Estate planning clients often seem to hold the misconception that once they have completed their estate plan, they are done. Nothing left to do but wait until they need to use it. Of course, for some, that “use it” date does not arrive for many, many years. In the interim, everything has changed, rendering their once state-of-the-art estate plan ineffective at best or harmful at worst. If you have a trust-based estate plan that was designed prior to a major change in estate tax law in 2012, your trust may well be in the “harmful” category today.
Prior to the American Taxpayer Relief Act of 2012 (“ATRA”), it was standard practice for estate planners to use a system known as an “AB Trust.” The point of an AB Trust was to shelter as many assets as possible from the dreaded estate tax. It used to be that the estate tax exemption was a “use it or lose it” exemption. When the first spouse died, a couple needed to pass some assets on to the next generation to use up the estate tax exemption of the first spouse. They did so using an AB Trust, to make sure that the couple was able to benefit from both spouses’ exemptions in passing property to the next generation.
The trade-off for this system is that assets passing to the next generation from the first spouse missed out on something known as a step-up in basis (essentially a savings on the beneficiary’s income tax). Pre-ATRA, no one cared about this. The step-up in basis would have been nice, but paled in comparison to using the estate tax exemption. Post-ATRA, that is no longer the case. In ATRA, Congress changed the exemption from “use it or lose it” into “use it or give it to your spouse.” This change (known as “portability”) means that AB Trusts are no longer necessary to use up the first spouse’s exemption.
Thus, the trade-off that used to be a no-brainer (give up step-up in basis in exchange for using the exemption) has become foolish. Using the AB Trust could result in losing the step-up in basis for no good reason. If you still have an old-fashioned AB Trust, you might be okay. Or, your trust could cause your beneficiaries to pay hundreds of thousands more in income taxes than they should. In other words, if you have an AB Trust, or you are not sure what sort of trust you have, you need to talk to the Learned Lawyer right away.