advanced snt drafting issues i: tax issues and drafting to hold iras academy of special needs...
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Advanced SNT Drafting Issues I: Tax Issues and
Drafting to Hold IRAs
Academy of Special Needs Planners
Vincent J. Russo, J.D., LL.M., CELACopyright March 2007
Westbury, Islandia, Woodbury and Lido Beach
1-800-680-1717www.vjrussolaw.com
Overview♦Special Needs Trusts♦Pooled Trusts♦IRAs♦Supplemental Needs Trusts♦Income Taxation of Person
with Special Needs
Vincent J. Russo & Associates, P.C.©2007
First Party Special Needs TrustsRequirements
♦Set up by parent, grandparent, legal guardian or a Court♦To or for the sole benefit of a person
who is disabled and under age 65♦Funded with the assets of the person
who is disabled♦Payback required to reimburse the
State for Medicaid Paid♦ 42 U.S.C. § 1396p (d)(4)(A)
Vincent J. Russo & Associates, P.C.©2007
Tax ConsequencesFirst Party Special Needs Trusts
♦Gift Tax Treatment ♦On Funding
♦Income Tax Treatment♦On Income Generation
♦Estate Tax Treatment♦On demise of the beneficiary
Vincent J. Russo & Associates, P.C.
©2007
Gift Tax ConsequencesFirst Party Special Needs Trust
♦Johnny, age 6 ♦Receives a $4,000,000 medical
malpractice settlement♦If funding the SNT is taxable ...
♦Federal gift tax is $920,690 ♦Calculated: $1,266,490 less unified
credit -$345,800♦If funding the SNT is not taxable ...
♦Federal gift tax is $0♦Estate Tax Consequences
Vincent J. Russo &
Associates, P.C.©2007
Gift Tax ConsequencesFirst Party Special Needs Trust
♦Gift Guidelines:♦$1,000,000 and under
♦no federal consequences
♦Over $1,000,000 ♦Gift tax rates from 41% to 45%♦Unified credit amount is $345,800 ♦ (shelters the first $1,000,000 of taxable
gifts)♦State gift tax laws - NC, LA, TN and Puerto
Rico♦CT (as of 2005) no longer impose gift tax ♦NY (as of 2000) no longer impose gift tax Vincent J.
Russo & Associates, P.C.
©2007
Gift Tax ConsequencesFirst Party Special Needs Trust
♦Example #1:♦Donor transfers property to trust ♦Trustee to pay income to the donor
or accumulate it in the discretion of the trustee
♦Donor retains a testamentary power to appoint the remainder among his descendants
♦No portion of the transfer is a completed gift
Vincent J. Russo & Associates, P.C.
©2007
Gift Tax ConsequencesFirst Party Special Needs Trust
♦Example #2:If the donor had not retained the
testamentary power of appointment♦Trust provides remainder to X or his heirs♦The entire transfer would be a completed gift.
♦Example #3: ♦If the exercise of the trustee’s power for
the grantor is limited by a fixed or ascertainable standard
♦Gift is incomplete to the extent of the ascertainable value of any rights retained by the grantor.
Vincent J. Russo & Associates, P.C.
©2007
Income Tax Consequences
Who is Taxed on the Trust IncomeFirst Party Special Needs Trust
♦Trust♦Complex Trust
♦Someone other than the grantor♦Complex or Simple Trust
♦Grantor treated as the owner♦Overrides Complex or Simple Trust
Rules♦Grantor Trust Rules - IRC Sections
671 -678♦Ignore IRC §676 - Power to Revoke
Vincent J. Russo & Associates,
P.C.©2007
Who is the Grantor - Income TaxSpecial Needs Trust - Definition of Grantor - PLR
9437034♦Facts:♦The lawsuit arose from an
accident in which the plaintiff was seriously injured.
♦The settlement proceeds compensated the decedent for his personal injuries.
♦Plaintiff was the transferor of the funds
Vincent J. Russo & Associates, P.C.
©2007
Who Pays the Income TaxFirst Party Special Needs Trust
♦General Rule♦Grantor should pay the tax♦Trust should never pay the tax
♦Exception: ♦ Qualified Disability Trust
♦Guideline: Less than $3,400 of income♦Example: $68,000 invested at 5% yields
$3,400
Vincent J. Russo & Associates, P.C.
©2007
Who Pays the Income TaxFirst Party Special Needs Trust
♦Exception: Have some trust income taxable to trust and to beneficiary♦Must be a Complex Trust
♦Can not be a Grantor Trust♦One of the following:
♦Trust is required to accumulate income annually, or
♦Trust actually makes principal distributions, or
♦Trust may pay or permanently set aside or use Trust principal for charitable purposesVincent J. Russo &
Associates, P.C.©2007
Income Tax ConsequencesFirst Party Special Needs Trust
♦Trust is taxed on income♦Rates - 35% over $10,450♦Exemption Amount - $100 complex/$300
simple♦Qualified Disability Trust
♦Exemption Amount - same as standard deduction for a single person ($3,400 in 2007)
♦Grantor is taxed on income ♦Rates - individual rates apply - 35% over
$349,700 Exemption Amount -$3,400 (single)♦Beneficiary is taxed on income
♦Rates - individual rates apply - 35% over $349,700
♦Exemption Amount - $3,400 Vincent J. Russo & Associates, P.C. ©2007
Income Tax ConsequencesFirst Party Special Needs Trust
♦Trust is funded with $3,000,000 ♦Annual Income - $180,000 ♦Who Pays the Income Tax...
♦If Trust Pays - federal income tax - $62K♦If Johnny Pays - federal income tax - $45K
(54K if subject to Kiddie Tax)♦If Johnny’s Parents Pay - federal income
tax -$54K♦Assuming Johnny’s parents other taxable
income is $100,000 and married filing jointly
Vincent J. Russo & Associates, P.C. ©2007
Grantor/Beneficiary Pays the Income Tax
Special Needs Trust - Trust Provisions
♦How does the Grantor make it happen:♦Grantor may Exchange Property of
Equivalent Value in non-fiduciary capacity ♦IRC §675
♦Power to remove Trustee and replace with a non-adverse party who is related to or subservient to Grantor. In such case Trustees powers are attributed to Grantor and Trust is a Grantor Trust
♦IRC §672, IRC §674
Vincent J. Russo & Associates, P.C.
©2007
Grantor/Beneficiary Pays the Income TaxSpecial Needs Trust - Trust Provisions
♦How does the Grantor make it happen:♦Income payable by nonadverse party to
the grantor♦IRC § 677
♦Adverse Party - any person who has a substantial beneficial interest in the trust which would be adversely affected
♦IRC §672♦Use Trust income to pay premiums of
insurance on life of Grantor or grantor’s spouse
♦IRC §677
Vincent J. Russo & Associates, P.C.
©2007
Grantor/Beneficiary Pays the Income TaxSpecial Needs Trust - Trust Provisions
♦How does the Grantor make it happen:♦Reversionary Interest--at least 5% of
property♦IRC §673
♦Testamentary GPOA-causes Grantor Trust as a reversionary interest
♦IRC §673♦Testamentary LPOAs generally do not
create grantor trusts for income tax purposes
♦Exception: Capital Gains on principal - grantor taxed on the capital gainVincent J. Russo &
Associates, P.C.©2007
Income Tax ConsequencesSpecial Needs Trust - Grantor Trust
♦Tax Identification Numbers ♦Option 1- no TIN number
obtained♦Trustee providers Grantor (unless Grantor is Trustee) with a statement
♦Option 2 - New TIN for Trust ♦Trust Income Tax Return (IRS Form 1041)♦Check the box for Grantor Trust in entity type♦Generates a Grantor Statement (analogous to a ♦ Schedule K- 1)
Vincent J. Russo & Associates, P.C.
©2007
Estate Tax ConsequencesSpecial Needs Trust - Arrington Matter
♦Valuation: Arrington v. United States♦Facts:
♦Parents file medical malpractice claim against doctor and hospital for injuries caused to their son.
♦Case was settled and an annuity was set up for the benefit of the son. In addition, a trust for the benefit of the son was set up to hold a lump sum certain. The son was the only beneficiary of the trust and the annuity.Vincent J. Russo
& Associates, P.C.
©2007
Estate Tax ConsequencesSpecial Needs Trust - Arrington Decision
♦Lump sum and the annuity was included in
son's estate under IRC §2031 and §2033♦Since the trust and the annuity were"beneficially owned" by the decedent-son
at his death.♦Beneficial ownership under the IRC
§2033 andIRC Regs 20.2033-1 is determined by
State Law.Vincent J. Russo & Associates,
P.C.©2007
Estate Tax ConsequencesFirst Party Special Needs Trust
♦Included in Estate for Estate Taxes Purposes
♦Decedent had a income interest and a vested remainder in the corpus of the trust and a present income interest and vested remainder in all of the annuity payments.
♦Decedent had a beneficial interest in the annuity and the trust under Texas law
♦The date of death value of the trust and the annuity payments were included in decedent's estate under IRC §2033
Vincent J. Russo & Associates,
P.C.©2007
Estate Tax ConsequencesFirst Party Special Needs Trust
♦Debt of the Estate - Pay Back Amount
♦Deduction Against Gross Estate♦IRC §2053(a)(2)♦PLR 200240018
Vincent J. Russo & Associates,
P.C.©2007
Estate Tax ConsequencesSpecial Needs Trust - TAM 9506004
♦Facts: ♦Decedent's parents reached a
settlement for medical malpractice which resulted in the establishment of two irrevocable trusts.
♦One trust was funded with settlement payments payable over ten years.
♦The second trust was funded with an annuity for A's lifetime. Vincent J. Russo
& Associates, P.C.
©2007
Estate Tax ConsequencesSpecial Needs Trust - TAM 9506004
♦A had a testamentary limited power ofappointment of the assets of both
trusts.♦In default of appointment, upon
A's death, ♦The assets of the first trust were
to pass to his intestate beneficiaries♦The assets of trust 2 were to be
held in trust for A's parents and their issue.
Vincent J. Russo & Associates,
P.C.©2007
Estate Tax ConsequencesSpecial Needs Trust - TAM 9506004
♦The transfer by the parent (as guardian of A) did
not constitute a gift ♦A retained the right to change the
beneficiaries of the trust until his death ♦This rendered the gift to the trust
incomplete.♦The periodic payments were awarded by thehospital and the doctors in respect of A's
injuries. ♦The payments were A's property.Vincent J. Russo
& Associates, P.C.
©2007
Estate Tax ConsequencesFirst Party Special Needs Trust
♦A retained the right to change beneficialenjoyment of the trust for his
lifetime♦The trust assets were included in
his estate under §2036(1) and §2038 of the IRC
♦Valuation of Future Periodic Payments on Structured SettlementsVincent J. Russo
& Associates, P.C.
©2007
Pooled Trusts under (D)(4)(c)Tax Consequences
♦No Definitive Authority♦Generally taxed as Complex Trusts
♦Treas. Reg. §1.642(c)-5
♦Receive deduction for DNI distributed toparticipants
♦Participants receive Schedule K-1
Vincent J. Russo &
Associates, P.C.©2007
IRAs and SNTsThe Medicaid Rules
♦IRAs♦Available versus Not Available♦Permanent Pay Status♦Required Minimum Distributions♦Annuities
♦SNTs♦Trust Assets not available -
Medicaid
Vincent J. Russo & Associates,
P.C.©2007
IRAs and SNTsIRA Tax Rules - Trust as Designated Beneficiary
♦IRC Reg. §1.401(a)(9)-4, A-5)♦Trust must be valid under state law♦Trust must be irrevocable or will, by its
terms, become irrevocable upon death of the participant
♦The beneficiaries must be “identifiable ... from the trust instrument”
♦Certain documentation must be provided to “the plan administrator” by 10/31 of the year following the year of participant’s death
♦All trust beneficiaries must be individuals
Vincent J. Russo & Associates, P.C.©2007
Designating SNT as IRA BeneficiaryCase Study
♦Bob’s only child, Krista, is 35 years old and has CP.
♦Option #1♦Bob creates a Living Third Party SNT for
Krista with nominal funding♦Bob designates SNT as beneficiary of the
IRA ♦Option #2
♦Bob’s Revocable Trust with SNT for Krista♦Bob’s Will with SNT for Krista♦Bob designates as his IRA beneficiary the
SNT for Krista under Revocable Trust, with the SNT under the Will as contingent beneficiary.
Vincent J. Russo & Associates, P.C. ©2007
IRAs and SNTsPrivate Letter Ruling - 200620025
♦Taxpayer A, age 69 died♦Four sons surviving; Child B is
disabled♦Sons are named beneficiaries of
the IRA
Vincent J. Russo & Associates,
P.C.©2007
IRAs and SNTsPrivate Letter Ruling - 200620025
♦Strategy♦Separate Sub-IRAs established
for each child♦Annual RMDs are made♦Court authorizes establishment
of SNT♦Mother - Guardian of Child B -
disclaims interest in the SNT
Vincent J. Russo & Associates,
P.C.©2007
IRAs and SNTsPrivate Letter Ruling - 200620025
♦Ruling♦SNT is a Grantor Trust
♦IRC §671♦If grantor is owner - income attributed
to grantor♦IRC §677(a)
♦Trustee (non adverse party) may distribute income to grantor, accumulated for future distributions or applied to the payment of life insurance premiums on the life of the grantor
♦Transfer of B’s share of the IRA to SNT is not a
taxable event Vincent J. Russo & Associates, P.C. ©2007
IRAs and SNTsPrivate Letter Ruling - 200620025
♦Letter Ruling Request♦Transfer of IRA X to SNT will be
disregarded for federal income tax purposes♦The Trustee of SNT may calculate the
annual distributions using Child B’s life expectancy♦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 BVincent J. Russo & Associates, P.C.©2007
SNTs - Gift and Estate TaxesPrivate Letter Ruling - 9437034
Vincent J. Russo & Associates,
P.C.©2007
♦Decedent created an Irrevocable Trust
♦Funded with structured settlementproceeds with a guaranteed payment♦Special Needs Trust created to be
therecipient of the settlement proceeds
♦SNT Provisions♦For sole benefit of Decedent♦Testamentary Special Power of
Appointment
SNTs - Gift and Estate TaxesPrivate Letter Ruling - 9437034
Vincent J. Russo & Associates,
P.C.©2007
♦Ruling:♦Included in Estate for Estate
Tax Purposes♦IRC §2038(a)(1)
♦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
Third Party Supplemental Needs TrustsEssential Provisions
♦Set up by a third party for another person’s
benefit♦Funded with the third party’s assets♦No pay back required to Medicaid♦Can be Inter Vivos Trust or a Trust
under a Will♦Medicaid Transfer Penalty Rules
Vincent J. Russo &
Associates, P.C.©2007
Tax ConsequencesThird Party Supplemental Needs Trusts
♦Gift♦Complete versus Incomplete♦Control by drafting trust
provisions♦Income
♦Grantor♦Simple Trust♦Complex Trust♦Conversion from Grantor Trust
Vincent J. Russo &
Associates, P.C.
©2007
Estate Tax ConsequencesThird Party Supplemental Needs Trusts
♦Included in Estate of Grantor♦Strings Attached
♦Maintain Control or Beneficial Enjoyment
♦Excluded from Estate of Grantor♦No Strings Attached
♦No Control or Beneficial Enjoyment Retained
Vincent J. Russo &
Associates, P.C.
©2007
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