Special Needs Trusts: What You Need to Know

Planning for the care of a loved one with special needs or a disability can have its challenges. For example, how can you ensure they are cared for and have everything they need? How can you provide them with assets and avoid jeopardizing their government benefits? 

You can help answer these questions and avoid some of these challenges by setting up a Special Needs Trust.

What is a Special Needs Trust?

A Special Needs Trust is a type of trust that assists with providing financial support to an individual with special needs. They are designed to help meet the beneficiary’s needs while not interfering with their government benefits.

The primary goal of Special Needs Trusts is to provide for or supplement the individual’s needs while not impacting government benefits like Medicaid or Supplemental Security Income (SSI).  Government benefits have limits on income and assets; receiving financial assistance or gifts could impact or cancel the individual’s eligibility. This is where the Special Needs Trust could help.

Special Needs Trusts may make distributions for items not covered under their government benefits. These distributions are considered supplemental and do not generally replace or reduce the individual’s existing benefits. 

Some examples of distributions include:

  • Building accessibility modifications to the beneficiary’s home, such as a wheelchair ramp or chair lifts
  • Service or support animals
  • Specialized services like physical therapy or water therapy
  • Certain medical, dental, or other health-related items not covered by Medicaid, including medicines
  • Clothing, whether tailored to accommodate a specific disability or day-to-day use
  • Other items for the beneficiary’s benefit, such as education, household furniture, or quality of life improvements

Types of Special Needs Trusts

Two common types of Special Needs Trusts are First-Party Special Needs Trusts and ThirdParty Special Needs Trusts. Both types can provide additional assistance for individuals with special needs while maintaining their eligibility for government benefits. 

Generally, both types have the same basic attributes:

  • Designates the trust for the sole benefit of the individual living with a disability.
  • Appoints a trustee to administer the trust and manage the funds
  • Provides language stating that distributions are made at the sole discretion of the trustee
  • Instructs the trustee to make distributions that supplement government benefits rather than using them for items and services that are already covered

Regardless of the type of Special Needs Trust, it is the trustee’s responsibility to ensure the funds are spent as intended and not used in a way that could jeopardize the beneficiary’s eligibility for government benefits. 

First-Party Special Needs Trust

First-Party Special Needs Trusts are created with the asset of the beneficiary or those to which they are legally entitled.  After the Special Needs Trust Fairness Act became law in 2016, mentally competent individuals, although legally disabled, became a “permissive settlor” of a Special Needs Trust. 

Before this law passed, any First-Party Special Needs Trusts had to be established via a legal guardian of the property, a conservator, or by court order.

There is a requirement that, upon the beneficiary’s death, Medicaid must be reimbursed for any medical assistance paid on their behalf. The remainder of any funds left in trust may be distributed to any additional beneficiaries if there are any remaining assets. 

If the trust has been exhausted and terminated, Medicaid has nothing to collect.

Third-Party Special Needs Trust

Third-Party Special Needs Trusts, as the name suggests, are created by someone else for the beneficiary’s benefit. For example, a woman might create a Third-Party Special Needs Trust for her disabled veteran brother to help him with his day-to-day needs.

Funds remaining at the beneficiary’s death may be passed on to other individuals. As the trust was created with assets that were not originally the beneficiary’s, there is no need for the trust to contain a Medicaid payback provision.

Who is Eligible for a Special Needs Trust?

Most often, Special Needs Trusts are established by family members of the beneficiary. However, any third party can establish a Special Needs Trust for the beneficiary’s benefit. 

Regardless of who is the grantor of the trust, it is vital to seek the assistance of counsel when drafting the trust document. A poorly drafted trust could risk being “invaded” by the very government entities that provide their public benefits.

First-Party Special Needs Trusts are governed by the Omnibus Budget Reconciliation Act of 1993 (as well as the guidance materials Social Security Administration Program Operations Manual System), which include the following statutory requirements:

  • The trust must be established by a permissible settlor (see above).
  • The beneficiary of a First Party Special Needs Trust must be under the age of 65 upon its creation and funding.
  • The trust must be irrevocable.
  • Depending on the type of Special Needs Trust, the beneficiary supplementing government benefits with the trust must be considered “permanently and totally disabled” within the meaning of the SSA.
  • The trust is for the sole benefit of the beneficiary.
  • Upon the beneficiary’s death, medical assistance providers (Medicaid) will be reimbursed for any property remaining.

What are the Advantages of a Special Needs Trust?

If an individual with special needs inherits a large sum of money while on government benefits, it could prove problematic. It might jeopardize their benefits or disqualify them from receiving additional government assistance. Setting up a Special Needs Trust for the individual can help prevent this.

Some other key benefits of a Special Needs Trust include:

  • Providing supplemental assistance for things that are needed but not covered under their government benefits
  • Ensuring that assets are used responsibly and for the benefit of the recipient
  • Helping protect the beneficiary’s assets should the beneficiary be involved in a lawsuit, as the funds are not subject to future creditors
  • May help supplement  the beneficiary’s needs even after your death, in the case of a Third-Party Special Needs Trust

What are the Disadvantages of a Special Needs Trust?

There are many things to consider when deciding whether to establish a Special Needs Trust for your loved one. Understanding and weighing all the pros and cons is crucial before utilizing any legal tool.

  • Some Special Needs Trusts must have a Medicaid payback provision to be completed upon the beneficiary’s death
  • The beneficiary must request any distributions from the trustee, which could result in a reduction in independence
  • There may be a minimum amount required to establish the account

When drafting your trust, it is essential to work with an attorney knowledgeable about Special Needs Trusts and estate planning. Alliance Trust Company of Nevada works with many trusted and capable lawyers that can help fulfill your requirements and get you established with the right person for your situation.

This article is for informational purposes only and should not be taken as legal or tax advice. Each individual’s legal and tax situation is unique and should be reviewed by licensed professionals. Laws and regulations are subject to change, and Alliance cannot be held responsible for reliance on the information contained herein.

NING Trusts for California

Many methods of income tax planning focus primarily on reducing federal tax liability. Individuals living in high state tax jurisdictions, such as California, also seek to mitigate state income tax. 

With some state income tax rates as high as 13.3%, it can be a significant burden for those with considerable income-generating assets. Establishing a NING trust may help reduce the state tax liability.

What is a NING Trust?

A Nevada Incomplete Non-Grantor Trust (sometimes referred to as a Nevada Incomplete Gift Non-Grantor Trust) is a type of self-settled trust. NINGs are drafted under Nevada law and thus receive the premier asset protections of Nevada. A NING is an irrevocable trust created for the grantor’s benefit and often their spouse and descendants. 

The NING structure is as follows:

  • The trust must appoint a Nevada resident trustee (often, this is a Nevada trust company).
  • The trust will have a distribution committee that includes the grantor and other beneficiaries; including two other members at all times. (Minor beneficiaries must have an appointed guardian-representatives on the committee.)
  • The gift must be incomplete for gift and estate tax purposes. The assets are considered part of the settlor’s estate and do not require filing a gift tax return. Additionally, the assets receive a step-up in basis upon the passing of the settlor. (See advantages below)
  • The transfer of assets to the trust is complete, for income tax purposes, meaning the trust is now the taxpayer.
  • Distributions back to the grantor by the distribution committee must not be considered gifts by the members. Instead, it is a return of property to the grantor. 
  • Gifts to others (not to the grantor) by the committee must be considered completed gifts from the grantor, not by committee members. 

Pros and Cons of a NING Trust 

While a NING Trust may help mitigate the effect of state income taxes, it is dependent on the assets transferred to the trust. Additionally, NINGs can provide various benefits, beyond state tax mitigation:

Benefits of a NING Trust:

  • Taxation: A Non-Grantor Trust is treated as a separate entity from the grantor and reports the income on a separate return. When a Non-Grantor Trust is established in a non-income-tax state, like Nevada, the trust will pay federal tax on the income, but not the state tax. Distributions made to a beneficiary are taxable to the beneficiary if their state of residence employs an income tax.  
  • Asset Protection: NINGs provide asset protection from creditor claims, between 6 months and 2 years after the trust is established, with certain exceptions related to fraudulent transfers.
  • Step-Up in Basis: Assets transferred to a NING trust are considered incomplete gifts, for estate tax purposes, providing a step-up in basis upon the grantor’s passing. It does not trigger filing a gift tax return at the time of funding of the trust.
  • Limited Power of Appointment: The grantor retains a limited power of appointment, permitting them to re-distribute the assets upon one’s death.

However, not all grantors, assets, or beneficiaries will be able to derive benefits from a NING Trust strategy.  

Disadvantages of a NING Trust:

  • Residents of New York will not benefit from a NING strategy. New York law declares that it will treat NING Trusts as a grantor trust, for state tax purposes.
  • Beneficiaries receiving distributions will be liable for the income tax on the gains in the year the distribution was received, in the state in which they are domiciled. 
  • California residents may be subject to a throwback income tax upon the distribution of accumulated income. See the California Throwback Tax consideration below for more information.

How are NING Trusts Taxed?

Ideal assets to contribute to a NING Trust may be intangible assets, such as an investment portfolio or assets intended to appreciate precipitously and may be sold in the future. Funding of the trust should generally come from the grantor’s surplus assets, where the grantor does not need the assets for their primary support. 

NINGs are not the best option for every scenario and require thoughtful planning and drafting. Most significant are the considerations related to state income accumulation and state throwback tax rules. 

California, for example, may subject accumulated income to a throwback tax, under certain circumstances. Check with your CPA and tax attorney for your state’s requirements.

  • Timing of Accumulation and Distribution: Where income has accumulated in the NING and is not subject to California tax in the year of accumulation, it may still be subject to California tax upon the later distribution:
  1. If the asset was subject to California tax in the year it was earned, the tax will be due upon distribution to a California non-contingent beneficiary. 

Example: Privately held stock transferred to the NING appreciates in the same year of transfer; it also sold in the same year, but California tax was not paid. California tax is due upon distribution.

  • California Throwback Tax: The rules are specific to the type of asset, date of accumulation, the timing of distribution, and residency of the non-contingent beneficiary.

1.  If the asset was not subject to California tax at the time of accumulation, but there was a California resident non-contingent beneficiary, upon distribution to such beneficiary, the throwback rules apply. The distribution will be taxed in the year of distribution based on if the distribution had been made ratably over the number of years preceding the actual year of distribution.

Example: Privately held stock transferred to the NING, appreciates in the following year, is then sold, and subsequently distributed to the California resident non-contingent beneficiary 4 years later; California income tax will be due as if the distribution had been included in the beneficiary’s income over the preceding four years.

2.  If the asset was not subject to California tax in the year of accumulation, and the non-contingent beneficiary is not a resident of California, then upon distribution, the distribution would not be subject to California tax.

Example: Privately held stock transferred to the NING, appreciated in subsequent years from the transfer date. The asset is then sold and later distributed to a non-California resident beneficiary; no tax should be due.

Note: If at any time in the preceding years the non-contingent beneficiary had been a California resident, examination of the residency rules must be addressed; throwback rules may still apply.

NING Trust Limitations

To be treated as a NING trust and avoid state income tax, by the grantor’s state of residence, it must be a non-grantor trust, also referred to as a complex trust. The IRS specifically delineates when a grantor will be treated as the “owner” of the trust, for income tax purposes. IRC sections 673-677 state how a grantor may be treated as the owner and would thus undermine the intent of a NING. 

Those circumstances are as follows:

1. The grantor shall be treated as the owner of any portion of a trust:

  • Reversionary Interest: in which s/he has a reversionary interest in either the corpus (principal) or income of the trust which exceeds 5 percent of the trust value. (see IRC 673)
  • Power to Control Beneficial Enjoyment: in which the beneficial enjoyment of the corpus (principal) or the income is subject to a power of disposition, exercisable by the grantor or a non-adverse party, or both, without the approval or consent of any adverse party. (see IRC 674)

2. Administrative Power: The grantor shall be treated as the owner of any portion of a trust if the trust allows for administrative control exercisable for the primary benefit of the grantor rather than for the other beneficiaries named in the trust. (see IRC 675) Including:

  • a power to vote or direct the voting of stock or other securities of a corporation in which the holdings of the grantor and the trust are significant from the viewpoint of voting control;
  • a power to control the investment of the trust funds either by directing investments or reinvestments or by vetoing proposed investments or reinvestments, to the extent that the trust funds consist of stocks or securities of corporations in which the holdings of the grantor and the trust are significant from the viewpoint of voting control; or
  • a power to reacquire the trust corpus by substituting other property of an equivalent value.

3. The grantor shall be treated as the owner of any portion of a trust:

  • Power to Revoke::Where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a non-adverse party, or both. (see IRC 676)
  • Income for Benefit of Grantor: Where the income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a non-adverse party, or both, may be distributed to the grantor, the grantor’s spouse, or applied to insurance premium payments on the life’s of or either of them. (see IRC 677)

In a related section, IRC 678 states that a person other than the grantor shall be treated as the owner of any portion of a trust if such person has the sole power to vest the corpus or the income in himself. Or such person has previously partially released or modified such power and then retains such control which would subject a grantor to treatment as the owner (within the principles of sections 671 to 677.) Meaning, that members of the distribution committee will not be treated as owners of the trust in such circumstances where none of the members have solely exercisable powers. (see PLR 201410002)

Why Choose Alliance Trust Company of Nevada?

Alliance has the benefit of Nevada’s favorable asset protection laws behind it, helping wealthy families from all across the globe. Please contact Alliance today if you believe a NING Trust could benefit your financial plan. 

Alliance has been in the trust industry since 2005, offering directed and delegated services on top of being a full fiduciary. In addition, we have relationships with many reputable lawyers, CPAs, and financial advisors that can help you finalize your documents and put your plans into motion.

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An often underutilized but valuable tool in estate planning is the Charitable Lead Trust.

Continue reading Charitable Lead Trusts: Types and Taxation

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We’re proud to highlight our team and show what makes us different than any other trust company you’ve ever seen. We Are Nevada.™

Continue reading Employee Spotlight: Shanna Coressel, Senior Trust Officer

Employee Spotlight: Natasha Davis, Executive Director of Client Development

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Alliance’s pride is in its people. Although the pandemic has shuttered many businesses and downsized others, Alliance Trust Company’s doors remain open, and the company continues to grow and expand. We’ve more than doubled our staff in the past three years to meet demand, investing in the best and brightest stars to add to our team.

We’re proud to highlight our team and show what makes us different than any other trust company you’ve ever seen. We Are Nevada.™

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Alliance administers many different kinds of Charitable Remainder Trusts. Learn more about how they are taxed differently than other types of trusts in this article.

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Estate Planning Tax Changes: What To Expect Under New Administration

Changes to Both Gift and Estate and Capital Gains Taxes expected under Biden’s administration

President Joe Biden presented reform strategies during his presidential campaign creating a prudent need for high net worth families to review their estate plans early in 2021. While campaigning, President Biden proposed several tax changes, with two of them significant estate planning tax changes.

The first is a premature reduction of the gift and estate tax exemption from the Tax Cuts and Jobs Act of 2017. The second is ending the step-up in tax basis for capital gains taxes on inherited property. Let’s take a look at both.

Continue reading Estate Planning Tax Changes: What To Expect Under New Administration

Part 2: Asset Protection and Nevada Asset Protection Trusts, Frequently Asked Questions

Examining Nevada Asset Protection Trusts: Common Questions Our Trust Officers Receive

In Part 2, we examine typical questions regarding Nevada Asset Protection Trusts. Nevada Asset Protection is sought after globally, and among the primary reasons estate planners look to Nevada as their preferred trust jurisdiction.

In part 1, we answered six general questions we often receive about Asset Protection Trusts in general.

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Part 1: Asset Protection and Nevada Asset Protection Trusts, Frequently Asked Questions

Six Common Questions Regarding Asset Protection Trusts

Part 1 focuses on general Asset Protection Trust questions we often receive from families and advisors. Part 2 focuses on Nevada Asset Protection Trusts.

Continue reading Part 1: Asset Protection and Nevada Asset Protection Trusts, Frequently Asked Questions

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