Tuesday, March 25, 2014
Presents
Taxation of First and
Third Party SNTs
With
Vincent J. Russo, J.D., LL.M. CELA, CAP
Sponsored by:
What We Will Cover
• Understanding
• Special Needs Trusts
• Trust Taxation and the Grantor
Trust Rules
• Taxation of
• First Party SNTs
• Third Party SNTs
• Tax Issues
• Tax Traps and Tips
Vincent J. Russo & Associates, P.C. ©2014
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Special Needs Planning: Trusts
• Exempt Trusts Under OBRA 1993
• First Party Special Needs Trusts
• D4a or Payback trust
• Pooled Trusts
• Asset and/or Income
• Third Party Special Needs Trusts
• Supplemental Needs
Vincent J. Russo & Associates, P.C. ©2014
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First Party Special Needs Trust
• Vehicle to Manage Assets and Income for a Person
with Special Needs
• Income and Assets Available for the Benefit of the
Person with Special Needs
• Maximizes and Maintain Government Benefits
• SSI and Medicaid
• Pay Back to State for Medicaid on Termination of Trust
Vincent J. Russo & Associates, P.C. ©2014
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Third Party Supplemental Needs
Trust
• Vehicle to Manage Assets and Income for a Person
with Special Needs
• Income and Assets Available for the Benefit of the
Person with Special Needs
• Maximize and Maintain Government Benefits
• SSI and Medicaid
• No Pay Back to State for Medicaid
Vincent J. Russo & Associates, P.C. ©2014
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Special Needs Trust:
Tax Issues
• Income Tax Rates
• Trust versus Individual
• Qualifying for Grantor Trust Status
• As to Income and Principal
• Step Up in Basis
• Filing of Tax Returns
• Trust and Personal Tax Returns
• Who reports the Trust Income
Vincent J. Russo & Associates, P.C. ©2014
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2014 Tax Bracket
Tax Rate
Single
Married-Joint
Estate or Trust
10%
up to $9,075
up to $18,150
N/A
15%
$9,076 -
$18,151
up to $2,500
36,900
73,800
$36,901 -
$73,801 -
$2,501 -
89,350
148,850
5,800
$89,351 -
$148,851 -
$5,801-
186,350
226,850
8,900
$186,351 -
$226,851 -
$8,901 -
405,100
405,000
12,150
35%
405,101 - 406,750
405,101 – 457,600
39.6%
over $406,750
over $457,600
25%
28%
33%
Vincent J. Russo & Associates, P.C. ©2014
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over $12,150
2013 Income Tax Traps
Taxable
Income
Single
Married- Joint
Estate or Trust
$10,000
$1,054
$1,000
$2,447
$20,000
$2,554
$2,108
$6,278
$50,000
$8,429
$6,608
$18,158
$100,000
$21,293
$16,858
$37,958
$200,000
$50,131
$43,466
$77,558
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes: Trust Income
• Must be Reported on the Trust Income Tax Return
(unless an exception is met)
• If Exception is met,
• All income may be reported on the grantor’s personal
income tax return
• All or part of the income may be reported on the
beneficiary’s personal income tax return
• All or part of the income may be reported on the trust
income tax return
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes:
Examples of Grantor Trusts
• All
• First Party Special Needs Trust
• Revocable Third Party Special Needs Trusts
• Optional
• Third Party Irrevocable Special Needs Trust
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes: Grantor Trust
(Taints)
• Reversionary Interest in the Trust (IRC §673)
• Grantor may Exchange Property of Equivalent Value in
Non-Fiduciary Capacity (IRC §675)
• Use Trust Income to Pay Premiums of Insurance on Life
of Grantor or Grantor’s Spouse (IRC §677)
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes: Grantor Trust
(Taints)
• Power to Revoke (IRC §676)
• Do not use the Power to Revoke if a First Party Special
Needs Trust (where the beneficiary is accessing or seeking
to qualify for Supplemental Security Income and/or
Medicaid)
• Income Payable by Grantor or Non-Adverse Party
(trustee) to the grantor (IRC §677)
• Without the consent of an Adverse Party (Trustee)
• any person who has a substantial beneficial interest in the
trust which would be adversely affected (IRC §672)
Vincent J. Russo & Associates, P.C. ©2014
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Obtaining Grantor Trust Status
Over Principal
• Important when Dealing with Appreciated Assets
• Will allow the Grantor to Maintain IRC § 121 exemption
on sale of primary residence
• Ensures that individual capital gains tax rates apply when
trust assets are sold
• For example, Sale of Stock and Bonds
Vincent J. Russo & Associates, P.C. ©2014
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Obtaining Grantor Trust Status
Over Principal
• Grantor Trust Powers that give Grantor Trust Status
with Respect to Principal
• Power to substitute assets of equivalent value or power
to add charitable beneficiaries
• Powers within the Internal Revenue Code which cause
Estate Tax Inclusion
• § 2036(a)(2) – testamentary power of appointment to
change beneficiaries
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes:
Non-Grantor Trusts
• All
• Testamentary Trusts
• Qualified Disability Trust
• Optional
• Third Party Irrevocable Special Needs Trusts
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes:
Advantages of a Grantor Trust
• Income Tax Consequences stay with the Grantor
• Consider the Tax Bracket of the Grantor
• Single Individual reaches 39.6% at $406,750 for 2014
• Trust reaches 39.6% bracket at $12,150 for 2014
• Simpler Tax Filings
• Easier to Explain to the Client
Vincent J. Russo & Associates, P.C. ©2014
16
Income Taxes: Advantages of a
Non-Grantor Trust
• Grantor does not have to come up with funds to pay
tax on “phantom income”
• Spread out the income tax consequences
• Beneficiary who receives the income pays the income
tax in beneficiary’s tax bracket
• Higher exemption amount as a “Qualified Disability
Trust”
Vincent J. Russo & Associates, P.C. ©2014
17
Income Taxes: Disadvantages of a
Non-Grantor Trust
• If not Careful, Higher Overall Taxes
• Beneficiary does not Understand that they need to
come up with Income Tax Payments
• More Complicated
• Trustee needs to pay attention to calendar year-end
distributions
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes: What The Grantor
Needs To Know
• Tax Impact on the Trust, the Grantor and Beneficiaries
• Filing of Income Tax Returns
• Trust
• Grantor
• Beneficiary
• Impact on Gift and Estate Taxes
Vincent J. Russo & Associates, P.C. ©2014
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Income Taxes: What the Trustee
Needs To Know
• Fiduciary Record Keeping
• Year End Income Tax Planning
• Sixty Five Day Rule
• Filing of Tax Returns
• Due April 15th (for Tax Years ended 12/31)
• Five-Month Extension Available
• Extension of time to file (not to pay)
Vincent J. Russo & Associates, P.C. ©2014
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Federal Uniform Gift and Estate
Tax System for 2014
• $5,340,000 Federal Exemption which can be used
either during Lifetime and/or at Death
• If during lifetime, offsets taxable gifts
• If at death, offsets estate tax on taxable estate (including
prior taxable gifts)
• Note : taxable gifts are gifts in excess of the annual
exclusion amount which has varied in years past
(currently $14,000 in 2013-2014)
Vincent J. Russo & Associates, P.C. ©2014
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Federal Estate Taxes
• Exemption Amount for 2014
• Exemption amount: $5,340,000 for gift and estate taxes
• Tax Rate: 40%
• Basis for Income Tax Purposes
• Step-up in Basis
• State Estate Taxes
Vincent J. Russo & Associates, P.C. ©2014
22
Trusts in a
Special Needs Practice
• First Party Special Needs Trust
• Pooled Trusts
• Third Party Special Needs Trust
Vincent J. Russo & Associates, P.C. ©2014
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First Party Special Needs Trusts:
Taxation
• Gift Taxation on Funding
• Incomplete
• Income Taxation on Income Generated
• Grantor Trust
• Estate Taxation on Demise of Beneficiary
• Included in the Estate
Vincent J. Russo & Associates, P.C. ©2014
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First Party Special Needs Trusts:
Gift Taxation
• Incomplete Gift
• IRC §2511
• Treasury Regulations, Subchapter B, §§25.2511-1 and
25.2511-2
Vincent J. Russo & Associates, P.C. ©2014
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First Party Special Needs Trusts:
Income Taxation
• Who is the Grantor?
• The Beneficiary
• Revenue Ruling 83-25
• Kiddie Tax Issue
• Who Pays the Income Tax?
• Grantor if Grantor Trust
• IRC §§ 671- 677
• IRC §673 – Reversionary Interest
Vincent J. Russo & Associates, P.C. ©2014
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First Party Special Needs Trusts:
Estate Taxation
• Included in the Estate of the Grantor/Beneficiary
• IRC §2036(a)(1)
• TAM 9506004
• Code §§2036 and 2038
Vincent J. Russo & Associates, P.C. ©2014
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First Party Special Needs Trusts:
Estate Taxation
• Consider: Valuation of Future Periodic Payments on
Structured Settlements
• Three Methods of Valuation
• Commercial Annuity
• § 7520 Rate
• Willing Seller and Willing Buyer will pay for the future
periodic payments
Vincent J. Russo & Associates, P.C. ©2014
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SNTs - Gift and Estate Taxes:
PLR 9437034
• Decedent Created an Irrevocable Trust
• Funded with Structured Settlement Proceeds with a
Guaranteed Payment
• Special Needs Trust Created to be the Recipient of the
Settlement Proceeds
• SNT Provisions
• For sole benefit of Decedent
• Testamentary Special Power of Appointment
Vincent J. Russo & Associates, P.C. ©2014
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SNTs - Gift and Estate Taxes:
PLR 9437034
• Included in Estate for Estate Tax Purposes
• IRC §2038(a)(1)
• Decedent has the right at death to alter disposition of
trust assets
• Decedent has the right at death to alter disposition of trust
assets
• Incomplete Gift
• IRC Reg. §25.2511-2
• Donor retained special power to change the enjoyment of
the trust assets
Vincent J. Russo & Associates, P.C. ©2014
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Income Tax Traps
(Issue Awareness)
• Income Tax Brackets
• Kiddie Tax
• Estimated Tax Payments
• State Income Tax Return Requirements
Vincent J. Russo & Associates, P.C. ©2014
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Pooled Trusts under OBRA
• Established by a Not for Profit
• Sub-Account for the Sole Benefit of a Person who is
Disabled
• Pay Back to the State unless the Remaining Funds are
held by the Trust or for the Benefit of the Charity
• 42 U.S.C. § 1396p (d)(4)(c)
Vincent J. Russo & Associates, P.C. ©2014
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Pooled Trusts: Income Taxes
• No Definitive Authority
• Income Taxes
• Treas. Reg. §1.642(c)-5
• Review the Master Pooled Trust and Joinder Agreement
• Income on Sub-Account reported as a:
• Grantor or Complex Trust
• Gift Taxes
• Incomplete gift on funding of the sub-account
• Estate Taxes
• Included in the Estate of the participant
Vincent J. Russo & Associates, P.C. ©2014
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Inter Vivos Third Party
Supplemental Needs Trusts
• Gift Taxation
• Complete or Incomplete
• Revocable or Irrevocable Trusts
• Income Taxation to Settlor, Trust, Beneficiary
• Grantor Trust or Complex Trust
• Estate Taxation
• Included or Not Included in the Estate
Vincent J. Russo & Associates, P.C. ©2014
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Inter Vivos Third Party
Supplemental Needs Trusts
• Grantor Trust for Income Tax purposes
• Power to Remove Trustee
• Discharge Obligation of Support
• Retention of Certain Administrative Powers
Vincent J. Russo & Associates, P.C. ©2014
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Inter Vivos Third Party
Supplemental Needs Trusts
• Income Taxation as a Complex Trust
• Retained Income Trust
• Distributed Income – Beneficiary
• Qualified Disability
• Trust Issues
• Distributable Net Income
• End of Year Distributions
Vincent J. Russo & Associates, P.C. ©2014
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Inter Vivos Third Party
Supplemental Needs Trust
• Tax Consequences
• Does the grantor have a taxable estate?
• When will the Trust be funded?
• Non – Taxable Estate
• Grantor Trust for Income Tax Purposes
• Incomplete Gift
• Included in Estate for Estate Tax Purposes
• Taxable Estate
• Income / Gift / Estate Tax Consequences
Vincent J. Russo & Associates, P.C. ©2014
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Third Party Supplemental Needs
Trusts: Taxes
• Gift
• Complete versus Incomplete
• Control by drafting trust provisions
• Income
• Grantor Trust
• Non-Grantor Trust
• Simple Trust or Complex Trust
• Conversion from Grantor Trust
Vincent J. Russo & Associates, P.C. ©2014
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Third Party Supplemental Needs
Trusts: Estate Taxes
• Included in Estate of Grantor
• Strings Attached
• Maintain Control or Beneficial Enjoyment
• Reversion
• Excluded from Estate of Grantor
• No Strings Attached
• No Control or Beneficial Enjoyment Retained
Vincent J. Russo & Associates, P.C. ©2014
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Testamentary Third Party
Supplemental Needs Trusts
• Gift Taxation
• Not subject to Gift Tax laws
• Income Taxation to Settlor, Trust, Beneficiary
• Complex Trust
• Estate Taxation
• Included in the Estate
Vincent J. Russo & Associates, P.C. ©2014
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Qualified Disability Trust
• Increased Personal Exemption
• From $100 to $3,950 for 2014
• Certain Requirements must be met:
•
•
•
•
•
Must be a Disability Trust
All Beneficiaries must be disabled
Irrevocable Trust
Sole Benefit of disabled beneficiary under age 65
Non-Grantor Trust for income tax purposes
Vincent J. Russo & Associates, P.C. ©2014
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IRAs, SNTs and Medicaid
• IRAs
•
•
•
•
Available versus Not Available
Permanent Pay Status
Required Minimum Distributions
Annuities
• SNTs
• Trust Assets not available as to Medicaid
Vincent J. Russo & Associates, P.C. ©2014
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IRAs: Trust as Designated
Beneficiary
• IRC Reg. §1.401(a)(9)-4, A-5)
• #1 - Trust must be valid under state law
• #2 - Trust must be irrevocable or will, by its terms, become
irrevocable upon death of the participant
• # 3- The beneficiaries must be “identifiable ... from the trust
instrument”
• #4 - Certain documentation must be provided to “the plan
administrator” by 10/31 of the year following the year of
participant’s death
• #5 - All trust beneficiaries must be individuals
Vincent J. Russo & Associates, P.C. ©2014
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Third Party Designation of
SNT as IRA Beneficiary
• Bob’s child, Krista, is 35 years old and has CP
• Options
• Bob creates a Living Third Party SNT for Krista
• Bob creates a Revocable Trust with SNT for Krista
• Bob creates a Will with SNT for Krista
• Bob designates SNT as his IRA beneficiary
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 200620025 Facts
• Taxpayer A, age 69 died
• Four sons surviving; Child B is disabled
• Sons are named beneficiaries of the inherited IRA
event
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 200620025 Strategy
• Separate Sub-IRAs Established for Each Child
• Make the Annual RMDs
• Court Authorized Establishment of First Party SNT with
a Pay Back Provision and the Transfer of Child B’s Share
of the IRA to the SNT
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 200620025 Ruling
• SNT is a Grantor Trust
• Transfer of B’s Share of the IRA to SNT is not a Taxable
Event
• Trustee may Calculate the Annual RMDs Based on Life
Expectancy of Taxpayer B
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 201116005
• Beneficiary’s Father Died Owning two IRAs Benefitting
Beneficiary and his Siblings.
• Beneficiary is Disabled and Medicaid Eligible.
• Beneficiary Proposed to Transfer his Share of the
Inherited IRAs to a First Party Special Needs Trust in
Order to Protect his Medicaid Benefits.
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 201116005
• IRS held that as a General Rule, if a Beneficiary
Transfers an Inherited IRA, there is an Immediate
Taxable Event
• However, in this case the Beneficiary’s Transfer of the
IRA to the SNT would not be a Taxable Event
• The Transfer was not a Gift as it was made to a Grantor
Trust. So essentially, the Beneficiary Transferred the
IRA to Himself.
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 201117042
• IRA Owner Established an IRA.
• IRA Owner then Contracted Muscular Dystrophy and
was deemed Disabled
• A Court Authorized the Creation of a SNT for IRA
Owner
• The Court Ordered that Amount Equal to Balance in
the IRA be Transferred to the SNT
Vincent J. Russo & Associates, P.C. ©2014
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IRAs and SNTs:
PLR 201117042
• When the IRA Owner tried to Comply with the Court
order, the IRA Provider Refused because an IRA cannot
be set up in the Name of a Trust. The IRA provider
Distributed the funds to a Non-IRA account and issued
a 1099 as a Taxable Event.
• IRS Allowed the IRA Owner to Roll the Funds over to a
New IRA.
Vincent J. Russo & Associates, P.C. ©2014
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Irrevocable Life Insurance Trust
with Supplemental Needs
• Crummey Powers
• Draft withdrawal provision so that the beneficiary with
special needs does not have a withdrawal power
• Provide for the Donor to control who has a withdrawal
power
• Provide for other beneficiaries with a withdrawal power
Vincent J. Russo & Associates, P.C. ©2014
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Credit Shelter and Marital
Trusts with Supplemental Needs
• Credit Shelter Trust
• Supplemental needs provisions as income and principal
• Marital Trust
• Supplemental needs provisions as to principal but not
income if qualifying the trust for the marital deduction
Vincent J. Russo & Associates, P.C. ©2014
53
Drafting: Supplemental Needs Trust
Provisions
• Drafting Supplemental Needs Provisions as a
Contingency Plan
• In connection with minor trusts, descendant trusts,
generation skipping trusts
• Can have trigger provisions as to Medicaid except for a
beneficiary–spouse and if the Trust is inter-vivos
Vincent J. Russo & Associates, P.C. ©2014
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In Summary
• Overview of Taxes in a Special Needs Practice
• Personal and Trust Income Taxes
• Gift and Estate Taxes
• IRAs and Special Needs Trusts
• Supplemental Needs Provisions in Various Trusts
Vincent J. Russo & Associates, P.C. ©2014
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Support
(866) 296-5509
support@specialneedsplanners.com
Vincent J. Russo & Associates, P.C. ©2014
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