Tax and Financial Planning for Special Needs
What Financial Aid Options Are Available for Those Affected by a Disability?
How can those who are impacted by a disability—whether personally or through a loved one— find financial relief? The cost of extra therapy, medications, and special equipment can quickly add up and become overwhelming. For instance, the cost of treating and managing cerebral palsy over a lifetime is estimated at $1.6 million. Even if certain services are subsidized, caregivers may struggle to find the time and energy to explore financial aid options.
Fortunately, the federal government provides a number of tax deductions and credits related to a variety of disabilities. Below we provide an overview of key benefits and details on eligibility criteria. For more individualized assistance identifying tax breaks that could lift a substantial financial burden, consider consulting a Certified Tax Planner.
Federal Tax Deductions & Credits for Disability Expenses
Taxpayers who take the route of itemizing their tax deductions may be eligible for some of the following deductions, income exclusions, and tax credits:
Medical and Healthcare Expenses
Taxpayers can write off any medical and dental expenses that exceed 7.5% of their adjusted gross income (AGI). Adjusted gross income is equal to gross income (wages, dividends, capital gains, business income, retirement distributions, and other income) minus adjustments to income (including educator expenses, student loan interest, alimony payments, and contributions to a retirement account).
This tax deduction can cover the costs of diagnosis, cure, mitigation, treatment or prevention of disease, as well as related equipment, supplies, diagnostic devices, and transportation. Examples of eligible expenses include:
- Prosthetic limbs
- Contact lenses, eyeglasses and hearing aids
- Wheelchairs used for the relief of sickness or disability
- Braille versions of books and magazines
- Service Animals for assistance
- Qualifying special schools
- Premiums for qualified long-term care insurance
- Medical-care improvements to a home
Taxpayers must use Schedule A on their 1040 tax return to claim these deductions.
Work-Related Expenses
Taxpayers with disabilities can claim a business deduction for costs incurred to enable them to work. These “ordinary and necessary business expenses” are not subject to a 7.5% limit. The expenses claimed should not be required or used in personal activities (except incidentally) and cannot be specifically covered under other income tax laws.
- Self-employed individuals claim deductions on Schedule C, E, or F.
- Employees file Form 2106 and report deductions on Schedule A.
Tax Benefits for Parents of Children with Disabilities
Parents and guardians may qualify for exemptions, deductions, and credits:
- Dependency Exemption: Parents can claim a child with a permanent disability, regardless of age.
- Sheltered Workshop Income Exclusion: Wages earned at a supervised workplace may be exempt from the parent’s income.
- Adoption Credit: Tax credit available for adopting a child with special needs.
- Earned Income Tax Credit (EITC): Available for disabled dependents, regardless of age.
- Child & Dependent Care Credit: Covers in-home care expenses for a spouse or dependent.
Tax Considerations for Social Security Benefits
Social Security disability benefits may be taxable if combined with other income sources. The formula determines tax liability based on half of the Social Security benefits plus total additional income.
- $25,000 threshold for single filers, heads of households, and qualifying surviving spouses.
- $32,000 threshold for married couples filing jointly.
- $0 threshold for married couples filing separately who lived together during the year.
Savings & Investment Accounts for Disability Expenses
There are two major financial tools that provide tax-advantaged savings options for individuals with disabilities: ABLE Accounts and Special Needs Trusts (SNTs). These accounts help cover essential expenses while preserving eligibility for government benefits.
ABLE Accounts
ABLE accounts allow individuals with disabilities to save without jeopardizing eligibility for federal benefits. These accounts cover expenses such as education, housing, healthcare, and assistive technology.
Key ABLE Account Features:
- Available for individuals with a disability onset before age 26.
- Contributions are capped at $17,000 per year (2023 limit).
- Account balance can reach $100,000 without affecting Social Security benefits.
- Tax-free withdrawals for qualified expenses.
- Some states offer tax deductions or credits for contributions.
Special Needs Trusts
Special Needs Trusts (SNTs) protect assets while maintaining eligibility for government benefits. Trust funds can provide financial support without counting as personal assets.
Types of Special Needs Trusts:
- First-Party SNT: Established using the beneficiary’s own funds, often from a legal settlement.
- Third-Party SNT: Created by family members or guardians to support a person with disabilities.
- Pooled Trusts: Managed by nonprofit organizations for multiple beneficiaries.
Trustees must file tax forms based on trust type. First-party SNTs are taxed as grantor trusts, while third-party SNTs may qualify as complex trusts or qualified disability trusts. For more information about special needs trusts, watch this video by one of our financial advisors, Arcadia Berjonneau-Keane:
How to Set Up Resources for a Disabled Adult
Let’s look at a real-life example of how some of these benefits and savings vehicles might look.
Todd and Meiying’s son, Alex, is diagnosed with autism at age three. He begins attending a special needs preschool, followed by other special education programs in grade school. This continues until he turns 21 and enters an agency-run residence for disabled adults.
Alex receives Supplemental Security Income (SSI) and Medicaid. His annual medical expenses never add up to 7.5% of $120,000—his parents’ combined adjusted gross income. However, they do pay $1,000 in tuition for Alex to attend special education and therapy. They obtain a letter of medical necessity and use a flexible spending account to pay for the tuition. Todd and Meiying also take the dependency exemption for Alex on their tax return (married filing jointly) even after he enters a sheltered workshop as an adult.
Todd and Meiying also set up a pooled trust with $10,000 for Alex run by the agency that provides his recreational services. They also start an ABLE account and contribute the maximum $17,000 in the first year. Alex’s grandfather contributes the same amount for two more years, bringing the total to $51,000. This is still below the threshold where the asset would affect Alex’s SSI eligibility.
In Summary
Life with a disability comes with innumerable challenges, but missing out on valuable tax reductions and tax-advantaged saving opportunities due to lack of information should not be part of this.
These benefits and programs were established to reduce at least some of the financial burden that comes with caring for a disabled child or adult. To ensure you and your family are aware of the disability-related tax benefits available and to determine whether certain sources of income could endanger these benefits, contact a Certified Tax Planner to receive expert assistance.
Frequently Asked Questions
What tax deductions are available for disability-related expenses?
Medical and dental expenses exceeding 7.5% of adjusted gross income (AGI) may be deducted, covering costs like prosthetics, service animals, and medical equipment.
Can work-related expenses for people with disabilities be deducted?
Yes, business expenses necessary for employment can be deducted, with self-employed individuals using Schedule C and employees filing Form 2106.
What tax benefits exist for parents of children with disabilities?
Parents may qualify for dependency exemptions, adoption credits, the Earned Income Tax Credit (EITC), and child care credits.
Are Social Security disability benefits taxable?
They may be taxable if total income exceeds $25,000 for single filers or $32,000 for joint filers, based on IRS thresholds.
What is an ABLE account and how does it help?
ABLE accounts allow individuals with disabilities to save up to $100,000 without affecting federal benefits, offering tax-free withdrawals for qualified expenses.
How does a Special Needs Trust (SNT) work?
An SNT protects assets while preserving eligibility for government benefits, with first-party, third-party, and pooled trust options available.
Can a Special Needs Trust impact taxes?
Yes, first-party SNTs are taxed as grantor trusts, while third-party SNTs may qualify as complex trusts or qualified disability trusts.
How can families plan financially for a disabled adult?
Families can use ABLE accounts, Special Needs Trusts, and tax deductions to reduce financial burdens and secure long-term stability.
By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
Founder, California Retirement Advisors