When creating a supplemental needs trust (“SNT”) for our clients, we are often asked whether the trust requires a separate Tax I.D. number. The short answer is, “Not until you fund it.” The majority of our clients who create SNTs leave them unfunded until they die, at which point the trust becomes irrevocable and a Tax I.D. number is required.
But not all funded SNTs need a Tax I.D. number, so the short answer probably should be, “Not until you fund it, and then it depends.” Specifically, it depends upon what kind of trust you have – a first party trust, or a third-party trust. A first party SNT, often called a “(d)(4)(A) trust,” is funded with the beneficiary’s own money. That type of trust can use the Social Security number of the beneficiary, and therefore no separate Tax I.D. number is needed, so long as the particular bank or financial institution accepts this approach. All income earned by the first party SNT will be reported on the income tax return of the disabled beneficiary.
A third-party SNT is created and funded by someone other than the disabled beneficiary, for the disabled person’s benefit. Whether a Tax I.D. number is required for the third party SNT once it is funded will depend upon how the trust is drafted. If it is irrevocable, a separate tax I.D. number is required. If it is revocable, and the creator of the trust (the grantor) maintains control of the trust for the benefit of the disabled beneficiary, no separate tax I.D. number is required -- it is considered a "grantor" trust, and all income is taxed to the grantor. If the grantor is not the trustee, but retains other identified rights, then the same rules apply. Alternatively, if the grantor creates a trust and retains no rights to revoke it, change it, benefit from it, or control its distribution, then it is probably a non‑grantor trust and will need a separate Tax I.D. number.
Whether the SNT was funded in life or not, when a grantor who created it and retained rights to make it a grantor trust dies, the third party SNT now becomes a "non‑grantor trust" and a separate Tax I.D. number is required. Annual income tax returns have to be filed for the SNT itself, but the actual tax will be deemed payable by either the beneficiary, or the trust, depending upon what distributions are made. The trust pays tax on capital gains and accumulated income that stay in the trust, while the beneficiaries pay tax on income that is distributed to them. For example, if a supplemental needs trust earned $12,000 in a year, and $10,000 was spent on behalf of the beneficiary, the $10,000 would be taxable to the beneficiary. The remaining $2,000 retained in the trust would be taxed at the trust tax rate and the tax payable by the trustee directly with the tax return filed by the trust.For more information on Supplemental Needs Trusts, contact Karen Mariscal at kbm@Margolis.com.