Special needs trust expenses

[John3cpa]

Client in process of setting up a Special Needs Trust for his disabled son with lump sum insurance proceeds. I "think" the medical expenses paid by the trust "pass through" to the son and are reported on his 1040. Can someone confirm this for me?

[Bees Knees]

A trust cannot pass through deductions to a beneficiary, except in the final year of the trust. If it isn’t in the final year, you can only pass through income to the beneficiary. Of course, any deductible expenses the trust incurs will reduce the income that is passed through to the beneficiary.

Another possibility is that it is a grantor type trust, in which you don't even bother with the 1041 or K-1. In that case, all income and expenses are reported directly on the grantor's 1040 as if the trust never existed. Maybe that is what you are thinking of.

[Armando Beaujolais]

I agree that there's no provision for passing medical deductions through to the beneficiary. However, couldn't the payments be considered distributions to the beneficiary as third-party payments? It seems to me it would have the same effect as distributing the money to the beneficiary, then the beneficiary pays the expenses and deducts them. The substance of the transaction seems to say "deductible on the beneficiary's return."

I'll do some more research and see what I can find out (in other words I'll talk to people who are smarter than I am and ask them if they know the answer) and I'll see what I can find out as far as an authority.

[natiro]

Special needs trust

Be careful about making distributions to the son who would in turn pay medical expenses in order to take the medical deduction. I believe that distributions to the beneficiary from a special needs trust would be considered income to the beneficiary for government program purposes (not necessarily tax purposes, although a distribution would carryout DNI) and may make the beneficiary ineligible for certain government programs such as SSI, or could impact the amount eligible for. Special needs trusts should pay eligible trust expenses directly and not through the beneficiary.

[Snaggletooth]

Trust Deduction

The Special Needs Trust was created to obsfucate (ask Black Bart) medical expense for the beneficiary. If payments are made from the trust to medical providers, why can't that be considered a deduction for the trust similar to admin fees? After all, this is why the trust was created -- not for greedy lawyers, custodians, and accountants, right?

If I am correct here, this would be a DEDUCTION for the trust, and not a distribution of "income" to the beneficiary. (WHAT "income?" - there isn't any - only the corpus paying expenses)

If this somehow is interpreted as "income" to the beneficiary, please let me know. It perturbs me somewhat that the IRS mindset is always anxious to impart taxable income to parties who never see the money, so I wouldn't be surprised either way.

[Armando Beaujolais]

I'll wonder if poor John3cpa is sorry he asked at this point.

Why does that name bring Star Wars to mind?

[natiro]

Special Needs Trust

If I am correct here, this would be a DEDUCTION for the trust, and not a distribution of "income" to the beneficiary. (WHAT "income?" - there isn't any - only the corpus paying expenses)

If this somehow is interpreted as "income" to the beneficiary, please let me know. It perturbs me somewhat that the IRS mindset is always anxious to impart taxable income to parties who never see the money, so I wouldn't be surprised either way.

I think the original question asked whether the deduction for the trust's payment of medical expenses passes through to the beneficiary. Armando mentioned the possibility of considering the medical payments as distributions to the beneficiary who would, in turn, pay for medical expenses and take the deduction. I was cautioning against this, as distributions from a special needs trust MAY POSSIBLY be considered income by non-IRS governmental agencies for other support purposes that the beneficiary may qualify for, such as SSI.

I tried to be careful in my answer to indicate that I was talking about non-IRS agencies in my answer. Sorry if that wasn't clear in my answer.

You are correct Snag in that if the trust pays the medical expenses, this would not be considered income (taxable or otherwise) to the beneficiary. I may have misread Armando's post, but it sounded as if he was suggesting some sort of deemed distribution so that beneficiary could get the medical deduction.

[JON]

Purpose of special needs trust?

The purpose of such a trust is to put assets into it so both the assets and income are not counted against qualifing for medical assistance and disability from social security. There are two kinds-one is funded by a third party and the other is funded with the beneficiary's assets. The difference is at the conclusion of the trust (death) third party created can go to other designated beneficiaries, while created by own assets it goes to the government.

If your not going for government assistance I do not think you have a "special needs trust". Maybe just a trust to handle financial affairs of someone who can not do it for himself.. States may have different rules.

From not an expert...

[Snaggletooth]

For Natiro

I was responding to the general question and not to you (but perhaps only to the extent that your comments might apply). Good to see you posting again, and wish we could hear more from you. You are among the elite minds on the board.

Actually, I agree that a distribution to the beneficiary so he could pay the medical provider himself could actually defeat the purpose. Instead of a tax deduction for the trust, we instead end up with a possible deduction for the beneficiary, diluted of course by the 7.5% threshold for medical expenses and dollar threshold for itemized deductions. Don't know how that would really shake out, but the paper trail for this arrangement essentially takes the deduction away from the trust and imparts it to the beneficiary, where it is of dubious tax value.

Additionally, if the distribution is from corpus, there should be no "income" to the beneficiary anyway - only to the extent that the fund actually had income itself.

But from what I'm hearing from Armando, does the question of income leave the entire playing field of the trust mechanics, and become income to the beneficiary as a "third party payment?" I sure hope not. Maybe the Borealis guy will tune in again...

[John3cpa]

Thanks everyone!!

The discussion was great and has helped me a great deal in an area I am not well versed in...as you could tell I'm sure.

This was my first post...I am impressed!!

Thanks again.

John(not from star wars)3cpa

[Unregistered]

Paying personal expenses of a benificiary are never an expense to a trust.