Form 1041 Compliance for Special Needs Trusts: First-Party vs. Third-Party, Qualified Disability Trusts

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1 Form 1041 Compliance for Special Needs Trusts: First-Party vs. Third-Party, Qualified Disability Trusts FOR LIVE PROGRAM ONLY TUESDAY, NOVEMBER 13, 2018, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at ext.1 (or ext. 1). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x1 (or x1) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 Form 1041 Compliance for Special Needs Trusts: First-Party vs. Third-Party, Qualified Disability Trusts TUESDAY, NOVEMBER 13, 2018 Darren J. Mills, Esq., CPA, ChFC, CLU, Attorney Mills Elder Law, Red Bank, N.J. Benjamin A. (Benji) Rubin, JD, LLM (Tax), Partner Rubin Law, Chicago

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

5 Form 1041 Compliance for Special Needs Trusts: First-Party vs. Third-Party, Qualified Disability Trusts Benjamin Rubin, Esq., LLM Darren J Mills, Esq., CPA, ChFC, CLU

6 Agenda Identifying SNT structures (first-party vs. third-party) Options for filing Form 1041 for first-party/grantor trusts Whether to obtain a TIN Disclosures when filing a separate return for SNT Grantor trust information letter Reporting third-party SNT income QDT special rules and tax reporting SNTs funded by retirement accounts and see-through provisions unique to SNTs 6

7 Identifying SNT structures (first-party vs. third-party) 7

8 Identifying SNT Structures Definitions: 1 st Party SNT: Funded with assets of the beneficiary (e.g., settlement (structured settlement annuity) or inheritance) Federal law 42 USC 1396p(d)(4)(A) ( d4a ) Irrevocable; 64 or younger; disabled; payback provision; no lookback 3 rd Party SNT: Funded with assets of someone other than the beneficiary No age restriction; generally funded by parents/grandparents; no payback Sole Benefit Trust ( SBT ) Payback provision in some states, but not required in others; used by parent/grandparent to obtain government benefits for themselves (no look-back) 8

9 Identifying SNT Structures ABLE Accounts States issuing ethics opinions: FL, NJ, OH & TN 9

10 Identifying SNT Structures Funding an SNT with life insurance. The Code provides that gross income generally does not include life insurance proceeds. IRC 101(a)(1). Exception: Transfer for Value ( TFV ) An absolute transfer for value of a right to receive all or a part of the proceeds of the policy. Exceptions to TFV: basis carryover transaction; a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer Exception: Transfer for Value ( TFV ) Consideration: Not just money or tangible property. E.g., the creation of an enforceable contractual right to receive all or part of the proceeds of the policy may constitute a TFV Pledging or assignment as collateral is not a TFV 10

12 Options for filing Form 1041 for first-party/grantor trusts 12

13 Options for filing From 1041 for first-party/grantor trusts Grantor trust or non-grantor trust Powers held by grantor, trustee or someone else Easier to make it a grantor trust than a non-grantor trust Grantor trust rules contained in IRC Transaction between settlor and grantor trust is disregarded. Rev. Rul (should be read broadly; see CCM ) Grantor trusts are disregarded as entities separate from their owners for all purposes of the IRC. CCM

14 Options for filing From 1041 for first-party/grantor trusts Support for d4a s to be grantor trusts: PLR and PLR a d4a Trust was a grantor trust because the trustee had the discretion to distribute the income of the trust to the grantor / special needs beneficiary PLR The ability of the trustee to invade principal for the benefit of the beneficiary should cause the entire trust to be treated as a grantor trust. IRC 673(c) Trust can pay tax liability My Trustee may make distributions of Trust Funds to pay for my income tax obligation, if any. Not a gift: Rev. Rul Not income for government benefit purposes 42 U.S.C. 1382(a) vs. 26 USC 61 14

15 Options for filing Form 1041 for first-party/grantor trusts Deemed owner of the grantor trust must include the activity of the trust on their individual tax return. Treas. Reg (a). Items of income, deduction, and credit attributable to any portion of a trust that is treated as owned by the grantor or another person, are not reported by the trust on Form 1041, "U.S. Income Tax Return for Estates and Trusts," but are shown on a separate statement to be attached to that form. Treas. Reg (a). 15

16 Options for filing Form 1041 for first-party/grantor trusts Filing options grantor trust: General approach File Form 1041 with statement attached Two alternative approaches File Forms 1099 Treas. Reg (b)(2)(iii) Payor reports to IRS under grantor s name, address and SSN. Treas. Reg (b)(2)(i)(A). Grantor trust tax information letter Required regardless of the reporting method chosen unless deemed owner is also trustee or co-trustee (which is not going to happen with a SNT/SBT) 16

17 Options for filing From 1041 for first-party/grantor trusts First alternative: Assets titled in the name of the trust; payor reports to the IRS using trust s name, address and TIN Trustee then uses Forms 1099 to shift income from trust to the deemed owner of the income Multiple types of income (e.g., interest, dividends, capital gain), likely more administrative burden then the general approach 17

18 Options for filing Form 1041 for first-party/grantor trusts Second alternative: Only available if the grantor trust is owned by one person. Objective is to allow the IRS to more easily match the reporting by the payor to the recipient Assets are still legally titled in the name of the trust Could cause questions/confusion with government agencies 18

19 Options for filing Form 1041 for first-party/grantor trusts To obtain a TIN or Not: Identity theft Financial institutions are insistent that one [EIN] is needed Further clarify title in the assets Grantor deceased 19

20 Reporting third-party SNT income 20

21 Reporting 3 rd Party SNT Income Intervivos or Testamentary Can be drafted as grantor or non-grantor trust Not income for government benefit purposes 42 U.S.C. 1382(a) vs. 26 USC 61 If grantor trust the settlor would usually be the grantor. The beneficiary cannot be the grantor. Consequences if Grantor Trust to parents: If grantor Trust for income tax purposes: tax liability owed by parents, if trust pays the taxes then trust is not sole benefit trust 21

22 Reporting 3 rd Party SNT Income Income taxation of non-grantor 3rd party SNTs: To the extent distributions are made for the benefit of the beneficiary they are reportable on the beneficiary s 1040 Compressed tax rates Taxable income not distributed is taxed at trust level on trust s 1041 Simple vs. complex trusts A simple trust is a trust that either distributes current income only or a trust described in section 651. Trusts subject to section 661 are referred to as complex trusts. Treas. Reg (a)-1 22

23 Reporting 3 rd Party SNT Income Income taxation of non-grantor 3rd party SNTs: Simple vs. complex trusts A complex trust is any trust other than a simple trust (akin to the definition of what is a capital asset) A trust may be a simple trust for one year and a complex trust for another year. Treas. Reg (a)-1 23

24 Reporting 3 rd Party SNT Income Income taxation of non-grantor 3rd party SNTs: Simple vs. complex trusts A simple trust is allowed an income distribution deduction for the amount of income that is required to be distributed currently under the terms of the trust. IRC 651(a)) Deduction is limited to the amount of the simple trust's distributable net income ( DNI ) IRC 651(b) 24

25 Reporting 3 rd Party SNT Income DNI is equal to the taxable income of a trust, computed with certain modifications. It is different from the fiduciary accounting income of a trust. (see, e.g., Uniform Principal and Income Act) DNI is used only: to limit the amount of the income distribution deduction allowable to a trust for distributions to beneficiaries; and to determine how much of a distribution to a beneficiary is includible in his gross income and the character of the distribution. Treas. Reg. Sec (a)-0 25

26 Reporting 3 rd Party SNT Income Income taxation of non-grantor 3rd party SNTs: Simple vs. complex trusts A simple trust provides that Son is to receive 60% of the trust income and Daughter is to receive 40%. Trust income required to be distributed is $10,000, but DNI is only $8,000. Although Son receives $6,000, he will include only $4,800 (60% of $8,000) in his gross income and Daughter will include $3,200 (40% of $8,000), even though she receives $4,

27 Reporting 3 rd Party SNT Income Income taxation of non-grantor 3rd party SNTs: Simple vs. complex trusts Complex trust is allowed an income distribution deduction equal to the sum of: (1) the amount of income required to be distributed currently under the terms of its governing instrument (IRC 661(a)(1)); and (2) any other amounts properly paid, credited, or required to be distributed (IRC 661(a)(2); Treas. Reg (a)-2(a)). 27

29 QDT special rules and tax reporting 29

30 QDT special rules and tax reporting Added by the Patriot Act (IRC 642(b)(2)(C)) All beneficiaries of the trust must be getting either SSI or SSDI SSA has interpreted 1396p(c)(2)(B)(iv) to require that the trust be established for the benefit of a single disabled person under age 65 Not a grantor trust In the case of any taxable year in which the exemption amount under section 151(d) is zero, clause (i) shall be applied by substituting $4,150 for the exemption amount under section 151(d). IRC 642(b)(2)(C) IRC 151(d)(5) exemption amount is zero due to TCJA 30

31 SNTs funded by retirement accounts and see-through provisions unique to SNTs 31

32 SNTs funded by retirement accounts Why are we so worried about IRAs and minimizing RMDs? Non-grantor trusts taxed at highest tax bracket of 37% plus 3.8%; Obamacare/ACA Surtax after just $12,500 income Tax planning can help avoid having income taxed at ordinary rates but with qualified retirement plans there is a day of reckoning taxed as ordinary income (i.e., RMDs) Stretch IRA? 32

33 SNTs funded by retirement accounts Trusts as a beneficiary of an IRA (four tests) Valid trust; Irrevocable; Trust s underlying beneficiaries must all be identifiable as being eligible to be designated beneficiaries themselves; and A copy of trust documentation must be provided to the IRA custodian by October 31st of the year following the year of the IRA owner s death. Treas. Reg (a)(9)-4, Q&A-5. Inherited IRAs not protected (Clark v. Rameker) 33

34 SNTs funded by retirement accounts Accumulation vs. Conduit RMDs do not have to be spent that year but, after taxes are paid, net proceeds can be kept in the trust for continued (taxable) investment and future use Conduit: If the trust requires that all required minimum distributions collected from the IRA will pass through directly and immediately to the underlying income beneficiary, that only the income beneficiary s life expectancy must be considered. Treas. Reg (a)(9)-5, Q&A-7 34

35 SNTs funded by retirement accounts Accumulation vs. Conduit Accumulation: both the current income and remainder beneficiaries must be considered 35

36 SNTs funded by retirement accounts d4a IRS ruled that a disabled individual could transfer two inherited individual retirement accounts to a specialneeds trust of which he was the beneficiary. PLR

37 SNTs funded by retirement accounts 3 rd Party RMDs are complicated as with all non-grantor accumulation trusts Need to look to contingent beneficiaries What about mere potential successor beneficiary? See PLR Balance between achieving client s testamentary objective and a potential tax issue depending upon interpretation 37

38 Q&A 38

39 Contact Information 39

40 Contact Information Darren J Mills, Esq., CPA djmills@millselderlaw.com 40

Filing Final Income Tax Return for Deceased Person: Mastering Allocations, Understanding IRD and More

Filing Final Income Tax Return for Deceased Person: Mastering Allocations, Understanding IRD and More FOR LIVE PROGRAM ONLY TUESDAY, SEPTEMBER 18, 2018, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE