Will Income from Special Needs Trust Affect Beneficiary’s SSI?

 In Special Needs Planning
special needs trust income

Special needs trust taxable income

Question:

I am helping a friend who has a 1st party special needs trust set up for his brother (funded from a personal injury settlement). His parents who were previously the trustees never administered it properly. The question is if it is taxed as a grantor trust with all income flowing through to disabled brother and the income appears on his tax return, will this income jeopardize his federal funds.

Response:

No.

By “federal funds,” I assume you’re talking about Supplemental Security Income (SSI). “Income” for tax purposes and “income” for SSI purposes are defined differently. So, if the trust income never touches the beneficiary’s hands or accounts, it’s not income for SSI purposes.

That said, sometimes Social Security Administration personnel get this mixed up and it’s necessary to explain the law. In the worse case scenario, this can mean a denial of benefits and the necessity of an appeal, but that is rare.

I’d add that the tax treatment of the trust appears to be in order. The trust was created with funds that belonged to brother into a trust for his benefit. As a result, it’s a “grantor trust” for tax purposes. In most cases, since these trusts are irrevocable, the do obtain their own tax identification number and file an annual 1041 return. But they don’t pay any taxes. Instead, the issue a K-1 to the beneficiary reporting any net income that was used on their behalf. And the beneficiary then reports that income on their tax return, just as they would for interest earned on a bank account.

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