A Charitable Gift Annuity Can Make Payments to a Special Needs Trust

A special needs trust is a type of irrevocable legal arrangement established for the benefit of an individual with physical or mental disabilities while at the same time allowing the beneficiary to receive essential needs-based governmental assistance. A parent, grandparent, guardian or a court typically creates a special needs trust, also known as a Third Party trust.  Some special needs trusts are set up with assets that the person with disabilities already owns, such as an inheritance or a legal settlement, and are called self-settled trusts, or First Party trusts.

A donor can direct the payments from a charitable gift annuity to a third-party special needs trust. The measuring term of the gift annuity is based on the life of the disabled beneficiary of the special needs trust. Payments from the annuity continue for the lifetime of that individual. The payments from the special needs trust are made at the discretion of the trustee of the trust. For the disabled individual to continue to qualify for governmental assistance, the annuity payments must be directed to cover the costs of special care, not those associated with basic care.

The special needs trust itself reports its own items of income, deduction and credit. The trust receives a deduction when it makes a payment to the disabled beneficiary. This acts as a counterbalance to the rules of IRS Sec. 662 that apply to complex trusts. The distributions to the beneficiary are included in the income of the trust beneficiary.

The taxation of a first party trust (created because the donor has a legal obligation to support the disabled person) is governed by the grantor trust rules. The grantor trust rules make the income tax and estate tax taxable to the person who created the trust. As such, the grantor (the person who created the trust for the disabled beneficiary) pays the income and capital gain tax generated by the trust rather than the disabled beneficiary or the trust.