| by Mary Aylward B.A. and Jeffrey H. Minde, Esq.
Special Needs Trusts and Tax Issues
The issue of Special Needs Trusts and taxes is one of the most obscure areas of the already obscure area of Special Needs Trust law. Even very experienced Certified Public Accountants and Estate Planning Attorneys have to hit the books on this subject.
What follows is a brief summary of tax issues in relation to Special Needs Trusts. It can be used as a guide, but we absolutely suggest consulting a knowledgeable accountant if you have specific tax issues, especially as regards the funding of a Special Needs Trust.
The Importance of a Federal I.D. Number
First and foremost, the assets in a Special Needs Trust are not the assets of the Disabled Beneficiary or of the Grantors. A Special Needs Trust must have its own Federal Identification Number (also called an Employer Identification Number, EIN, Tax Identification Number, or TIN) to be valid. This unique number means that the Trust is its own entity, and that it does not belong to anyone but itself. This independence is the very reason that a Special Needs Trust functions at all.
Thus, the assets, income, interest and losses of the Special Needs Trust do not, and we repeat, do not count as the assets, income, interest and losses of the Disabled Beneficiary. If they did, then those assets would in every likelihood disqualify the Disabled Beneficiary from governmental benefits. Since benefits qualification is a core purpose of a Special Needs Trust, a Special Needs Trust that would cause disqualification would be useless.
First Party or Self-Funded Special Needs Trust Tax Issues
Despite what you may have read elsewhere, the fact that a Special Needs Trust can be funded with the Disabled Beneficiary’s own assets does not make those assets countable, taxable or applicable to the Disabled Beneficiary once they are used to fund the Trust. Once properly funded, even a First-Party Special Needs Trust is not properly considered a “Grantor Trust”.
Until December of 2016, it is important to note that a Disabled Beneficiary could not even create a Special Needs Trust for themselves even if the SNT contained assets that had previously belonged to them. They could not be the Grantor. The law stated that “a parent, grandparent, guardian, or a court” had to be the one establishing the Trust. In December 2016, Congress added “an individual” to the list of potential creators, but did not alter the law to make SNTs into Grantor Trusts. Again, a Trust document that would count the assets in the SNT as belonging to the Disabled Beneficiary would be useless for its intended purpose.
Third Party Special Needs Trust Tax Issues
The same basic rule applies to Third-Party Special Needs Trusts. Assets placed into the Special Needs Trust by a family member, a Court, a friend, or some other source are neither counted as the asset of the Grantor or of the Disabled Beneficiary. There may be tax issues in regard to the act of transfer (prior to the receipt of the assets by the SNT) and for these issues we suggest you consult your tax professional.
What’s Taxable and What Isn’t
Most Special Needs Trusts are not powerfully funded. And since the funds in the Trust are meant to be spent for the supplemental and extra care of the Disabled Beneficiary rather than being invested and conserved as in other types of Trusts, most SNTs show a decrease in their net worth over time, and so have limited tax liability.
Even in a situation involving a well-funded Special Needs Trust the reality is that because the Trust exists to provide for “supplemental needs” relating to a medical (physical, cognitive, or psychiatric) disability, the preponderance of expenses paid by the Trust are readily deductible.
A brief and hardly exhaustive list of deductions might include such things as physical and other therapies, physical education, adaptive sports, orthopedic aids such as wheelchairs or canes, durable medical equipment, modifications to the home, vans or cars, travel for therapeutic purposes, home health aides and other assistants, and the costs for upkeep of any and all of the above.
It is important for the Trustee to keep careful records of any such expenditures.
The Tax Return
When doing a tax return for a Special Needs Trust remember to file a Form 1041 and use the Trust’s Employer Identification Number.
Never use your Social Security Number or the Social Security Number of the Disabled Beneficiary for Trust taxes. Never complete a Form 1040 for the Trust.
If you have more questions please call us.
Thanks to Mary Aylward for her contributions and her advice on trust tax issues.