What are the Tax Implications of an Irrevocable Trust?
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Generally, Social Security Disability (SSD) payments are not subject to attachment or other legal process. SSD benefits are, however, attachable for child support purposes.
A “special needs trust” may be set up to provide for a disabled child’s or adult's extra and supplemental needs, other than basic food, shelter and health care expenses that may be covered by public assistance benefits that the beneficiary may be entitled to receive under various programs such as Supplemental Security Income (“SSI”) and Medicaid.
The special needs trust is primarily governed by federal law under 42 U.S.C. § 1396p (d) (4), which permits the use of special needs trusts, making them valid throughout the country.
Generally, the designated trustee is given broad discretionary powers to distribute income and principal to or for the child’s or adult's benefit. Terms vary by agreement, but the trustee may have sole and absolute discretion over payments of income and principal in order to maximize your child’s eligibility for public assistance benefits under current law. The trust may also allow the trustee to terminate the trust if it is possible that your ward may in the future become sufficiently competent to manage his or her own assets. The special needs trust must be carefully drafted to comply with Medicaid and SSI rules in order to preserve the ward's eligibility for Medicaid, SSI and other governmental programs.
Irrevocable trusts are normally established to obtain certain tax benefits. The trade-off is that assets conveyed to an irrevocable trust remain subject to its terms and conditions until the established time for distribution. The irrevocable trust may be designed for the purpose of holding property and accumulated income until needed by the beneficiary for such purposes as college education, establishing a business, or providing for the general support and maintenance of the Trust beneficiary. A major goal of such a trust is often to remove the trust property from the donor’s estate and to shift income from the high tax bracket donor/parent to the trust (or beneficiary). To achieve these basic goals, the trust must be irrevocable.
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If a trust is irrevocable, the trust's income can be taxed to the settlor, the trust, or the trust's beneficiaries, depending on the terms of the trust. Most irrevocable trusts are designed so that the settlor is not taxed on the income, and, if that is true, then the income tax is paid by the trust (at the trust's steeper rates) if the income is accumulated and by the beneficiaries (at the beneficiary's rates) if the income is distributed -- or required by the trust to be distributed -- to the beneficiaries. On the other hand, some trusts are intentionally designed as "grantor trusts" so that the settlor pays the tax on all trust income, even if it is distributed to the trust's beneficiaries.