Income and estate tax planning for special needs trusts.

Author:Savoth, Paul G.


* The CPA often plays an important role as a financial and tax adviser in the planning, implementation and management of special needs trusts.

* A special needs trust can provide for a disabled beneficiary's special needs, without tainting his or her ability to receive government benefits, such as Medicaid and SSI.

* There are many legal, tax and personal issues to be addressed in establishing the trust's terms; the tax adviser must anticipate the income and estate tax consequences.


A special needs trust may be advisable when a client or family member is disabled and receiving government benefits. This article discusses the characteristics of such trusts and focuses on the income and estate tax planning considerations.

A client's son has been seriously injured in a motorcycle accident. Another client's newborn child has a genetic defect that will result in severe mental retardation. Such events will change the lives of clients and their families forever. After sorting through the immediate medical problems and grief, clients may seek their CPA's help. Because a family member will now require special care for the remainder of his or her life--the resources for which may come from family assets, insurance, a tort recovery and/or government benefit programs--the CPA's financial projections and assumptions on which advice was previously based will dramatically change.

If government benefits are available, a special needs trust may be advisable as part of the family's financial plan. This article discusses the general parameters of the special needs trust, focusing primarily on the particular income and estate tax considerations presented. Although an attorney will prepare the trust documents and provide advice on qualifying for certain government programs, the CPA is often the closest adviser to the family and can play an important role in implementing and administering the trust.


A special needs trust is created to invest and distribute funds for the benefit of a disabled beneficiary. Typically, it supplements the beneficiary's government benefits, without tainting his or her ability to receive them. Those benefits may include an apartment paid for by a state housing program, a monthly stipend from the Federal Supplemental Security Income (SSI) program, adult day programs provided by a state social services agency and medical care paid for by Medicaid. However, government programs will most likely not cover special needs such as birthday gifts, vacations, training programs, consumer electronics, furniture and medical procedures and equipment not covered by Medicaid. These special needs can be provided by the special needs trust, without reducing government benefits.

Government Program Qualifications

Many programs, such as Medicaid and SSI, specifically limit a beneficiary's income and resources. (1) Income, for these purposes, generally includes amounts received in cash or kind that can be used for food, clothing or shelter. (2) Resources include cash or other assets that can be converted to cash for support and maintenance. (3)

To avoid disqualifying a special needs trust beneficiary for government benefits, any payments to or for the beneficiary must not be deemed income, and the trust assets must not be deemed resources of the beneficiary. To avoid inclusion, payments or in-kind distributions should either be discretionary or only for the beneficiary's comfort and happiness. The trust document should specifically state that distributions should not be for support. Specific examples of anticipated needs may be cited in the trust document, such as supplemental dental expenses, a wheelchair-accessible van, training programs, personal items, holiday gifts or vacations. To avoid including trust assets as a resource, the trust document should not enable the beneficiary to request a distribution of trust principal.

Whether the trust will be deemed a resource for SSI and Medicaid purposes will depend on whether it is created by a third party from the third-party's assets (a third-party trust) or from the disabled individual's assets (a self-created/self-settled trust).

Third-Party Trusts

A third-party trust is one created and funded by someone other than the disabled individual, such as a parent or grandparent. It can be established during the grantor's life (inter vivos) or at his or her death (testamentary).

Tax Effects of Distributions

A third-party trust will be classified as a complex trust under Regs. Sec. 1.661-(a)(1), because it will not be required to distribute all of its income currently. The trust will be entitled to an income...

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