Tax benefit of grantor trust

Submitted by Alan Baker on Thu, 2014-05-22 20:02

Can wife and I designate my disabled son’s 1st party special needs trust as the beneficiary of our IRA’s so that he gets MRD’s based on his age and so that the MRD’s are included as income on his personal return and taxed at his rates rather than trust rates. The special needs trust of course cannot not distribute cash to my son and can only buy goods and services for his sole benefit. Our non-retirement(non-IRA) assets will go to a third party trust but earnings there will be taxed at higher trust rates.

thanks

PS: Also how should the beneficiary designation read. a)”John Doe 1st pty spl needs trust dated 99/99/2012″ or b) Trustee of the John Doe1st pty spl needs trust dated 99/99/2012″. I posted a more complex question earlier. Hopefully this one is easier to comment on.



Submitted by Alan - IRA critic on Fri, 2014-05-23 03:14

  • This would best be addressed by an estates and trust attorney, the the following article should help:  http://test.specialneedsanswers.com/q-a-with-natalie-choate–providing-for-a-disabled-beneficiary-13828. The article distinguishes between the situation where you name the qualified SNT as your IRA beneficiary vs. a self settled trust as described in PLR 2006 20025. It is critical to retain a legal specialist in this very complex and specialized area of law since the SNT must meet specific state requirements and must also meet the IRS requirements of a look through (qualified) trust. The article also explains the consequence of the SNT not being qualified and that includes the trustee failing to meet IRS deadlines of providing documentation to the IRA custodian. With respect to the beneficiary wording, I suggest using a large professional IRA custodian who should be able to work with the trust attorney to arrive at wording that satisfies both the IRA custodian’s processing platform and state requirements.
  • With respect to your other post, I was hoping that Bruce Steiner, an estates attorney who posts here would respond. The key question there was distributing out of one trust to the other trust to access lower individual tax rates.  Can’t answer that one.


Submitted by Alan Baker on Fri, 2014-05-23 16:58

Thanks for the feedback.  The article is helpful and sites a post mortem path for getting the IRA and MRD’s into son’s 1st pty trust but recommends advance plannning  🙂  . (I will assume that the IRA can be stretched over the beneficiary’s lifetime as the article states.)My bigger question and main motivation for this post has to do with how the MRD’s will be taxed in a 3rd party vs a first party trust and weather I have the option to direct my IRA assets to either type. So my question: Is it correct that I can leave IRA’s to either a third party or a first party trust? and that the tax difference could be substantial?  MRD’s from the IRA(s) are large if we pass today,and I estimate the taxation difference at around 30 to 40k per year.  The tax difference is my main motivation for the question and is caused by the difference between grantor trust (1st party) rates and the accelarted trust rates of a 3rd party trust.I am aware of the 1st party payback provision but am more concerned about the tax cost.Thanks Again



Submitted by Bruce Steiner on Fri, 2014-05-23 21:22

Alan:  thanks for the kind words.  In this context, first party means that it’s the beneficiary’s money that went into the trust, and third party means that it’s someone else’s money that went into the trust.  In the Medicaid context, a first party trust is subject to certain requirements.  For income tax purposes, since it’s the beneficiary’s money that went into the first party trust, the trust is ignored for income tax purposes, and the beneficiary is taxable on the trust’s income.  The ruling allowed a beneficiary of an IRA to put the inherited IRA into a first party trust.  If you leave an IRA to such a trust, it would seem to be a third party trust as to the portion of the trust.  So I’m not sure how you would accomplish this. 



Submitted by Alan Baker on Sun, 2014-05-25 00:21

Is the take away that with a special needs child and per the PLR 2006-20025 one parent’s IRA was able to pass to the special needs child and stretched based on the child’s age and the MRD’s are taxed at individual rates however if the parents try to specify (through planning) where the IRA should go it is going to wind up in a third party special needs trust with a very significat tax burden do to trust rates on the MRD’s.  Am I understanding correctly?I guess one would have to consider not leaving the IRA to the trust but just to the individual and requesting that the trustee go the PLR route after the parents pass.I really appreciate your time on this.



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