1. Taxation of Special Needs Trusts
Robert B. Fleming
Fleming & Curti, PLC
Tucson, Arizona

2. Taxation of Special Needs Trusts
Five kinds of trusts:
Self-settled (“d4A”) trusts
Third-party trusts
“Sole benefit” trusts
Pooled trusts
“Miller” trusts
Three kinds of taxation:
Income
Gift
Estate

3. Income Taxation Issues
Taxation of trusts
Separate taxpayer / EIN
Compressed tax rates
Deductions available to trusts
Grantor Trust rules
Internal Revenue Code (IRC) §§
Logic of grantor trust rules
Effect of grantor trust treatment
You say “income,” I say “income” and she says “income”

4. Non-Grantor Trusts Who is the Grantor? Further distinction:
“Simple” trusts
“Complex” trusts
Qualified Disability Trusts
IRC §642 (“Victims of Terrorism Act of 2001”)
Trust receives exemption (of $3400 in 2008)
For “kiddie tax” trust, AMT may be avoided

5. Let’s Apply Those Principles: Self-Settled SNTs
(almost) Always a grantor trust
 (therefore):
Separate EIN not required
Separate return not permissible
Extra trust-specific deductions not available
Query: Can a self-settled SNT ever be a non-grantor trust? A Qualified Disability Trust?

6. IRC §673. Reversionary interests
(a) General rule: “The grantor shall be treated as the owner of any portion of a trust in which he has a reversionary interest in either the corpus or the income therefrom, if, as of the inception of that portion of the trust, the value of such interest exceeds 5 percent of the value of such portion
(c) Special rule: “For purposes of subsection (a), the value of the grantor’s reversionary interest shall be determined by assuming the maximum exercise of discretion in favor of the grantor.”

7. Belt / Suspenders Approach to Self-Settled (Grantor) Trusts
Drafter might include (pick one):
Power of appointment (§674(a)), but what about:
Doctrine of Worthier Title?
State as beneficiary / creditor / supercreditor?
Capacity of beneficiary to exercise power?
Power to “reacquire the trust corpus by substituting other property of an equivalent value” (§675(4)(C))
Selection of a “non-adverse” trustee (§677(a))

8. Let’s Apply These Principles (II): Third-Party SNTs
Is the SNT still a grantor trust?
Do we wish it was a grantor trust?
If not a grantor trust, is it
Simple, or
Complex?
Might it be a Qualified Disability Trust?

9. Qualified Disability Trusts (§642(b)(C)(ii))
… “ ‘qualified disability trust’ means any trust if – (I) such trust is a disability trust described in” 42 USC §1396p(c)(2)(B)(iv)
That section, in turn, provides that “[a]n individual shall not be ineligible for medical assistance by reason of paragraph (1) to the extent that … (B) the assets – … (iv) were transferred to a trust (including a trust described in subsection (d)(4) of this section) established solely for the benefit of an individual under 65 years of age who is disabled….”
Yes, that (d)(4) mention does reference (d)(4)(A), (d)(4)(B) and (d)(4)(C) trusts.

10. Let’s Apply These Principles (III): Sole Benefit, Pooled and Miller Trusts
Sole Benefit trust:
Is it a grantor trust? Probably not
If not, is it a Qualified Disability Trust? Likely
Pooled trust:
Is it a grantor trust to the extent of the grantor’s interest?
Can a pooled trust be partly Qualified Disability Trust and partly not?
Miller trust – this one is easy, isn’t it?

11. Executive Summary Most of the Time:
Self-settled SNTs are Grantor trusts
Third-party SNTs are complex trusts (occasionally Grantor trusts to the Grantor)
Sole benefit trusts are complex trusts (occasionally Grantor trusts to the Grantor)
Pooled trusts are complex trusts (possibly Grantor trusts to the donor/beneficiary)
Miller trusts are Grantor trusts

12. Gift Taxation Issues Gifts must be completed
Annual gift tax exclusion (currently $12,000) applies to gifts not in trust
Crummey (397 F.2d 82, 9th Circ. 1968) powers and special needs trusts generally
Enter Cristofani (97 T.C. 74, 1991). Kohlsaat (T.C. Memo ), anyone?
Is this simply too esoteric?

13. Too Esoteric (I): Application to Self-Settled SNTs
Probably of no moment. Transfers to the trust might be completed, but retained interests probably exclude treatment as gift…
…and that’s good, because there would be no annual exclusion available

14. Too Esoteric (II): Miller & Pooled Trusts
Miller trusts should not have any gift tax issues, since only income can be assigned and the share of cost calculation continues to apply
Pooled trusts should be subject to analysis comparable to self-settled ((d)(4)(A)) trusts

15. Too Esoteric (III): Third-Party and Sole Benefit SNTs
Gifts from donors under the estate tax exemption equivalent amount ($2,000,000 in 2008) and/or the lifetime gift tax exemption amount ($1,000,000) may not need to consider the gift tax effect
Gifts from wealthier donors should probably implement Cristofani, rather than Crummey, powers of withdrawal

16. Estate Tax Issues Estate tax exemption equivalent amount:
$2,000,000 in 2008
$3,500,000 in 2009
Estate tax repealed in 2010
$1,000,000 in 2011
Assets subject to estate tax (whether tax imposed or not) receive stepped-up basis on death of taxpayer – often a significant income tax benefit to recipients

17. Application of Estate Tax Issues: Blessed Simplicity
Self-Settled SNTs: Probably completely includible. Commutation provision for structured settlements?
Third-Party SNTs: May be includible in grantor’s estate, but not in beneficiary’s
Miller trusts: Shouldn’t be anything left
Pooled trusts: beneficiary is a combination of the State and a non-profit (not always a charity). Shouldn’t be an issue
Sole Benefit trusts: Hard to imagine transfer of a taxable estate to secure eligibility for the donor, but it could happen….