By Anthony J. Enea, Esq.
In my practice, and I suspect in many Elder Law practices the focus is often upon the needs of a chronically ill elderly person and his or her spouse. It has been well documented in recent years that millions of "baby boomers" are coming of age, and that their aging will have a significant impact upon our Medical and long term care infrastructure. However, the one aspect of the aging of the baby boomers that is often overlooked is that the baby boomers are the parents and care givers for millions of non-elderly disabled children, and the impact their aging will have on the care and well being of said child.
Unfortunately, it appears that little is being done to educate the aging baby boomers as to what steps should be taken to provide for the future care and well being of their non elderly disabled children.
Special Needs Trusts, a/k/a Supplemental Needs Trusts play an important role in the planning for a disabled child. They are generally considered the legal centerpiece of a plan for a disabled person.
I. Pre-Drafting Issues and Analysis
When drafting a Supplemental Needs Trust ("SNT") just knowing that the beneficiary of the trust is disabled is not enough. It is important that the attorney prepare a checklist of questions and factors for assessment. The following is a sample of the type of inquiry that needs to be made:
1) Obtain biographical details as to the beneficiary of the Trust. The age of the beneficiary is an important factor to consider especially when drafting a Self Settled SNT.
2) Obtain specific details as to the nature of the disability, and level of incapacity of the beneficiary of the trust. Inquire as to whether the incapacity is physical or mental. Make inquiry as to the medications, if any, the beneficiary is taking. Is the medication psychotropic? How long has he or she been disabled? Is his or her illness progressive? How long is the disability anticipated to last? Is the illness Medically recognized? Obtain details as to the nature of the disability.
3) What are the functional abilities and limitations of the proposed beneficiary? For example:
(a) Is he or she able to cook, clean and attend to his or her own personal hygiene? Can he or she handle his or her finances and live independently?;
(b) Is he or she able to participate in decisions?;
(c) Is he or she employed? Nature of Employment? Salary? Is there a history of employment?;
(d) What is his or her level of education? Has he or she received any special training?;
4) Where is the proposed beneficiary presently residing? What type of housing is it anticipated the beneficiary will need in the future (Group home, Institutional, Living with family/ renting an apartment)? Is the housing Federally subsidized?
5) What government benefits is the beneficiary, if any, receiving? (SSI/SSD/Medicaid Community/Institutional);
How long has the beneficiary received these benefits?
6) What are the anticipated future needs of the proposed beneficiary?
7)Any potential sources of assets? Inheritance, family, siblings, etc. One should inquire as to whether the trust beneficiary is presently a named beneficiary or a contingent beneficiary in a Will or Trust.
The above stated is exemplary of the nature of the analysis that should be made prior to the drafting of an SNT.
It is also important to explain to the client that the SNT is for non-basic needs. That it is not a trust for basic needs, such as food, clothing and shelter. Explain to the client that the purpose of the SNT is to provide for the preservation of funds that are permitted to be made available to a disabled person without affecting his or her eligibility for government benefits such as Medicaid and SSI (Supplemental Security Income). It is also important to explain to the client the federal standard for determination that the beneficiary of the SNT is a "disabled person" as required by statute.
Under federal law, 42 U.S.C. 1382C(a)(3) a disabled person is defined as a person "unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months."
(If one is receiving Medicaid or SSD, he or she is considered "disabled")
II. 3 Basic Types of Supplemental Needs Trusts
A. "Third Party SNT"
1. A Third Party SNT is a Trust created and funded by someone other than the disabled beneficiary. It is generally created by a parent, grandparent or sibling. The source of funds used to fund a Third Party SNT are not from the disabled person. A disabled beneficiary's funds should never be used to fund a Third Party SNT. Any individual can fund this type of trust for a disabled beneficiary without effecting the beneficiaries entitlement to government benefits.
It is important to note that the SNT can be "Inter-Vivos" or "Testamentary". The spouse of a disabled beneficiary or the parent of a minor disabled beneficiary can not create and fund an "inter-vivos" SNT and get the protections under §7-1.12 of EPTL for government benefits. However, the spouse or parent can fund and create a "testamentary" trust for the disabled beneficiary.
All too often we tend to think of SNTs as inter vivos trusts. However, their use in Testamentary documents such as a Last Will should be given consideration.
EPTL §7-1.12 codifies Matter of Escher, 94 Misc. 2d 952, aff'd 75 A.D. 2d 531, 426 NYS 2d 1008. In Escher, the Bronx County Surrogate's Court held that a testamentary trust established by parents of a disabled daughter which provided that principal was to be used only for the "necessary support and maintenance of daughter" was protected from the claim of the State for reimbursement of the amount it had paid on behalf of the daughter. The Court found that the Testator had intended principal be used for daughter during her lifetime.
It should also be noted that the funding of a Third party SNT has Medicaid planning benefits for the Grantor of the Trust. The transfer is considered an exempt transfer. Thus no period of ineligibility is created. See 42 USC 1382 c(a)(3)
B. "Self settled SNT or First Party SNT"
Self Settled Trusts are authorized by the Omnibus Budget Reconciliation Act of 1993 ("OBRA93"). These are SNTs funded with a disabled beneficiaries own funds, or funds to which he or she is entitled such as personal injury award or inheritance. In order for the disabled beneficiary to establish and fund a Self Settled SNT, he or she must establish the following:
(a) Must be disabled (proof of SSI or SSD generally sufficient);
(b) Must be under the age of 65 to establish it (As of the date the assets are transferred to the Trust);
(c) Must be established for the benefit of the disabled beneficiary, by a parent, grandparent, guardian or court. Once established it may be funded by the disabled beneficiary. If the disabled beneficiary has no parent or grandparent, it will be necessary to obtain a Court order, pursuant to Article 81 of Mental Hygiene Law or SCPA 2101 and 202.
The transfer of disabled beneficiaries funds to the Self Settled SNT creates no look back period or ineligibility period for Medicaid nursing home benefits, so long as the disabled beneficiary is under the age of 65 at the time the gift to the Trust is made.
(d) Must have a "Payback Provision". Upon the death of the disabled beneficiary all remaining trust principal and accumulated income must be paid back to Medicaid to reimburse Medicaid for all benefits paid to the disabled beneficiary during his or her lifetime. Any funds left over may be paid to the named beneficiary of the Trust.
C. When is a Court Order Required to Create & Fund a Self Settled SNT?
If the disabled beneficiary is competent, and has a parent or grandparent willing to be the creator, a Court Order is not required. If the disabled beneficiary is mentally incapacitated, then regardless of the existence of a parent or grandparent, a Court Order is required for the assets or income of the beneficiary to be transferred to the SNT. If the disabled person is competent, and has no parent or grandparent, a Court Order is required.
Court Orders are normally obtained within an Article 81 Guardianship (can be a single transaction guardianship), or if the matter involves an inheritance, or if funds are received by a developmentally disabled or mentally retarded person then within a 17A Proceeding in the Surrogate's Court.
D. "Pooled Self Settled SNT"
A Pooled Self Settled SNT is one that must be managed by a Non-profit Association. For example, the United Jewish Appeal ("UJA") and the New York State Association of Retarded Citizens ("NYSARC") sponsor such Pooled Trusts for disabled persons.
The funds transferred to the trust are pooled in the Trust, but a separate account is established for each individual beneficiary. The beneficiary can be under or over the age of 65. However, if the beneficiary is over the age of 65 there is a penalty period for assets transferred to the Pooled Trust for Medicaid nursing home benefits. These Trusts are usually utilized where there is no family member to act as a trustee or when the beneficiary is over age 65.
Depending on the terms of the Pooled Trust, the disabled person may be able to provide how the remaining balance of his or her account is to be distributed upon his or her death, however, this would be subject to a payback to Medicaid. If the balance on death is retained by the Pooled Trust, then Medicaid is not entitled to a payback of the benefits paid.
Pooled Trusts play an important role when the disabled beneficiary has fixed income that exceeds the monthly amount permitted by the Medicaid home care program. For example, if a Medicaid home care applicant has income in excess of the permitted $700 per month for the year 2007, he or she is allowed to contribute said excess income to a Pooled Trust. The Trust will then pay the disabled beneficiary's household expenses such as mortgage, rent and taxes which he or she would not be allowed by Medicaid to pay. The Pooled Trust in many cases allows the beneficiary to remain at home, and still be eligible for Medicaid Home Care.
III. Tax Considerations Relevant to Inter Vivos and Testamentary Third party SNTs
A testamentary SNT is created out of the decedent's estate, and thus, has no gift or special estate tax issues. The assets used to fund the testamentary SNT will be part of the estate of the decedent for estate tax purposes.
If the trust can distribute in favor of a "skip person", there will be Generation Skipping Tax Considerations ("GST"). The current exemption is $2 million per person. In 2010 the GST is set to be repealed, in 2011 it reverts back to the amount it was before 2001 Tax Act( $1Million per person). There is a concern as to what the amount of the transfer will be at the time it passes to the skip person. It is important to assess the potential future value, and inquire as to whether the amount going to a skip person will be greater than the GST exemption.
Income generated from the trust principal will be taxable. Because the trust income tax rate is generally higher than the disabled beneficiaries individual tax rate, the trust should be set up as a Grantor Trust. If it is a Grantor Trust, all ordinary income and capital gains will be taxed at the Grantor's tax rate.
For example, if the Grantor of a Third Party SNT retains the right to the enjoyment or possession of the property transferred to the trust, such as a life estate in real property, or a life income interest that the income of the trust will be taxable to the Grantor.
Additionally, the retention by the Grantor of a §2036 of IRC "Life Income Interest" or §2038 of IRC, right to alter or amend terms of Trust, will allow the beneficiary to obtain the property in the trust at a "stepped up basis" upon the death of the Grantor. Assuming that there is still an Estate Tax in existence at the time of death of the Grantor, the beneficiary's cost basis in the property for income tax purposes will be the date of death value of the property.
Unless the Grantor retains sufficient powers over the Trust there will be a gift tax upon the funding of the Third Party SNT. The funding does not qualify for the $12,000 per person annual exclusion for gift tax purposes.
It should also be noted that a Testamentary Third Party SNT is entitled to a distribution deduction. If the trustee makes a distribution, the Trust is entitled to a distribution deduction, the beneficiary will be required to report a corresponding amount as income.
IV. Tax Consideration for a 1st Party "Self Settled SNT"
By their nature a Self Settled SNT qualifies as a Grantor Trust under §671 of the IRC. The income generated from the Trust principal should be taxed at the disabled beneficiary's tax rate. The assets in a Self Settled SNT are included as part of Grantor's taxable estate for estate tax purposes.
The initial payment to a Self Settled SNT as part of a Court settlement is not taxable income to the disabled beneficiary.
If proceeds of settlement are used to fund the Self Settled SNT there should be no gift tax consequence. If the funds of the disabled beneficiary are used then there would be a gift tax consequence.
V. General Drafting Considerations for SNTs
The following are some provisions to consider including in an SNT:
(a) Make specific reference to Matter of Escher within the body of the Trust, and that the trust is intended to comply with Escher.
(b) Make specific reference to EPTL 7-1.12 within the body of the Trust, and that the Trust is intended to comply with its' provisions.
(c) Utilize the requisite provision that the trust corpus is to be used on behalf of the disabled individual to "supplement" and "not supplant" government benefits such as Medicaid and SSI, and that the funds are not to be used for basic needs such as food, clothing and shelter. However, despite the aforestated provision it is still important to give the Trustee the power to make distributions to meet the beneficiary's basic needs (food, clothing and shelter), even if it will diminish or impair the beneficiary's receipt of government benefits. This is commonly referred to as the "Notwithstanding Consequent Effect" provision of an SNT.
Third Party Trusts should also provide that the Trustee has the full and absolute discretion to pay out principal and income. However, the use of an ascertainable standard such as "for health, education, maintenance or support" should be avoided.
VI. Drafting Considerations for a SNT to be Approved by Court
When requesting that the Court approve an SNT, the Petition to the Court seeking said approval should articulate the following:
(a) The disabled beneficiary's life expectancy and life care plans;
(b) Projected growth of funds;
(c) Project how long the funds will last.
With respect to Court Ordered SNTs, the Court's have required different drafting requirements. (See Matter of DiGennaro, 202 AD 2d 259 (2nd Dept 1994), Matter of Goldblatt, 162 AD 2d 888 and Matter of Morales, NYLJ 7/28/95 (Supreme Court Kings County). In Morales, the Court offered a model SNT to be used in New York City. The Department of Social Services must be notified when a Court Ordered Self Settled SNT is being requested.
In drafting an SNT it is important to be familiar with the specific disability the beneficiary of the Trust is afflicted with. For example, the needs of a competent physically disabled non-elderly beneficiary will be different than those of someone who is mentally incapacitated and physically disabled. The competent physically disabled beneficiary can be actively involved in the decisions concerning the drafting and implementation of a Self Settled SNT and his or her future care plan. For example, he or she can be made a member of an Advisory Committee to the Trustees.
It is also important to know what government benefits program or programs will support the beneficiary. Will it be institutional or non-institutional? This will provide the attorney draftsman an idea as to how trust assets can be used, and the specific terms to be contained in the Trust as well as for the preparation of an additional memo to Trustees about their use.
For example, a severely developmentally disabled individual residing in a group home may have more predictable needs than an individual suffering from a psychiatric illness whom resides in federally subsidized housing, and receiving outpatient mental health services.
The individual suffering from a psychiatric illness who resides in the federally subsidized housing will most likely be receiving SSI, and any distributions for food or shelter by the Trustee of the SNT will impact the SSI coverage.
Conversely, the individual in the group home may be receiving basic community Medicaid without SSI, so the Trustee may be free to use trust funds to support a reasonable housing arrangement and provide other necessities that will enhance the beneficiary's ability to reside in the community.
It is important to consider the functional level of the beneficiary, his or her ability in an advisory capacity to participate in decisions regarding trust expenditures and management.
VII. Sole Benefits Trust
Finally, I thought it would be important to describe a new special type of SNT that has been gaining increased popularity. Generally, a Sole Benefits Trust ("SBT") is a special type of Third Party Trust. It will not be counted as an available resource to the trust beneficiary for purposes of determining his or her Medicaid and SSI eligibility so long as it is set up as a Third Party SNT. The Third party funding an SBT may do so without incurring a transfer penalty for purposes of his or her own eligibility for Medicaid and SSI.
Often used when a Plaintiff settling a claim or suit will want to set aside funds from the settlement to provide for a disabled friend, child or grandchild while still preserving his or her own eligibility for Medicaid or SSI.
A Sole Benefits Trust must meet all of the Third Party SNT requirements. It must provide that the beneficiary is the only person who will benefit from the funds in the trust, presently and at any time in the future. The trust must also provide that the assets in the trust will be spent or distributed in a manner that is "actuarially sound." Assets are to be distributed each year in an amount that is calculated to deplete the trust within the beneficiary's remaining life expectancy
A Sole Benefits Trust does not have to meet the "actuarially sound" requirement if it is an exempt SNT or Pooled Trust under OBRA93 and the Foster Car Independence Act of 1999 (FICA). However, it would then lose its primary advantage over an OBRA93 and FICA exempt trust in that it does not need to be created by a Court, parent, grandparent or legal guardian of the beneficiary, and is not required to contain a State payback provision. It is recommended that an SBT be actuarially sound in order to maintain the flexibility it has. It only needs to provide a minimum amount be paid to the beneficiary that will deplete the trust over his or her life expectancy.
An SBT can be funded with a lump sum or annuity. However, it must be fully funded before the beneficiary reaches the age of 21. It is administered the same as a Third Party SNT to preserve beneficiary's eligibility for Medicaid or SSI. Any Third Party can transfer funds to a Sole Benefits Trust.
In the situation where the beneficiary's ability to qualify for Medicaid or SSI is not a concern, the SBT can be administered to provide for the beneficiary's general health, education, welfare, support, maintenance and comfort, so long as the trust is created for the Grantor's blind disabled or minor child, or for any other disabled individual under age 65, and the trust meets the SBT requirements. The Grantor's transfer of assets to fund the trust will not subject the Grantor to a transfer penalty for Medicaid.
Where there is a concern about Medicaid or SSI eligibility for the Plaintiff and the beneficiary, neither the Plaintiff, the beneficiary, the spouse of the Plaintiff or beneficiary may act as a Trustee. Otherwise, the assets in the trust would be considered an available resource, and adversely effect their Medicaid and SSI eligibility. If beneficiary's eligibility for Medicaid and SSI is not an issue, the beneficiary and his or her spouse could act as Trustee.
Tax Consideration for a Sole Benefits Trust
Funding of the trust for a beneficiary who has Medicaid and SSI concerns will have gift tax consequences for the Grantor. Grantor can not use the $12,000 per person annual exclusion, because the beneficiary is not considered to have a present interest as a result of the restrictions on the beneficiary's ability to control assets or compel distributions.
However, if beneficiary has no Medicaid or SSI concerns, you can give the beneficiary the power to compel limited distributions, for example, a five and five power (5,000 or 5% whichever is greater) or even have beneficiary act as Trustee.
Thus, if the beneficiary has a present/immediate interest, the Grantor will be able to utilize the $12,000 per person annual exclusion for gift tax purposes. Another way to avoid a gift tax issue would be to provide the Grantor with a limited /special power of appointment. This would make the funding of the trust an incomplete gift for gift tax purposes.
One can also have a Sole Benefits Trust qualify as a Grantor Trust. Assets in trust will be later included in gross estate of Grantor. Additionally, if SBT qualifies as a Grantor Trust, the income earned will be taxed at Grantor's income tax rate not the higher trust rate.
VIII. Effect of Medicaid Lien on Funding of an SNT
The U.S. Supreme Courts' decision in Arkansas HHS v. Ahlborn, 547 US 268, 126 S. Court 1752 (2006) dramatically impacted the law on Medicaid liens and the funding of Supplemental Needs Trusts.
Under Ahlborn, when a Medicaid recipient receives a personal injury settlement following the payment by Medicaid of medical costs, the Medicaid lien amount is limited to the amount of proceeds meant to compensate the recipient for medical costs, and not for damages for pain and suffering, lost wages and loss of future earnings. This rule also applies to the personal injury settlement or award of a minor.
In Ahlborn, there was an agreement apportioning the settlement between medical costs and other damages, but, the Court held the result would be the same for a Judge allocated settlement or a jury award which establishes liability for both medical care and other kinds of damage.
Prior to Ahlborn, the rule in New York was that a valid Medicaid lien may be enforced against the entire amount of a personal injury settlement, award or verdict before the proceeds are transferred into a Supplemental Needs Trust. Please see Cricchio v. Pennisi and Link v. Town of Smithtown, 90 NY 2d 296, 683 NE 2d 301.
The use of a properly drafted Special Needs Trust will help give the parents of a non elderly disabled child a level of comfort in knowing that they have taken a significant step in assuring the future care and well being of their child. It is truly the cornerstone of any planning for a disabled person.