By Richard L. Sayre, Esq., Spokane, WA
It’s time to begin organizing your tax documents, an exercise that can be particularly confusing when a family member has special needs. Here are some suggestions to bear in mind.
Exemptions and Deductions
When a loved one has special needs, the cost of health care is usually a major concern, so be sure that you claim all the deductions to which you’re entitled. Eligible outlays totaling over 7.5 percent of the taxpayer’s adjusted gross income can be subtracted. They include the unreimbursed cost of medical and dental care, related travel, insurance premiums, certain types of equipment and attendance at conferences on chronic illnesses. Expenses for medically required stays in a long-term care facility should also be included.
In some cases, it may be better to deduct disability-related job expenses ̶ such as special transportation or adaptive equipment—separately rather than as medical expenses. While these expenses may be subject to a two percent threshold, they won’t be held to the higher 7.5 percent threshold applicable to medical expenses.
Don’t forget that if you’re paying for over half the support of an adult child or frail parent, they can be claimed as dependents, as long as the exemption exceeds their personal income. A higher standard deduction is available for individuals with vision-related disabilities.
Tax Credits
Families should also be aware of the following credits:
- Dependent Care – Up to 35 percent of day care expenses incurred while the taxpayer is working or seeking employment.
- Earned Income Tax Credit – For low- to moderate-income families with children under 19 (up to age 23, if children are full-time students). This also applies to adults with disabilities who work.
- Elderly Disabled – For individuals 65 or older who are filing income taxes.
- Disability income from a previous employer’s benefit plan – Eligibility is dependent upon income level.
SNT Income
Perhaps the most important tax decision occurs long before April 15, when a special needs trust (SNT) is first established for a child with disabilities. While the investment income generated by SNT-held funds doesn’t affect eligibility for means-tested government benefits, it is taxable. The applicable tax rate, though, depends on how the trust is structured and can vary greatly. It’s important to work with a knowledgeable special needs attorney in order to minimize that liability. Trusts are taxed at a much higher rate than personal incomes are ̶ up to 39.6 percent for income of $11,950 in 2013. In addition to the income tax, trust investment income, such as interest, dividends and capital gains, is subject to a 3.8% Medicare surtax. But if an SNT is structured as a “grantor trust,” the lower rate may apply. For a detailed discussion of trusts and taxation, see the January 2012 and February 2012 issues of The Voice.
Tax planning is clearly a complex matter for families with special needs and regulations may shift from year to year. Obtaining qualified advice can prevent costly mistakes.
About this Article: We hope you find this article informative, but it is not legal advice. You should consult your own attorney, who can review your specific situation and account for variations in state law and local practices. Laws and regulations are constantly changing, so the longer it has been since an article was written, the greater the likelihood that the article might be out of date. SNA members focus on this complex, evolving area of law. To locate a member in your state, visit Find an Attorney.
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Are there any tax deductions for students with learning disabilities if our expenses are less than 7.5% of our AGI?
I am not aware of any additional deductions available to someone in your situation.
Dick Sayre
If my IRA is going into a SNT does the trust need special terms to receive an IRA? and be able to be accumulated and not have to be paid out to the beneficiary?
Shannon:
The special needs trust does not have to have special language to be named as a beneficiary of your IRA. But you will want to discuss with your attorney whether the trust’s structure (particularly remainder beneficiaries) or provisions ought to be reconsidered in light of naming it as the IRA beneficiary.
In general, special needs trusts are usually already constructed so that they would be “accumulation” trusts for IRA beneficiary designation purposes. But if there is a charitable beneficiary upon the death of the primary trust beneficiary, or if some of the possible beneficiaries are much older than the special needs trust’s primary beneficiary, then you might want to make changes. It is a complicated area, but not overwhelmingly so.
Be sure to talk with your lawyer about the beneficiaries, make sure that she realizes that you plan to have your IRA pay out to the special needs trust, and ask about the effect on minimum distribution requirements. Good luck with getting the details just right.
Robert Fleming, attorney
Fleming & Curti, PLC
Tucson, Arizona
Robert Fleming covered it pretty well. Most special needs trusts work for this purpose; however, there are tax ramifications relative to trusts holding qualified funds (IRA’s) which need to be considered in the trust design.
You can use a Special Needs Trust (SNT) to hold an inherited IRA, which means you can put your IRA into trust for a disabled child. Such trusts must be carefully drafted by attorneys with sufficient skill to understand which form of trust is best for you, however.
There are three basic forms of SNT’s which can hold IRA funds, but for most people, the accumulation trust is the best. Most SNT’s follow this accumulation format.
The first is called a ‘d4a’ trust. This is short for 42 USC 1396 p (d)(4)(A), the federal law which authorized this form of SNT. The d4A trust holds funds which belong to the disabled person in a SSI and Medicaid exempt SNT for that individual. Critically, a d4A trust requires that the funds originate with the disabled person, which means you must put the IRA into the name of the child or disabled person at your passing, and either a family member, guardian or court then places those funds into a d4a trust containing provisions which allow it to own ‘qualified’ IRA funds. The reasons not to do this are many. First, you have to pay out required minimum distributions (RMD’s) to the disabled person, which can compromise benefits until they are placed into trust. The second, and more important reason not to use a d4A, is that the residuary beneficiary of a d4A must be the State Medicaid agency, who is entitled to a payback of all Medicaid expenses paid on behalf of the beneficiary since birth at such time as the trust terminates. In some States, these trusts will terminate when disability ends, even if that is before the beneficiary dies. As a practical matter, we use d4A trusts to deal with emergency situations where no planning was done, rather than as a planning technique.
The second form of special needs trust which can hold an inherited IRA is known as a ‘conduit’ trust. This form of SNT will hold an IRA which you directly fund into the trust, so it does not pay out to the disabled person first. Significantly, this means there is no payback to the State Medicaid agency upon the death of the person or end of disability. While this works, the IRA in a conduit trust MUST pay out RMD’s during the life of the disabled person. If 100% of such payments can be used for or on behalf of the disabled person by the trustee, and are not given to the person, the payouts should not disqualify the person for benefits in most States; however, if the RMD’s exceed the need, extra funds are income for public benefit programs and could significantly impact or even terminate ongoing benefits. While a conduit trust works, it is only our second choice overall, but depending upon your circumstances, it may be the best fit. Only a skilled attorney can decide which best fits, depending upon the person and his or her needs.
The most common form of SNT used to hold qualified (IRA) funds is called an ‘accumulation’ trust. Unlike a conduit, it may accumulate the RMD’s, and is not required to pay them out, so this trust should not impact ongoing benefits by forced distributions. It is funded by the IRA owner upon their death. The trustee may then use RMD’s paid and accumulated by the trust for the disabled beneficiary’s ‘special needs’ in a manner which will not impact ongoing benefits. Unlike the d4A, (but similar to the conduit trust) there is no payback requirement to the State Medicaid agency if you use an accumulation trust.
Each trust I’ve described is designed for a specific use, and all must be carefully drafted to meet the needs of the user. There is no ‘form’ d4A, conduit or accumulation trust.
Very few lawyers understand these forms of trust sufficiently to draft one. Careful inquiry must be made to insure your lawyer is aware of all three options. Members of the Special Needs Alliance work with these and other trusts regularly, making contact with one of our members in your area the surest way to get the skills and expertise you need.
Richard Sayre
you are very kind to give such a detailed answer. I thank you very much.
My father-in-law has very kindly set aside money for my son with a disability for his college expenses. We asked that he shift the money from an UGMA to a 529 plan several years ago. My son is now 18, and we are preparing to apply for SSI, but I just learned that the shift did not happen and the funds are still in an UGMA. Can these funds be shifted to a 529 or (d)(4)(a) trust prior to the age of majority without it being viewed as a transfer of resources for SSI purposes? If it is viewed as a transfer of resources, can we wait the 36 months and then proceed with seeking SSI eligibility, or will we have to use all the funds before he will be eligible for SSI?
If my adult disabled child receive a budget from mental health for caregivers and lives in her own home21 days a month and seven days with parents per mnth. can she be claimed on income tax. Her ssdi only pays for rent and utilities, we pay all of her needs besides.