The question among many practitioners is, does a supplemental needs trust need a separate tax I.D. number and have to file a separate income tax return? The answer is, it depends. So let's examine when an SNT needs a separate tax I.D. and when it doesn’t.
A supplemental needs trust will be a first party or third party trust. A first party supplemental needs trust is funded with assets of the disabled individual who is also the beneficiary of the trust. Under law a first party supplemental needs trust can only be created by the parent or grandparent of the individual, or a court. Once the first party supplemental needs trust is created, it will not require a separate tax I.D. number, but instead will use the tax I.D. number of the disabled beneficiary. All income earned by the first party supplemental needs trust will be reported on the income tax return of the disabled beneficiary, but will not affect or be counted toward their continuing eligibility, as long as distributions are made on the beneficiary’s behalf and not made directly to the beneficiary.
A third party supplemental needs trust is created and funded by someone other than the disabled beneficiary, but for the benefit of a disabled beneficiary. Whether a tax I.D. number is required for the third party SNT will depend upon how the trust is structured. In most third party SNT’s, the creator of the trust (grantor) wishes to maintain control of the trust for the benefit of the disabled beneficiary. In this case, no separate tax I.D. number would be required as it would be considered a "grantor" trust and all income would be taxed to the grantor. If the grantor is not the trustee, but retains other identified rights, then the same rules would apply. Alternatively, if the grantor creates a trust and retains no rights to change it, benefit from it or control its distribution, then it may be a non‑grantor trust and need a separate tax identification number.
Similarly, after the grantor who created the trust and retained rights to make it a grantor trust dies, the third party supplemental needs trust now becomes a "non‑grantor trust" and requires a separate tax identification number. Annual income tax returns would have to be filed for non-grantor SNT’s but the actual tax will be deemed payable by either the beneficiary, or the trust, depending upon the actual distributions made. For example, if a supplemental needs trust earned $10,000.00 in a year, and they used $7,000.00 of it for the beneficiary, it would "pass through" the $7,000.00 in taxable income to the beneficiary on a Form K1. The remaining $3,000.00 retained in the trust, would be taxed at the trust tax rate and payable by the trustee directly with the tax return filed by the trust with the IRS. Finally, in relation to IRAs, the IRS has ruled in Private Letter Ruling 200820026, that an IRA payable to a supplemental needs trust at the death of the IRA owner, will not be required to be liquidated and, but instead, the age of the disabled beneficiary will be used for "stretch purposes" and it will be considered a grantor trust of the beneficiary for purposes of the IRA distribution.
So does a supplemental needs trust need a tax I.D. number? No and yes it all depends how you create the trust during lifetime and how you plan for it!
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David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center