First, an A-B trust may only be needed for married couples whose estates are worth, or could be worth, more than $2,000,000, the current federal estate tax exemption (in 2008). If your estate is worth less than $2,000,000, then you will not owe federal estate tax. . . for the time being. In California, many estates qualify for the tax deduction because of the value of real estate combined with life insurance policies and other assets. An estate that does not meet the requirement now may eventually meet that limit given inflation and the eventual rebound of the California housing market. Even if you don’t qualify for an A-B trust, you should use a trust to avoid probate (see “Advantages of a Living Trust“).

The A-B trust works by placing both spouses’ property interests in trust while they are living. Typically, both spouses remain trustees and may revoke or amend the trust at any time before their death. Upon the death of the first spouse, the overall estate is divided into two smaller trusts for tax purposes. The trust property is split and may be distributed into a survivor’s share, a marital deduction share, and a non-marital share.

When the first spouse passes away, assets from the deceased spouse’s separate and community property are placed into Trust A, which becomes irrevocable. This trust is kept separate from the survivor’s estate, but typically allows the survivor to receive all income from the trust property, to use the trust property, or to spend the trust principal for health, education, maintenance and support.

The assets of the surviving spouse are placed into Trust B, or what is typically called the survivor’s trust. This trust remains revocable by the survivor, and includes the spouse’s separate and community property share.

What is the effect of these transactions? First, the surviving spouse retains a measure of control over the estate. Second, because the estate is split into two trusts, one of which is considered for tax purposes to be outside of the survivor’s control, after the death of both spouses the children (or other beneficiaries) take all of the remaining estate tax free up to the tax credit limit.