With an AB trust, the assets in an estate of, say, $4 million would be divided half and half between A and B spouses, thus doubling up on the exclusion. However, the creators of the AB Trust had to pay a price in the form of an income tax.
That, says Klueger, is where the step up in basis to fair market value part of the tax code comes into play. For example, say a client buys shares in a company for $10 and sees the stock price appreciate to $100, resulting in a capital gain of $90. But if that person inherits the stock, the capital gain is forgiven and the beneficiary gets a new basis of $100, so that if the heir sells for $101, his capital gain is $1, not $91.
However, because of the way the IRC is written, if the property was in the B Trust, the beneficiary would not get the step up in basis to fair market value.
Klueger says that before the recent changes in the estate tax provisions, this was not of great concern because the estate tax rates were always higher than the income tax rates: capital gains rates were 15%, while estate taxes rates went as high as 55%. So many clients were willing to pay the income tax in order to save on the estate tax.
Tax Law Holds Serious Implications for AB Trust Holders | Advisor One