Compatibility of phylogenetic trees is the most important concept underlying widely-used methods for assessing the agreement of different phylogenetic trees with overlapping taxa and combining them into common supertrees to reveal the tree of life. The notion of ancestral compatibility of phylogenetic trees with nested taxa was introduced by P. Daniel and C. Semple in 2004. In this paper we analyze in detail the meaning of this compatibility from the points of view of the local structure of the trees, of the existence of embeddings into a common supertree, and of the joint properties of their cluster representations. Our analysis leads to a very simple polynomial-time algorithm for testing this compatibility, which we have implemented and is freely available for download from the BioPerl collection of Perl modules for computational biology.