The Voice is the e-mail newsletter of The Special Needs Alliance. This issue is devoted to a timely topic: taxes. Alliance member Ron M. Landsman, Esq. of Rockville, Maryland, addresses some common questions about taxation of special needs trusts.

Mr. Landsman is co-author (with fellow Alliance member Robert B. Fleming of Tucson, Arizona) of a short but detailed analysis of the federal income tax provision that classifies some (but not all) special needs trusts as “Qualified Disability Trusts” (or QDisTs). Their article is available on the Special Needs Alliance’s website, along with other informative articles by Alliance members. In fact, members of the Special Needs Alliance are frequent contributors to the leading journals and publications on special needs issues; another detailed tax article (this one by Alliance member Dennis Sandoval of Riverside, California) recently appeared in the NAELA News, a quarterly publication of the National Academy of Elder Law Attorneys. Mr. Sandoval’s article is also available on the Alliance’s website.

April 2009 - Vol. 3, Issue 4

Tax time approaches, and trustees of special needs trusts (and their accountants) should pay attention to the “Qualified Disability Trust” provisions of the Internal Revenue Code. A new publication from the Special Needs Alliance addresses the Qualified Disability Trust (QDisT) tax rule and explains when to use it.

The federal tax code is complicated and difficult to navigate; the QDisT provision is not an exception. The details of Qualified Disability Trust treatment are beyond this newsletter’s scope — they are fully explained in the article, which is available online – but the key issues for families and tax preparers are addressed here.

Q: Why would I want my trust to be treated as a Qualified Disability Trust?

A: Lower taxes. Trusts that qualify are entitled to take an additional personal exemption, that is, in effect, an additional deduction from income tax liability of $3,500 (for 2008 tax year returns). For trusts with income above $10,700, the savings are $1,190 in total taxes paid.

Q: Can my self-settled Special Needs Trust claim Qualified Disability Trust treatment?

A: No. It is not available for self-settled trusts. But that is not as unfair as it sounds since you already have your own personal exemption of $3,500. The idea behind QdisTs is to extend the same benefit to so-called third party trusts.

Q: Can any other Special Needs Trust claim the benefit of QDisT status?

A: Most, but not all. To qualify:

  1. All of the current beneficiaries of the trust must be getting SSI based on disability or SSDI benefits. SSI is the Federal welfare program; SSDI refers to Social Security benefits for disabled individuals (based on their own work records or that of a parent). Most Special Needs Trusts will have only one beneficiary, but the tax law allows trusts with more than one beneficiary – if all are disabled – to qualify.
  2. The trust must have been established when the beneficiary was (or the beneficiaries were) under age 65. However, the trust can continue to claim QDisT treatment after the beneficiary (or beneficiaries) turn 65.

Q: I am disabled (on SSDI) and the beneficiary of a trust in my father’s will, but it does not have specific “special needs” language. Can it still claim to be a QDisT?

A: Yes.

Q: Assuming I meet all of the requirements, how do I get QDisT treatment?

A: Look at IRS Form 1041, the income tax return for trusts. In the upper left corner there is a list of trust types that the filer should choose among. The fourth one down is “Qualified Disability Trust.” Mark that box. Then, in line 20, claim the full $3,500 exemption (instead of the $100 exemption that applies to most trusts).

Q: I don’t mean to look a gift horse in the mouth, but that’s not all that much of a benefit. Isn’t there anything else?

A: No. It isn’t much of a benefit, but it’s what there is now. The good news is that there are proposals before Congress to extend “529 plan” type benefits to disability trusts. If not caught in the backwash of the Federal government’s response to the current economic crisis, something like that seems likely to be enacted.

Those are the basics. The SNA article explains the interplay of the tax provision and Federal Medicaid law and where the answers to these questions appear in the tax code. The article also explains how the authors come to the conclusions that they do.

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.

 Requirements for Reproducing this Article: The above article may be reprinted only if it appears unmodified, including both the author description above the title and the “About this Article” paragraph immediately following the article, accompanied by the following statement: “Reprinted with permission of the Special Needs Alliance –” The article may not be reproduced online. Instead, references to it should link to it on the SNA website.