard will not be included in the surviving spouse’s estate under IRS rules. The remainder of the combined estate ($1 million) would pass to the Survivor’s Trust. Upon his or her death no tax is due because the surviving spouse’s estate equals the Oregon exclusion amount and the assets in the Family Trust are excluded. Even if the surviving spouse acquires new assets or the value of the assets appreciates significantly, the estate will only pay tax on assets or appreciation over $1 million.
An A/B trust effectively separates a couple’s combined estate and allows each spouse to take full advantage of the Oregon exclusion amount. As illustrated in the examples above, adding an A/B trust to an Oregon couple’s estate plan typically saves $101,250 in taxes on the first $2 million in value. These savings can be passed along to the beneficiaries, preserving additional wealth for future generations.
Table 1—Oregon Estate Tax Rates
|Taxable Estate |
Equals or is Greater Than:
|But is Less Than:||Tax rate on Taxable Estate|
|$1,000,000||$1,500,000||$0 + 10%|
|$1,500,000||$2,500,000||$50,000 + 10.25% amount over $1,500,000|
|$2,500,000||$3,500,000||$152,500 + 10.5% amount over $2,500,000|
|$3,500,000||$4,500,000||$267,500 + 11% amount over $3,500,000|
|$4,500,000||$5,500,000||$367,500 + 11.5% amount over $4,500,000|
|$5,500,000||$6,500,000||$482,500 + 12% amount over $5,500,000|
|$6,500,000||$7,500,000||$602,500 + 13% amount over $6,500,000|
|$7,500,000||$8,500,000||$732,500 + 14% amount over $7,500,000|
|$8,500,000||$9,500,000||$872,500 + 15% amount over $8,500,000|
|$9,500,000||$1,022,500 + 16% amount over $9,500,000|