Knowing a little about how special needs trusts are taxed can help

Having a little practical knowledge of how trusts are taxed can help you plan for your person with special needs. It will also help you work more effectively with your accountant, attorney, and trustees.

First, it is important to realize that most trusts are separate entities and may be subject to state and federal income taxes. This applies to trusts established by family members and to trusts that hold a disabled person’s own assets. The rules can be very different for everyone.

TRUSTS HAVE DEDUCTIONS AND DEDUCTIONS

The IRS gives taxable trusts a $ 600 deduction. If a trust fund is small enough, I often advise clients to keep interest income below $ 600 per year to avoid filing a return. fiduciary tax. The beneficiary may still have to file their own return. The IRS calls the trust’s tax return a “pass-through” statement, since most income, taxes, and deductions are “rolled-over” to the beneficiary. The return is filed with the IRS on Form 1041. Trusts pay taxes in a calendar year ending December 31.

TRUST PAYMENTS AVOID TRUST TAX

Trusts generally take an income tax deduction for all money they distribute to a beneficiary or pay for the beneficiary’s treatment, support, or needs. Frankly, this is how good trustees should use the money of a person with special needs. The trust deducts the part of your income that it pays. The capital spent or paid is generally not taxable for the trust or beneficiary.

It is often helpful to look at a simple example. If a trust has a principal value of $ 100,000 and you simply deposit the money into a bank account and it does not earn interest or income, the trust does not have to pay any income tax or file a return. If the trustees distribute a portion of that account, for example $ 30,000 for the beneficiary’s medical needs, the principal distribution is not taxable income for the beneficiary.

TEST YOUR TRUST ASSETS TAX FREE

The income a trust receives from investing in a tax-free source maintains its “character” and is tax-free to the beneficiary when spent for its needs. Knowing this, we often advise clients to put some or all of the beneficiary’s funds in municipal bonds tax-free.

SEE THE END OF THE YEAR AND PLAN AHEAD

The second big rule of thumb is that many, but not all, deductions that are available to individuals may also be available to trusts. However, the trust tax rate on income that a trust earns but does not pay to a beneficiary is much higher than the individual tax rate that your special someone will pay. To avoid this, it often makes sense to plan ahead and spend all of the trust income before December 31 of each year. Currently, trusts pay about a 38% federal tax on the income that the trust accumulates and does not spend on behalf of a beneficiary. Your state income tax can add to this burden.

HELP PREPAY TAXES

It is important to know that income from the trust that is spent for a beneficiary that is likely to be taxable on the beneficiary’s personal return is important. The trust can make estimated income tax deposits on Form ES1040 and transfer the benefit of those advance income tax payments to your beneficiary. This can cover any tax liability your beneficiary may owe due to the income from the trust. It can help alleviate concerns, adequately prepaying tax liability and paying taxes caused by trust income is almost always a legitimate trust expense.

DOUBLE DEDUCTION

Congress added a special provision to the tax code for qualified disability trusts. It is found in section 642 and can be useful for a D4a trust as long as the trust is not a “grantor” trust. Effectively, it doubles the personal deduction of $ 3,300 by giving the trust the benefit of a personal deduction and allowing the beneficiary to keep a similar personal deduction. In practice, this is difficult to achieve for most larger trusts, but is worth exploring. You should ask your accountant if it can work for your family.

MAKE THE CONFIDENCE HIRING AN ASSISTANT

A trust can pay employees on behalf of your beneficiary with special needs. Don’t forget that workers’ compensation insurance is required. FUTA withholding is required if an employee is paid more than $ 1,000 in a quarter. Social Security must be withheld and paid if an employee is paid more than $ 1,500 in a calendar year. Generally, filing a 1099 is required when a trust makes payments to providers that exceed $ 600.00.

This article just shares a bit of information on some of the general trust tax rules. There are places where you can start looking for tax breaks if you work with your accountant, trustees, and attorneys. Note that trusts are subject to alternative minimum tax, estimated withholding, capital gains taxes, depreciation, and carry-on-loss regulations. It is important that your professionals always check the current code sections as they apply to your specific family situation. Of course, you should also check your state’s specific tax regulations.