The Health and Education Exclusion Trust (HEET) is a dynasty trust intended to pay medical and tuition expenses of persons two or more generations younger than the person who creates the trust. Usually, grandparents create a Health and Education Exclusion Trust for the benefit of their grandchildren. These trusts are created for generation-skipping transfer (GST) tax purposes.
To qualify as a HEET, the trust must have at least one beneficiary that is a charity with a substantial present economic interest. Because a charity is a non-skip-person, by vesting a charity with an interest, the trust avoids taxable transfers either upon creation or at the time of any subsequent distribution, unless the charity was included primarily to postpone or avoid application of the GST. There is no guidance as to the definition of “substantial present economic interest.” Most attorneys consider a 10% unitrust amount paid annually to charity sufficient to demonstrate that the charity is a bona fide continual non-skip-person beneficiary.
A Health and Education Exclusion Trust can be structured as a grantor or a non-grantor trust. A grantor trust would not be diminished by income tax during the grantor’s lifetime. Upon the grantor’s death, it would cease to be a grantor trust and would instead be taxed as a complex trust. A non-grantor trust would be able to maximize the use of the charitable deduction. There are no charitable deduction adjusted gross income limitations applicable to trusts as with individual taxpayers. So, a non-grantor trust may deduct up to 100% of its income for charitable contributions. On the other hand, a non-grantor trust creates an income tax liability for its non-charitable beneficiaries. Distributions paid on behalf of an individual beneficiary may carry out income on behalf of that beneficiary, who would then be required to pay income tax on that distribution under IRC §652 or §662.
The trust should specifically define those distributions that are “qualified transfers,” so that a trustee without familiarity of the Code would have a guide built into the trust document. With respect to education, these include tuition payments to an educational organization described in IRC §170(b)(1)(A)(ii) for income tax purposes (one that maintains a regular faculty and has both a regularly-enrolled body of students and an established curriculum), for the education or training of an individual, if paid on behalf of the skipperson directly to the educational institution. Payments for other expenses, such as books, room, board, and fees–even if they are made directly–are not qualified transfers and would be subject to GST tax upon distribution.
Qualified transfers for health care are defined as payments to any person who provides medical care (as defined in IRC §213(d) for income tax purposes) as payment for such medical care.14 Accordingly, qualified transfers for medical care include medical and long-term care insurance premiums, which are within the definition of medical expenses for income tax purposes. Over-the-counter medications and cosmetic surgery would not be eligible transfers.