Qualified Disability Trusts (“QDisTs”) came into being with the 2001 Tax Act (affectionately known by tax practitioners as “Egg Tray” … the Economic Growth and Tax Relief Reconciliation Act of 2001). Exactly what trusts qualify as QDisTs is not the subject of this article; rather, we will tell you some good news about the effects of the 2017 Tax Act on QDisTs. Actually, two pieces of good news about QDisTs – one new, and one old but which almost no one knows about.
Normally a trust has a Personal Exemption for federal income tax purposes of only $100. EGTRRA changed the tax code in 2001 so that a new kind of trust … Qualified Disability Trusts … got the full Personal Exemption afforded a single individual … in 2017, that number was $4,050.
The 2017 Tax Act did away with the Personal Exemption, however, and instead raised the Standard Deduction for individuals to $12,000, and to $24,000 for a married couple filing jointly. So, most of us thought the usefulness of a QDisT was a thing of the past.
But no! The old Personal Exemption amount is still in force for QDisTs! For 2018, that amount is $4,150.
The Old News
But wait … there’s more! In yesterday’s blog post, we talked about the Kiddie Tax, and the changes to it under the 2017 Tax Act. What is the Kiddie Tax? The unearned income of a child under the age of 18, and some children under the age of 24, is taxed at high rates using the compressed tax brackets applicable to trusts and estates. (Prior to the 2017 Tax Act, the unearned income was taxed at the parents’ top rate. Either way, the idea of the Kiddie Tax was to prevent unearned income from being taxed at a child’s rate which was typically much lower than the parents’.)
Before I get to the good Old News, you need to understand that distributions from a trust (funded by someone other than the child-beneficiary) to or for the benefit of the beneficiary carry out any ordinary taxable income the trust may have to the beneficiary. So, if such as trust had $1,000 of net interest income for the year, and paid for a $1,500 iPad for the beneficiary, that would add $1,000 of taxable income to the child for the year, and would not in turn be taxed to the trust.
So now for the good Old News: since 2006, all such distributions from a QDisT to or for the benefit of the beneficiary are not subject to the Kiddie Tax! Rather, they are taxed to the child, just as though the Kiddie Tax did not exist.
Putting it all together
In sum, this means that a child with a QDisT could (1) get a $4,150 Personal Exemption for income retained in trust, something individuals no longer enjoy; (2) have his/her own $12,000 Standard Deduction; (3) have his/her own ride up the income tax brackets just like any other individual; and (4) have all investment ordinary income of the trust that is spent in the same year for the benefit of the child taxed at the child’s individual brackets/rates, not at the Kiddie Tax rates.
Wow! In other words, Qualified Disability Trusts are better than ever!