The Special Needs Trust Exception

Thursday, September 08, 2011 23:24
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The Special Needs Trust Exception

Tags: IRS | tax planning | trusts

In PLR 201116005, the Internal Revenue Service demonstrated a trait that is not at the forefront of most taxpayer’s minds: compassion. 

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In PLR 201116005, the Internal Revenue Service (the Service) addressed whether an IRA designated beneficiary’s transfer of an IRA to a special needs trust, which the designated beneficiary was a beneficiary of, was a sale or disposition for federal income tax purposes or a transfer for the purposes of IRC §691(a)(2). The Service ruled the transfer was not a sale or disposition for federal income tax purposes or a transfer for the purposes of §691(a)(2).

 
In this ruling, the decedent owned several IRAs. The designated beneficiaries of these IRAs were the children of the IRA owner — including a disabled child. The disabled child intended to transfer his share to a trust. This trust was a special needs trust set up to benefit the disabled child.
 
The taxpayer asked whether an IRA designated beneficiary’s transfer of an IRA to a special needs trust, which the designated beneficiary was a beneficiary of, was a sale or disposition for federal income tax purposes or a transfer for the purposes of §691(a)(2).
 
§ 691(a)(1)(B) of the Code provides in part:
 
“… all items of gross income in respect of a decedent which are not properly includible in respect of the taxable period in which falls the date of his death… shall be included in the gross income, for the taxable year when received, of:…the person who, by reason of the death of the decedent, acquires the right to receive the amount...”
 
§ 691(a)(2) of the Code provides:
 
“If a right, described in [§ 691(a)(1)], to receive an amount is transferred by the estate of the decedent or a person who received such right by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent, there shall be included in the gross income of the estate or such person, as the case may be, for the taxable period in which the transfer occurs, the fair market value of such right at the time of such transfer plus the amount by which any consideration for the transfer exceeds such fair market value. For purposes of this paragraph, the term “transfer” includes sale, exchange, or other disposition, or the satisfaction of an installment obligation at other than face value, but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the right of such person to receive such amount by reason of the death of the decedent or by bequest, devise, or inheritance from the decedent.”
 
Furthermore, if the right conferred pursuant to § 691(a)(1) is given to another as a gift, the fair market value is subject to income tax. § 1.691(a)-4(a). A distribution to an IRA beneficiary is also subject to income tax. Rev. Rul. 92-47, 1992-1 C.B. 198.
 
Also, § 677(a) of the code provides in part:
 
“The grantor shall be treated as the owner of any portion of a trust, whether or not he is treated as such owner under section 674, whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be—
(1) distributed to the grantor or the grantor’s spouse;
(2) held or accumulated for future distribution to the grantor or the grantor’s spouse…
 
Pursuant to § 691(a)(2) the value of the IRA transferred to the trust should be included in the gross income of the disabled child. However, the Service ruled that the value of the IRA did not need to be included in the disabled child’s income to transfer the IRA to the trust. The IRS has carved out an exception for special needs trusts, by ruling that moving the IRA into the trust was neither a sale, nor disposition for the purposes of § 691(a)(2). This ruling speaks to the significant discretion held by the IRS. On a lighter note, it also speaks to a trait of the IRS that is not at the forefront of most taxpayer’s minds: compassion.

 

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