Skip to main content
A Better Partnership


May 2013
May 01, 2013

Estate Planning Tip: Medicare Surtax May Hit Some Special Needs Beneficiaries

In an example of the law of unintended consequences, the 3.8% Medicare surtax may end up hitting some of the neediest Americans – beneficiaries of special needs trusts.

Beneficiaries of special needs trusts are typically disabled persons who are unable to work and, therefore, are usually low income. Parents or other relatives are often motivated to leave inheritances or gifts to these persons in special needs trusts to allow a trustee to manage the assets for the disabled person and to preserve eligibility for means tested government benefits.

With the adoption of Obamacare, Congress imposed a new tax intended for high-income earners to help pay for Medicare. The new tax is imposed on “net investment income,” which to keep things simple can pretty much be defined as income other than wage income. The tax kicks in only at the highest tax bracket for each category of taxpayer.

The problem is that the highest tax bracket for trusts is reached at a relatively low income level - $11,950 in 2013. Another Congress some years ago apparently decided that trusts were tools for the wealthy and tightly compressed the income tax brackets that apply to trusts. As a result, even special needs trusts will pay the 3.8% Medicare tax on relatively low amounts of income.

Now there are several mitigating factors that will make this result less harsh.
  • First, if the trustee spends trust income on benefits for the special needs beneficiary, the income will be treated as having been distributed to the beneficiary and will be taxed at the beneficiary’s presumably lower rate.
  • Second, the trust will likely qualify as a “qualified disability trust.”  That means the trust will get to take the equivalent of a personal exemption, which will allow the first $3,900 of the trust’s income to escape taxation.
  • Finally, if the beneficiary has large medical expenses, as disabled persons often do, they can claim medical expense deductions.  This will allow them to offset trust income that is deemed to have been distributed to them as a result of having been spent on their expenses.

Trustees of special needs trusts could also plan the investments of the trust to minimize currently taxable income and in favor of assets that will appreciate over time so long as the assets are not sold in the current tax period.  Obviously, trustees of special needs trusts will need professional advice more than ever.  


NOTICE. Although we would like to hear from you, we cannot represent you until we know that doing so will not create a conflict of interest. Also, we cannot treat unsolicited information as confidential. Accordingly, please do not send us any information about any matter that may involve you until you receive a written statement from us that we represent you.

By clicking the ‘ACCEPT’ button, you agree that we may review any information you transmit to us. You recognize that our review of your information, even if you submitted it in a good faith effort to retain us, and even if you consider it confidential, does not preclude us from representing another client directly adverse to you, even in a matter where that information could and will be used against you.

Please click the ‘ACCEPT’ button if you understand and accept the foregoing statement and wish to proceed.



+ -