Who Pays the Tax on a Special Needs Trust?

POSTED ON: August 12, 2021

The main financial vehicles of supporting disabled individuals—the special needs trust and the Achieving a Better Life Experience (ABLE) account—both come with special tax conditions that advisors need to consider.

Who Pays the Tax on a Special Needs Trust?

One of the reasons to use a Special Needs Trust (SNT) or open an ABLE account is to prevent federal or state benefits for a disabled person to be put at risk. The SNT is a way to hold property for someone without interfering with their eligibility. However, there are no tax advantages to the trust, according to a recent article titled  “How To Factor In Taxes When Considering Special Needs Trusts, Accounts” from Financial Advisor.

Tax results depend on who creates the trust, the terms of the trust and how it’s administered. The trust pays no taxes on any income it earns, as long as that income is passed on to the beneficiary. Trust tax rates are generally higher than individual tax rates. The income to the beneficiary will be taxable at their income tax rate. In some cases, all of the income of a trust might be taxed to the beneficiary, while in others the parent or person who created the trust might bear a tax burden, or the trust itself may be responsible for the tax liability.

An ABLE account is also a tax-favored vehicle, similar to a 529 college saving account. For a person to qualify for an ABLE account, they must have a disability that began before age 26 or be a recipient of Supplemental Security Income (SSI) or Social Security disability insurance benefits or meet other disability requirements.

The ABLE account will not reduce the major part of SSI benefits under the dollar-for-dollar SSI direct support rules, and it won’t be counted as an asset. The disabled person may also use their ABLE account to save earned income. The ABLE account can be inherited, and new rules allow funds in a 529 college savings account to be rolled into an ABLE account.

You can only contribute $15,000 a year to most ABLE accounts, and if the account plus other resources exceeds $100,000, SSI benefits will be suspended. These accounts must be managed carefully to protect eligibility.

The ABLE account varies, depending on the requirements and rules of the state where it is established. Some states offer additional tax benefits, if the person uses the ABLE accounts offered by their home state.

Depending on the state where you open the account, there can be deductions for contributions to an ABLE account. Louisiana currently does not offer a state income tax deduction for contributions to ABLE accounts, but earnings in the account are not subject to taxes.  Keep in mind that the funds in the ABLE account may only be used tax-free for qualified expenses that result from living with a disability. Those include education, housing, employment training and special assistance.

The ABLE account is a useful financial tool for disabled individuals, but it does not completely replace a Special Needs Trust or trust planning.

An ABLE account is usually most useful when there are modest sums that are left to an individual with special needs.  When there are substantial funds, however, such as those from an inheritance, litigation settlement or a major gift, most estate planning attorneys recommend that those funds go into a Special Needs Trust.

BOOK A CALL with me, Ted Vicknair, to learn more about how a Special Needs Trust or ABLE accont and how a special needs trust pays taxes, and also discuss how you can help your special needs loved one live his or her life to the fullest.

Reference: Financial Advisor (July 12, 2021) “How To Factor In Taxes When Considering Special Needs Trusts, Accounts”

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