Each month, I host a presentation called “Special Needs Planning for Parents” aimed at taking a look at the complex issues involved in creating an estate plan centered around an individual with special needs. Part of the presentation talks about the cons of implementing a special needs trust. One of those, sometimes significant, cons is the potential for a high income tax rate. The reason for that is pretty simple: the income tax rate for irrevocable trusts, regardless of the amount of income earned in a year, is the highest tax bracket – currently 39.6%. So, even a modest amount of income generated by a special needs trust can equate to tax at a rate almost identical to the federal estate tax. Not a great outcome. But, there is hope.
Tax Deductions
Under the current tax code, special needs trusts operate a lot like a business for the purposes of tax deductions. Businesses can deduct business expenses, wages paid, etc. from their yearly gross income. Similarly, special needs trusts can deduct amounts paid for qualified expenses of the special needs trust beneficiary. With an “active trust” – meaning one that is actively supporting an individual with special needs – the qualified expenses will generally outpace the income earned on the assets, unless there is a significant amount of wealth in the trust. So, for most people, the trust tax issue won’t be much of a concern. Most people will see significantly more expenses than income in any given year, even in a strong market.
Stagnant Trusts
The issue becomes, then, that “stagnant trusts” – those trusts holding income-producing assets but not actively supporting an individual with special needs – will be the ones most likely to take the tax hit mentioned above. A stagnant trust will not be making qualified expense payments, but will still be realizing taxable income. One way to reduce the impact would be to reassess the types of assets and investments held in a stagnant trust and shift to assets with lower returns while the trust is stagnant. Another option would be to wait to fund the special needs trust until it will be an active trust.
While income tax can be a significant issue for irrevocable special needs trusts, most active trusts would not be impacted. It’s always a good idea to work with an experienced special needs planning attorney and a financial advisor versed in these issues.
Author Bio
Paul Yokabitus
Founder & Estate Planning Lawyer
Paul Yokabitus is the founder of Cary Estate Planning, where he helps North Carolina families protect what matters most through wills, trusts, probate, and special needs planning. Known for his “planning, not paperwork” approach, Paul turns complex legal concepts into clear, practical strategies so clients feel informed and confident at every step. He has been recognized as a Business North Carolina Legal Elite attorney and a Super Lawyers Rising Star, and was named to the Triangle Business Journal’s 40 Under 40. A graduate of Campbell University School of Law, Paul lives in the Triangle with his wife, Alix, and their two sons.
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Paul and his team at Cary Estate Planning are fully committed to creating a personalized experience to develop thorough and comprehensive estate plans. They value their clients and go above and beyond to make sure that no details are missed. I would highly recommend Paul to anyone looking to create an estate plan.
I was referred to Paul by my Real Estate Attorney and I could not say enough about how exceptional the client service has been from everyone I spoke to. The communication is prompt and I feel like they really took the time to answer all my questions and set things up exactly as I wanted, but also recommended things to make it easier on my family down the line.
After attending one of Paul’s estate planning seminars, my husband and I knew we wanted Paul to assist us with our estate planning. His honest, professional approach to this necessary part of life put us at ease with the process. We will continue to recommend Paul and Cary Estate Planning.
We had a great experience working with Paul Yokabitus and the team at Cary Estate Planning to set up our Will and Estate Plan. The process was clear and easy, and in the age of COVID, our signing session was very well done, easy, and safe.
The Cary Estate Planning team will make sure that you have the information you need to be confident in your estate planning decisions. I learned so much from videos, a one-on-one in-person consultation, the website, emails, and a newsletter mailed the old fashioned way. The fee is very reasonable given the importance of estate planning. No matter the size or number of your assets, don’t procrastinate like I did!
Paul is a masterful attorney. He’s very good at taking your intentions and defining that into a durable Trust and Will. Best of all he is as simple and plain-spoken as you like. Or as fast as intellectual as you may be. It’s all about your your speed and your desired outcomes. Would strongly recommend this firm.
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