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Third Party Special Needs Trusts

Posted by: Thomas D. Begley, Jr.

A. INTRODUCTION

In the course of protecting our client’s eligibility for important public benefits, which often make a huge difference in their quality of life, attorneys are called upon to draft and assist in administering various types of trusts.  We are also expected to counsel our clients as to whether a particular trust is appropriate.  Some of these trusts include the following:

  • Third Party Special Needs Trust
  • Self-Settled Special Needs Trust
  • Pooled Trust
  • Income Only Trust
  • Children’s Trust
  • Donee Trust
  • Disability Annuity Trust
  • Disability Annuity Special Needs Trust

Third Party Special Needs Trusts, Self-Settled Special Needs Trusts and Pooled Trusts are generally used in the context of disability planning while Income Only Trusts, Children’s Trusts, Donee Trusts, Disability Annuity Trusts and Disability Annuity Special Needs Trusts are more commonly used in the context of Medicaid planning.

There are several important issues involved.  Different trusts must be drafted to address different issues.  Recurring issues are:

  • Availability
  • Transfer of Assets Penalty
  • Payback Requirements
  • Risk Factors
  • Tax Considerations

B. BENEFIT PROGRAMS AFFECTING THE DISABLED

Disability is defined in the Social Security Act.[1] It is “The inability to do any substantial gainful activity by reason of any medically-determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than 12 months.”  This means the person must have severe impairment that makes it impossible for him or her to perform his or her previous job or any other substantial gainful activity in the national economy.[2] For a child under 18 years of age disability is defined as a medically-determinable physical or mental impairment that results in “marked and severe functional limitations.”[3] For 2010, “substantial gainful activity” is the ability to earn $1,000 per month[4] if a person is disabled and $1,640 if a person is blind.

In order to determine when the use of a trust is appropriate and what type of trust is appropriate it is necessary to have an understanding of government benefit programs affecting the disabled.  The principal programs are:

  • SSI
  • Medicaid
  • SSD
  • Medicare
  • Federally-assisted Housing

1. SSI

a. Benefits

The purpose of the SSI payment is to provide the recipient with income to be used for food and shelter.[5] SSI is an income maintenance program for poor people.  It is designed to provide recipients with 75% of the federally-defined poverty level.  For 2010, the maximum federal SSI monthly payment for an individual was $674 per month.[6] For a couple, the maximum monthly payment was $1,011.[7] Many states provide a small supplement to the federal benefit.  Any countable income paid to the recipient is deducted from the basic federal SSI payment.  Income is countable whether earned or unearned, and certain in-kind assistance is also deemed as income.

b. Eligibility

There are five eligibility requirements for SSI.

  • Categorical
  • Residence
  • Financial
  • Application for Other Benefits
  • Non-Institutionalization

(1) Categorical

An applicant for SSI must be at least 65 years of age, blind, or disabled.[8]

(2) Residence

An SSI recipient must be a citizen of the United States or a qualified alien and a resident of the United States.  Residency must be for a period of 30 consecutive days.[9] Absence from the United States for a period of 30 consecutive days terminates a person’s rights to SSI, but a new application can be made after a new 30-day period of residency is established.

(3) Financial

SSI recipients must first meet financial tests.  SSI is a means-tested program.

(a) Income

SSI categorizes income as countable and non-countable, earned or unearned, and cash or in-kind.  The first $20 of most income received in a month is disregarded.  Income is defined as “anything a person receives in cash or in-kind that can be used to meet a person’s needs for food or shelter.[10] Certain items cannot be used for food and shelter and are, therefore, not counted as income.  These are found at 20 C.F.R. §416.1103.  Receipt of cash income reduces SSI payments dollar-for-dollar.

(b) Earned income

Earned income is defined as wages before deductions and net earnings from self-employment.[11] However, there are certain exclusions from earned income.  These exclusions include:  federal assistance payments; $10 per month of infrequent income; $65 plus one-half of remaining income per month[12].  Certain special exclusions apply to blind and disabled persons.

(c) Unearned income

Unearned income is defined as all income that is not earned.[13] Examples of unearned income include:  interest; dividends; alimony; annuities; pensions; and, inheritances.  Exclusions from unearned income are limited to tuition scholarships, $20 of infrequent income, and one-third of child support payments to the disabled child.

(d) ISM rules

In-kind Support and Maintenance (ISM) is the receipt of food or shelter furnished by a third party.[14] This will reduce a recipient’s benefits.[15] The idea is that since SSI benefits are specifically intended to pay for a person’s food and shelter, if that person receives food and shelter from another source, then less SSI benefits are needed.  The reduction of SSI benefits for ISM is not on a dollar-for-dollar basis as with cash.  A recipient’s living arrangements determine whether in-kind support and maintenance is valued by the one-third reduction rule or the presumed-value rule.  If a recipient lives in the household of another, the SSI benefit would be reduced by one-third.[16] However, there is no reduction if the recipient pays a pro rata share of the food or shelter expenses.[17]

Where the recipient lives in his or her own household, the “presumed-value” rule does apply.[18] This means that the payment is reduced by one-third of the benefit rate plus $20.

(e) Deeming of income

Income of an ineligible spouse or ineligible parent or sponsor of an alien is deemed to the SSI applicant.[19] Living arrangements determine when deeming occurs.  If the claimant lives in the same household as the ineligible spouse or parent, deeming will occur.  This means that in calculating the income of the SSI applicant, the income of the ineligible spouse or parent living in the same household will be attributed to the SSI applicant.  Income from the sponsor of an alien is deemed to the SSI applicant, even if a residence is not shared.  If a child under 18 lives in the household of a parent, the income of the parent is deemed to the child.  This is why children under 18 seldom receive SSI payments unless their parents have income below the poverty line.  Once a child reaches 18, the income of the parent is no longer deemed to the child.

(f) Resources

As a general rule, the countable resources of a single person cannot exceed $2,000, and the countable resources of a married couple cannot exceed $3,000 if they are living together.[20] “Resources” means cash or other liquid assets, or any real or personal property that a person or his/her spouse own and can convert to cash for support and maintenance.[21]

As with income, resources are deemed.  Living arrangements determine the deeming of resources.  A person living with an ineligible spouse has the resources of the ineligible spouse deemed himself or herself.  A child under 18 years of age living with an ineligible parent suffers the same result.  However, upon the child attaining 18, the resources of the parent are no longer deemed to the child living in the household of a parent.  Similarly, resources of an alien’s sponsor in excess of $2,000 for an individual, $3,000 for a couple, are deemed to the alien.

However, certain resources are non-countable.  These include:  the individual’s home, if it is occupied by the individual as his or her principal residence or, if the person is institutionalized, if the home is occupied by the spouse, or by a child under 21 blind or disabled[22]; household goods and personal effects with a value of not more than $2,000; an automobile with a value of $4,500, unless used for employment or medical treatment or specially-equipped for a handicapped person in which event there is no dollar limit; the cash values of life insurance policies are excluded if the face value does not exceed $1,500 on all such policies; and, burial plot and funds for burial up to $1,500 per individual are also excluded.

(g) Application for other benefits

A person must file an application for SSI benefits and also for any other benefits to which the person may be entitled.[23] Receipt of the other benefits will reduce or eliminate the SSI benefit.  Reduction is on a dollar-for-dollar basis.  This explains why certain disabled persons receive SSI, Medicaid, as well as SSD and Medicare.  For this combination to occur, the SSD payment must be lower than the SSI benefit, which the individual would have received if he or she were not also eligible for SSD.

(h) Transfer penalties

An individual or spouse who disposes of resources for less than fair market value during a 36-month lookback period,[24] the individual is ineligible for benefits for a period of time.  The period is calculated by dividing the uncompensated value of the transfer by the amount of the maximum monthly benefit payable, including any state supplement.[25] The penalty is rounded to the nearest whole number with a cap of 36 months.[26] The penalty begins the first month in or after which resources were transferred which does not occur during any other period of ineligibility.[27]

2. Medicaid

Generally, Medicaid is a welfare program that pays medical bills for the aged, blind and disabled who meet certain requirements.  It is a medical payment program, not a medical insurance program.  Medicaid is means-based with both income and resource testing.  The law is found at 42 U.S.C. §1396 and 42 C.F.R. § Parts 430, 431, and 435.  The Medicaid law is Title XIX of the Social Security Act.

Medicaid pays for a very broad spectrum of medical services including hospital stays, physician services, community-based health care and nursing services, and prescriptions.  It also pays certain housing costs, and for some, vocational and employment services and transportation.  There are no deductibles, co-payments or financial limits on coverage.

3. Social Security Disability

This program is known as the Old-Age, Survivors, and Disability Insurance (OASDI).  It is found at Title II of the Social Security Act.[28] The regulations are found at 20 C.F.R. §404.1 et seq. Unlike SSI, which is a means-tested welfare program, Social Security Disability (SSD) is an insurance program.  Coverage is based on quarters of Social Security insurance coverage during the applicant’s employment.

The disabled wage-earner is entitled to benefits.  The spouse and children of a disabled wage-earner are entitled to Dependent’s Benefits based on the record of the retired wage-earner.  A disabled surviving spouse and surviving disabled or non-disabled children may all be entitled to Survivor’s Benefits based on the record of the deceased wage-earner.

4. Medicare

Medicare is a program that pays the medical costs of eligible beneficiaries.  Unlike Medicaid, which is a welfare program, Medicare is an insurance program.  Medicare pays for acute-care, hospitalization, limited skilled nursing care, doctor’s fees, drugs and medications used in the hospital and home care under certain circumstances.  Home care is the fastest growing area of the Medicare budget and includes some care for the chronically ill.  Medicare has open enrollment at any time without any problem with pre-existing conditions.  This is true of traditional Medicare and Medicare managed care.  The law is found at 42 U.S.C. §1395.  Regulations are found at 42 C.F.R. Parts 405-421.

Medicare is divided into three parts.  Part A covers hospital care, Part B covers physician and outpatient services.  Part C is a new managed care program called Medicare Part C Plus Choice Program, which is essentially a Medicare HMO.

5. SSI/SSD and Medicaid/Medicare Comparison Charts

These two charts are designed to indicate, at a glance, the differences between SSI and SSD, and Medicaid and Medicare.

The chart 2-1 is designed to show at a glance the principal differences between SSI and SSD.

ISSUE SSI SSD
Basis Welfare Insurance
Benefit 75% of Federal Poverty Level Based on Earnings Record
Must Apply for Other Benefits Yes No
Income Limits Yes No
Resources $2,000 Unlimited
Transfer Penalty Yes No
Medical Medicaid Medicare After Two Years
Disability SSA Definition SSA Definition

The chart 2-2 is designed to show at a glance the principal differences between Medicaid and Medicare.

ISSUE MEDICAID MEDICARE
Hospital Coverage Yes Yes
Doctor Coverage Yes Yes
SNF Coverage Yes Severely Limited
Home Care Limited Limited
Deductible, Co-Payments and Limits None Yes
Financing Federal and State Tax Funds Payroll Deduction Taxes and Premiums

6. Section 8 Housing

Section 8 Housing provides for rental assistance for low-income families and individuals.  Income of such applicants cannot be higher than 80% of the locality’s median income.[29] While the program is not limited to the elderly and disabled this group tends to benefit significantly because many live on low fixed incomes.  Section 8 rental housing can be using anywhere.  Assistance is provided to the tenant rather than the project.  The idea is to scatter low-income residence throughout the community.  HUD pays the difference between 30% of the individual’s or family’s income and the established fair market rent.[30] Eligibility is based on income not in excess of 80% of the area’s median income.[31] While there are no transfer penalty rules per se for Section 8 Housing HUD continues to impute income to the individual for the individual’s transferred resources based upon the current passbook savings rate as determined by HUD.  HUD looks back two years preceding the date of application.[32]

C. THE STATUTES AND THE POMS

Statutory authority for Miller Trusts, “Sole Benefit of” Trusts, Pooled Trusts and Self-Settled Special Needs Trusts are found at 42 U.S.C. § 1396p(a), (b), (c) and  (d).  This was originally part of OBRA ’93.  The Foster Care Independence Act of 1999 applies to Self-Settled Special Needs Trust.[33] This applies only to Self-Settled Special Needs Trusts.

POMS §§ SI.01120.200 also govern trusts.

D. KEY ISSUES

The key issues that must be considered in drafting a trust involving SSI, Medicaid or other public benefits are availability, transfer rules and payback requirements.

1. Availability

Whether or not a trust is available depends on the discretion given to the trustee.  Under the POMS trust assets are available if the individual has the legal authority to direct a distribution from the trust for his/her support and maintenance or has the right to revoke the trust.[34] Therefore, a discretionary trust is not available. The POMS defines a discretionary trust as “a trust in which the trustee has full discretion as to the time, purpose and amount of all distributions.  The trustee may pay to or for the benefit of the beneficiary all or none of the trust as he or she considers appropriate.  The beneficiary has no control over the trust.[35] Therefore the discretion of the trustee will really determine the issue of availability.  The discretion of the trustee varies with the type of trust.

a. Support Trusts

The typical trust that a parent creates for a child is known as a support trust.  The trust usually contains language that the funds in the trusts are to be used by the trustee for the beneficiary’s “health, education and support,” “health, education and welfare,” “health and support,” “comfort and support,” or similar language.  It is clearly the intention of the settlor of such a trust that the monies be used to support the beneficiary of the trust.  Support generally includes food shelter, and medical care.  Assets in such a trust are clearly “available” to the beneficiary.

b. Purely Discretionary Trusts

A trust can be drafted which gives the Trustee absolute discretion as to payment of income and/or principal to a beneficiary.  This is a purely discretionary trust.  In some cases, courts have held that the discretion of the trustee must be exercised in a reasonable manner to accomplish rather than thwart the purpose of the trust.  These cases, again, revolve around the intention of the testator/settlor.

c. Discretionary Support Trusts

A discretionary support trust is a hybrid between a support trust and a purely discretionary trust.  The trust is drawn in such a way as to give the trustee the discretion as to whether or not to use income and/or principal for the support of the beneficiary.  The issue is whether or not such trust assets are available.  As always, courts interpret such trust provisions based on the intention of the trust’s settlor.

Pennsylvania has a series of cases that illustrate the difficulty of predicting outcomes where a discretionary support trust is used.  There are five cases.  In three cases, the court held the trust assets to be available,[36] in two unavailable.[37]

2. Transfer of Assets Penalty

A second key issue in drafting trusts is whether or not the funding of the trust constitutes a transfer subject to the transfer of assets penalty rules of the SSI and/or Medicaid. The key to understanding the rules on trusts is to understand when the transfer has taken place.

a. Is the Asset Available After the Transfer?

If there is a transfer from an individual to a trust under conditions by which the trust assets are still available to the individual, there has been no transfer.  Therefore, where the trust is revocable, the assets are still available to the individual after the trust is funded so there is no transfer at this point.  The transfer is considered to have taken place on the date of payment from the trust to the third party.

If the trust is irrevocable, the transfer is considered to have been made as of the date the trust was established, or upon such later date that payment to the Settlor was foreclosed.  However, if the Settlor can still benefit from the assets with which the trust is funded, those assets are still available so there is no transfer.  If and when those assets are paid out to a third party, the transfer occurs.  If the Settlor places assets in an irrevocable trust and can no longer benefit from any of the trust corpus, there has been a transfer of assets when the trust is funded.[38]

The regulations pertaining to trusts under OBRA-93 are found in HCFA Transmittal 64.[39] A trust is defined as including any legal instrument or device that is similar to a trust, but not including testamentary trusts.[40] The individual is considered to have established the trust, if the individual’s assets were used to fund the trust, and if the trust was established by the individual, the individual’s spouse, a person, including a court or administrative body, acting on behalf of the individual or the individual’s spouse, or a person, including a court or administrative body, acting at the direction of the individual or the individual’s spouse.

b. Revocable Trusts[41]

The entire corpus of the trust is an available resource.  Payments to the trust are not transfers, because the assets remain available.  Payments to or for the benefit of the individual are counted as income.  Payments from the trust to third parties are considered transfers.  The lookback period is 60 months.

c. Irrevocable Retained Interest Trusts[42]

(1) Payments

Payments from income or from principal paid to or for the benefit of the individual are treated as income.

(2) Available income

If income could be paid for the benefit of the individual, it is treated as an available resource.

(3) Available corpus

Any portion of the corpus that could be paid to or for the benefit of the individual is treated as an available resource.

(4) Lookback and transfer

This type of trust is the most confusing in understanding the lookback and transfer rules.

(5) Available portion of corpus

To the extent that a portion of the trust corpus is available to the individual, there has been no transfer and there would be no applicable lookback.  If assets are transferred from the trust to a third party from the available portion, the lookback period is three years.  This is inconsistent with the theory that makes transfers from an available revocable trust subject to a five-year lookback, but it is the HCFA interpretation, nevertheless.

(6) Corpus unavailable

Where a transfer has been made to an irrevocable trust and the corpus of the trust is unavailable to the Settlor, the lookback period is five years.  Transfers from the trust assets, which were unavailable to the Settlor, are not considered transfers and there is no applicable lookback period.

d. Calculation of Penalty

For SSI there is a three-year lookback for transfers of resources.  The penalty is calculated by dividing the uncompensated value of the transfer by the amount of the maximum monthly benefit payable, including any state supplement.  See Section B (3) (h).

For Medicaid the penalty is calculated by dividing the uncompensated value of the transfer by the lowest average cost of a nursing home bed in a particular state.  The penalty is not rounded up or down to the nearest whole month, but is determined as a partial month.

3. Payback

The payback provisions are a creature of statute.  They were established in OBRA ’93.  They apply only to Miller Trusts,[43] Pooled Trusts,[44] and Under 65 Disability Trusts or Self-Settled Special Needs Trusts.[45] The Health Care Financing Administration (HCFA) has clarified and confirmed this interpretation in a letter dated January 19, 2001, to Ramon B. Harvey.[46] However, New Jersey does not always follow this clarification.  For example, under federal law a Disability Annuity Trust would clearly not require a payback, but the New Jersey Medicaid agency requires such a provision.  This is ripe for challenge.

4. Risk Factors

If assets are transferred to children, there are certain risk factors to be considered:

  • Creditor.  Assets held by children are subject to claims by the children’s creditors.
  • Divorce.  Assets held by children may become entangled in the children’s divorce.
  • Bad Behavior.  It is foolish to transfer assets to children who are alcoholics, drug addicts or spendthrifts.
  • Financial Aid.  If grandchildren are applying for financial aid to college and assets are transferred to their parents, the grandchild may receive less financial aid or, in some cases, no financial aid because the parent is holding assets of the grandparent.

5. Tax Considerations

  • Gift Tax Limit.  Gifts to children are limited by the $13,000 per person per year annual exclusion amount combined with the $1 million lifetime exemption.  A gift to an intentionally defective grantor trust can avoid these limits.
  • Step Up in Basis.  If a gift is made to children, carryover basis applies.  Where there are highly appreciated assets it may make sense to transfer to a trust to obtain step up in basis on the parent’s death.
  • I.R.C. § 121 Exclusion.  If a home is transferred to children, carryover basis applies.  If a home is transferred to a properly-drafted trust, the I.R.C. § 121 Exclusion for Capital Gains Tax on the Sale of the Principal Residence can be preserved.
  • Income Tax.  If assets are transferred to children, they are responsible for payment of the income tax on any earned income.  The children are usually in a higher tax bracket than the parents.  A trust can be designed so that if assets are transferred to the trust, the parent pays the income tax.

E. ANALYSIS OF TRUSTS BY TYPE

1. Special Needs Trust

a. Purpose

The purpose of a Special Needs Trust is to enrich the life of the disabled beneficiary while maintaining the beneficiary’s public benefits, especially SSI and Medicaid.

b. Statutory Authority

There is no statutory authority for a Third Party Special Needs Trust.  Authority for a Self-Settled Special Needs Trust is found at 42 U.S.C. § 1396p(d)(4)(A).  Additional statutory authority is found at H.R. 3443 Foster Care Independence Act of 1999 § 205.  However, authority for a Third Party Special Needs Trust is found in POMS at Section POMS SI 01120.200 et seq.

c. POMS Considerations When Drafting a Special Needs Trust

Drafting a special needs trust requires designing it in a manner that takes into consideration the Program Operations Manual System (POMS), which is published by the Social Security Administration (SSA) and contains the operating procedures for SSI.  Significant changes were made in 1999 in the sections pertaining to trusts.[47] A discussion of the POMS is instructive.

(1) Trust

The POMS recognize the trust device.  In fact, the POMS contain a definition of a trust.  “A trust is a property interest whereby property is held by an individual (trustee) subject to a fiduciary duty to use the property for the benefit of another (the beneficiary).[48]

(2) Discretionary

The POMS defines a discretionary trust as “A discretionary trust is a trust in which the trustee has full discretion as to the time, purpose and amount of all distributions.  The trustee may pay to or for the benefit of the beneficiary, all or none of the trust as he or she considers appropriate.  The beneficiary has no control over the trust.”[49] The key to the entire issue of “availability” is the discretion of the trustee.  If the beneficiary has no right to compel distribution or to revoke the trust, the trust is discretionary and the trust assets will be unavailable.

(3) Residual beneficiary

When considering a Self-Settled Special Needs Trust, whether the trust has named a residual beneficiary is important in some states in determining whether or not the trust is revocable and, therefore, available.  A residual beneficiary is defined as “A residual beneficiary is not a current beneficiary of a trust, but will receive the residual benefit of the trust contingent upon the occurrence of a specific event, e.g., the death of the primary beneficiary.”[50]

(4) Trusts as resources

SSA follows state law with respect to whether or not a trust is revocable.  Most states follow the general principal that if a grantor is also the sole beneficiary of the trust the trust is revocable, but if there is a named “residual beneficiary” then the trust is irrevocable.[51]

(5) Revocation

In a third party special needs trust, revocation is not usually an issue, because the grantor and the beneficiary are different and a residual beneficiary is named to take the trust assets upon the death of the beneficiary.  The beneficiary, therefore, has no authority to revoke the trust.  Draftsmen do not always include a residual beneficiary and, therefore, revocation becomes an issue.  The POMS state “A beneficiary generally does not have the power to revoke a trust.  However, the trust may be a resource of the beneficiary, in the rare instance, where he/she has the authority under the trust to direct the use of the trust principal.  (The authority to control the trust principal may be either specific trust provisions allowing the beneficiary to act on his/her own or by ordering actions by the trustee.)  In such a case, the beneficiary’s equitable ownership in the trust principal and his/her ability to use it for support and maintenance means it is a resource.”[52] This would apply to a support trust where the beneficiary would have the right to compel distributions from the trust to or on behalf of the beneficiary.

(6) Availability

Thus, the POMS recognize a two-pronged test for purposes of determining “availability.”  If the beneficiary of the trust has no right to revoke the trust or to direct the use of the trust assets for his/her own support and maintenance, then the trust principal is not the individual’s resource for SSI purposes.[53]

The revocability of a trust and the ability to direct the use of the trust principal depends on the terms of the trust agreement and/or on state law.  If a trust is irrevocable by its terms and under state law cannot be used by an individual for support and maintenance, it is not a resource.

This is really the legal basis for a special needs trust.

(7) Disbursements From Trust

A special needs trust must be properly drafted and funded, but it is crucial that it also be properly administered.  These rules apply equally whether the trust is a third-party special needs trust or a self-settled special needs trust.  Improper distributions from a properly-drafted and funded trust can cause the loss of public benefits to the beneficiary of the trust.

(a) Income

“If the trust principal is not a resource, disbursements from the trust may be income to the SSI recipient beneficiary, depending on the nature of the disbursements.  Regular rules to determine when income is available apply.[54]

“Cash paid directly from the trust to an individual is unearned income.”[55] Therefore, it is crucial for the trustee of a special needs trust to have a clear understanding of the SSI income rules and to limit distributions to those expenditures which are appropriate.

“Disbursements from the trust by the trustee to a third party that result in the individual receiving items that are not food or shelter are not income.”[56]

(b) In-kind support and maintenance

Disbursements which result in Receipt of In-kind Support and Maintenance are defined as food or shelter received as a result of disbursements from the trust by the trustee to a third party in the form of in-kind support and maintenance and are valued under the presumed maximum value (PMV) rule.[57] It is often appropriate to make ISM payments and for the beneficiary to have a reduction in benefits.  Therefore, a trust document might contain language authorizing the trustee to make distributions for “food and shelter” for the beneficiary.  The SSI monthly payment may be inadequate to provide the appropriate level of food and shelter for the beneficiary.  As long as the SSI payment is maintained, although at a reduced level, Medicaid eligibility is maintained.

(c) Third party non-income payments

Since these distributions do not result in any reduction of SSI benefit, they are the most desirable types of distributions for a trustee to make.  It is important that the distributions be made directly to the third party, not to the trust beneficiary.  “Disbursements from the trust by the trustee to a third party that result in the individual receiving items that are not food or shelter are not income.  For example, if trust funds are paid to a provider of medical services for care rendered to the individual, the disbursements are not income for SSI purposes.”[58]

These rules are the basic rules for trust administration and define what distributions can be made from a trust, and what the impact of such distributions is on the SSI benefit of the trust beneficiary.  It is crucial that trustees are aware of these rules.

(d) Home ownership

If a third party special needs trust owns a house used as a home for the beneficiary, the house is not a resource to the beneficiary.[59] SSA considers the beneficiary to have an “equitable ownership under a trust.”

The beneficiary living in the home is not considered to be receiving in-kind support and maintenance in the form of rent-free shelter because he/she has an ownership interest.[60] However, the purchase of the home by the trust results in ISM for the month in which the purchase is made.  The ISM is valued at no more than the presumed maximum value (PMV).[61] If the home is purchased subject to a mortgage, each mortgage payment constitutes ISM.[62]

Payment of household operating expenses by the trust constitute ISM.  These include improvements or renovations, including those renovations needed to make the home handicapped accessible.  But, improvements which increase the value of the home are not considered operating expenses and do not constitute ISM.[63]

d. Key Issues – Third Party Special Needs Trust

(1) Availability

Assets in a properly-drafted Third Party Special Needs Trust are not available.  The key is the discretion of the trustee.

(2) Transfer Penalties

There are no transfer penalties for transfers to a Third Party Special Needs Trust if the transfer is testamentary in nature.  If the transfer is made during the lifetime of the third party, the transfer penalties apply.

(3) Payback

There is no payback requirement to the State Medicaid Agency from Third Party Special Needs Trusts.  Those trusts can provide that upon the death of the disabled beneficiary assets are distributed to remaindermen.

(4) Risk Factors

Risk factors are eliminated by transferring to a Third Party Special Needs Trust, even if a child is trustee.

(5) Tax Considerations

The trust can be designed to achieve avoidance of federal gift tax limits, attain step up in basis, attain the I.R.C. § 121 Exclusion and have the income taxable to the parent.  Conversely, the trust could be designed to have the income taxable to the beneficiary and to remove assets from the parent’s estate.  The grantor must decide what tax features offer the most appeal and draft the trust accordingly.

e. Self-Settled Special Needs Trust – Design

There are several statutory requirements for a Self-Settled Special Needs Trust.[64] These include the following:

  • Assets of the Individual.  The trust must be funded with assets of the individual.  “Individual” in this context means the beneficiary.
  • Under 65 Years of Age.  A Self-Settled Special Needs Trust can be established only for a person under 65 years of age.  This means the trust document must be in place and funded prior to the beneficiary’s attaining his or her 65th birthday.  It may continue after age 65.
  • Disabled.  The beneficiary of the trust must be disabled as defined in the Social Security Act.[65]
  • For the Benefit of Such Individual.  The trust must be established for the benefit of the individual.  This has been interpreted to mean that the trust must be for the “sole benefit of” the disabled person.[66]
  • Established By.  The trust can be established only by a parent, grandparent, legal guardian of the individual, or a court.
  • Payback.  The trust must contain a payback provision providing that the State Medicaid Agency will receive all amounts remaining in the trust upon the death of the beneficiary up to an amount equal to the total medical assistance paid.

f. Key Issues – Special Needs Trust

(1) Availability

Assets in a properly-drafted Self-Settled Special Needs Trust are not available.  The key is the discretion of the trustee.

(2) Transfer Penalties

There are no transfer penalties for a transfer to a Self-Settled Special Needs Trust, because such transfers are exempt under 42 U.S.C. § 1396p(d)(4)(A).

(3) Payback

In a Self-Settled Special Needs Trust a payback provision is required.

(4) Risk Factors

Since the Self-Settled Special Needs Trust is funded with assets of the individual, the assets are subject to claims by third party creditors other than Medicaid.  This would include spouses in the event of a divorce.

(5) Tax Considerations

A Self-Settled Special Needs Trust is a generally a grantor trust because the trust usually contains one or more of the following features:

  • Special Power of Appointment.  The grantor/beneficiary is given the right to reacquire trust corpus by substituting property of equal value.
  • Income.  Income may be distributed to the grantor without the approval or consent of an adverse party.  Since the trust is a grantor trust transfers to the trust are not subject to federal gift tax limits, step up in basis is achieve on death and the I.R.C. § 121 Exclusion is maintained for the sale of a principal residence and tax on the income is paid by the grantor/beneficiary.

2. Pooled Trust

a. Purpose

The purpose of a Pooled Trust is to ensure that the trust assets are used to enrich the life of the disabled person while maintaining vital public benefits.

b. Trust Design

A Pooled Trust must be estab­lished and managed by a non-profit organization.  They are autho­rized under OBRA-93.[67] These trusts are funded with the assets of a disabled person.  The SSI definition of “dis­ability” is used.  There must be a separate account for each beneficiary.  Funds are pooled for invest­ment and management.  The account is solely for the benefit of the disabled individual. A person can be over 65 at the time of the establishment of a trust.  A disabled person can estab­lish his own trust. On death, the funds remain­ing in the Pooled Trust must be retained by the trust or reimburse Medicaid.

There is no ex­pressed limit on the amount or type of payment.  It may be wise to limit payments to “in-kind” payments.  In-kind payments do not reduce public assistance.

An advantage of a pooled is that corpus is not counted as an asset.  Also, a Community Trust already exists and does not have to be created.  The Community Trust requires only a joinder agreement.

c. Key Issues

(1) Availability

Assets in a properly-drafted Pooled Trust are not available.  The key is the discretion of the trustee.

(2) Transfer Penalties

Transfers into a Pooled Trust by a person 65 or under are exempt from the lookback provisions and transfer penalties.[68] Transfers into a Pooled Trust by persons over 65 are subject to a five-year lookback.[69]

(3) Payback

A payback from a Pooled Trust is required to the extent that the remaining funds are not retained by the trust.[70] Any funds not retained by the trust are to be paid to the State of New Jersey up to an amount equal to the total amount of medical assistance paid.

(4) Risk Factors

Risk factors are avoided by utilizing a Pooled Trust.

(5) Tax Considerations

Pooled Trusts are usually utilized where the amount of money is relatively small so tax considerations are seldom an issue, but generally each sub-account in a Pooled Trust is considered a grantor trust enabling the grantor to exceed federal gift tax limits, achieve a step up in basis on death, retain a I.R.C. § 121 Exclusion on Sale of a Principal Residence and be responsible for payment of income tax.  In many situations where the Pooled Trust is used the beneficiary is disabled and has large medical expenses, which may offset the income tax.

3. Income Only Trust

a. Purpose

Income only trusts are a means by which persons may transfer assets to a trust rather than to their children.  Seniors tend to view transfers to trusts as protection while they tend to view transfers to children as gifts.  Trusts provide them with a sense of dignity and security.   Income only trusts are permitted by OBRA-93.[71] Income only trusts must be irrevocable.

b. Authority

The requirements for Income Only Trusts were spelled out in letters from Sally K. Richardson, Director Medicaid Bureau, Health Care Financing Administration, Department of Health and Human Services to Elice Fatoullah, dated December 23, 1993, the Elder Law Report, Volume V, Number 7, Page 2 and from Robert A. Streimer, Director, Disabled and Elderly Health Programs Group at HCFA’s Center for Medicaid and State Operations to Dana E. Rozansky, dated February 25, 1998, The ElderLaw Report, Vol. IX, Number 9, April 1998, page 9.

c. Trust Design

(1) Income

The trust may provide that income shall be distributed to the grantor or may be distributed to the grantor at the discretion of the trustee.  From a Medicaid standpoint, it is better to permit the trustee to use discretion in distributing income.  From an income tax standpoint, it is usually better to distribute the income to the grantor to avoid income tax at the trust’s highly-compressed tax rates.

(2) Principal

There can be absolutely no access to principal by either the grantor or the grantor’s spouse.  If either the grantor or his spouse has access to principal, the assets in the trust would be “available” for Medicaid eligibility purposes.

(3) Principal distribution provisions

The trust should be designed to permit the trustee to make distributions to third parties.  Through this mechanism, the trustee can stop income payments to a grantor who will be requiring Medicaid and can avoid estate recovery in those states that use a broad definition of “estate.”  The disadvantage to distributing the assets from the income only trust is that the opportunity for a “step up” in basis will be lost.

Care must be taken in considering whether to authorize the trustee to make distributions of trust principal to himself.  Authorization of such distributions would be considered a general power of appointment held by the trustee.  If the trustee predeceases the grantor, the value of the trust assets could be included in the estate of the trustee for federal estate tax purposes.

d. Key Issues

(1) Availability

The assets in an Income Only Trust are unavailable to the grantor if the trust is properly drafted so as to limit the trustee’s discretion to distributions of principal to persons other than the grantor or the grantor’s spouse.

(2) Transfer Penalties

The transfer of assets to the Income Only Trust is subject to a five-year lookback and normal transfer penalties.  Distributions from the Income Only Trust are not considered transfers.

(3) Payback

No payback is required to the State Medicaid Agency from an Income Only Trust.

(4) Risk Factors

An Income Only Trust provides protection from risk factors previously discussed.

(5) Tax Considerations

The Income Only Trust can be designed as a grantor trust enabling the grantor to exceed the federal gift tax limits, to achieve step up in basis on death, to retain the I.R.C. § 121 Exclusion on Sale of a Principal Residence, and to have the income taxed to the grantor.

e. Special Issue

In New Jersey estate recovery extends to an interest in a Living Trust.  It includes assets transferred to the Living Trust by the Medicaid applicant during the previous five years.[72] Therefore, the practice has been to distribute the funds in the trust at the time of the Medicaid application.  However, New Jersey has now unofficially taken the position that the transfer of the assets constitutes a transfer of income subject to the Medicaid transfer of assets penalty.  While the penalty is relatively small compared to the amount protected, it is an issue to be considered.

4. Children’s Trust

a. Purpose

Children’s Trusts are used by persons who want to transfer assets to a trust rather than to their children.  The decision is often driven by a desire to minimize risk factors and maximize tax benefits.

b. Authority

There is no specific authority for establishment of a Children’s Trust.

c. Trust Design

(1) Income

The trust provides that the trustee shall have no authority to distribute income to the grantor or the grantor’s spouse.

(2) Principal

The trust provides that the trustee shall have no authority to distribute principal to the grantor or the grantor’s spouse.

(3) Distribution Provisions

The trust is designed to permit the trustee to make distributions to third parties such as children.

d. Key Issues

(1) Availability

The assets in a Children’s Trust are unavailable to the grantor since there are no circumstances under which the grantor would have access to either income or principal.

(2) Transfer Penalties

The transfer of assets to the Children’s Trust is subject to a five-year lookback and normal transfer of asset penalties.  Distributions from the Children’s Trust should not be considered transfers.

(3) Payback

No payback is required to the State Medicaid Agency from a Children’s Trust.

(4) Risk Factors

A Children’s Trust provides protection from risk factors previously discussed.

(5) Tax Considerations

The Children’s Trust can be designed as a grantor trust enabling the grantor to exceed the federal gift tax limits, to achieve step up in basis on death, to retain the I.R.C. § 121 Exclusion on Sale of a Principal Residence, and to have the income taxed to the grantor.

5. Donee Trust

a. Purpose

The purpose of a Donee Trust is to transfer assets to children who then establish a trust.  The trust might provide that the trustee have discretion to distribute income to the grantor or not.  The assets of the grantor can be consolidated into one larger account to receive better money management, and parents have a greater sense of security knowing that the assets are managed in a trust, rather than distributed to their children.

b. Authority

There is no authority for establishment of a Donee Trust.

c. Trust Design

(1) Income

The trust could give the trustee the discretion to pay income to the parent.  Alternatively, the trust could be designed to prohibit income distribution to the parent.

(2) Principal

Theoretically, there should be no reason why a Donee Trust could not give the trustee the purely discretionary authority to distribute principal to the parent.  However, it is likely that the State Medicaid Agency would attack such a vehicle claiming that the assets are “available.”

(3) Distribution Provisions

The trust is designed to permit the trustee to make distributions of income and principal to third parties including one or more children.  It should be unnecessary to authorize discretionary payments to parents.

d. Key Issues

(1) Availability

If the Donee Trust provides for no discretion to distribute income or principal to the parent, the assets should be unavailable for SSI and Medicaid eligibility purposes.

(2) Transfer Penalties

The transfer of the assets to the children is subject to a five-year lookback.  The transfer of the assets from the children to the trust should not have any affect on the parent’s SSI or Medicaid eligibility.  Distributions from the Donee Trust to third parties should not be considered transfers.

(3) Payback

No payback is required to the State Medicaid Agency from a Donee Trust.

(4) Risk Factors

Risk factors are not eliminated by utilization of a Donee Trust, because it is a Self-Settled Trust on the part of the child or children and remains subject to claims of the child or children’s creditors, including spouses in a divorce context.

(5) Tax Considerations

When the assets were transferred to the children, the parent’s basis would carry over to the children.  Therefore, the transfer from parent to child would be subject to the federal gift tax maximums, there would be no step up in basis on the death of the parent, the parent would not retain a I.R.C. § 121 Exclusion from Capital Gains Tax on the Sale of the Principal Residence and the income would be taxable either to the trust or to the third party to whom it is distributed.

6. Disability Annuity Trust

a. Purpose

A Disability Annuity Trust can be established for a disabled child or any disabled individual.[73] However, in considering the use of an annuity trust for a disabled person, care must be taken to examine the other government benefits currently being received, or which may in the future be received, by the person with disabilities.

If the person is receiving SSI, that person also receives Medicaid.  SSI is a means-based program.  Both resources and income are considered in determining eligibility.  If the person with disabilities receives distributions from the annuity trust, this may well disqualify that person from receiving SSI and cause a loss of Medicaid.  If a Disability Annuity Trust is designed as a Special Needs Trust, public benefits may be preserved.

If the person with disabilities is receiving SSD, this is usually accompanied by Medicare.  SSD and Medicare are insurance-based programs, rather than means-based programs.  Receipt of income from the annuity trust would not cause a loss of SSD or Medicare.  However, consideration should be given to other benefits, which the person with disabilities may receive in the future.  For example, will the person with disabilities be a candidate for group housing in the future?  If so, the existence of the annuity trust may cause them to lose that benefit.

b. Trust Design

(1) The concept

A Disability Annuity Trust is a “sole benefit of” trust.  A “sole benefit of” trust is a creature of HCFA Transmittal 64.[74] These trusts have traditionally been used in crisis planning.  They can be established for the benefit of a disabled person.  Under federal law the assets in the trust are then paid out to the beneficiary on an actuarially sound basis using the actuarial tables contained in HCFA Transmittal 64.[75] Unfortunately, New Jersey does not follow federal law and requires a payback provision so that the State Medicaid Agency is repaid upon the death of the disabled beneficiary.

(2) Definition of “sole benefit of”

HCFA Transmittal 64 deals with transfers of assets and treatment of trusts.[76]For the sole benefit of” is defined.[77] “A transfer is considered to be for the sole benefit of a spouse, blind or disabled child, or a disabled individual if the transfer is arranged in such a way that no individual or entity except for the spouse, blind or disabled child, or disabled individual can benefit from the assets transferred in any way, whether at the time of the transfer or at any time in the future.  For a transfer or trust to be considered for the sole benefit of one of these individuals, the instrument or document must provide for the spending of funds involved for the benefit of the individual on a basis that is actuarially sound based on the life expectancy of the individual involved.”  The individual does not necessarily have to be a disabled child.

(3) Key Issues

(a)  Availability

The key issue concerning trusts “for the sole benefit of” is availability.  In a private letter, the Health Care Financing Administration has taken the position that a trust established for the sole benefit of a community spouse under HCFA Transmittal 64 is an available resource.[78] It should be noted that the letter from HCFA is not law.  There has been no letter from HCFA, CMS or other governmental agency suggesting that assets in a Disability Annuity Trust are “available.”  However, this remains an open question.

(b) Transfer penalty

HCFA Transmittal 64 states that transfers for the sole benefit of a disabled person are exempt transfers.

(c) Payback

Under federal law there is no payback requirement for a Disability Annuity Trust.  However, New Jersey does not follow federal law and its regulations require that a payback provision be included in the trust instrument.

(4) Risk Factors

A Disability Annuity Trust provides protection from risk factors previously discussed.

(5) Tax Considerations

The Disability Annuity Trust can be designed as a grantor trust enabling the grantor to exceed the federal gift tax limits, to achieve step up in basis on death, to retain the I.R.C. § 121 Exclusion on Sale of a Principal Residence, and to have the income taxed to the grantor.

7. Disability Annuity Special Needs Trust

a. Purpose

The purpose of a Disability Annuity Special Needs Trust is to qualify the grantor for Medicaid immediately while preserving the public benefits of the beneficiary.

b. Key Issues

(1) Availability

Because of the special needs language, the assets in the trust should not be considered an available resource.

(2) Transfer Penalty

Since the transfer is for the sole benefit of the disabled person, there is no transfer penalty.

(3) Payback

Under federal law there is no payback requirement for a Disability Annuity Trust.  However, New Jersey does not follow federal law and its regulations require that a payback provision be included in the trust instrument.

(4) Risk Factors

A Disability Annuity Special Needs Trust provides protection from risk factors previously discussed.

(5) Tax Considerations

The Disability Annuity Special Needs Trust can be designed as a grantor trust enabling the grantor to exceed the federal gift tax limits, to achieve step up in basis on death, to retain the I.R.C. § 121 Exclusion on Sale of a Principal Residence, and to have the income taxed to the grantor.



[1] 42 U.S.C. §§ 416(i)(1), 423(d)(1)(A); 20 C.F.R. § 404.1505(a).
[2] 42 U.S.C. § 423(d)(2)(A); 20 C.F.R. § 404.1505(a).
[3] 42 U.S.C. § 1382(c)(a)(3)(H).
[4]74 Fed. Reg. 55614 (Oct. 28, 2009).
[5]20 C.F.R. § 416.110.
[6]74 Fed. Reg. 55614 (Oct. 28, 2009).
[7]Id.
[8]42 U.S.C. § 1382c(a)(1)(A).
[9]42 U.S.C. § 1382(f).
[10]20 C.F.R. § 416.1102.
[11]42 U.S.C. § 1382a(a); 20 C.F.R. § 416.1110.
[12]20 C.F.R. §§ 416.1112(b) and (c).
[13]42 U.S.C. § 1382a(a)(2); 20 C.F.R. § 416.1120.
[14]20 C.F.R. § 416.1130(b).
[15]20 C.F.R. §§ 416.1100 and 416.1130(b).
[16]42 U.S.C. § 1382a(a)2(A); 20 C.F.R. § 416.1131.
[17]20 C.F.R. § 416.1133(a).
[18]20 C.F.R. § 416.1140.
[19]20 C.F.R. § 416.1160(a).
[20]20 C.F.R. § 416.1205(c).
[21]20 C.F.R. § 416.1201(a).
[22]42 U.S.C. § 1382b(a); 20 C.F.R. §§ 416.1210 and 416.1212.
[23]42 U.S.C. § 1382(e)(2); 20 C.F.R. §§ 416.210(a) and (b).
[24]H.R. 3443 Foster Care Independence Act of 1999 § 206(c)(ii)(I).
[25]Id. at § 206(iv).
[26]Id.
[27]Id. at § 206(iii).
[28]42 U.S.C. § 401 et seq.
[29] 42 U.S.C. §§ 1437f, 1437a(b).
[30] 20 C.F.R. § 813.106.
[31] 42 U.S.C. § 1437a(a); 24 C.F.R. § 813.101.
[32] 24 C.F.R. § 5.603(b)(3).
[33] 42 U.S.C. § 1382b(c)(1)(C)(ii)(IV).
[34] POMS SI.01120.200.D.1.(a).
[35] POMS SI.01120.200.B.10.
[36]Commonwealth Bank and Trust Co. v. Commonwealth of Pennsylvania Dept. of Public Welfare, 528 Pa. 482, 598 A.2d 1279 (1991); Rosenberg v. Dept. of Public Welfare, 679 A.2d 767, 545 Pa. 27 (1996); Shaak v. Dept. of Public Welfare, 707 A.2d 1199 (Pa. Cmwlth March 2, 1998) (1999).
[37]Lang v. Commonwealth Dept. of Public Welfare, 528 A.2d 1335, 515 Pa. 428 (1987); Snyder v. Commonwealth of Pennsylvania Dept. of Public Welfare, 598 A.2d 1283, 528 Pa. 491 (1991).
[38]HCFA Transmittal 64 § 3258.4E; 42 U.S.C. § 1396p(c)(1)(B).
[39]HCFA Transmittal 64 § 3259.
[40]42 U.S.C. § 1396p(d)(6); HCFA Transmittal 64 § 3259.1A1.
[41]HCFA Transmittal 64 § 3259.6A.
[42]HCFA Transmittal 64 § 3259.6.
[43] 42 U.S.C. § 1396p(d)(4)(B).
[44] 42 U.S.C. § 1396p(d)(4)(C).
[45] 42 U.S.C. § 1396p(d)(4)(A).
[46] Representing the Elderly Client, Law & Practice, Thomas D. Begley, Jr. and Jo-Anne Herina Jeffreys, Aspen Publishing Company, Appendix 8A.
[47]POMS S.I. 01120.200.
[48]POMS S.I. 01120.200.B.1.
[49]POMS S.I. 01120.200.B.10.
[50]POMS S.I. 01120.200.B.12.
[51]POMS S.I. 01120.D(3).
[52]POMS S.I. 01120.200.D.1.b. Beneficiary.
[53]POMS S.I. 01120.200.D.2.
[54]POMS S.I. 01120.200.E.1.
[55]POMS S.I. 01120.200.E.1.a.
[56]Id.
[57]POMS S.I. 01120.200E.1.b.
[58]POMS S.I. 01120.200.E.1.c.
[59]POMS S.I. 01120.200.F.1.
[60]POMS S.I. 01120.200.F.2.
[61]POMS S.I. 01120.200.F.3.a.
[62]POMS S.I. 01120.200.F.3.b.
[63]POMS S.I. 01120.200.F.3.c.
[64]42 U.S.C. § 1396p(d)(4)(A).
[65]42 U.S.C. § 1382c(a)3A.
[66] N.J.A.C.  10:71-4.11(g).
[67]42 U.S.C. § 1396p(d)(4)(C).
[68]42 U.S.C. § 1396(p)(d)(4).
[69]“Set Up Pooled Disability Trust,” The Elder Law Report, Vol. V, No. 5, 8 (Dec. 1993).
[70]42 U.S.C. § 3946p(d)(4)(C)(iv); N.J.A.C. 10:71-4.11(2)(iv).
[71]42 U.S.C. § 1396p(d)(3)(B).
[72]N.J.A.C. 10:49-14.1(l)2.
[73]HCFA Transmittal 64 § 3257(B)(6).
[74]HCFA Transmittal 64 § 3257.
[75]Id.
[76]HCFA Transmittal 64 § 3257.
[77]HCFA Transmittal 64 § 3257(B)(6).
[78]Letter dated April 16, 1998 from Robert A. Streimer, Disabled and Elderly Health Programs Group, Center for Medicaid and State Operations, Health Care Financing Administration, to Jean Galloway Ball.

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