How to Treat Trusts When Calculating Household Income
When certifying or recertifying households at your tax credit site, it’s not uncommon to discover that a household member is the creator or beneficiary of a trust. If so, you’ll need to account for the trust when calculating the household’s income. If you don’t know how to treat trusts, you’ll make mistakes when trying to determine a household’s eligibility to occupy a low-income unit.
The HUD Handbook sets out rules for treating trusts when certifying and recertifying your low-income households [HUD Handbook 4350.3, par. 5-7(G)(1)]. We’ll explain what a trust is so you can identify trusts that your applicants or households have. And we’ll tell you what the Handbook says to do if you discover that a member of one of your low-income households is the creator or the beneficiary of a trust.
What’s a Trust?
The Handbook defines a trust as “a legal arrangement generally regulated by state law in which one party (the creator or grantor) transfers property to a second party (the trustee) who holds the property for the benefit of one or more third parties (the beneficiaries)” [Handbook 4350.3, par. 5-7(G)(1)(a)(1)].
A trust can contain cash or property that could be converted to cash. Generally the assets are invested by the creator for the benefit of the beneficiaries. You must account for a trust when calculating a household’s income if a household member is either the creator of the trust or its beneficiary.
When Household Member Is Creator of Trust
How you must treat a trust that a household member has created depends on whether the member has access to the income or principal from the trust. Here’s a rundown on what the Handbook says you must do:
Revocable trusts. A revocable trust is a trust that the creator of the trust may amend or end (revoke). When there is a revocable trust, the creator has access to the funds in the trust account. In other words, a household member who’s the creator of a revocable trust may amend or revoke (that is, end) the trust and has access to the trust funds. Because of this, you must treat revocable trusts as assets. To do this, add the trust’s “cash value” (that is, the amount the household member would get if he withdrew all the funds) to the household’s total net assets. Also, add any interest income from the trust to the household’s actual income from assets.
Nonrevocable trusts. A household member who’s the creator of a nonrevocable trust can’t revoke it once it’s set up. And the member can’t access the trust funds.
Because a household member who’s the creator of a nonrevocable trust doesn’t have access to the principal, the Handbook says that you generally must treat this type of trust as an asset disposed of for less than fair market value [Handbook 4350.3, par. 5-7(G)(1)(b)(4)]. This means you must count the principal as part of your asset calculations—but only if the trust was created within two years before the household’s certification or recertification date. After the two-year period is over, don’t include the principal of the trust in your asset calculations.
However, you mustn’t consider a nonrevocable trust as an asset disposed of for less than fair market value if the trust was created using funds received through a settlement or judgment [Handbook 4350.3, par. 5-7(G)(8)(e)]. In any case, if the household member gets interest from the nonrevocable trust, treat this amount as part of the household income (just as you would if it were a revocable trust).
When Household Member Is Beneficiary of Trust
If a member of one of your low-income households is the beneficiary of a trust, how you account for the trust depends on whether the beneficiary gets the funds at once or in periodic payments [Handbook 4350.3, par. 5-7(G)(1)(b)(5)]. Here’s how to handle each situation:
Household member gets full value of trust at once. If the household member who’s the beneficiary of a trust gets all the trust funds in one payment, it’s a lump-sum receipt and must be treated as an asset.
Household member gets periodic income from trust. If the household member gets payments of interest or principal from the trust, you must consider these payments as regular income or gifts and count them as part of the household income.
A household member may be the beneficiary of a “special needs trust,” which is a trust that’s often created for the benefit of a person who’s disabled and can’t make financial decisions for himself. If that’s the case, the household member probably won’t have access to the funds, which means you can disregard the trust when certifying or recertifying the household. However, if the household member gets any income payments, you must count them as part of the household income, just as you would with any other trust [Handbook 4350.3, par. 5-7(G)(1)(c)].