SPECIAL NEEDS TRUSTS AND THEIR IMPORTANCE
FOR ASSET PRESERVATION
In the area of asset preservation, the particular areas of concern may pertain to tax avoidance, avoiding claims of third parties, protecting or obtaining eligibility for public benefits, or preserving or providing for liquidity needs of a decedent’s estate.
Why is asset preservation and special needs planning so important?
A trust of one or another type will generally be the most efficacious and flexible vehicle for addressing these issues. See Clifton B. Kruse, Jr., Third Party and Self-Created Trusts, Third Edition, ABA Section of Real Property, Probate and Trust Law (2002).
Using Trusts for Asset Preservation.
"Absolute" discretion with no objective standard makes the trust a fully discretionary trust which can likely be immune from the claims of creditors if spendthrift provisions are used, and possibly, but not necessarily, protected from claims of Medicaid agencies and other third parties.
"Absolute" discretion with instructions not to make distributions that would reduce or replace government benefits is the basis of a "special needs trust."
Although not intended to represent an exhaustive analysis of Indiana law on the issue of third-party created trusts where the settlor retains no beneficial interest, the following may be expository:
What works and what doesn’t?
Trusts must be irrevocable in order to protest assets. Be aware, however, of the gift tax and other tax implications of irrevocable and other trusts.
Trusts can be used if planned effectively to protect assets for a beneficiary who is receiving public benefits or who may require long-term care.
The chart attached as Exhibit "A" identifies various types of trusts, how they are created, and the Medicaid and other implications of those trusts.
Self-settled versus third-party trusts.
Personal injury cases.
Alternatives to trusts for the preservation of assets.
Transfers of Assets Generally.
There is currently no penalty, speaking generally, for a person at home receiving regular Medicaid except in the case of certain waivered services (Home and Community-Based Services under the Developmental Disabilities, Autism, Assisted Living, Support, Service or Medically Fragile Children’s Waivers).
The applicable penalty period is determined by dividing the value of the property transferred by a set rate.
The following are the major changes between pre-DRA and DRA transfers.
Transfers before 11/01/09
Transfers On or After
3 years; 5 years for some trusts
Beginning date of Penalty
Month After Transfer
When otherwise eligible for Medicaid with an approved application or month in which transfer occurred, whichever is later
Treated separately unless occur in same or consecutive months
Add them all together
Partial month penalties
No partial month penalties; round down to nearest whole number of months
Can be partial month penalties. Calculated as number of months and days.
Remember that it is the penalty period which controls and not the look-back period.
SSI Trust and Transfer Rules.
The "penalty period" (that period of time during which a person cannot receive SSI because of a transfer) can never be more then 36 months, while there is no "cap" on Medicaid transfers except to the extent that the "look-back period" applies, and is calculated by dividing the amount gifted by the maximum SSI benefit (federal benefit plus state supplement, if applicable) which the individual could receive based upon his or her living arrangement (in 2010, $674 for an individual and $1,011 for a couple).
As in the case of Medicaid, certain transfers of a home may be exempted (e.g., if to the spouse of the transferor, a child of the transferor who has not attained 21 years of age or is blind or disabled, a sibling of the transferor who has an equity interest in the home and who resided in the transferor’s home for a period of at least one year immediately before the date the transferor becomes institutionalized, etc.), as well as other transfers of resources to the spouse, and transfers to certain Medicaid exempt trusts.
Under current SSI regulations, anything received by an individual during the course of a month, such as the settlement of a personal injury case, is income. It does not lose its character as income and become a resource until the first moment of the following month. Consequently, the transfer of the settlement proceeds may affect SSI during future months, and of course, in any event, the receipt of "income" in the month of receipt will affect the SSI benefit for that month.
The SSI transfer penalty rules apply only to transfers occurring on or after December 14, 1999. No penalty applies to transfers that took place before that date. Also, transfers giving rise to a penalty may be "cured" by the person to whom the gift was made by returning the gift to the transferor. Again, as previously noted, there are many exceptions to the transfer rules, as in the case of Medicaid, such as a trust for the benefit of a blind or disabled child, and so called "under age 65" (d)(4)(A) trusts and a (d)(4)(C) "pooled trust."
Benefit programs that will not be considered in this presentation since they are not based on need:
Benefit programs based on financial need:
Although a complete analysis of veterans benefits will not be addressed in this presentation in any significant way, the following matters should be noted:
Housebound benefits are available to a veteran or widow(er) who is determined to be disabled and essentially confined to the home.
A&A benefits are available to a veteran or widow(er) or a veteran who is blind, living in a nursing home, or unable to attend to certain activities of daily living.
For the permissible family income limits to precede either housebound or A&A benefits, seewww.va.gov.
Veterans may obtain free assistance with filling out the application from accredited veterans service organizations. Organizations or individuals, including attorneys, are not permitted to charge fees for assisting a client with the application process. However, if the claim is denied or approved for less benefits than expected, the claimant may hire a paid representative to assist in the appeal. An advisor may also charge for planning and advice.
Other VA benefits that will not be addressed include claims for dependency and indemnity compensation and VA health care.
For the purpose of determining VA pension benefits, the assets in a self-settled special needs trust must be considered in determining eligibility for a VA pension. Department of Veterans Affairs, Office of the Regional Council, Washington, DC, VAO Pg. Cp. Rec. 33-97.
Types of Special Needs Trusts.
In general, a third party trust does not need to be established for the "sole benefit" of a beneficiary, and can include a number of beneficiaries. Consequently, more tax planning opportunities are available, including the ability to distribute IRA and other qualified distributions among a number of beneficiaries in order to avoid the income tax "trapping" problem that can exist in the case of a "sole benefit" special needs trust.
42 U.S.C. §1396p(d)(4)(A) [SSA §1917(d)(4)(A)] Trusts.
This type of trust does not give rise to a Medicaid transfer penalty, and the assets in the trust are protected as long as they are used to provide for the "supplemental needs" of the beneficiary and not for support.
The assets transferred for the beneficiary might be funds received from an inheritance or a personal injury settlement. The excess resources could be transferred to a (d)(4)(A) trust without incurring a Medicaid penalty. The beneficiary’s eligibility for Medicaid and SSI would not be affected.
The income will be attributable to the beneficiary for income tax purposes, in most instances, but as long as it is used to provide for the beneficiary’s "special needs," no disqualification for Medicaid or SSI should occur.
Upon the death of the beneficiary, however, the remainder must be made available to the state Medicaid agency for reimbursement of medical assistance. This is the so-called "pay-back requirement."
Attached as Exhibit "B" is a form of (d)(4)(A) trust.
Remember that for all forms of special needs trusts based on disability, the definition of "disability" is the same definition contained in the Social Security Act for determining eligibility for SSI or SSDI. 42 U.S.C. §1382c(a)3A. If a special needs trust is being considered before the beneficiary has been determined to be disabled by the Social Security Administration, consider obtaining an advisory opinion from an experienced Social Security Disability attorney as the foundation to proceed in drafting the special needs trust. The POMS provide that if there has not been a determination of disability, the case can be sent for a medical determination after the trust has been established. POMS SI 01150.121.
A self-settled trust of this type may be helpful to deal with a tort recovery, an inheritance or any other unanticipated payment. Although certain payments might be deemed to be income rather than assets, an irrevocable assignment of child support or alimony payments made directly to a trust as a result of a court order are not income, as long as the assignment is irrevocable. POMS SI 01120.200G.1.d.
Payments under a structured settlement received after age 65 do not disqualify the trust from self-settled special needs treatment, so long as the structure was in place prior to age 65.
A (d)(4)(A) trust must be established for the "sole benefit" of a beneficiary.
42 U.S.C. §1396p(d)(4)(B) [SSA §1917(d)(4)(B) Trusts.
The SIL (or maximum income) for waived services is $2,022 as of January 1, 2009 (which did not change for 2010). This is equal to 300 percent of the maximum benefit payable under the SSI program, and increases annually when SSI increases in January of each year. In the case of an individual with a large monthly income who may be diverted from a nursing home to the home under the home diversion waiver, if the Medicaid recipient’s income level is greater than the SIL, the individual would be ineligible for Medicaid for the purpose of the home diversion waiver. In other words, the individual could be eligible for Medicaid in the facility, utilizing the spousal impoverishment rules, but lose eligibility when he returns home under the diversion waiver because of the excess monthly income. Utilizing the (d)(4)(B) trust can avoid this result.
Attached as Exhibit "C" is a form of (d)(4)(B) trust. See also Regan, Morgan and English, Tax, Estate & Financial Planning For the Elderly, Section 10.13([b]) p.10-133 et seq (2009).
42 U.S.C. §1396p(d)(4)(C) [SSA §1917(d)(4)(C)] Trusts.
Essential SSI (d)(4)(A) elements.
Some regional offices have published regional instructions relating to what is necessary to have a valid irrevocable trust under state law. In certain states, the trust must specify a particular person or entity as the residual beneficiary. While "children," "issue," or "descendants," is specific enough, "heirs" or "my estate" are not sufficient terms.
In certain states, any residual beneficiary, even an unborn child, is adequate for the purpose of establishing irrevocability. In others, as long as the trust names a residual beneficiary other than an unborn child, then the trust would be considered to be irrevocable. If the residual beneficiary is an unborn child or children, and the grantor has no child or children, and there is evidence that the grantor is unable to have children, then the trust might be considered to be revocable.
In certain states, if a specific person or entity is designated, it would also be permissible to name in addition an estate or heirs to establish a sufficient residual beneficiary.
Be careful of structured settlements, particularly if parents may be receiving annuitized payments in addition to the amount used to fund the child’s (d)(4)(A) trust. Since structured settlement annuities may be liquidated, they have been treated as a resource in some cases, even if the amount of the deemed income to the parent would not adversely affect the child’s SSI eligibility.
There are a number of definitional provisions in the POMS, such as the "fiduciary," the "trustee," and the "trust beneficiary," etc. See POMS SI 01120.200B.
Special Needs Trust ("SNT") Basics.
For SSI purposes, a discretionary trust is "a trust in which the trustee has full discretion as to the time, purpose and amount of all distributions."
The Medicaid trust rules are somewhat different:
Self-settled trusts will generally be considered available for SSI purposes unless created prior to January 1, 2000, in which case such grandfathered trusts, if irrevocable and discretionary, in most cases will not be considered to be available until funds are distributed.
"Supplemental needs" (d)(4)(A) trusts for disabled persons under age 65, and (d)(4)(C) "pooled trusts" for disabled persons of any age, are exempted for both Medicaid and SSI purposes.
For "needs-based" benefits, "income" is cash, or anything that can be used for food or shelter.
Income for tax purposes requires an entirely distinct analysis.
An SNT that is the designated beneficiary ("DB") of a retirement plan or account will be subject to the trust income rules found in I.R.C. §§ 641, et seq.
After death of the participant, distributions of qualified dollars are generally taxed as income in respect of a decedent ("IRD"), taxed to the beneficiary when received, with taxation being accelerated if the right to receive the income is transferred by the beneficiary or the decedent’s estate.
If the expected needs of the SNT beneficiary are less than the minimum required distribution ("MRD") from the retirement plan or account, then the SNT may not be the most desirable beneficiary.
Life insurance is an excellent funding vehicle for a special needs trust because of the absence of income tax and Indiana inheritance tax consequences.
Consider including the following provisions in special needs trusts, and in particular first party or "self-settled" trusts:
Consequences of Distributions for Benefit Purposes.
SSI is a "needs-based" benefit requiring disability and imposing resource and income limitations.
The SSI amount is set annually at the federal level and supplemented by certain states (but not Indiana) to meet basic needs for food and shelter.
Receipt of anything not specifically exempted which can be applied, either directly or indirectly, by sale or conversion, to meet basic needs of food and shelter, will be treated as income.
A trustee’s payment to a third party not providing a disabled beneficiary with food or shelter does not cause disqualification or diminution of benefits.
Trust ownership or purchase of home:
Although SSI criteria in the case of SNTs may be more restrictive than the Medicaid criteria, Ramey v. Rizutto, 72 F.Supp.2d 1202 (D.C. Colo. 1999), aff'd Ramey v. Reinertson, 268 F.3d 955 (10th Cir. 2001), held that an individual who is eligible for SSI under the federal social security regulations cannot be denied Medicaid benefits by the application of more restrictive state laws or regulations.
Indiana Medicaid Income Differences.
The Indiana income standards will increase annually in the same percentage amount that is applied to SSI benefits under 42 U.S.C. 1382(f).
See 405 IAC 2-3-3, et seq.
Special Needs Trust Drafting and Administration Issues.
The trust should state that the trustee is to consider the best interest and needs of the disabled person over all others, including the Medicaid program.
All distributions should be made with knowledge and awareness of the income and resource implications.
The family may consider giving special instructions to the trustee for guidance in the administration of the trust for the principal beneficiary.
What specific medical issues need to be addressed, such as medications that he/she takes and who are his/her medical providers?
Is he/she employed and what are his/her work capabilities?
What foods does he/she like and what are his/her eating habits?
Does he/she like to travel, and what are his/her entertainment preferences?
Is he/she able to vote, and if so, how much assistance does he/she need?
What are his/her funeral preferences?
Are there any eccentricities that should be considered?
Tax issues in the planning and administration of special needs trusts.
Where a grantor is treated as the owner of the trust and the trustee is not the grantor, then the trustee may choose between two approaches for tax reporting:
Generally, and as noted previously, the practical result of undistributed income if the SNT is not a grantor trust is usually an increase in the income tax liability because of the compressed trust tax rates.
IRC §642(b)(2)(C), enacted by the Victims of Terrorism Tax Relief Act of 2001, PL. 107-134, §116(a), provides that a "qualified disability trust" is allowed a personal exemption equal to the IRC §151(d) personal exemption for an individual.
For income tax purposes, the grantor of a trust may be the beneficiary who furnished the trust funds in a self-settled trust, who may not necessarily be the individual named as the grantor in the trust agreement.
When creating self-settled trusts, practitioners often include provisions to have the trust treated as a grantor trust:
The income tax grantor treatment may be different then the estate tax treatment.
If a parent establishes a third party special needs trust and is designated as the trustee, and retains the power to accumulate income for the child’s benefit, or if distributions will be made at the parents’ discretion which is not covered by an ascertainable standard, the trust assets would be taxed in the parents’ estate for federal estate tax purposes.
Other trust provisions.
Spendthrift provision - the trust should contain a provision protecting the trust assets from the claims of the beneficiary’s creditors.
Authorizing trustee compensation and payment of fees, taxes and administrative expenses.
Amendment by the trustee or court as necessary to comply with applicable federal and state laws, regulations and policies concerning SNTs.
Depending on the desirability of doing so, drafting the trust as an intentionally defective grantor trust, or avoiding grantor trust status in order to meet the qualified disability trust requirements of I.R.C. § 642(b)(2)(C).
Fraudulent transfer and related issues.
Related issues of which planners need to be aware: