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Read moreMany individuals engaging in estate planning opt to create a third-party special needs trust to provide for their loved one living with a disability. However, did you know that these trusts may have to pay taxes on any income generated from the trust assets and retained by the trust for future use? If the trust is a qualified disability trust (QDT), it can minimize unnecessary tax consequences.
To qualify as a QDT, a trust must meet the following basic requirements:
It must be irrevocable.
If a trust meets these requirements, it can reap significant tax benefits. Without the QDT designation, a trust normally may exempt up to $100 to $300 of income it generates from taxation, depending on whether it is required to distribute all its income. However, a QDT may take an exemption equal to what an individual filing a personal income tax return may take. Per the Internal Revenue Code, this is $5,000 plus an annual adjustment for inflation.
In addition to the exemption, an individual benefits from more favorable tax brackets on income than a trust. A QDT also gets this benefit. For tax years starting after 2023, the highest income trust bracket for a trust applies to amounts over $15,200, and the highest tax rate for trusts is 37 percent. In contrast, an individual taxpayer is not taxed at the highest rate of 37 percent until their income reaches $609,3500 or more.
Local Special Needs Planners in Columbus, OH
Hansen Legal LLC provides a full range of estate planning legal services, from your initial consultation, drafting all of the documents necessary for a comprehensive estate plan, to properly executing and notarizing the documents. Estate planning at Hansen Legal LLC consists of wills, trusts, advanced directives, power...
When Britta decided to work in personal finance, she researched the best way to enter the profession without compromising her ideals. She realized that the best way forward would be to become a Certified Financial Planner (CFP®) and practice in a fiduciary, fee-only, and holistic capacity. Britta considers financi...
This preferred tax treatment can make a difference, especially when a trust wishes to retain income for future use. Alternatively, a trust may not want to distribute all income. This way, it can protect beneficiaries from losing means-tested benefits such as Medicaid or SSI. Paying fewer taxes on retained income means more is left over for beneficiaries.
A QDT will have to file a tax form called Form 1041 to receive these benefits every year. A trust may need the assistance of a tax professional. However, this expense is well worth it when you consider the potential tax savings.
If you are setting up a special needs trust through your will, a best practice tip is to avoid vague terms and specifically name the beneficiary of the anticipated QDT. This will allow them to elect the QDT treatment on appropriate tax forms.
You should also carefully select your trustee. A trustee of a QDT will have serious fiduciary responsibilities that can last a lifetime. They should be financially savvy and willing to invest time and resources in correctly maintaining and administering a QDT. This includes keeping up with all annual tax filings.
By engaging in proper planning when setting up a special needs trust for your loved ones, you are setting them up for a better and brighter future. Working with an attorney to set up your trust correctly to qualify for QDT status may make an immeasurable difference in the lives of your beneficiaries.
For guidance in planning, consult with a qualified special needs planning attorney in your area.
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