Tax concerns are rarely top of mind with a family planning for loved ones with special needs.
“The families that we assist rely on a diverse team of advisors … taking in the full picture for each individual,” said Joanne Shallcross, senior vice president and senior relationship manager at Bryn Mawr Trust in Berwyn, Pa.
Still, accounts and trusts to cover some long-term expenses for someone with special needs can come with many tax breaks—and restrictions.
An ABLE (“Achieving a Better Life Experience,” aka a 529 ABLE or 529A) is a state-run savings program for eligible people with disabilities. ABLEs can be created for persons whose long-lasting disability occurs before age 26 and can fund “qualified disability expenses” such as education and other quality-of-life services. Annual contributions are capped at $15,000 for 2020.
“Our clients tend to utilize third-party special needs trusts because of the ability to devote more per year, among other benefits, and an increased amount of control over their money,” said Michael Rudegeair, CPA/CFP and tax director in the New York City office of Anchin’s Private Client and Trusts and Estates Services groups. SNTs hold assets for persons who qualify for government benefits to pay for uncovered, qualified expenses. Trust assets are not “available” to the disabled person and so don’t disqualify them benefits, he said.
Among the types of trusts, self-settled, or first-party SNTs are funded with a disabled person’s own assets (such as from a legal settlement) and require using leftover money to pay back, at the end of the special-needs individual’s life, for government benefits, Rudegeair said.
Parents of a disabled child often choose a third-party SNT, which is created and funded by a party other than the beneficiary. A third-party SNT can provide for the same needs and eventually go to other beneficiaries instead, Rudegeair added. Contributions by parents or grandparents are reportable gifts to the trusts but are not present-interest gifts in that the beneficiary can’t enjoy the gift currently. This means the gifts are not eligible for the gift tax annual exclusion.
Structuring trusts can often involve hunting for the best tax rate. Parents or grandparents, for instance, may consider drafting the SNT as a grantor trust.
“The parent or grandparent will be taxed on the trust income during their lifetime,” Rudegeair said. This allows the trust assets to grow without bearing its own tax cost and can be helpful if the grantor’s tax rate is less than that of a trust. The type of trust also determines its tax obligation.
Contributions to an ABLE aren’t deductible but distributions, including the interest and other earnings in the account, are tax-free as long as they go for such qualified uses as housing, education and training, basic living expenses, health and wellness and some professional fees, among others, said Robbin E. Caruso CPA, partner and co-managing partner of national tax controversy practice at Prager Metis in Cranbury, N.J.