Wellesley, Massachusetts
Law Office of Lawrence G. Hoyle
Special Needs Trusts

 

A.    The Types of Special Needs Trusts and How to Create Them

 

1.      Introduction.Special needs trusts can be categorized as either “self-settled” or “third party” trusts.  A self-settled special needs trust is an irrevocable living trust created for the benefit of a disabled person and funded with the disabled person’s own property.  A third party special needs trust is a living trust created for the benefit of a disabled person and funded with property owned by someone other than the disabled person. 

 

2.      Creation.  All special needs trusts, with the exception of a pooled trust, require the person who is creating a trust and funding it (funding means transferring ownership of property into the trust) to execute a written trust instrument that includes terms and conditions necessary to comply with applicable law and regulations.  As with all living trusts, the trust instrument must include at least one Settlor, one Trustee, one Beneficiary, a valid purpose and sufficient terms to permit the administration of the trust.  Also required for the creation of a living trust is that the trust must own some property.  Consequently, in conjunction with the execution of a trust instrument, property is transferred into the name of the trust.  With regard to how a trust holds title to property, generally the ownership documents will include the name of the trust, the date it was created and the name of the Trustee.  Depending on the type of trust, the tax identification number used for the trust will either be the disabled person’s own social security number or a separate trust taxpayer identification number (EIN).  A pooled trust also has a written trust instrument, but it is a trust that has been created by a non-profit organization for the benefit of many disabled individuals. A person who wants to transfer property into a pooled trust transfers it to the Trustee of that trust and a separate account it created for the person’s benefit.

 

3.      Self-Settled Special Needs Trusts.  Self-settled special needs trusts must meet the requirements of 42 USC 1396(d)(4)(A) or (C) for Supplemental Security Income (SSI) eligibility purposes and 130 CMR 515.001 for MassHealth (Medicaid) eligibility purposes.  The provisions of 42 USC 1396(d)(4)(A) and (C) are set forth in subparagraph (c) below.  The pertinent section of the Federal Program Operations Manual is set forth in subparagraph (d) below.  The provisions of 130 CMR 515.001 are set forth in subparagraph (e) below.

 

The primary purpose of a self-settled special needs trust is to exclude the trust assets from being considered as countable assets for both SSI and MassHealth purposes.  Other purposes are to provide for the management of the disabled person’s assets by a trustee who can handle investment decisions; determine when and for what purposes distributions of income or principal should be made to or for the benefit of the disabled person; to the extent possible, avoid the necessity of conservatorship proceedings for the disabled person with respect to the trust property; and to avoid the necessity of probate court proceedings upon the death of the disabled person with respect to the trust property.

 

A special needs trust permits the assets and the income earned on the assets to be used for the benefit of the disabled person as a supplement to his or her SSI and/or MassHealth benefits, instead of having to spend down the assets to $2,000 in order to maintain eligibility.  A trust that meets the requirements of 1396(d)(4)(A) and also the 515.001 definition of a special needs trust is referred to as a “Special Needs Trust.”  A trust that meets the requirements of 1396(d)(4)(C) and also the 515.001 definition of a pooled trust is referred to as a “Pooled Trust.”

 

a.      Special Needs Trust.  A Special Needs Trust can only be created for a disabled person who is under the age of 65.  The person cannot create the trust for himself or herself, although it must be funded with the disabled person’s own assets.  Assets of a disabled person may include inherited assets, gifted assets, funds received as a result of a lawsuit or other sources.  The class of persons or entities who can create a Special Needs Trust for a disabled person are: a parent, a grandparent, a legal guardian or a court.  The trust must be irrevocable; the trustee must be someone (a person or an entity such as a bank or trust company) other than the disabled person; and the trust must provide that upon the death of the disabled person, after payment of taxes and permitted expenses, the remaining assets must be used to reimburse the state or states where the person resided for any MassHealth (Medicaid) benefits paid for the disabled person before any distributions can be made to anyone else.

 

 

b.      Pooled Trust.  A Pooled Trust must be created by a nonprofit organization for the benefit of many disabled persons.  Assets contributed to the trust can be commingled for purposes of investment, but each person must have a separate account.  An account can be created with a Pooled Trust for the benefit a disabled person at any age.  There is no requirement that a Pooled Trust account be created prior to age 65.  The account must be funded with the disabled person’s own assets.  The class of persons or entities who can set up an account with a Pooled Trust for a disabled person are: the disabled person himself or herself, a parent, a grandparent, a legal guardian or a court.  The Pooled Trust must be irrevocable and provide that upon the death of the disabled person, after payment of taxes and permitted expenses, the remaining balance in the deceased disabled person’s account must be used to reimburse the state or states where the person resided for any MassHealth (Medicaid) benefits paid for the disabled person.  If assets remain after the reimbursements, the trust can provide for them to go to one or more beneficiaries.

 

c.       Federal Law

 

Exception for assets held in a special needs trust from being considered countable for SSI eligibility purposes

 

Social Security Act, 42 USC 1396(d)(4)(A) and (C):

 

                (4) This subsection shall not apply to any of the following trusts:

(A)  A trust containing the assets of an individual under age 65 who is

disabled (as defined in section 1382c (a)(3) of this title) and which is established for the benefit of such individual by a parent, grandparent, legal guardian of the individual, or a court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual under a State plan under this subchapter.

 

(C)  A trust containing the assets of an individual who is disabled (as

defined in section 1382c (a)(3)of this title) that meets the following conditions :

(i)                 The trust is established and managed by a non-profit

association.

(ii)               A separate account is maintained for each beneficiary of the trust, but, for purposes of investment and management of funds, the trust pools these accounts.

(iii)             Accounts in the trust are established solely for the benefit of individuals who are disabled (as defined in section 1382c (a)(3)of this title) by the parent, grandparent, or legal guardian of such individuals, by such individuals, or by a court.

(iv)             To the extent that amounts remaining in the beneficiary’s

account upon the death of the beneficiary are not retained by the trust, the trust pays to the State from such remaining amounts in the account an amount equal to the total amount of medical assistance paid on behalf of the beneficiary under the State plan under this subchapter.

 

d.      Federal Programs Operations Manual System (POMS)

 

SI 01120.203 Exceptions to Counting Trusts Established on or after 1/1/00:

A.    Introduction To Medicaid Trust Exceptions

We refer to the exceptions discussed in this section as Medicaid trust exceptions because sections 1917(d)(4)(A) and (C) of the Social Security Act (the Act) (42 U.S.C. § 1396p (d)(4)(A) and (C)) set forth exceptions to the general rule of counting trusts as income and resources for the purposes of Medicaid eligibility and can be found in the Medicaid provisions of the Act. While these exceptions are also Supplemental Security Income (SSI) exceptions, we refer to them as Medicaid trust exceptions to distinguish them from other exceptions to counting trusts provided in the SSI law (e.g., undue hardship) and because the term has become a term of common usage. Development and evaluation of Medicaid trust exceptions are based on the type of trust under review. There are two types of Medicaid trusts to consider:

·         Special Needs Trusts

·         Pooled Trusts

B.Policy For Exception To Counting Medicaid Trusts

1.Special needs trusts established under Section 1917(d)(4)(A) of the Act

a.General rules for special needs trusts

NOTE: Although this exception is commonly referred to as the special needs trust exception, the exception applies to any trust meeting the following requirements and does not have to be a strict special needs trust.

The resource counting provisions of Section 1613(e) do not apply to a trust:

·         Which contains the assets of an individual under age 65 and who is disabled; and

·         Which is established for the benefit of such individual through the actions of a parent, grandparent, legal guardian or a court; and

·         Which provides that the State(s) will receive all amounts remaining in the trust upon the death of the individual up to an amount equal to the total medical assistance paid on behalf of the individual under a State Medicaid plan.

CAUTION: A trust which meets the exception to counting the trust under the SSI statutory trust provisions of Section 1613(e) must still be evaluated under the instructions in SI 01120.200, to determine if it is a countable resource. If the trust meets the definition of a resource (SI 01110.100B.1.), it would will be subject to regular resource-counting rules.

b.Under age 65

To qualify for the special needs trust exception, the trust must be established for the benefit of a disabled individual under age 65. This exception does not apply to a trust established for the benefit of an individual age 65 or older. If the trust was established for the benefit of a disabled individual prior to the date the individual attained age 65, the exception continues to apply after the individual reaches age 65.

c.Additions to trust after age 65

Additions to or augmentation of a trust after age 65 (except as outlined below) are not subject to this exception. Such additions may be income in the month added to the trust, depending on the source of the funds (see SI 01120.201J) and may be counted as resources in the following months under regular SSI trust rules. Additions or augmentation do not include interest, dividends or other earnings of the trust or portion of the trust meeting the special needs trust exception. If the trust contains the irrevocable assignment of the right to receive payments from an annuity or support payments made when the trust beneficiary was less than 65 years of age, annuity or support payments paid to a special needs trust are treated the same as payments made before the individual attained age 65 and do not disqualify the trust from the special needs trust exception.

                             d.Disabled

To qualify for the special needs trust exception, the individual whose assets were used to establish the trust must be disabled for SSI purposes under section 1614(a)(3) of the Act.

e.Established for the benefit of the individual

Under the special needs trust exception, the trust must be established for and used for the benefit of the disabled individual. SSA has interpreted this provision to require that the trust be for the sole benefit of the individual, as described in SI 01120.201F.2.Other than trust provisions for payments described in SI 01120.201F.2.b.and SI 01120.201F.2.c., any provisions that:

·         provide benefits to other individuals or entities during the disabled individual's lifetime, or

·         allow for termination of the trust prior to the individual's death and payment of the corpus to another individual or entity (other than the State(s) or another creditor for payment for goods or services provided to the individual), will result in disqualification for the special needs trust exception. Payments to third parties for goods and services provided to the trust beneficiary are allowed under the policy described in SI 01120.201F.2.b.; however, such payments should be evaluated under SI 01120.200Ethrough SI 01120.200Fand SI 01120.201Ito determine whether the payments may be income to the individual.

f.Who established the trust

The special needs trust exception does not apply to a trust established through the actions of the disabled individual himself or herself. To qualify for the special needs trust exception, the assets of the disabled individual must be put into a trust established through the actions of the disabled individual's:

·         parent(s);

·         grandparent(s);

·         legal guardian(s); or

·         a court.

In the case of a legally competent, disabled adult, a parent or grandparent may establish a “seed” trust using a nominal amount of his or her own money, or if State law allows, an empty or dry trust. After the seed trust is established, the legally competent disabled adult may transfer his or her own assets to the trust or another individual with legal authority (e.g., power of attorney) may transfer the individual's assets into the trust. In the case of a trust established through the actions of a court, the creation of the trust must be required by a court order. Approval of a trust by a court is not sufficient.

NOTE:Under 1613(e) of the Act, a trust is considered to have been “established by” an individual if any of the individual's (or the individual's spouse) assets are transferred to the trust other by will. Alternatively, under the Medicaid trust exceptions in 1917(d)(4)(A) and (C) of the Act, a trust can be “established by” an individual who does not provide the corpus of the trust, or transfer any of his/her assets to the trust, but rather someone who took action to establish the trust. To avoid confusion, we use the phrase “established through the actions of” rather than “established by” when referring to the individual who physically took action to establish a special needs or pooled trust.

g.Legal authority and trusts

The person establishing the trust with the assets of the individual or transferring the assets of the individual to the trust must have legal authority to act with respect to the assets of that individual. Attempting to establish a trust with the assets of another individual without proper legal authority to act with respect to the assets of the individual will generally result in an invalid trust.

For example, a parent establishing a seed trust for his adult child with his or her own assets has legal authority over his own assets to establish a trust. He or she only needs legal authority over his child's assets if he or she actually takes action with the child's assets, e.g., transfers them to a previously established trust. A power of attorney (POA) is legal authority to act with respect to the assets of a disabled individual. However, a trust established under a POA will result in a trust we consider to be established through the actions of the disabled individual himself or herself because the POA merely establishes an agency relationship.

                             h.State Medicaid reimbursement requirement

To qualify for the special needs trust exception, the trust must contain specific language that provides that upon the death of the individual, the State(s) will receive all amounts remaining in the trust, up to an amount equal to the total amount of medical assistance paid on behalf of the individual under the State Medicaid plan(s). The State(s) must be listed as the first payee and have priority over payment of other debts and administrative expenses except as listed in SI 01120.203B.3.a. The trust must provide payback for any State(s) that may have provided medical assistance under the State Medicaid plan(s) and not be limited to any particular State(s). Medicaid payback may also not be limited to any particular period of time, i.e. payback cannot be limited to the period after establishment of the trust.

NOTE: Labeling the trust as a Medicaid pay-back trust, OBRA 1993 pay-back trust, trust established in accordance with 42 U.S.C. § 1396p, or as an MQT, etc. is not sufficient to meet the requirements for this exception. The trust must contain language substantially similar to the language above. An oral trust cannot meet this requirement.

                        2.Pooled trusts established under Section 1917(d)(4)(C) of the Act

a.General rules for pooled trusts

A pooled trust is a trust established and administered by an organization. It is sometimes called a “master trust” because it contains the assets of many different individuals, each in separate accounts established through the actions of individuals, and each with a beneficiary. By analogy, the pooled trust is like a bank that holds the assets of individual account holders. Whenever you are evaluating the trust, it is important to distinguish between the master trust, which is established through the actions of the nonprofit association, and the individual trust accounts within the master trust, which are established through the actions of the individual or another person for the individual.

The provisions of the SSI trust statute do not apply to a trust containing the assets of a disabled individual which meets the following conditions:

·         The pooled trust is established and maintained by a nonprofit association;

·         Separate accountsare maintained for each beneficiary, but assets are pooled for investing and management purposes;

·         Accounts are established solely for the benefit of the disabled individuals;

·         The account in the trust is established through the actions of the individual, a parent, grandparent, legal guardian, or a court; and

·         The trust provides that to the extent any amounts remaining in the beneficiary's account upon the death of the beneficiary are not retained by the trust, the trust will pay to the State(s) the amount remaining up to an amount equal to the total amount of medical assistance paid on behalf of the beneficiary under State Medicaid plan(s).

NOTE: There is no age restriction under this exception. However, a transfer of resources to a trust for an individual age 65 or over may result in a transfer penalty (see SI 01150.121).

CAUTION: A trust which meets the exception to counting the trust under the SSI statutory trust provisions of 1613(e) must still be evaluated under the instructions in SI 01120.200 to determine if it is a countable resource.

b.Disabled

Under the pooled trust exception, the individual whose assets were used to establish the trust account must meet the definition of disabled for purposes of the SSI program.

c.Nonprofit association

The pooled trust must be established through the actions of a nonprofit association. For purposes of the pooled trust exception, a nonprofit association is an organization established and certified under a State nonprofit statute. (For development, see SI 01120.203F).

d.Separate account

A separate account within the trust must be maintained for each beneficiary of the pooled trust, but for purposes of investment and management of funds, the trust may pool the funds in the individual accounts. The trust must be able to provide an individual accounting for the individual.

e.Established for the sole benefit of the individual

Under the pooled trust exception, the individual trust account must be established for the sole benefit of the disabled individual. (For a definition of sole benefit, see SI 01120.201F.2). Other than the payments described in SI 01120.201F.2.b.and SI 01120.201F.2.c., this exception does not apply if the trust account:

·         provides a benefit to any other individual or entity during the disabled individual's lifetime, or

·         allows for termination of the trust account prior to the individual's death and payment of the corpus to another individual or entity

                             f.Who established the trust account

In order to qualify for the pooled trust exception, the trust account must have been established through the actions of the disabled individual himself or herself or through the actions of the disabled individual's:

·         parent(s);

·         grandparent(s);

·         legal guardian(s); or

·         a court.

A legally competent, disabled adult who is establishing or adding to a trust account with his or her own funds has the legal authority to act on his or her own behalf. A third party establishing a trust account on behalf of another individual with that individual's assets must have legal authority to act with regard to the assets of the individual. An attempt to establish a trust account by a third party with the assets of an individual without the legal right or authority to act with respect to the assets of that individual will generally result in an invalid trust. In the case of a trust established through the actions of a court, the creation of the trust must be required by a court order. Approval of a trust by a court is not sufficient.

                                    g.State Medicaid reimbursement provision

To qualify for the pooled trust exception, the trust must contain specific language that provides that, to the extent that amounts remaining in the individual's account upon the death of the individual are not retained by the trust, the trust pays to the State(s) from such remaining amounts in the account an amount equal to the total amount of medical assistance paid on behalf of the individual under the State Medicaid plan(s). To the extent that the trust does not retain the funds in the account, the State(s) must be listed as the first payee(s) and have priority over payment of other debts and administrative expenses except as listed in SI 01120.203B.3.a. The trust must provide payback for any State(s) that may have provided medical assistance under the State Medicaid plan(s) and not be limited to any particular State(s). Medicaid payback may also not be limited to any particular period of time, i.e., payback cannot be limited to the period after establishment of the trust.

NOTE: Labeling the trust as a Medicaid pay-back trust, OBRA 1993 pay-back trust, trust established in accordance with 42 U.S.C. § 1396p, or as an MQT, etc. is not sufficient to meet the requirements for this exception. The trust must contain language substantially similar to the language above. An oral trust cannot meet this requirement.

3.Allowable and prohibited expenses

The following instructions about trust expenses and payments apply to Medicaid special needs trusts and to Medicaid pooled trusts.

a.       Allowable administrative expenses

Upon the death of the trust beneficiary, the following types of administrative expenses may be paid from the trust prior to reimbursement of medical assistance to the State(s):

·         Taxes due from the trust to the State(s) or Federal government because of the death of the beneficiary;

·         Reasonable fees for administration of the trust estate such as an accounting of the trust to a court, completion and filing of documents, or other required actions associated with termination and wrapping up of the trust.

b.      Prohibited expenses and payments

Upon the death of the trust beneficiary, the following expenses and payments are examples of some of the types not permitted prior to reimbursement of the State(s) for medical assistance:

·         Taxes due from the estate of the beneficiary other than those arising from inclusion of the trust in the estate;

·         Inheritance taxes due for residual beneficiaries;

·         Payment of debts owed to third parties;

·         Funeral expenses; and

·         Payments to residual beneficiaries.

NOTE:For the purpose of prohibiting payments prior to reimbursement of medical assistance to the State(s), a pooled trust is not considered a residual beneficiary.

c.       Applicability

This restriction on payments from the trust applies upon the death of the beneficiary. Payments of fees and administrative expenses during the life of the beneficiary are allowable as permitted by the trust document and are not affected by the State Medicaid reimbursement requirement.

 

 

e.       Massachusetts Regulations

 

Definitions pertaining to special needs trusts from 130 CMR 515.001:

 

Disability Determination Unit– a unit that consists of physicians and disability evaluators who determine permanent and total disability using criteria established by the Social Security Administration under Title XVI, and criteria established under state law. This unit may be a part of a state agency or under contract with a state agency.

 

Permanent and Total Disability– a disability as defined under Title XVI of the Social Security Act or under applicable state laws.

(1) For Adults and 18-Year-Olds.

(a) The condition of an individual, aged 18 or older, who is unable to  

engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that

(i) can be expected to result in death; or

(ii) has lasted or can be expected to last for a continuous period of  

not less than 12 months.

(b) For purposes of 130 CMR 515.001: Permanent and Total Disability, an

Individual aged 18 or older is determined to be disabled only if his or her physical or mental impairments are of such severity that the individual is not only unable to do his or her previous work, but cannot, considering age, education, and work experience, engage in

any other kind of substantial gainful work that exists in the national economy, regardless of whether such work exists in the immediate area in which the individual lives, whether a specific job vacancy exists, or whether the individual would be hired if he or she applied for work. "Work that exists in the national economy" means work that exists in significant numbers, either in the region where such an individual lives or in several regions of the country.

(2) For Children Under Age 18.

The condition of an individual under the age of 18 who has any medically determinable physical or mental impairment, or combination of impairments, that causes marked and severe functional limitations, as defined in Title XVI of the Social Security Act, and can be expected to cause death or can be expected to last for a continuous period of not less than 12 months. Disability for children eligible for MassHealth CommonHealth under 130 CMR 519.012(B) is determined in accordance with the definition for permanent and total disability for children under the age of 18 in 130 CMR 501.001.

 

Pooled Trust– a trust that meets all the following criteria as determined by the MassHealth agency.

(1) The trust was created by a nonprofit organization.

(2) A separate account is maintained for each beneficiary of the trust, but the  assets of the trust are pooled for investment and management purposes.

(3) The account in a pooled trust was created for the sole benefit of the Individual by the individual, the individual's parents or grandparents, or by a legal guardian or court acting on behalf of the individual.

(4) The trust provides that the Commonwealth of Massachusetts will receive amounts remaining in the account upon the death of the individual up to the   amount paid by the MassHealth agency for services to the individual. The trust may retain reasonable and appropriate amounts as determined by the MassHealth agency.

(5) The individual was disabled at the time his or her account in the pool was created.

 

Special-Needs Trust– a special-needs trust is one that meets all the following criteria as determined by the MassHealth agency.

(1) The trust was created for a disabled individual under the age of 65.

(2) The trust was created for the sole benefit of the individual by the individual's parent, grandparent, legal guardian, or a court.

(3) The trust provides that the Commonwealth of Massachusetts will receive amounts remaining in the account upon the death of the individual up to the amount paid by the MassHealth agency for services to the individual.

(4) When the member has lived in more than one state, the trust must provide that the funds remaining upon the death of the member are distributed to each   state in which the member received Medicaid based on each state’s proportionate share of the total amount of Medicaid benefits paid by all states on the member’s behalf.

 

Supplemental Security Income (SSI) Program– a program that provides financial assistance to needy persons who are aged 65 or older, blind, or disabled. This program is established under Title XVI of the Social Security Act and is administered by the Social Security Administration. Such persons automatically receive MassHealth.

 

4.      Third Party Special Needs Trusts.  A third party special needs trust is not subject to the limitations of the regulations described above for self-settled special needs trusts.  The purposes of a third party trust include preserving assets to be given or devised to a disabled person from having to be spent down to maintain SSI and MassHealth eligibility; protecting assets from creditors of a disabled person; protecting assets from individuals who might otherwise try to take advantage of the disabled person financially; providingfor the management of the disabled person’s gifted or devised assets by a trustee who can handle investment decisions anddetermine when and for what purposes distributions of income or principal should be made to or for the benefit of the disabled person;and preventingthe necessity of conservatorship proceedings during lifetime or probate proceedings upon death to manage and distribute the gifted or devised assets.

 

When a person (the “Settlor”) decides to create and fund a trust for a disabled person with the Settlor’s own assets, the Settlor can put any restrictions on the use and disposition of income and principal that he or she desires.  Those restrictions can include mandatory or non-binding directions to the Trustee not to make distributions to a disabled beneficiary that would reduce or eliminate the beneficiary’s eligibility for government programs based on need, such as SSI, MassHealth (Medicaid) or housing.  While it is not required to include these specific restrictions in the third party trust, it is important for this type of trust to include a provision making distributions to or for the benefit of the disabled person fully discretionary as determined by the Trustee.  Terms such as “health, education, maintenance and support” should not be used.

 

The Trustee can be anyone other than the disabled person. If the trust is revocable by the Settlor, the disabled person should not become a vested beneficiary under the terms of the trust until after the Settlor’s death, which is when the trust becomes irrevocable.  While it may be preferable not to name the disabled person as a current non-vested beneficiary of a revocable during the Settlor’s lifetime, it is alright to do so.  It would be prudent to include a clause stating that the Trustee of the revocable trust is prohibited from making distributions to any beneficiary that would reduce or eliminate that beneficiary’s eligibility for government benefits based on need.  If a third party trust is to be funded (gifted) and used solely for the benefit of the disabled person during the Settlor’s lifetime, the trust should be irrevocable.

 

 

 

B.     Taxation of Special Needs Trusts

 

1.      Self-Settled Special Needs Trusts and Pooled Trusts.  Self-settled special needs trusts and pooled trusts (with respect to each individual account), are treated as “grantor” trusts for federal and Massachusetts income tax purposes.  Internal Revenue Code Section 677(a) provides that one of the retained interests that results in grantor trust status is funding a trust with a person’s own property and retaining the right to receive distributions of income without the consent of an “adverse” party.  There may be other retained powers in the trust instrument that would result in grantor trust status under IRC Sections 672 through 677.  A grantor trust is a disregarded entity for income tax purposes, IRC Section 671. 

 

The grantor’s social security number may be used as the tax id number for the special needs trust during that person’s lifetime.  Items of income, gain, loss, deduction or credit are reported directly on the federal and state individual income tax returns of the disabled person.  However, if a separate tax id number is obtained for a grantor trust, then an annual IRS Form 1041 and annual Massachusetts Form 2G are filed for information purposes only.

 

Internal Revenue Code Section 671 is set forth in Subparagraph a below. Internal Revenue Code Section 677 is set forth in Subparagraph b below. The portion of the Instructions to IRS Form 1041 relating to tax reporting methods for a grantor trust are set forth in Subparagraph c below.

 

2014 IRS Form 1041 can found at http://www.irs.gov/pub/irs-pdf/f1041.pdf.  The complete instructions to the form can be found at http://www.irs.gov/instructions/i1041.   2014 Massachusetts Forms 2-G; 2; 2 K-1, IDD and instructions can be found at http://www.mass.gov/dor/forms/fiduciary-and-partnership-tax-forms/2014/form-2-fiduciary-tax-form-and-schedules.

 

See Section E below of sample filled in forms of IRS Form 1041 with grantor trust attachment and DOR Form 2G.

 

a.      Internal Revenue Code Section 671. Trust Income, Deductions, and Credits Attributable to Grantors and Others As Substantial Owners.

Where it is specified in this subpart that the grantor or another person shall be treated as the owner of any portion of a trust, there shall then be included in computing the taxable income and credits of the grantor or the other person those items of income, deductions, and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account under this chapter in computing taxable income or credits against the tax of an individual. Any remaining portion of the trust shall be subject to subparts A through D. No items of a trust shall be included in computing the taxable income and credits of the grantor or of any other person solely on the grounds of his dominion and control over the trust under section 61 (relating to definition of gross income) or any other provision of this title, except as specified in this subpart.

 

b.      Internal Revenue Code Section 677Income For Benefit of Grantor.

                677(a) General Rule.—

The grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under section 674, whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be—

                677(a)(1)  

                distributed to the grantor or the grantor's spouse;

               677(a)(2) 

held or accumulated for future distribution to the grantor or the grantor's spouse; or

                677(a)(3) 

applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor's spouse (except policies of insurance irrevocably payable for a purpose specified in section 170(c) (relating to definition of charitable contributions)).

This subsection shall not apply to a power the exercise of which can only affect the beneficial enjoyment of the income for a period commencing after the occurrence of an event such that the grantor would not be treated as the owner under section 673 if the power were a reversionary interest; but the grantor may be treated as the owner after the occurrence of the event unless the power is relinquished.

 

c.       IRS Instructions for Form 1041.  The following is the portion of the 2014 IRS Form 1041 instructions that relate to tax reporting for grantor trusts.

                       Grantor Type Trusts

A trust is a grantor trust if the grantor retains certain powers or ownership benefits. This can also apply to only a portion of a trust. See Grantor Type Trust, later, for details on what makes a trust a grantor trust.

In general, a grantor trust is ignored for income tax purposes and all of the income, deductions, etc., are treated as belonging directly to the grantor. This also applies to any portion of a trust that is treated as a grantor trust.

                        Note.

If only a portion of the trust is a grantor type trust, indicate both grantor trust and the other type of trust, for example, simple or complex trust, as the type of entities checked in Section A on page 1 of Form 1041.

The following instructions apply only to grantor type trusts that are not using an optional filing method.

How to report.  If the entire trust is a grantor trust, fill in only the entity information of Form 1041. Do not show any dollar amounts on the form itself; show dollar amounts only on an attachment to the form. Do not use Schedule K-1 (Form 1041) as the attachment.

If only part of the trust is a grantor type trust, the portion of the income, deductions, etc., that is allocable to the non-grantor part of the trust is reported on Form 1041, under normal reporting rules. The amounts that are allocable directly to the grantor are shown only on an attachment to the form. Do not use Schedule K-1 (Form 1041) as the attachment. However, Schedule K-1 is used to reflect any income distributed from the portion of the trust that is not taxable directly to the grantor or owner.

The fiduciary must give the grantor (owner) of the trust a copy of the attachment.

                        Attachment.

                                On the attachment, show:

·         The name, identifying number, and address of the person(s) to whom the income is taxable;

·         The income of the trust that is taxable to the grantor or another person under sections 671 through 678. Report the income in the same detail as it would be reported on the grantor's return had it been received directly by the grantor; and

·         Any deductions or credits that apply to this income. Report these deductions and credits in the same detail as they would be reported on the grantor's return had they been received directly by the grantor.

The income taxable to the grantor or another person under sections 671 through 678 and the deductions and credits that apply to that income must be reported by that person on their own income tax return.

                                 Example.

The John Doe Trust is a grantor type trust. During the year, the trust sold 100 shares of ABC stock for $1,010 in which it had a basis of $10 and 200 shares of XYZ stock for $10 in which it had a $1,020 basis.

The trust does not report these transactions on Form 1041. Instead, a schedule is attached to the Form 1041 showing each stock transaction separately and in the same detail as John Doe (grantor and owner) will need to report these transactions on his Form 8949, Sales and Other Dispositions of Capital Assets and Schedule D (Form 1040). The trust does not net the capital gains and losses, nor does it issue John Doe a Schedule K-1 (Form 1041) showing a $10 long-term capital loss.

                        Optional Filing Methods for Certain Grantor Type Trusts

Generally, if a trust is treated as owned by one grantor or other person, the trustee may choose Optional Method 1 or Optional Method 2 as the trust's method of reporting instead of filing Form 1041. A husband and wife will be treated as one grantor for purposes of these two optional methods if:

·         All of the trust is treated as owned by the husband and wife, and

·         The husband and wife file their income tax return jointly for that tax year.

Generally, if a trust is treated as owned by two or more grantors or other persons, the trustee may choose Optional Method 3 as the trust's method of reporting instead of filing Form 1041.

Once you choose the trust's filing method, you must follow the rules under Changing filing methods if you want to change to another method.

Exceptions.  The following trusts cannot report using the optional filing methods.

·         A common trust fund (as defined in section 584(a)).

·         A foreign trust or a trust that has any of its assets located outside the United States.

·         A qualified subchapter S trust (as defined in section 1361(d)(3)).

·         A trust all of which is treated as owned by one grantor or one other person whose tax year is other than a calendar year.

·         A trust all of which is treated as owned by one or more grantors or other persons, one of which is not a U.S. person.

·         A trust all of which is treated as owned by one or more grantors or other persons if at least one grantor or other person is an exempt recipient for information reporting purposes, unless at least one grantor or other person is not an exempt recipient and the trustee reports without treating any of the grantors or other persons as exempt recipients.

Optional Method 1.  For a trust treated as owned by one grantor or by one other person, the trustee must give all payers of income during the tax year the name and TIN of the grantor or other person treated as the owner of the trust and the address of the trust. This method may be used only if the owner of the trust provides the trustee with a signed Form W-9, Request for Taxpayer Identification Number and Certification. In addition, unless the grantor or other person treated as owner of the trust is the trustee or a co-trustee of the trust, the trustee must give the grantor or other person treated as owner of the trust a statement that:

·         Shows all items of income, deduction, and credit of the trust;

·         Identifies the payer of each item of income;

·         Explains how the grantor or other person treated as owner of the trust takes those items into account when figuring the grantor's or other person's taxable income or tax; and

·         Informs the grantor or other person treated as the owner of the trust that those items must be included when figuring taxable income and credits on his or her income tax return.

Grantor trusts that have not applied for an EIN and are going to file under Optional Method 1 do not need an EIN for the trust as long as they continue to report under that method.

Optional Method 2.  For a trust treated as owned by one grantor or by one other person, the trustee must give all payers of income during the tax year the name, address, and TIN of the trust. The trustee also must file with the IRS the appropriate Forms 1099 to report the income or gross proceeds paid to the trust during the tax year that shows the trust as the payer and the grantor, or other person treated as owner, as the payee. The trustee must report each type of income in the aggregate and each item of gross proceeds separately. The due date for any Forms 1099 required to be filed with the IRS by a trustee under this method is March 2, 2015 (March 31, 2015, if filed electronically).

In addition, unless the grantor, or other person treated as owner of the trust, is the trustee or a co-trustee of the trust, the trustee must give the grantor or other person treated as owner of the trust a statement that:

·         Shows all items of income, deduction, and credit of the trust;

·         Explains how the grantor or other person treated as owner of the trust takes those items into account when figuring the grantor's or other person's taxable income or tax; and

·         Informs the grantor or other person treated as the owner of the trust that those items must be included when figuring taxable income and credits on his or her income tax return. This statement satisfies the requirement to give the recipient copies of the Forms 1099 filed by the trustee.

Optional Method 3.  For a trust treated as owned by two or more grantors or other persons, the trustee must give all payers of income during the tax year the name, address, and TIN of the trust. The trustee also must file with the IRS the appropriate Forms 1099 to report the income or gross proceeds paid to the trust by all payers during the tax year attributable to the part of the trust treated as owned by each grantor, or other person, showing the trust as the payer and each grantor, or other person treated as owner of the trust, as the payee. The trustee must report each type of income in the aggregate and each item of gross proceeds separately. The due date for any Forms 1099 required to be filed with the IRS by a trustee under this method is March 2, 2015 (March 31, 2015, if filed electronically).

In addition, the trustee must give each grantor or other person treated as owner of the trust a statement that:

·         Shows all items of income, deduction, and credit of the trust attributable to the part of the trust treated as owned by the grantor or other person;

·         Explains how the grantor or other person treated as owner of the trust takes those items into account when figuring the grantor's or other person's taxable income or tax; and

·         Informs the grantor or other person treated as the owner of the trust that those items must be included when figuring taxable income and credits on his or her income tax return. This statement satisfies the requirement to give the recipient copies of the Forms 1099 filed by the trustee.

Changing filing methods.  A trustee who previously had filed Form 1041 can change to one of the optional methods by filing a final Form 1041 for the tax year that immediately precedes the first tax year for which the trustee elects to report under one of the optional methods. On the front of the final Form 1041, the trustee must write “Pursuant to section 1.671-4(g), this is the final Form 1041 for this grantor trust,” and check the Final return box in item F.

For more details on changing reporting methods, including changes from one optional method to another, see Regulations section 1.671-4(g).

Backup withholding.  The following grantor trusts are treated as payors for purposes of backup withholding.

1.      A trust established after 1995, all of which is owned by two or more grantors (treating spouses filing a joint return as one grantor).

2.      A trust with 10 or more grantors established after 1983 but before 1996.

The trustee must withhold a certain percentage of reportable payments made to any grantor who is subject to backup withholding.

                        For more information, see section 3406 and its regulations.

                               Pooled Income Funds

If you are filing for a pooled income fund, attach a statement to support the following:

·         The calculation of the yearly rate of return,

·         The computation of the deduction for distributions to the beneficiaries, and

·         The computation of any charitable deduction.

See section 642 and the regulations thereunder for more information.

You do not have to complete Schedules A or B of Form 1041.

Also, you must file Form 5227, Split-Interest Trust Information Return, for the pooled income fund. However, if all amounts were transferred in trust before May 27, 1969, or if an amount was transferred to the trust after May 26, 1969, for which no deduction was allowed under any of the sections listed under section 4947(a)(2), then Form 5227 does not have to be filed.

Note.  Form 1041-A is no longer filed by pooled income funds.

2.      Third Party Special Needs Trust.  A third party special needs trust should be characterized as a “complex” trust for federal and state income tax purposes pursuant to IRC Section 661 and the U.S. Treasury Regulations promulgated thereunder.  A complex trust is a trust where income and principal may be distributed to the beneficiary at the discretion of the Trustee.  A complex trust files an annual federal fiduciary income tax return, Form 1041, along with a Schedule K-1 if distributions are made during the tax year.  The corresponding annual Massachusetts fiduciary income tax return is a Form 2, along with a Schedule 2K-1 and a Schedule IDD.  Sample filled in forms are included in Section E below.  

 

To the extent that the Trustee actually makes distributions during each year to the disabled person or pays expenses of the disabled person, the taxable income of the trust is passed on to the beneficiary to be reported on his or her own federal and state income tax returns.  The Schedule K-1 and 2K-1 each provide the beneficiary with the information he or she needs to complete his or her own individual federal and state income tax returns.  The trust gets a deduction for those distributions, knows as a “distributable net income” deduction.  If any taxable income remains, the trust pays the income taxes on that income.  The trust also pays the income taxes on capital gain income.

 

If possible, it is usually better for income tax purposes to have the trust income taxed to the beneficiary instead of to the trust, because a complex trust has  compressed marginal federal income tax brackets.  The following charts are a comparison of trust versus individual income tax brackets for 2014 and 2015 tax years.

 

 

 Non-Grantor Trusts (i.e. simple and complex trusts)

 

2014


Taxable Income

           

of the

Over

But Not Over

 

Pay

+

% on Excess

 

Amount over—


$0—

$2,500

 

$0

   

15%

 

$0

2,500—

5,800

 

375.00

   

25

 

2,500

5,800—

8,900

 

1,200.00

   

28

 

5,800

8,900—

12,150

 

2,068.00

   

33

 

8,900

12,150—

 

 

3,140.50

   

39.6

 

12,150

 

 

2015


Taxable Income

           

of the

Over

But Not Over

 

Pay

+

% on Excess

 

Amount over—


$0—

$2,500

 

$0

   

15%

 

$0

2,500—

5,900

 

375.00

   

25

 

2,500

5,900—

9,050

 

1,225.00

   

28

 

5,900

9,050—

12,300

 

2,107.00

   

33

 

9,050

12,300—

 

 

3,179.50

   

39.6

 

12,300

 

 

 

Single Individuals

 

2014


Taxable Income

           

of the

Over

But Not Over

 

Pay

+

% on Excess

 

Amount over—


$0—

$9,075

 

$0

   

10%

 

$0

9,075—

36,900

 

907.50

   

15

 

9,075

36,900—

89,350

 

5,081.25

   

25

 

36,900

89,350—

186,350

 

18,193.75

   

28

 

89,350

186,350—

405,100

 

45,353.75

   

33

 

186,350

405,100—

406,750

 

117,541.25

   

35

 

405,100

406,750—

 

 

118,118.75

   

39.6

 

406,750

 

 

2015


Taxable Income

           

of the

Over

But Not Over

 

Pay

+

% on Excess

 

Amount over—


$0—

$9,225

 

$0

   

10%

 

$0

9,225—

37,450

 

922.50

   

15

 

9,225

37,450—

90,750

 

5,156.25

   

25

 

37,450

90,750—

189,300

 

18,481.25

   

28

 

90,750

189,300—

411,500

 

46,075.25

   

33

 

189,300

411,500—

413,200

 

119,401.25

   

35

 

411,500

413,200—

 

 

119,996.25

   

39.6

 

413,200

C.    Who Can Be the Beneficiary and How is the Special Needs Trust Administered

 

1.      Self-Settled Special Needs Trusts and Pooled Trusts.  Only a disabled person can be the beneficiary of a self-settled Special Needs Trust or Pooled Trust during that person’s lifetime.  The trust can provide for other persons to become beneficiaries after the death of the disabled person, subject to the right to reimbursement to the Commonwealth of Massachusetts (and other states if applicable) and subject to payment of taxes and expenses.  While it is not necessary to address this in the trust instrument, the Trustee should be made aware that distributions made directly to the disabled person in excess of $20 per month will reduce that person’s SSI benefits dollar for dollar, and that distributions made in kind for food, clothing or shelter will reduce the person’s SSI benefits one dollar for every three dollars distributed. Similarly, payments of medical expenses for the disabled person may reduce MassHealth (Medicaid) benefits.

 

 A Pooled Trust may provide that a percentage of the funds remaining upon the death of a beneficiary, for example 25%, will remain in the trust to benefit the other disabled persons who have accounts in the trust.  Each Pooled Trust has its own rules and policies on how the Trustee determines when and in what amount a distribution should be made to a beneficiary; the amount of annual trustee fees, tax preparation fees, attorney fees, accountant fees and other administrative expenses; and how much stays in the trust after a beneficiary dies.  See the websites listed in Section D, Paragraph 1 below for examples of Pooled Trusts.

 

2.      Third Party Special Needs Trusts.   Anyone can be beneficiary of a third party special needs trust.  The trust does not have to be limited to disabled persons.  There is no requirement that the Commonwealth of Massachusetts (or other states) have a right of reimbursement. As with a self-settled special needs trust, the Trustee should generally pay expenses of the disabled person rather than make distributions directly to the disabled person. The expenses paid by the Trustee should be the type of expenses that do not reduce the public benefits of the disabled person. 

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