A Work In Process – Stay Tuned For Update On The Kiddie Tax And The New Tax Law

By Stephen J. Silverberg
New York Elder Law Attorney

The article on QDiSTs published on this blog on January 31 is a complex topic, even for those of us who routinely scale the heights of tax law. I have realized it was too complicated and I am completing a scaled-down version.  Meanwhile, here is an update.

The core concept: I am making the case to consider non-grantor third-party trusts, a concept which most Elder Law attorneys routinely dismiss out-of-hand largely because they do not know about IRC 1(g). 

The new law makes the QDiST an important tool in our planning arsenal. 
In 2001, I received a call from counsel to the Congressional Joint Conference Committee on Tax. They had called Clifton Kruse, a nationally acknowledged expert in trust law; he referred them to me. I reviewed the proposed legislation with them and told them most trusts were grantor trusts, so the effect of the proposed legislation was limited. Counsel told me this was the proposed legislation and they would entertain no other proposals.
Under the prior law, there was a $4,050 trust exemption (indexed), and there was no Kiddie Tax — but no one seemed to know that. The standard deduction for the beneficiary was the lesser of earned income plus $350 or $1,050.

Under the new law, the exemption is $4,150, and the beneficiary gets a full standard deduction of $12,000. And until the beneficiary income exceeds $39,000, the beneficiary’s capital gains tax rate is zero.

If the beneficiary is under 24, there are virtually no income tax repercussions.

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 is invested for growth.
I spoke extensively with leading tax sources, and neither of them knew that QDiST income is earned income for Kiddie Tax. Another leading source agrees the QDiST is a more viable strategy.

To date, I have found no one who knew that since 2006, QDiST income is deemed earned income — since 2006!
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.

QDiST’s shine when made the Designated Beneficiary of an IRA or pension.

If a QDiST is the Designated Beneficiary of an IRA, the tax benefits 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.
I have also seen accountants who took the $4,050 trust exemption but still paid Kiddie Tax. 

Thank you for bearing with me as I work through the knots of this complex but equally potentially beneficial approach.

If you have questions or want a spirited debate, call me at 516-307-1236, or email sjs@sjslawpc.com. I welcome further discussion on this and related topics.

About the Author
Stephen J. Silverberg is nationally recognized as a leader in the areas of estate planning, estate administration, asset preservation planning, and elder law. He is a past president of the prestigious National Academy of Elder Law Attorneys (NAELA), and a founding member and past president of the New York State chapter of NAELA.
Posted in Tax