The main financial vehicles of supporting disabled individuals—the special needs trust and the Achieving a Better Life Experience (ABLE) account—both come with special tax conditions that advisors need to consider.

One of the biggest concerns is “how support may interfere with benefits an individual may receive from the federal or state government,” said Bryan Kirk, director of financial and estate planning with Fiduciary Trust International in San Mateo, Calif.

A special needs trust is a way to hold property for someone without interfering with their eligibility for government benefits. “There’s no tax advantage to the trust,” Kirk said. “But actual tax results will depend on who creates the trust, the terms of the trust and how it’s administered.”
The trust pays no taxes on any income that it earns as long as that income is passed on to the beneficiary (trust tax rates are generally higher than individuals’ rates). The income to the beneficiary is taxable to his or her income tax rates.

In some cases, Kirk added, all income of a trust may be taxed to the beneficiary—typically the case with a first-party special needs trust, where the beneficiary is establishing the trust with his or her own funds, often with proceeds from a judgment or litigation settlement. “In others, the parent or other person who created the trust may bear the tax burden. Or the trust itself may be responsible for all or a portion of the tax liabilities,” Kirk said.

An ABLE account, created some seven years ago, is a tax-favored vehicle, also designed not to interfere with an individual’s eligibility for benefits but generally easier and cheaper to establish than a trust. To qualify, an individual generally must have a disability with onset before age 26 or be receiving Supplemental Security Income (SSI) or Social Security disability insurance benefits or meet other disability test requirements.

An individual can only have one ABLE account. Annual contributions are generally capped at $15,000. If an individual’s total resources, including the ABLE account, go over $100,000, SSI benefits will be suspended.

But an ABLE “will not directly reduce the major part of SSI benefits under the dollar-for-dollar SSI direct support rules, and it won’t be counted as assets,” said Cameron Hess, a CPA and partner with Wagner Kirkman Blaine Klomparens & Youmans in Northern California. ABLEs can be inherited, he added, and the disabled person may use the account to save earned income. New rules enable the rollover of funds in a 529 to an ABLE.

“While helpful and with somewhat more favorable tax rules, trusts are not designed to have any unique tax benefits,” Hess said. “An ABLE account is different. Investment earnings are generally tax-exempt. And if properly spent, the distributions are generally tax free to the beneficiary.”

(The ABLE National Resource Center details each state’s program. Some states offer additional tax benefits for those who use their home state’s plan.)

“In some states, there can be deductions for contributions to an ABLE account. Earnings in the account are not subject to tax,” Kirk said, adding that the account can only be used tax-free for qualified expenses resulting from living with a disability, such as education, housing, food, employment training and special assistance, among others.

Still, “an ABLE account is a useful tool, but it should not replace use of a special needs trust or trust planning,” Hess said.

“When more substantial funds are at play, the special needs trust is your solution,” added Terry Colleran, managing director with Fiduciary Trust International in Radnor, Pa. “Inheritance, litigation settlements, major gifts should go into a special needs trust.”

The new administration’s tax proposals could impact special needs trust to the extent trust income tax rates change. “Also, the administration’s proposal to require realization of capital gains upon the making of a large gift or inheritance over $1 million could impact those making large contributions to special needs trusts,” Kirk said.