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 and Credits for Special Needs Families
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
- Additional costs for Braille versions of books and magazines
- A guide dog or other assistance animal
- Qualifying special schools
- Premiums for qualified long-term care insurance
- Medical-care improvements to a home
Taxpayers should use Schedule A, alongside their 1040 tax, return to claim these deductions.
Employment 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 taxpayers can deduct these business expenses on a Schedule C, E or F. Taxpayers working for an outside employer can use Form 2106 for “Employee Business Expenses” and use Schedule A to list the amount on Form 2106 related to impairment.
Parents of Disabled Children
Parents and guardians can also qualify for special tax exemptions, deductions, and credits if their child is permanently and totally disabled, regardless of that child’s age. Parents can also claim a dependency exemption for a qualifying child or relative who works at a sheltered workshop (a supervised workplace for adults with a physical or intellectual disability). Any income the disabled worker earns at the sheltered workshop could be exempted from the parent’s gross income.
Parents may qualify for Federal tax credits, including an adoption credit for a child with special needs; the Earned Income Tax Credit (disabled children qualify no matter their age); and the Child and Dependent Care Credit, which covers the cost of necessary in-home care for a dependent or spouse regardless of the disabled person’s age.
The IRS provides instruction books for tax credits and deductions for blind, elderly disabled, and other disabled taxpayers who work (see the 2022 version here). Individuals with special needs may also qualify for tax breaks related to flexible spending accounts and health savings accounts. If the taxpayer is able to obtain a letter of medical necessity (LMN) confirming that special education qualifies as a medical need, tuition can qualify for a tax break.
Tax payers must navigate whether sources of income might interfere with their eligibility for disability-related tax benefits. For instance, Social Security disability benefits may be taxable if the taxpayer receives money from other sources, such as dividends or tax-exempt interest. This is the formula used: if half of the taxpayer’s Social Security benefits plus all of their remaining income is greater than the base amount for the taxpayer’s filing status, benefits are considered taxable.
Currently, the base amount is $25,000 for a single taxpayer, head of household, qualifying surviving spouse, or married filing separately and living apart from the spouse for the entire year. The base amount is $32,000 for married filing jointly, and $0 for taxpayers who are married filing separately and who lived with their spouse at any time during the tax year.
ABLE Accounts
For years, individuals with disabilities could hold no more than $2,000 in assets before they risked losing their Social Security benefits. Today, two types of savings vehicles provide a way around this. The first is known as an ABLE account.
ABLE accounts now make up a $1.5 billion market with over 150,000 accounts nationwide. This option became available through the Achieving a Better Life Experience Act. Proponents pointed out that parents had tax-advantaged ways to save for their children’s education (such as 529 accounts), but parents of special needs children had no such vehicle.
Generally, the ABLE account holder’s disability onset date must have occurred before age 26. The account holder must be receiving Supplemental Security Income, Social Security disability insurance benefits, or meet other disability test requirements.
An individual is only allowed to hold one ABLE account, but anyone age 18 or older can open one (although certain states have a two-figure contribution minimum). Yearly contributions are capped at the same limit as the federal gift tax exclusion, which was $17,000 in 2023. The total aggregate account limit typically matches your state’s limits for 529 accounts. Since these contributions are after-tax dollars, they are not deductible on federal income tax returns. Some states may offer their own deductions and tax credits.
ABLE funds can go toward any qualified expenses such as education, housing, healthcare, transportation, assistive technology, and legal/administrative fees. Withdrawals for non-qualified expenses that usually incur income taxes on the portion of the withdrawal that consists of investment earnings and a 10% tax penalty.
Additional details:
- Disabled workers are allowed to save a total of $30,590 in their ABLE accounts under the Able to Work Act (this amount is higher in Alaska and Hawaii).
- Contributions may also qualify for the federal Saver’s Credit.
- Funds from a 529 education savings account are now eligible for a one-time rollover into an ABLE account.
- The first $100,000 in an ABLE account will not affect Social Security benefits.
Special Needs Trusts
Special Needs Trusts (SNTs) are a more established planning tool that can typically hold much more in value than an ABLE account. Assets in an SNT do not affect eligibility for Social Security benefits because the SNT beneficiary does not own the assets in the trust.
Special Needs Trusts can either be first-party trusts or third-party trusts. First-party SNTs are created for the beneficiary with their own money. Sometimes this money has been granted through a lawsuit related to the cause of the disability. From a tax perspective, SNTs are treated as “grantor trusts,” which means that all income earned by the trust is taxable and must be reported on the beneficiary’s personal income tax return.
The trust may need a separate taxpayer identification number, which will generate a Form 1099 to the trust. The trustee may also need to file Form 1041 to report “U.S. Income Tax Return for Estates and Trusts” and a “Grantor Trust Information Letter.”
Third-party Special Needs Trusts are created so that others can make contributions to provide for the needs of a disabled person. For tax purposes, these are generally considered “complex trusts” or “qualified disability trusts.” This will require a more complete 1041 form than for a first-person trust. The trust itself will be responsible for its own tax reporting. Certain trusts, such as a pooled Special Needs Trust, may be overseen by an organization that provides special needs services. In this case, that organization would file tax forms for the trust.
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.
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.
By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
Founder, California Retirement Advisors