Madison Eubanks

Jul 15, 2024

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Qualified Disability Trusts: Everything You Need to Know

For families planning for individuals with disabilities or special needs, special considerations have to be made to ensure the person is cared for long-term. In some cases, specialized planning tools like qualified disability trusts can be used to achieve certain benefits like tax exemptions or federal aid eligibility. 

At the most basic level, a qualified disability trust (also known as a QDisT or QDT) is a trust that qualifies for a federal tax exemption. It’s a financial planning tool that an individual with special needs or disabilities’ family or caregivers may use to provide for their needs. 

Here, we’ll walk through more on what a QDT is, the requirements for setting one up, the pros and cons of this type of trust, and the circumstances in which one may be used.

What is a qualified disability trust? 

A qualified disability trust is a type of trust that benefits a person who has a disability and receives specific tax benefits as determined by the Internal Revenue Code. Qualified disability trusts are eligible to avoid some of the income tax burdens that occur in other types of trusts. 

For example, if a family created a special needs trust for a child with a disability, and that trust generated income of which part went to pay for the child’s medical needs, any income remaining in the trust could be taxable. For grantor trusts, this income would be added to the grantor’s other income and then taxed the grantor’s rate. For non-grantor trusts, the special needs trust would pay the trust’s tax rate on it, and trust rates top out at 37% for only $15,200 of taxable income (using 2024 tax tables). Either of these options could result in undesirably high tax burdens for the family. 

This is where qualified disability trusts can be useful. Up until 2018, QDTs were afforded the same exemptions as individuals on tax returns. The Tax Cuts and Jobs Act suspended personal exemptions until 2025, but specified that QDTs would still receive a yearly exemption. In 2024, the exemption was $5,050 for qualified disability trusts. 

Who needs a qualified disability trust and what are the requirements? 

In many cases, a qualified disability trust is created by the parents or grandparents of an individual with special needs. 

In order to be eligible for tax exemptions, a qualified disability trust has to meet several requirements as determined by the IRS. 

Here are some of the key qualified disability trust requirements: 

• A QDT must be a third-party trust, meaning that all of its funding must come from someone besides the disabled beneficiary. 
• The trust must be irrevocable. 
• The disabled beneficiary must be under 65 years old when the trust is funded. 
• The disabled individual must be the trust’s sole beneficiary. 
• The beneficiary’s disability must be included in the definition of disabled pursuant to the Social Security Act. 
• The trust must be a non-grantor trust whose income is reported annually on an IRS Form 1041.

If the trust fails to meet any of these requirements, it will not be considered a qualified disability trust and therefore will not receive the associated yearly tax exemption. 

What are the pros and cons of a QDT? 

There are several advantages of establishing a qualified disability trust. As mentioned, a QDT receives a yearly tax exemption ($5,050 in 2024) that other types of trusts do not, reducing the trust’s income tax burden. 

A QDT can also allow a disabled individual to maintain eligibility for public benefits like Medicare. If the beneficiary received the funds outright, they would likely forego any public benefits they might have qualified for. 

A qualified disability trust also avoids the Kiddie Tax, a tax intended to prevent parents from claiming income under their children’s names to achieve a lower tax bracket. 

As with any trust, there are potential consequences to consider with a qualified disability trust as well. Setting up and maintaining a QDT can be administratively complicated and the associated legal fees, trustee fees, and other administrative expenses can be costly. 

Additionally, the tax implications of a QDT should be carefully considered before establishing one—especially since this type of trust is irrevocable. Even though a QDT’s yearly tax exemption can shield a portion of the trust’s income, the remaining income will be taxed at trust rates, which can be significantly higher than tax rates for an individual. 

What are the tax exemptions for a qualified disability trust? 

Originally, a QDT’s income was subject to the same tax exemptions as an individual. This meant there would be a fixed dollar amount adjusted for inflation each year. The Tax Cuts and Jobs Act suspended personal tax exemptions from 2018 to 2025. This would have also eliminated the tax benefits provided to QDTs as well, but the same act established that there will be an exemption allowed for QDTs in any year when personal exemptions don’t exist. 

The qualified disability trust exemption for 2024 is $5,050, up from the $4,700 in 2023. This means that, in 2024, the first $5,050 of a QDT’s income won’t be taxed. 

Is a qualified disability trust a special needs trust? 

In many cases, a qualified disability trust can also be classified as a special needs trust, but there are key differences between the two types of trusts. 

Essentially, a QDT’s primary purpose is to achieve tax benefits, while a special needs trust (SNT) is mainly intended to protect the disabled individual’s government benefit eligibility. 

Each type of trust has advantages and disadvantages depending on the grantor’s situation and the beneficiary’s unique needs. It’s important to enlist the help of a planning professional to select which type of trust will best serve the family’s and the individual’s needs over time. 

Read more about planning for individuals with special needs in this comprehensive guide.

The information provided here does not constitute legal, financial, or tax advice. It is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with an estate attorney, financial advisor, or tax professional who can advise as to your particular situation.