Using Structured Settlements to Mitigate Higher Tax Liability
The Tax Cuts and Jobs Act (TCJA), signed into law at the end of 2017, had a significant impact on how individuals and trusts are taxed. This article will explore the changes that are most relevant to injury victims and strategies for avoiding or mitigating the increase in tax liability.
First, it will be helpful to briefly review how trusts are taxed because trusts are a prudent way for injury victims to manage settlement proceeds. For the most part, trusts are taxed in the same way that individuals are taxed. Distributed income is taxed at the beneficiary’s tax rate and results in an income deduction for the trust. Accumulated income is taxed at the same rate as the trust. Injury victims with a resulting disability and public benefits, such as SSI or Medicaid, may find it necessary to place their funds in a Special Needs Trust (SNT) to protect benefit eligibility. Injury victims without those needs may wish to use a settlement management trust to preserve funds for the future. First-party trusts (those funded with the beneficiary’s own funds, like those from a settlement) are considered grantor trusts. All income and expenses of a grantor trust are attributable to the “grantor,” who is generally also the beneficiary. For this reason, an injury victim who has or is considering setting up a first-party trust must understand how the new tax laws impact taxation of their trust.
As part of the TCJA, many of the deductions previously available to trust beneficiaries have been eliminated, resulting in higher taxable income across the board, even if the beneficiary took no distributions. This hurts beneficiaries with high trust administration expenses because those expenses can no longer be deducted from the trust’s income.
The impact of the new tax law was felt especially hard for anyone under the age of 19 (24 if the person is a college student) due to an increase in “Kiddie Tax” rates. Prior to the TCJA, a child’s unearned income (such as that received from a trust) beyond the threshold of $2,100 was taxed at the parent’s rate. The amount the child receives beyond the threshold is now taxed at the same rate as trusts and estates. Adults pay the highest tax rate (37%) when their taxable income exceeds $600,000. Trusts pay at this rate when taxable income reaches only $12,500. This means that instead of paying at the same tax rate as their parents, a child whose trust income exceeds $12,500 will now jump into the top tax bracket. In some cases this will increase the tax bill by thousands of dollars, potentially doubling it from just a year ago.
What this means for injury victims, particularly injury victims who are minors, is that careful preparations must be made for funds received from settlements. One strategy for avoiding this tax is to utilize a structured settlement as a funding mechanism for the trust since these payments remain tax-free. It is important to remember that if a structured settlement is selected, payment from the defendant must go directly to the selected life insurance company. If funds are received by the plaintiff or the plaintiff’s attorney, the funds will be considered actually or constructively received and a structured settlement will no longer be an option.
For the injury victim who also has public benefits, such as SSI or Medicaid, payments can be made from a structured settlement into a Special Needs Trust (SNT) to protect eligibility. Special language is required in the settlement documents to accomplish protection of the structure from being countable income. Further, selecting a trust with low administrative expenses is even more important because the cost is no longer deductible. A solution that keeps these costs low is utilizing a pooled special needs trust. These trusts are operated by non-profit organizations and the cost of administration (trustee fees, investment costs, etc.) is shared by those who have sub-accounts within the pool. This means costs are much lower than private banks but provide many of the same benefits, like having access to a corporate trustee.
Pooled Trust Services created pooled settlement trusts specifically for the types of personal injury settlements discussed above. The Settlement Management National Pooled Trust (SMNPT) is a pooled settlement management trust that offers injury victims a low-cost trust solution for their settlement. By joining the SMNPT, an injury victim can protect their settlement proceeds, have professional management of their money with affordable trustee fees and obtain needed healthcare coverage through the Affordable Care Act.
Pooled Trust Services also offers a pooled SNT that can be used anywhere in the United States for clients who are disabled and are receiving SSI/Medicaid. The Settlement Solutions National Pooled Trust (SSNPT) is a low-cost SNT solution. SSNPT’s fees are among the lowest in the country. Even though it is low cost, it has world class customer service and unique features. For example, this trust partners with TEAM services for those family members who are being paid as caregivers. This allows them to work on behalf of their family member yet have workers’ compensation coverage in addition to having payroll automatically handled.
The trustee of both the SMNPT and SSNPT is the Foundation for Those with Special Needs a 501(c)(3) non-profit created specifically to act as trustee for trusts such as this. The investment advisory services are provided by True Link Financial. Trust participants have access to the True Link Visa card to make using their trust money easier and faster. SMNPT and SSNPT offers safety, protection, and growth for injury victims at an affordable price.
To learn more, visit www.pooledtrustservices.com