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
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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
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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
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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
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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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Vincent J. Russo & Associates, P.C. ©2014
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