Family Transfers Under the Deficit Reduction Act

nusrsing home applicants face major dilemmas in explaining their gifting patterns and estate plans

As State revenues fall and budgets continue to tighten, government agencies are forced to closely scrutinize expenses. This is especially so in the public benefits context, most notably Medicaid. The Deficit Reduction Act of 2005 (“DRA”) has been in effect since February 8, 2006 and was intended to eliminate planning techniques that previously escaped such scrutiny. Particular emphasis has recently been seen in the context of intra-family transfers. Although DRA and applicable regulations typically do not impose different requirements for transactions between related parties, Medicaid agencies across the country have still attempted to classify many arrangements as gratuitous transfers. This article explores the current state of such transfers, and recent cases illustrating the steps being taken by some of the states.

A disqualifying transfer of resources is any transfer during the appropriate look-back period by the nursing-facility resident or spouse of a resource, or interest in a resource, owned by or available to the nursing-facility resident or the spouse for less than fair-market value. When it is believed that a disqualifying transfer of resources has occurred, the applicant typically bears the burden of demonstrating an intent to convey the assets for either fair market value or other valuable consideration and for purposes other than qualification for medical assistance. (42 U.S.C. § 1396p(c)(2)(C)). If a transfer is in fact for fair market value, then it is not a disqualifying transfer regardless if it occurred within close proximity to the application date.

Pursuant to DRA, the look-back period was extended to five (5) years for all transfers, whether the transfer is outright or to trust. As a result, the legislation effectively imposes at least a five (5) year period of ineligibility from the date of any gratuitous transfer. Prior to DRA, the length of the ineligibility period was calculated at the time of the gift and the penalty imposed as of that date. Therefore, it was very easy to calculate when the period of ineligibility would end. After DRA, however, the penalty period does not begin until the applicant’s assets are below the applicable level and he or she is in need of nursing home level care.

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For example, if an individual made a transfer that resulted in a 10 month penalty period on January 1, 2010, prior to DRA the penalty period would end November 1, 2010 and the individual could apply without the transfer adversely impacting eligibility. Under DRA, however, the start of the penalty period tolls until the applicant’s assets are below the threshold amount and is in need of long term care. Therefore, the penalty start date could be any day in the five years after the transfer. As a result, any transfer essentially creates a five year and one day disqualification period so long as an applicant applies after this look back period expires from the date of the transfer.

Even though no distinction is made in the regulations for transactions between family members versus unrelated parties, states are creating such a distinction from a policy standpoint to challenge transactions rather than relying on the plain reading of the applicable regulations.

Sale or transfer of Asset for Promissory Note/Annuity

Suppose for example a couple’s assets consist of the principal residence as well as a vacation home that has been in the family for some time. It is their intent to pass the home on to their children at death, but one of them requires long-term care. Because only the principal residence is exempt for Medicaid eligibility, the vacation home is deemed an available resource that must be used for the cost of care prior to applying for Medicaid. One option would be to sell the property in exchange for a promissory note.

In order for a promissory note to be valid and not a disqualifying transfer, it must have an ascertainable fair market value embodied in a valid contract that is legally and reasonably enforceable by the applicant, member or spouse. Furthermore, the transaction must satisfy the statutory requirements for a promissory notes: (1) the repayment terms of the note are actuarial sound; (2) the note provides for equal payments during the life of the loan with no deferral and no balloon payments; and (3) the note prohibits cancellation of the balance upon the death of the lender. It has been argued that in addition to being non-asssignable and non-transferable that the note should have no acceleration clause in the event of default, should not have an interest rate increase in the event of default, should not impose attorney’s fees in the event of default, and should not waive the requirements for presentment, notice of  dishonor and protest.

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The principal argument raised by states is enforceability: mother will not take daughter to court to enforce the arrangement or does not have the ability to do so because of her age. Those subscribing to this argument apparently have not had much experience in the estate planning context, do not have an understanding of contract law, and ignore the numerous family disputes which can arise from such agreements. The note is an enforceable, legally binding agreement and simply because the parties are related does not mean that it cannot be enforced.

Courts have recently rejected these arguments, and in Clark v. Dehner, Office of Medicaid, Mass Super No. CV 08-02427 (Middlesex, August 17, 2009)(Murtagh, J.) the judge granted a motion for judgment on the pleadings, finding that the sale of an interest in real estate to the applicant’s daughter in exchange for a note was for fair market value. The court held a private transaction between family members is reasonable enforceable and that the regulations do not specifically prohibit such a transaction between related parties. The court added that it was not appropriate to assume the payee of the note will not seek to enforce the obligation in event of default. If this is the intended result, the regulations should expressly provide such limitations between family members.

Other decisions underscore the importance of following applicable law or regulations for the transaction to be respected. The applicant in Wilson v. Dehner, Mass Super No. 08-5304G (Suffolk, August 2, 2009)(Ball, J.), was denied benefits after transferring a remainder interest in exchange for a promissory note. Two major points of concern were (1) the promissory note provided for one balloon payment at the end of a ten-year term, and (2) the note was for $170,000 yet the remainder interest was valued at $267,355. As a result, the note clearly violated applicable law as it did not provide for periodic payments and was for less than the value of the remainder interest. A similar result occurred in O’Connor v. Office of Medicaid, 2009 Mass. Super LEXIS 16, (Mass. Super. Ct. Jan 23, 2009), which involved an annuity payable to the applicant. Because the annuity in question failed to name the Commonwealth as remainder beneficiary (a new requirement under DRA) and was payable for life versus a term certain (and could end before his actuarial life expectancy), the transaction violated the regulations and was doomed from the start.

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One case of note, Vieth v. Ohio Dept. of Job & Family Servs., 2009 Ohio 3748 (July 30, 2009), provides a good illustration attempts to deny Medicaid benefits under DRA. The community spouse in this case purchased a commercial annuity and properly followed the requirements set forth under DRA and applicable state regulations. The income of the community spouse is excluded when determining the eligibility of the institutionalized spouse. Therefore, by purchasing a qualified annuity, otherwise countable assets are converted into an income stream for the community spouse. Although the parties agreed that the annuities in question complied with the regulations, the governing agency, still sought to reject eligibility because the annuities was purchased with assets in excess of the community spouse resource allowance. The agency claimed the income stream to the community spouse was an available resource under DRA, even though it was clearly preserved prior to the enactment. The court rejected this argument, citing contrary authority clearly indicating that assets used to purchase such an annuity are not countable resources for Medicaid purposes. Choosing to look at the statutory language itself, the court added that DRA did not alter the long standing rule preserving the community spouse’s income from eligibility requirements.

Pennsylvania’s Department of Public Welfare tried to use the enactment of DRA to classify annuities as available resources, but to no avail. In Weatherbee v. Richman, (3rd. Cir., No. 09-1399, Nov. 12, 2009), the court rejected the state’s argument that an annuity bought by a community spouse was an available resource. In its decision the court dismissed the existence of a secondary market for the annuity, stated that federal law preempted the more restrictive state statute, and that the changes under DRA are not ambiguous and must be read within the context of the long standing rule that the community spouse’s income is not available to the institutionalized spouse.

Purchase of Joint Interest in Real Estate

Also garnering additional scrutiny is an applicant’s purchase of an interest in the principal residence of a family member, whether a joint interest or life estate. The applicant is using countable assets, such as cash, to purchase an interest in real estate that is also his or her personal residence. This is common in the context of an applicant living with a child that also provides care. If the purchase is for a life estate or joint interest with rights of survivorship, at death the interest passes outside of probate and will avoid any Medicaid lien. Furthermore, the interest is not countable since it is the applicant’s principal residence.

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Foley v. Dehner, Office of Medicaid, Mass. Super No. CV 08-00850 (Hampden, June 3, 2009)(Kinder, J.), involved the transfer of assets in exchange for a one-half joint interest in real estate. Prior to DRA, an individual could purchase a life estate interest in real estate and it would be exempt provided it was the individual’s principal residence. Therefore, at death of the life tenant the property would pass to the remainderman outside the probate estate and free of any possible Medicaid lien. Under DRA, however, if an individual purchases a life estate in real estate, he or she must live in the residence for a year for the transaction to be respected. No such restriction is imposed with respect to a joint interest, and the property will be exempt if it is the applicant’s principal residence. In Foley, the Agency argued this was a transfer of assets for less than fair market value and was akin to a life estate. But, the Court found the applicant had in fact purchased the interest for roughly one half the assessed value. In support of this finding, the Court noted the Agency ignored the plain language of the regulation and tried to extend its reach by analogizing the purchase of a joint tenancy with the purchase of a life estate. If successful, the transaction would have been a disqualifying transfer under the regulations. As such, because the transaction was structured properly as the purchase of a joint tenant interest and not a life estate the agency could not recharacterize the transaction and treat it as a disqualifying transfer.

In a similar matter involving the purchase of a family business as opposed to real estate, the North Carolina Appeals Court held the agreement is not an available resource. (Estate of Wilson v. Div. of Social Serv. (N.C. Ct. App., No. COA09-216, Nov. 3, 2009)). The agreement was between the applicant’s wife and their son with payments made over 60 installments. The court rejected the argument that the agreement was a promissory note or chattel with an ascertainable value and allowed the application for benefits.

Care Contracts

Care contracts between family members are one of the biggest targets, and any arrangement must be carefully documented to be respected. Again, there is nothing under DRA precluding such arrangements, but unless it is documented prior to services being provided, it is presumptively deemed a gratuitous action on the part of the family.

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A caregiver contract is a formal written agreement between two or more parties in which one or more of those parties agree to provide personal and/or managerial services in exchange for compensation paid by the party receiving the services. In the Medicaid context, the applicant’s resources are often transferred in a lump sum to a family member in exchange for services to be provided by the family member for the applicant. For Medicaid eligibility purposes, a determination must be made as to whether the applicant received or will receive fair market value for the resources transferred to the caregiver.

But, challenges are still being made when an executed contract is in place. Similar to the arguments raised in the promissory note context, states have argued that such contracts have no value and are not reasonable enforceable due to the relationship of the parties. Any claim that the parties have no incentive to seek enforcement in the case of breach is pure speculation and conjecture. If a breach occurs, each party is in a position to seek damages. One argument even included a claim that the contract is unenforceable because specific performance is an unlikely remedy. However, specific performance is only used in limited circumstances when other remedies of damages and/or restitution appear insufficient. Because homemaker services could be provided by another person, damages can be easily calculated as the cost for replacement services.

The importance of the contract formality is clearly outlined in Piers v. Bigney, Office of Medicaid, Mass. Super No. CV 07-00443 (Plymouth, March 21, 2009)(Hely, J.) and Andrews v. Division of Medical Assistance, 68 Mass. App. Ct. 228 (2007). The issue in Piers related to a care contract between the applicant and daughter. During the four months after entering the nursing home, the applicant transferred a total of $132,000 to her daughter. As a result, the parties tried to use a corrective transfer to reduce the penalty period that was imposed along with creation of a prepaid caregiver agreement after the applicant had entered the nursing home. The parties entered into a “prepaid caregiver employment agreement” requiring 35-40 hours of service a week. As such, the agreement provided for services already being received and covered by the nursing home. Therefore, the agreement was disregarded because the services were duplicative.

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Andrews also involved the payment of monies to family members in exchange for services, this time after well after any services were preformed. The applicant moved to a nursing home and her daughter looked to sell the residence to provide funds for her mother’s care. Prior to selling, she and her husband spent a great deal of time and expense renovating the house to maximize the sale price. At the time of the closing, the daughter learned of Medicaid as an option to cover her mother’s care. As a result, the applicant transferred $100,000 to her daughter and son-in-law for labor and materials associated with renovating her house. The transfer took place after the house was sold without any expressed agreement that the services were performed with the intent of being compensated, and after learning about potential MassHealth eligibility. Essentially they were being compensated for prior services as opposed to services performed pursuant to a pre-existing agreement. The courts in each case did not hold that such contracts were invalid per se, but must follow the requirements set forth in the regulations. Essentially each case involved the use of an illusory agreement to provide services that were entered after the fact.

The scrutiny appears to increase as well when the caregiver is not only related, but also the applicant’s power of attorney. This was a factor in the Clark case as well. As it related to the sale of an asset, the court dismissed the argument given there is a fiduciary duty as attorney in fact. That same duty exists when a relative is providing care services, and these relationships do not negate the validity of the contract.

The existence of a care contract lead to an unlikely result in Lusignan v. Bigney, Office of Medicaid, Mass Super No. CV 07-01114 (Bristol, October 17, 2008)(Moses, J.), which involved an applicant’s request for hardship waiver. The applicant made the request because the applicant’s daughter refused to return transferred assets and claimed she had exhausted all attempts to retrieve these assets. The court ruled the existence of a service contract greatly impeded her ability to retrieve the transferred resources. It was clear that the applicant had transferred substantial real estate to her daughter resulting in disqualification, but the court noted paid particular attention to the service contract in place between the parties. Of particular note, the court acknowledged that a valid service contract limits the applicant’s right to retrieve transferred assets. As a result, the court remanded the matter for further inquire as to whether all appropriate steps were taken to retrieve the assets under an undue hardship claim which was later denied. This opinion is of note given the court’s reference to requests for undue hardship. Although discretionary, (the MassHealth agency may waive a period of eligibility), it is hard to find a practitioner that has been successful making such an argument.

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Prepayment of nursing home care can be problematic as well, as outlined in Shelales v. Director of the Office of Medicaid (Mass. App. Ct., No. 08-P-2052, Oct. 30, 2009). The applicant gifted money to her children in January 2007 and prepaid nursing home costs for six months. She then applied for Medicaid coverage beginning in January 2007, expecting to get rejected to start the penalty period created by the gift to the children. However, the state successfully argued that the penalty period would not begin until the prepayment amount was exhausted because until that point her cost of care was covered. As a result, she was not otherwise eligible for benefits until the prepayment was used up.

The planning techniques described above are all effective tools in creating Medicaid eligibility and maximizing asset preservation for your clients. Be aware, however, the need to pay particular attention to the formalities of any such transaction as it is vital to support the substance of the transaction if questioned or attacked by the agency determining eligibility.

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