An overview of a qualified disability trust?

On Behalf of | Dec 27, 2023 | Trusts

A qualified disability trust is a type of trust, most often set up for someone with special needs, and it qualifies for tax exemptions in Indiana. The earnings from all trusts were subject to income taxes, a situation that changed in 2003 when Congress permitted some disability trusts to reduce their tax liability.

What are qualified disability trusts?

There are certain requirements that a qualified disability trust, also known as a special needs trust, must meet in Indiana. The Special Needs Alliance, an organization of disability lawyers, has identified important criteria that include:

  • The trust being irrevocable
  • The trust being solely for the benefit of the person with the disability
  • The beneficiary being under 65 at the time of the trust’s creation
  • The beneficiary having a condition defined as a disability by the Social Security Act

The funding for the trust must come from a third party other than the beneficiary. In most cases, the third parties are the parents or grandparents of the beneficiary.

What is an example of how qualified disability trusts work?

An example of a qualified disability trust is an irrevocable trust that parents set up for a disabled child. The child’s grandparents contribute $500,000 to the trust, which earns $25,000 yearly. Out of the $25,000 every year, $10,000 goes toward the child’s care.

There are different scenarios for paying taxes. The two most common are paying taxes on the parents’ returns or on the child’s income that comes from the trust.

When the parents pay the taxes, the trust income is considered “on top of” their regular earnings. The marginal tax rate is what the parents pay.

When the child pays the taxes, they pay trust income tax rates. These rates can be considerably higher than the rates that parents might pay.

Setting up a trust might seem like a major undertaking. However, the process doesn’t need to be difficult if you make the right preparations.