In everyday practice, trust and estate planning attorneys often advise clients and their family members about the importance and benefits of various trust arrangements. When planning for a family member with a disability, the dominant topics are ongoing asset management and preservation of eligibility for government benefits. However, an important component is often neglected in considering the choice of the appropriate type of trust—the taxation of the different trust arrangements.
Two Categories of Trusts: Revocable and Irrevocable
A revocable trust is a trust which can be revoked or amended by its creator at any time and without anyone’s consent. Of course, the trust’s creator retains unrestricted control of the trust assets as long as he or she is competent. The trust usually continues after the creator’s death for traditional estate planning purposes.
Irrevocable trusts are the other (and more common) category of trusts used in special needs estate planning. The primary characteristics of an irrevocable trust are that the creator cannot amend the provisions of the trust and cannot spend trust funds for the benefit of anyone other than the beneficiary unless the terms of the trust document specifically authorize it. Sometimes the trust document grants the trustee a limited right to amend certain provisions if changes in the beneficiary’s life justify or require an amendment. For example, this need could be triggered by the beneficiary moving to another state with different laws or policies, or by changes in trust, tax, or public benefits law.
Family members and the professionals helping them often fail to consider and discuss the various options available in establishing an SNT and how choices affect the taxation of the trust. Being aware of the income tax aspects of these commonly used estate planning tools can help the attorney and client make choices that can minimize the federal and state income taxes payable at different stages of the trust’s existence. Failing to consider these consequences may result in unintended contributions being made to the IRS. As one can glean from this article, trust taxation is a complex but very important topic. Families and trustees need to work with a practitioner who has both knowledge and experience with SNTs and trust taxation.