Thanks to my colleagues at Jaspan Schlesinger for hosting this month’s Estate Planning Council of Nassau County’s Study Group. I gave a presentation on the “new and improved” use of QDiSTs under the new tax law and the information was very well received. My colleagues in the study group were excited to learn of the tax savings possibilities that the QDiST now presents for their clients, and I have been invited to speak on this topic for the full group meeting in the Fall.
If you have not already read my recently published analysis, the article appeared in the June 2018 issue of the National Academy of Elder Law Attorney (NAELA) Tax Section. The new tax law makes the QDiST an important tool in our planning arsenal.
Under the prior law, a QDiST had a tax exemption equal to the personal exemption ( $4,050 in 2017), and all trust income was deemed earned, eliminating the Kiddie Tax. The beneficiary's standard deduction was limited to the lesser of the beneficiary's earned income plus $350 or $1,050.
Under the new law, the QDiST’s income tax exemption is $4,150, and the beneficiary is eligible for full standard deduction of $12,000, even if they are considered dependents. Additionally, until the beneficiary income exceeds $39,000, the beneficiary's capital gains tax rate is zero.
The Kiddie Tax under the new law uses the higher trust and estate tax rate instead of the parents' marginal tax rate. However, since the Kiddie Tax does not apply to QDiST income, if the beneficiary is under 18 (24 if the beneficiary is a student), the income tax savings can be as much as 90%.
Also, going forward, there is still a trust exemption of $4,150 indexed for inflation, while other non-grantor trusts have only a non-indexed $100 or $300 exclusion. The trust can retain the exemption amount tax-free and can accumulate as a substantial fund for future needs, especially if it is invested for growth.
What is interesting is income from a QDiST distributed to the beneficiary has been treated as "earned" income for Kiddie Tax purposes and therefore taxed at the beneficiary's rate since 2006.
I spoke extensively with leading tax experts, and they were not aware the Kiddie Tax did not apply to QDiSTs. In fact, I have yet to find anyone who knew about this. I have seen many returns for QDiSTs who used the $4,050 trust exemption, but still paid the Kiddie Tax on the income.
This could be a considerably powerful tool in our planning arsenal. If the parents are the taxpayers, the effective tax rate on the trust income is substantially higher.
If the Special Needs Trust produced $15,000 in income, a grantor trust would produce upwards of $5,000 of tax to the parents; if the trust is a QDiST, there is no tax due.
One expert agreed QDiSTs shine when made the Designated Beneficiary of an IRA or Pension. The income tax savings are enormous. Clients wanted to name their children as Designated Beneficiaries because they thought that if they left part of their deferred compensation plans to grandchildren with special needs, the tax burden would be prohibitive.
RMD's on a $500,000 IRA between ages 10 and 24 produces less than $5,000 income tax, versus over $278,000 of distribution in a QDiST opposed to over $70,000 if the trust is not a QDiST.
The article goes into all of this in greater depth.