Some Taxes Are Optional
It's worth starting with a principle that shapes everything in this post: some taxes are optional. Not in the sense that you can simply refuse to pay them — but in the sense that with the right planning and the right documents in place, certain taxes that would otherwise fall on your family can be legally reduced or eliminated entirely.
The capital gains issue described in this post is one of those taxes. For many families with older estate plans, it is a tax that could be avoided — but only if the problem is identified and addressed before it's too late.
The Problem with Older Estate Plans
Before 2011, married couples faced a significant estate tax challenge. Each spouse had a federal estate tax exemption — an amount that could pass to heirs free of estate tax. But that exemption was "use it or lose it." When the first spouse died, their unused exemption disappeared unless it was specifically preserved through careful planning.
To solve this problem, estate planners created what is commonly called an AB trust (also known as a bypass trust, credit shelter trust, or exemption trust). When the first spouse died, the trust split into two parts:
- The "A" trust — the surviving spouse's share, which remained revocable and under the surviving spouse's control
- The "B" trust — an irrevocable bypass trust funded with assets up to the deceased spouse's estate tax exemption, designed to preserve that exemption for the family
For its time, this was sound planning. The B trust ensured that the deceased spouse's exemption was not wasted. For families with larger estates, it could save significant estate tax dollars.
What Changed: Portability
In 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which introduced a concept called portability. Portability allows the unused portion of a deceased spouse's federal estate tax exemption to transfer to the surviving spouse — without the need to lock assets in an irrevocable trust.
Portability was initially a temporary provision, but Congress made it permanent in 2013.
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Pre
Before 2011
No portability. AB trusts were widely used to preserve the first spouse's estate tax exemption. The irrevocable B trust was standard, necessary planning.
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10
2010
Portability introduced temporarily by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.
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13
2013
Portability made permanent. The primary reason most AB trusts were created no longer exists. Estate plans written after this point could preserve the exemption without an irrevocable B trust.
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Now
Today
Many older AB trust plans remain in place — and the irrevocable B trust structure that was once protective may now create an unnecessary capital gains tax problem.
The New Problem: Step-Up in Basis
This is where the hidden tax problem comes in, and it affects families of all sizes — not just large estates.
When you inherit an asset, tax law generally provides a step-up in basis: your cost basis for capital gains purposes is reset to the asset's fair market value on the date of the owner's death. This is enormously valuable. It means that if your parents bought their home for $100,000 and it's worth $600,000 when they die, you inherit it with a $600,000 basis — and owe no capital gains tax on the $500,000 of appreciation that occurred during their lifetimes.
Assets held in a revocable trust receive this step-up in basis when the surviving spouse dies, because those assets are still considered part of their taxable estate.
Assets locked in the irrevocable B trust, however, typically do not receive that second step-up. They got a step-up when the first spouse died — but because they are no longer part of the surviving spouse's estate, there is no step-up when the surviving spouse passes. Your heirs inherit those assets carrying the basis from the first spouse's death, and they may owe capital gains tax on every dollar of appreciation that occurred after that point.
Example: The B trust holds the family home, valued at $400,000 when the first spouse died. By the time the surviving spouse passes, the home is worth $700,000. Without a step-up, your heirs' basis remains $400,000. If they sell, they may owe capital gains tax on $300,000 of appreciation — a tax that could have been eliminated with the right planning.
Here's the painful part: under current law, if those same assets had simply remained in the revocable trust — with portability handling the exemption preservation — they would receive a full step-up when the surviving spouse dies, and the capital gains tax disappears entirely.
The B trust that was created to save estate tax may now be generating a capital gains tax that is larger than the estate tax it was designed to avoid.
Is Your Plan Affected?
Not every AB trust creates this problem. The answer depends on how the B trust portion of your plan is structured. There are a few important distinctions:
Plans most likely to need attention
Trusts written before portability was made permanent in 2013 that require the B trust to be funded upon the first spouse's death — particularly those written to hold assets up to the full estate tax exemption in the irrevocable portion — are most likely to have this issue. If the trust is mandatory and the B trust holds appreciated assets, the capital gains exposure can be significant.
Plans that may be fine
Some AB trusts were written with more flexibility. If your trust gives the surviving spouse the option of whether to fund the B trust — rather than requiring it — you may be able to simply choose not to fund the irrevocable portion. Similarly, some trusts hold the maximum of the surviving spouse's exemption in the revocable portion rather than in the irrevocable B trust, which reduces or eliminates the step-up problem.
If your plan includes either of these provisions, it may not need to be revised. But it is worth confirming — because the difference between "optional" and "required" in the trust language is not always obvious to a non-attorney reader.
If you have an estate plan with AB trust language — especially one written before 2013 — a free estate plan review is strongly advised.
About half of people who come in for a review don't need to make any changes. The other half do. There is no cost to find out which half you're in.
The Solutions
If your plan does have this problem, there are two primary solutions — and the right one depends on your specific trust language and circumstances.
Trust Restatement
A trust restatement replaces the language of the existing trust with updated provisions that reflect current law and eliminate the problematic structure. The trust itself continues — with the same name and the same assets — but the terms are modernized. This is often the cleanest solution when both spouses are still living and the trust has not yet split.
Decanting to a New Trust
Decanting is the process of "pouring" assets from one trust into a new trust with updated terms — similar in concept to decanting wine from one vessel to another. Under Utah law, this can sometimes be used to move assets out of a problematic irrevocable structure and into one that will receive the step-up in basis upon the surviving spouse's death.
When to Act
Both solutions are most straightforward while both spouses are still alive — when all options are available and no irrevocable decisions have been forced by the death of one spouse. Depending on the specific language of the trust, it may still be possible to address the problem during the surviving spouse's lifetime. But the window may be narrower, and some options may no longer be available.
If you or your parents have an older estate plan with AB trust language, the time to review it is now — not after the first spouse has passed.
Is your estate plan affected?
Bring your trust documents to a free review appointment. We'll read the language, identify whether the problem exists, and explain your options clearly — no obligation.A Note on Estate Tax vs. Capital Gains Tax
One question worth addressing directly: does the estate tax itself still apply?
The federal estate tax exemption is currently very high — most Utah families will never owe federal estate tax regardless of whether they have an AB trust or not. For those families, the B trust is no longer doing any useful work on the estate tax side. It is simply locking assets in an irrevocable structure where they will not receive a step-up in basis — creating a capital gains liability in exchange for no estate tax benefit.
Even for families with larger estates, the math often favors a simpler structure. The capital gains tax that accumulates on appreciated assets in the B trust may exceed the estate tax benefit the trust was designed to provide.
This calculation is worth having with an attorney who understands both the estate tax and the capital gains implications of your specific plan.
What to Do Next
If you have an estate plan — especially one drafted before 2013 — here are the steps worth taking:
- Find your trust documents and bring them to a review appointment
- Look for language that describes what happens when the first spouse dies — specifically whether the trust splits into separate parts
- Schedule a free review — we'll read the language and tell you whether your plan has this issue
- Act while both spouses are alive — this preserves all available options and avoids a more complicated analysis later
Frequently Asked Questions
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An AB trust (also called a bypass trust or credit shelter trust) is a trust structure commonly used before 2013. When the first spouse died, the trust split into two parts: the "A" trust (the surviving spouse's revocable share) and the "B" trust (an irrevocable bypass trust funded up to the deceased spouse's estate tax exemption). The structure preserved the deceased spouse's exemption but may now create capital gains tax issues that are unnecessary under current law.
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Portability, made permanent in 2013, allows the unused portion of a deceased spouse's federal estate tax exemption to transfer to the surviving spouse. This eliminated the main reason most AB trusts were created — the exemption can now be preserved without locking assets in an irrevocable bypass trust.
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When you inherit an asset, your cost basis for capital gains purposes is reset to the asset's fair market value at the date of the owner's death — wiping out capital gains that accumulated during their lifetime. Assets in a revocable trust receive this step-up when the surviving spouse dies. Assets locked in an irrevocable B trust typically do not receive that second step-up, meaning heirs may owe capital gains tax on years of appreciation that could have been eliminated.
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If your estate plan was drafted before 2013 and includes a trust that splits into two or more parts upon the death of the first spouse, it may have this issue. However, some AB trusts give the surviving spouse the option of whether to fund the bypass trust, or hold the maximum of the surviving spouse's exemption in the revocable portion — these may not need to be revised. A free estate plan review is the best way to determine whether your specific plan is affected.
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Ideally, this is addressed while both spouses are still alive — when all options are available. Depending on the specific language of the trust, it may still be possible to address while the surviving spouse is living. A review while both spouses are alive preserves the most flexibility.
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No. The capital gains issue can affect families of any size. Some AB trusts were written in ways that require funding the irrevocable portion regardless of the estate's size. Any family whose B trust holds appreciated assets — a home, investments, or other property — may face this issue. The question is not whether your estate is large enough to owe estate tax, but whether your trust holds assets that have appreciated since the first spouse's death.