For example, recipients of supplemental security income (SSI) are entitled to receive $20 of unearned income per month without reduction in SSI benefits. Receipt of unearned income in excess of $20 per month, however, results in a dollar-for-dollar reduction in benefits.

Because distributions from special needs trusts are considered unearned income, distributions in excess of $20 per month result in a benefit reduction. In addition, using trust property to provide food or shelter for the person with a disability results in unearned income as well.

How can this limitation on trust distributions be avoided?

Have the special needs trust purchase items for the person with a disability and retain ownership, permitting the person with a disability to use, but not own, the property, and do not use the special needs trust to provide food or shelter.

Under the SSI eligibility rules, special needs trust distributions that do not result in the person with a disability receiving food or shelter, or anything that can be used to obtain these items, do not count as unearned income.

Thus, the trustee can use the special needs trust assets to pay for items such as vacations, recreation and leisure activities, companion or housekeeping services, special job training, vocational or employment supports, lawn care, laundry services, CD players, television sets, VCRs, computers, medical insurance, improved medical or dental care, telephone bills, or furniture without any reduction in benefits.

If, instead, the trustee were to give the person with a disability the money to pay for these items, the distribution to the person with a disability would count as unearned income, resulting in a possible reduction in benefits.

Similarly, if the person with a disability were to actually own, rather than merely have the right to use, the item purchased, the receipt of the item would be considered unearned income because the item could be sold and converted to cash.

The trustee will also be required to perform various administrative functions related to the special needs trust. The trustee will need to obtain a taxpayer identification number and file annual tax returns.

Generally trust income that is used for the beneficiary will be taxed to the beneficiary, and the trustee may need to help the beneficiary with his or her taxes as well. Trust income that is not used for the beneficiary will be taxed directly to the special needs trust.

The trustee will generally have a fair amount of discretion in investing trust assets, but investments should generally be conservative in order to preserve the property in the special needs trust for the benefit of the person with a disability.

Investment in tax-exempt securities may be advisable both to protect the special needs trust property and due to the generally high rate of tax applicable to trust income.

The trustee will need to keep good records of trust income and expenditures both because the special needs trust document is likely to require that accountings be provided to a person specified in the document, and because trust activity may later be questioned by the government to make sure that the trust has not been administered in a way that affects the beneficiary's entitlement to government benefits.

The trustee will also need to be sure to avoid commingling property in the special needs trust with other property owned by the trustee or the beneficiary of the trust.

Copyright (c) 2007 L. Mark Russell