The United States government will not provide assistance to persons with special needs if they have assets worth more than $2,000. This stipulation makes it difficult for parents and caregivers to plan for the person's financial needs. A special needs trust provides a way to meet the financial needs without disqualifying the disabled person from benefits, since the assets in the trust are not in the person's name, but are available for the person's use to pay for necessary care.
Setting Up the Trust
Any fees associated with setting up the trust are a tax deduction for the parents or guardian of the child. These fees include those from attorneys, accountants or financial planners that you use to help you write and implement the trust. The trust must have its own Employer Identification Number from the Internal Revenue Service, and any bank or brokerage accounts must use the EIN instead of the beneficiary's Social Security number, to protect the beneficiary's interest.
These trusts typically pass income and deductions through to the beneficiary. This allows the trust to use the beneficiary's tax rate instead of a trust tax rate, which can be much higher. With a self-settled trust, the trust must file a return with the IRS using Form 1041, but the return is for the IRS' information only. These trusts generally receive initial funds from an inheritance or a settlement that names the disabled person as the beneficiary. Any monies remaining in the trust after the beneficiary's death must go to pay back Medicare for expenses paid during life before distributing any remaining money to the trust's heirs.
A parent or guardian sets up a third-party trust with funds that do not belong to the disabled person. If the tax-deductible withdrawals from the trust do not equal or exceed the income from the trust, the government taxes the excess income at the trust tax rate. As with a self-settled trust, all necessary expenses not covered by Medicare or other government assistance program are tax deductions for the trust. Third-party trusts do not require the executor for the trust to pay back Medicare, but the trust can be responsible for estate taxes after the death of the beneficiary.
Regardless of the type of special needs trust, the trustee can use the income — and principal — from the trust to meet the needs of the beneficiary that government programs do not. The trust can pay assistants to help the beneficiary with his daily activities, and also fund customized vehicles to accommodate the beneficiary's needs, and maintenance and insurance for the vehicle. Other tax-deductible withdrawals from the trust include funds to pay for vacations and recreational activities, hobbies and service animals.