TAXES

Tax Issues are Complex for Special Needs Families 

By Mary Anne Ehlert, CFP^®

We all want the best for our families and children, and that’s particularly true for families with a family member who has a disability. At tax time, these special-needs families have to grapple with especially complex issues the average tax preparer or CPA may be unfamiliar with.

It’s impossible to make you an expert in the space of one article. We can, though, share with you some of the situations that may arise for the special-needs families you have among your clients.

Probably the first thing to do is ask clients if they have members of their families with physical, emotional, or developmental disabilities who they are caring for, and may be caring for during their entire lives. There are more than you might think, which is why firms like Protected Tomorrows stay so busy.

Here are some of the tax questions and situations that come up frequently for special-needs families.

ABLE Accounts

These are tax-advantaged savings accounts for individuals with disabilities and their families, created as a result of the passage of the Stephen Beck Jr. Achieving a Better Life Experience Act of 2014. The account pays for health and quality of life expenses not covered by government benefits.

Income earned in these accounts, similar to 529 college savings accounts, is not taxed. Nor are withdrawals taxed if they pay for qualified disability expenses—for example, the legal expense of setting up a special needs trust (SNT) or hiring a physical therapist who helps a child with a disability improve their mobility.

ABLE Account holders should know two things:

• Annual contributions are limited by the gift tax exclusion of $18,000 per person. That $18,000 is the maximum that can currently be contributed from any source per year, with the exception of funds contributed from work income of the person with the disability, which also has additional limitations.
• They must keep receipts and documentation for the expenses for three years or even longer if the person with the disability will need to prove the contribution in the future relative to their benefit redetermination. Contributions are deductible from state income taxes in some states.

There are more ins and outs to discover about ABLE accounts: Should SSI benefits be deposited? How often can withdrawals be made? Good sources of answers are the ABLE National Resource Center and ABLE Today.

Special Needs Trusts

We know money shouldn’t be left to a disabled child or family member; they can only have $2,000 in resources to qualify for SSI government benefits and states have set new asset limits in resources to qualify for Medicaid benefits. So most families will have SNTs, which are a wonderful tool but can be complicated. Revocable or irrevocable? First-party or third-party? Who is the grantor? Whose tax ID number is attached to it? It’s important to review these estate documents regularly with clients.

In the case of taxes, it’s important to know that earnings in a SNT may be taxable to the grantor (usually the parent) whose Social Security number is on it. If someone contributes to the trust, it may be taxable as a gift to the grantor.

Tax issues that arise with SNTs are best directed to those with specialized knowledge to ensure someone isn’t over- or underpaying taxes.

Another common issue is when a tax return for a first-party SNT is treated like a complex trust, when in fact it is a grantor trust and the K1 should go to the person with the disability. The K1 should clearly identify  the source of the income coming from the first-party (D4A) trust, to not force the person with the disability to become disqualified from important benefits.

Dependency

One of the most common questions involves the ability to claim an adult child with disabilities as a dependent. In general, it depends on whether they have lived with the parent for at least half the year, whether the parent provided at least half of their support, and whether the child is filing a return of their own.

If the parent is providing enough support to claim the dependent, it might have an impact on benefits—for example, providing food and shelter could reduce SSI payments. It’s important to know what the limits are.

And what if the child is living in a group home? The IRS may consider a stay at a group home as a “temporary absence,” which is allowable for a dependent. But if the child isn’t expected to return, they can’t be claimed as a dependent. That said, if the parent is making a charitable contribution to the group home in exchange for residency, that might be deducted in certain circumstances.

Other Big Issues

Should the person with disabilities file their own return? There are so many permutations to this. It depends on whether they meet the $25,000 threshold for taxable income, are earning income from a job, and other factors. SSI income in itself is not considered taxable income. Sometimes it’s a good idea to file just to claim the earned income tax credit or get a refund of taxes paid by an employer.

If I charge rent for my child to obtain full SSI, won’t I owe taxes on the income? Yes, but there are many expenses associated with providing a rental, so it’s likely to result in a deductible loss. 

Is Medicaid waiver funding considered income? Yes, it’s considered earned income but may not be taxable by virtue of it being a “difficulty of care” payment. Again, it’s best to get guidance from an expert familiar with these situations. Many professionals don’t realize though that even if the waiver funds are considered tax exempt income, it is earned income and the personal support worker may contribute to their IRA or Roth IRA since the income is considered earned income.

If there’s one bit of advice I could leave you, it would be to download IRS Publication 3966. It’s the key to all other publications and forms in regard to being responsible for someone with a disability. If nothing else, it might tell you what you don’t know and give you the tools to ask the right questions that will help your clients.

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Mary Anne Ehlert, CFP^®, specializes in financial planning for families with a disabled family member. She founded Protected Tomorrows in Lincolnshire, Ill., now a Simplicity Company, where she’s a partner. For more information, contact her at 847-522-8086 or protectedtomorrows.com.

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