The federal gift tax system is one of the most misunderstood concepts in special needs planning, and for good reason: it\’s incredibly complicated. This complexity has resulted in the propagation of one of the most common estate planning-related myths of all time, namely the idea that you can only give away $14,000 to a person in each calendar year without being taxed. Nothing could be further from the truth, and once you begin to understand how the gift tax system really works, you may be pleasantly surprised to learn that most people can fund a special needs trust for a person with disabilities with a lot more than $14,000 a year.
In order to talk about gifts to special needs trusts, we first have to explain the basics of the gift tax. The federal gift tax is a tax on the giver of a gift, not the recipient, but it only applies once the donor has made more than $5.45 million worth of taxable gifts during her lifetime (in 2016). So, if your total taxable estate is not worth $5.45 million, and if you don\’t expect to give away even close to that amount over the course of your lifetime, then in all likelihood the gift tax is never going to apply to you. If this is the case, it means that you are free to gift as much as you\’d like to as many people as you feel comfortable giving gifts to, and that if you haven\’t made lifetime taxable gifts of more than $5.45 million, you don\’t owe any gift tax when you file the return.
So where does this $14,000 limit on yearly gifts come in? This figure is called the \”annual exclusion\” and it is the amount (which slowly rises every few years) that a donor can give to one person during the calendar year without having to even file a gift tax return declaring the gift. Because you don\’t have to file a gift tax return for these small gifts, they don\’t count towards your $5.45 million lifetime gift total either. So annual exclusion gifts are a good idea if you have a lot of money and you don\’t want to eat up your gift tax exemption. But for most people who don\’t have to worry about gift taxes, the $14,000 annual exclusion amount is irrelevant because, as we\’ve described above, most people don\’t ever pay the federal gift tax. You’ll just have to file a gift tax return along with your federal income tax return telling the government that you\’ve made a large gift.
This brings us back to making gifts to special needs trusts. Due to several obscure and complicated tax rules, gifts to most irrevocable special needs trusts will typically never qualify for the gift tax annual exclusion. (As with all things legal, there are exceptions to this rule, and some trusts can be carefully drafted to actually qualify for the annual exclusion.) In other words, the $14,000 amount that you may be worried about probably has no bearing on a gift to an irrevocable special needs trust; you will always need to declare the gift on a gift tax return. (If the trust is revocable, and the person making the gift into the trust is also the grantor of the trust, then she hasn\’t made a gift at all and no tax return is required.) Therefore, in most cases, a friend or family member who isn\’t a millionaire and who is transferring money into a loved one\’s irrevocable special needs trust can give as much as she wants and will never pay gift tax on the transfer.
The rules governing gift taxes and their interaction with the estate tax system are extremely complicated, so it is critical that, regardless of your financial position, you talk with your special needs planner about the best way to structure gifts to a special needs trust.