The Disability Trust

A Discussion of the Tax Regime Governing Disability Trusts

The treatment of disability trusts for tax and Medicaid purposes can be very different. This article analyzes the types of trusts for the elderly and disabled that will comply with the Medicaid rules, in light of developing case law.

Over the last decade, Congress and the states have wrestled with the need to provide for the elderly and disabled while the practice of establishing asset protection trusts has become increasingly popular. Attempting to balance this dichotomy, the federal government and the states have created a tax and regulatory regime that has become a myriad of conflicting and confusing statutes and rules. These often contravene the original intent of Congress when it enacted Medicaid and Social Security Disability (SSI), two programs for the poor, disabled, and elderly.

The types of trusts used in disability planning are considerably different from those driven by estate tax planning. Trusts used in disability planning include simple revocable trusts, retained interest trusts, self-funded trusts, income-only trusts, nonretained interest trusts, third-party created trusts, pooled trusts, supplemental needs trusts, and testamentary trusts.

FEDERAL STATUTES AND CONSTITUTION

Federal pre-emption. Congress has empowered the states to adopt regulations in order to implement various federal programs such as Medicaid. These state rules are pre-empted by federal Medicaid statutes (42 U.S.C. § 1396a and 42 U.S.C. § 1382b) and the U.S. Constitution, which explicitly provides that the laws of Congress made pursuant to its authority supercede all state provisions to the contrary--a principle that is fundamental to Constitutional law.¹ Although 42 U.S.C. § 1396a allows considerable latitude to the states in establishing Medicaid regulations, it prevents states from determining Medicaid eligibility requirements that are more restrictive than the federal methodology.²

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In one New York case, the plaintiff challenged the Department of Social Services' decision to require Medicaid applicants to provide more than subjective evidence of an intent to return to their principal residence. Establishing an intent to return home after a nursing home stay is necessary for a Medicaid applicant to receive a homestead exemption and qualify for Medicaid benefits. The court held that the state regulations violated the prohibition of 42 U.S.C. § 1396a(r)(2)(B) against "more restrictive" methodologies. The court noted that under the New York regulation: "Claimants who manifest an "intent" to return, yet cannot muster enough competent medical evidence to overcome the State's presumption that there is no "expectation" of returning, would be forced to choose between their house and their Medicaid benefits."³

Privileges and immunities. State regulations may not contravene the privileges and immunities clause of the U.S. Constitution as it has been interpreted in the "right to travel" cases before the Supreme Court. Article IV, Section 2, clause 1 of the U.S. Constitution provides that "the citizens of each state shall be entitled to all privileges and immunities of citizens in the several states." The Supreme Court has relied on this clause to invalidate state legislation denying welfare benefits to newly arrived residents.

For example, in Saenz v. Roe,⁴ the Supreme Court struck down a California statute limiting the maximum welfare benefits available to citizens who had resided in the state for less than 12 months. California's argument that the statute was justified by its budgetary concerns was rejected. The Court found that distinguishing between citizens based on length of residence was analogous to the creation of degrees of citizenship. The Court held this was inconsistent with the privileges and immunities clause.

Equal protection. State regulations may not violate the guarantees of equal protection provided by the Constitution in Article XIV. Under the 14th Amendment, a state may make distinctions between its citizens so long as the classification is reasonable and not arbitrary, and has some fair and substantial relation to the purpose of the legislation.⁵

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In Shapiro v. Thompson,⁶ another "right-to-travel" case, the welfare agencies of Pennsylvania, Connecticut, and the District of Columbia appealed decisions of their state courts which invalidated statutes that would have denied welfare assistance to residents who had not resided in the jurisdiction for at least a year before applying for welfare. The states and the District of Columbia contended that the one-year waiting period was necessary to preserve the fiscal integrity of their programs. The Supreme Court concluded that the mere saving of welfare costs could not justify an invalid classification, and affirmed the lower court decisions.

TAX RULES APPLICABLE TO TRUSTS

Grantor trusts. One of the primary techniques used to qualify the poor, disabled, and elderly for federal poverty and disability programs is the use of trusts. The treatment of disability trusts for income, gift, and estate tax purposes can be very different.

Under IRC Sections 674(a) and 675, the grantor is treated as the owner of the portion of a trust "of which the beneficial enjoyment of the corpus or income therefrom is subject to a power of disposition, exercisable by the grantor or a non-adverse party, or both, without the approval or consent of an adverse party." Two basic issues raised under Section 674(a)are the scope of the power and the identity of the powerholder. A broad power to control beneficial enjoyment may not cause the grantor to be taxed on the trust income if the power to control enjoyment is assigned to another person.

The grantor's retained control of an irrevocable inter vivos trust will cause the trust to be included in the grantor's estate for estate tax purposes, based on Section 2036(a)(2) (relating to the right to designate the persons who will possess or enjoy the trust property or its income), or Section 2038 (relating to a power to alter, amend, revoke, or terminate the trust). These Code sections are the estate tax equivalent of Sections 674 and 675, which are income tax provisions. However, Sections 674 and 675 distinguish between direct and indirect powers over beneficial enjoyment, while the estate tax sections encompass the entire field of retained control over the beneficial enjoyment of trust assets.

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The estate tax statutory provisions (i.e., Sections 2036 and 2038) do not contain the preciseness of the comparable income tax rules (i.e., Sections 674 and 675), and have had wide interpretation. For instance, trusts have been included in the gross estate of a decedent who retained the power to control the time and manner of enjoyment by a specified beneficiary.

The gift tax provisions, particularly Section 2511(a) and its definition of transfers, are completely silent about when a transfer is deemed complete for gift tax purposes.

A grantor of an irrevocable inter vivos trust, on the one hand, might accept the need--for tax reasons--to reduce or eliminate a personal benefit of the grantor from the trust assets. On the other hand, the grantor may be more reluctant to terminate all control over beneficial enjoyment. For estate tax purposes, Section 2038 will include in the donor's gross estate any transferred assets over which the donor retains until his death any power to alter, amend, revoke, or terminate the enjoyment of such property.

Tax implications for disability trusts. Under normal circumstances, the income tax rates applicable to trusts are higher than individual income tax rates. Therefore, it is preferable for a trust to be taxed as a grantor trust. This also means that self-funded disability trusts are treated as grantor trusts for income tax purposes so long as the trustee has the discretion to distribute income and principal without the intervention or consent of an adverse party. "Adverse party" is defined in Section 672(a) and includes only those who have a future or present interest in the trust.

A self-funded disability trust is included in the grantor's estate under Sections 2036 and 2038. A testamentary power of appointment could also create grantor trust status under Reg. 1.674(b)-1(b)(3).

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The only types of self-funded disability trusts clearly delineated in the federal law are so-called D4A trusts. In order for a grantor to continue or be eligible for SSI and/or Medicaid benefits, the trust must clearly follow the provisions of 42 U.S.C. § 1396p(d)(4)(A). D4A trusts are typically created after medical malpractice or personal injury settlements have been awarded. The trusts are established for individuals who are already receiving or who may become eligible for SSI and/or Medicaid benefits. The public policy objective is to permit a person to qualify for or maintain government benefits, while at the same time allowing trust funds to be used to supplement but not replace public benefit programs. Supplemental benefits might include educational programs, vacations, transportation, telephone charges, cable television, and personal gift items--in other words, anything except basic food, clothing, or shelter which can enhance a person's quality of life.

D4A trusts cannot be created by the grantor himself, even though they are treated as grantor trusts under the Tax Code. Such trusts can be created by court order after a personal injury or medical malpractice settlement, or by parents or guardians who fund the trust with resources of the beneficiary-for instance, a large inheritance that was given outright to a disabled beneficiary without any consideration of the bequest's impact on public benefits received by the beneficiary. Some practitioners believe that limited cash distributions can be made for pocket money, but this should be avoided, if possible.

Two key features of D4A trusts include (1) a provision to pay the beneficiary's taxes directly to the government and (2) a payback provision at the beneficiary's death, which allows the state to reach the trust assets in order to recoup payment for services provided during the beneficiary's life. Because of this latter requirement, it is important to consider the beneficiary's life expectancy when making distributions from the trust in order to provide as little payback (if any) as possible.

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EXAMPLE 1

An SSI beneficiary who is also receiving Medicaid health benefits, is involved in a car accident. To protect the SSI and Medicaid benefits, a civil suit must be initiated and the settlement agreement must include a provision that the net proceeds will be held in a D4A trust. In the case of a settlement where no suit has been filed, the plaintiff's attorney must coordinate a post-settlement suit and settlement agreement with a copy of the trust. In some jurisdictions, the court will allow the filing of the suit, a hearing on the complaint, and approval of the settlement within the same day.

A third-party trust for another where the grantor is not the beneficiary and where the trust corpus is not property owned by the beneficiary upon transfer has similar tax consequences. This form of trust can take advantage of the grantor trust rules in order to use the $250,000 principal residence exclusion ($500,000 for a couple) and thereby eliminate any capital gains tax on the sale of a home.

EXAMPLE 2

Mom places her home in a defective irrevocable trust and maintains an occupancy interest or a life estate; she is also the trustee. This creates a disqualifying transfer for her in the event that she needs nursing home care and wants to qualify for Medicaid. At her death, the property will pass to a discretionary or supplemental needs trust for her disabled son. As a result, he will be able to maintain his benefits. If the house is sold during Mom's life, the principal residence exclusion under Section 121 can be used. Upon her death, the residence exclusion may also be used; if the house is sold later, it will have a stepped-up estate tax value basis, and capital gains tax will be avoided.

To obtain grantor trust status, the grantor could serve as trustee or the grantor could retain (1) the right to substitute assets in the trust, (2) the power to borrow without adequate interest or security, (3) a testamentary power of appointment, and/or (4) a life interest or life estate in an asset or parcel of real estate, such as the principal residence. Under these circumstances, transfers to such trusts will not be completed gifts.⁷

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In most instances, it will be desirous to have the trust assets included in the grantor's estate to obtain a step-up in basis. Conversely, the trust will also be subject to estate tax at the grantor's death. The same result would apply for an income-only trust in which the grantor retains the right to income but not to principal.

EXAMPLE 3

Dad transfers his multi-family income-producing real estate to an income-only trust. The principal will be protected if he enters a nursing home, but the income will be available to help pay for his care. This is a grantor trust and will be included in his taxable estate at death. There will also be a step-up in basis at death and avoidance of capital gains tax if the property is then sold.

Difficulties can arise when two parents create a discretionary or supplemental needs trust for a child without taking into account the estate tax applicable exclusion amount for the first spouse to die. If the trust remains revocable until the second spouse's death, the surviving parent will be deemed to have a general power of appointment over the trust and it will be included in that parent's estate.

Example 4

Dad dies and leaves a marital trust and a family trust. However, the family trust has a supplemental needs provision for a disabled daughter that does not meet the usual standard of providing for the health, education, support, and maintenance of the daughter. When Mom subsequently dies, the family trust will be converted to a special needs trust for their disabled daughter. This will result in the family trust being included in Mom's estate, and the tax advantage of the family trust will have been lost. Some or all of Dad's estate tax applicable exclusion amount should have been used at his death to create the disability trust immediately.

A limited and curious form of disability entity is the qualified pooled trust. These trusts are generally created as master trusts for nonprofit agencies serving the disabled. This arrangement allows the relatives of certain groups of disabled persons to fund trusts for their family members without going through the expense of creating a trust themselves. This technique is particularly helpful if the funding is minimal. Sub-trusts or sub-accounts are created for individual beneficiaries. At a beneficiary's death, funds not consumed remain in the pooled fund for others within the larger class of beneficiaries. These trusts are often created by organizations such as a state, regional, or local arm of an association for retarded citizens. The trusts, nevertheless, are considered grantor trusts under Section 677, except for distributions that require the consent of an adverse party.

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THE REGULATORY REGIME

The regulatory regime governing disability trusts begins with the Medicaid Catastrophic Coverage Act of 1988 (MCCA '88), which was predated by TEFRA in 1982 and OBRA '85, and is postdated by OBRA '93, HIA '96, BBA'97, FCIA '99, the Social Security Act, 42 U.S.C. § 1382b(e), 42 U.S.C. § 1396, HCFA Transmittal No. 64 (1994), and Section 1932 of the Deficit Reduction Act of 2005.

If a Medicaid or SSI applicant is the grantor and beneficiary of a trust, the principal and income are considered available resources unless the trust is a D4A trust. This is true for revocable and irrevocable trusts. Full discretion of a trustee to make distributions for the beneficiary's health, education, support, and maintenance also equates to total access of the beneficiary to the trust assets. Trusts that are exempt for Medicaid purposes include (1) discretionary or spendthrift trusts established for the Medicaid applicant by another person with assets not belonging to the applicant, (2) supplemental or special needs trusts if created by a third party or if the trust is a D4A trust, and (3) discretionary trusts (not a traditional marital trust) established by the will of a spouse for the surviving spouse applicant.

EXAMPLE 1

Client A establishes a fully discretionary trust for his own benefit which is not a D4A trust. This trust will be fully countable in determining his eligibility for Medicaid because it was created by the beneficiary himself, is not limited to supplemental benefits, and has no payback provision.

EXAMPLE 2

Mom creates a discretionary trust with a limited standard of distribution for the benefit of her son, and funds the trust with her own assets. The trust is exempt for purposes of determining the son's Medicaid eligibility, and does not have to be a D4A trust because federal regulations and state laws allow the creation of spendthrift or discretionary trusts by one person for the benefit of another. It is a valid supplemental needs trust.

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EXAMPLE 3

Mom creates a discretionary trust for son, but the trust instrument provides that the trustee may distribute income and principal in his sole discretion for the beneficiary's health, education, support, and maintenance. Because of the broad distribution standard, the discretionary language will not prevent the trust from being counted for Medicaid eligibility purposes. The trust will be treated as a general support trust and will be considered fully available to the beneficiary, resulting in the denial of Medicaid benefits.

EXAMPLE 4

Husband dies owning all the family assets. He leaves a testamentary trust for the benefit of his wife, with income and principal to be distributed in the discretion of the trustee. Mom would immediately be eligible for Medicaid benefits no matter what the size of the trust because the regulations permit the creation of a testamentary discretionary trust by one spouse for the other.

CASE LAW TRENDS

Several years ago, the U.S. District Court of Oregon dismissed Peebler and Nay v. Reno,⁸ the first and only significant case in which the "Granny Goes to Jail" law was applied to individuals who transferred assets to do Medicaid planning. The most important result was the federal government's response explaining its interpretation of the law.⁹ The government interpreted the new act as being applicable to anyone who applies for Medicaid during the disqualification period. Subsequently, a federal judge in New York ruled the law unconstitutional.

In New York State Bar Association v. Reno,¹⁰ and Magee,¹¹ the Justice Department refused to defend the constitutionality of the "Granny's Lawyer Goes to Jail" law, and said that it would not bring criminal prosecutions against attorneys and other professionals for counseling their clients to engage in Medicaid planning. In the New York State Bar case, the state bar association filed for a preliminary injunction preventing the Justice Department from enforcing the statute, and won. This stands as the leading judicial ruling on the statute.

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Since November 1994, the primary guide for MCCA has been HCFA Transmittal No. 64, which applies to all transfers made--and trusts established--on or after 8/10/93, the date of enactment of OBRA '93. Not knowing about or understanding HCFA No. 64 could easily result in malpractice for any practitioner, because HCFA No. 64 deals with two broad categories-- transfers of assets for less than fair market value (gifts) and trusts--both of which are important to estate planners. Those gifts often involve the home of an elderly parent.

Section 3258 of the HCFA Transmittal interprets section 13611 of OBRA '93 as to the denial of Medicaid coverage resulting from gift giving prior to entering a nursing home. Section 3259 of the Transmittal sets forth the rules under which trust principal or income will be considered in determining Medicaid eligibility for institutionalized and noninstitutionalized individuals. The Transmittal discusses both revocable and irrevocable trusts and exemptions for certain types of trusts.

State courts have begun to decide a number of disability trust cases, often involving exculpatory clauses. An exculpatory clause by its very nature is troublesome because it defeats the purpose of a trust created for tax planning and at the same time defeats the trust's designed intent to protect an individual's public benefits.

EXAMPLE 1

Husband creates a testamentary marital trust for his wife to provide for her health, education, support, and maintenance and to otherwise provide for her according to her accustomed manner of living, except that if she enters a nursing home, the trustee is instructed not to make any distributions for her benefit. Because of the latter ("except that . . ."), the trust will not qualify for the marital deduction. Because of the former language (regarding support), the trust will fail to qualify as a disability trust.

In discussing exculpatory clauses in general, Justice Fried of the Massachusetts Supreme Judicial Court has referred to them as devices intended to allow an individual to "have his cake and eat it too."¹² In Cohen v. Comm'r of Division of Medical Assistance,¹³ the Massachusetts Supreme Judicial Court also decided three other cases through consolidation. These cases typify the application of federal law by the states after OBRA ‘93. However, Massachusetts expanded the federal law by applying it to pre-OBRA ‘93 trusts; this application should be invalid under the theory of pre-emption but has gone unchallenged.

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Justice Fried has criticized "Medicaid qualifying trusts" (MQTs) (i.e., trusts established by Medicaid applicants who retained some beneficial interest). MQTs, which are designed to protect a person's assets, actually prevent an applicant from qualifying for Medicaid. Since 1986, MQTs have been subject to particularly rigorous scrutiny; for example, an applicant's "countable assets" for purposes of Medicaid eligibility include the maximum amount of assets a trustee might distribute to the applicant regardless of whether the trustee actually exercised the discretion described in the trust instrument. The Cohen case noted that the concept of available resources was extended further, in OBRA ‘93, to incorporate "the maximum amount of payments that the trustee has discretion to disburse to the applicant or recipient under the terms of the trust for the applicable budget period."¹⁴ Cohen also referred favorably to a letter from HCFA, instructing the state Medicaid agency to disregard all exculpatory clauses in MQTs, as if it had the force of a formally adopted regulation.

Cohen observed that in each of the consolidated cases, "the grantor of an irrevocable trust, of which the grantor (or spouse) is a beneficiary and to which the grantor has transferred substantial assets, claims eligibility for Medicaid assistance because the trust, while according the trustee substantial discretion in a number of respects, explicitly seeks to deny the trustee any discretion to make any sums available to the grantor if such availability would render the grantor ineligible for public assistance."¹⁵ Reviewing other states' decisions, the court found that "all [have ruled] that the trust assets are available to the grantors thereby rendering them ineligible for Medicaid assistance to the extent of such assets."

The status of the law in Rhode Island has remained clear and simple, and that state's law stands for the basic proposition governing disability trusts. In Chenot v. Bordeleau,¹⁶ the Rhode Island Supreme Court took the common law notion of spendthrift trusts and applied it in the modern context of public benefits programs.

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In Chenot, Edward Chenot was a mildly retarded adult. His father executed a will that left the bulk of his estate (including the family home) in trust. The will named a bank as trustee and stated that "the trustee may at any time or times pay all or any portion of the net income or principal or both net income and principal of the trust to or for the benefit of my son, Edward A. Chenot, as the said trustee, in its sole and uncontrolled discretion, shall deem necessary or advisable for his comfort, support and welfare. Upon the death of my son, Edward A. Chenot, the trustee shall provide for and pay for all necessary funeral expenses out of the trust estate and the remainder after the payment of said expenses shall be divided equally among my children...share and share alike. It is my intention that the trustee shall exercise its discretion primarily for the benefit of Edward A. Chenot because of his special needs and circumstances."

The father died in late 1977. Edward and his sister continued to live in the family home. In 1985, however, the sister became unable to care for Edward and to maintain the residence. As a result, the home was sold, and Edward was sent to a facility that would teach him the skills necessary to live independently. Initially, Edward was considered eligible for Medicaid, but benefits were later denied when it was learned that the family home had been sold and the proceeds placed in the trust.

The question before the court was as follows: When a grantor creates a discretionary spendthrift trust for another with assets of the grantor, are the assets countable resources when determining the beneficiary's eligibility for Medicaid? The answer was "no."

The Rhode Island Supreme Court held that the trust was a discretionary trust and thus the beneficiary could not compel the trustee to make distributions of income or principal for his support. The court ruled that the Department of Human Services had erred by counting the trust assets as the beneficiary's resources. Similar case law has involved two types of trusts: support trusts and discretionary trusts. If a trust is determined to be a support trust and the Medicaid applicant is the beneficiary, courts have held that the trust assets are considered resources of the applicant. But, when a discretionary trust is involved, the trust assets are not considered the beneficiary's assets, because the trustee has complete discretion in making distributions.

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The holding in Chenot is consistent with federal regulations and case law that existed prior to the ruling and that have developed or been decided since then. Chenot stands for the basic premise governing all disability trusts: under the Chenot rule, trust assets that are fully available to the beneficiary according the to the trust language are fully countable when the beneficiary applies for Medicaid. In contrast, trust assets that are limited by discretionary trust language are not deemed available for purposes of determining Medicaid eligibility, provided that the trust (1) was not created by the beneficiary or (2) conforms to federal rules if it was created by the beneficiary for himself. More recent cases in other states confirm this proposition.

ADDITIONAL JUDICIAL DECISIONS INVOLVING TRUSTS

Johnson v. Guhl,¹⁷ a New Jersey case, involved Medicaid applicants and potential Medicaid applicants residing in long-term care facilities whose spouses were noninstitutionalized and were beneficiaries of community spouse annuity trusts (CSATs). These trusts were hybrid forms of grantor annuity trusts that were created for Medicaid planning. In the case of a CSAT, an institutionalized person typically would transfer assets to a grantor trust and have annuity payments made to the community spouse. This technique was based on federal guidelines for the conversion of assets into income. By doing this, an institutionalized husband, with retirement assets in his name, could liquidate them, pay the taxes, and transfer the net proceeds to a trust for his wife which provided annuity payments to her. When the husband applied for Medicaid benefits, the trust and annuity payments would not be counted as assets available to him.

In Guhl, the plaintiffs were married couples; one spouse lived in the community ("community spouse"), and the other spouse resided in a nursing facility ("institutionalized spouse"). Some of the institutionalized partners were denied Medicaid benefits and filed for a fair hearing. Some plaintiffs were waiting for a decision regarding their Medicaid applications, and other plaintiffs had not yet applied for Medicaid but would do so in the future. The community spouses were the beneficiaries of the CSATs.¹⁸

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The plaintiffs sued the Commissioner of the New Jersey Department of Human Services, as well as other state officials, disputing the treatment of CSATs as countable resources in determining eligibility for Medicaid. The court said that when an institutionalized person who has transferred assets applies for Medicaid, the application is subject to the look-back rules applicable to transfers and trusts. According to the court, these rules were enacted by Congress to close the loophole whereby a couple could shelter resources in the community spouse's name while the institutionalized individual received Medicaid.

Under OBRA, an institutionalized spouse may be denied benefits if that person (or his spouse) has transferred any nonexempt asset or his home for less than fair market value during the 36-month look-back period (the look-back period is 60 months for transfers to or from trusts). If an asset was transferred during the look-back period, the applicant is subject to a penalty period (which is basically a period of ineligibility that is calculated by dividing the uncompensated amount of the assets transferred by the average monthly cost of nursing home care in the applicant's state).

The state in Guhl explained that because a CSAT can be paid at some point to the community spouse, the entire corpus is considered available to the community spouse. Realizing that some Medicaid applications were submitted based on the prior approval of CSATs and that some applications were still pending, the state Medicaid agency offered to permit the community spouse to convert the CSAT into a commercially purchased annuity naming the state as the first remaining beneficiary.

The use of these trusts was an attempt to avoid the rules regarding the use of commercial or private annuities for Medicaid planning. Still allowable under the federal rules is the conversion of countable assets into income streams. Each state may vary slightly in its treatment of this planning technique, but states are precluded under federal law from not allowing annuity planning at all.

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Example. Client A has $100,000 in assets and would like to apply for nursing home care. He has assets in excess of the usual $2,000 threshold. If, however, he purchases a commercial annuity paying equal monthly installments over his actuarial life expectancy, only the monthly income payments will be counted toward paying for his care (subject to new lien provisions under the federal Deficit Reduction Act of 2005). If he dies before the end of the annuity payment period, the balance of the annuity will be paid to his beneficiaries.

Example. Client B has $100,000 and is married. He transfers $100,000 to his wife who already has $189,000 in her own name. After the transfer, she has excess assets of $200,000 because the maximum resource allowance for the community spouse is $89,000. If the wife purchases a $200,000 fixed annuity, the excess assets will be now be treated as spousal income which the wife will keep, and Client B will qualify for Medicaid. His contribution toward his care will likely equal all his monthly income minus available deductions for personal needs and health insurance.

Private annuity agreements are also allowable in some jurisdictions. CSATs were an attempt to avoid (1) private annuity agreements, which must follow IRS Regulations and rates, or (2) the purchase of commercial annuities, which might not be economical in some instances.

Trusts are also used to protect the principal residence, which is often a family's primary asset.

In Shaak v. Pennsylvania Dept. of Public Welfare,¹⁹ Mrs. Shaak created an irrevocable trust on 4/6/88, into which she transferred ownership of her house; her two children were named as trustees. She reserved the right to live in the home, and upon her death, the trust was to be liquidated and the proceeds distributed to her heirs. The trust also allowed her children to lease or sell the property after Mrs. Shaak vacated the home. In October 1990, Mrs. Shaak began living in a nursing care facility.

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At the time, neither Mrs. Shaak nor her children disclosed information regarding the trust to the nursing facility, and they did not do so later when she was transferred to a different facility. In 1992, the house was sold by the trustees, and the proceeds were deposited in an account. In 1994, a caseworker contacted one of the trustees to obtain information regarding Mrs. Shaak's assets. The caseworker was advised of the sale of the house and of the trust account holding the proceeds. In January 1995, the caseworker notified Mrs. Shaak that she was ineligible for Medicaid benefits because the trust was an "excess countable resource." Mrs. Shaak filed an appeal.

The question for the court was whether the inter vivos trust created by Mrs. Shaak was an available resource to be considered when determining her Medicaid eligibility. The Pennsylvania Supreme Court held that under prior case law, the main element determining eligibility was the identity of the beneficiaries. The court ruled that the trust created by Mrs. Shaak was for her sole benefit, and therefore the trust assets were considered available resources. In making its decision, the court looked to the intent of the settlor and whether the settlor intended that the trust be used for the sole benefit of the subject beneficiary or for multiple beneficiaries.

The court also examined the actual language of the trust instrument, including whether the trust provided for more than one beneficiary and whether the beneficiary received public assistance during the settlor's lifetime. If the trust document allowed multiple beneficiaries, then it can be presumed that the settlor did not intend for the entire trust corpus to be used for a sole beneficiary. On the other hand, the court explained that if the trust document gave the trustee discretion to use principal for the welfare of a sole beneficiary, it could be presumed that the settlor intended for the principal to be an available resource. Mrs. Shaak clearly intended that the trust be used for her benefit during her lifetime. The document provided that the trust assets were for the primary benefit of the settlor, and allowed principal "without limit as to amount" to be distributed for "the maintenance, welfare, comfort, and happiness of the Settlor." Mrs. Shaak was the sole beneficiary of her trust and as such, the trust assets constituted available resources in determining Medicaid eligibility. Consequently, she lost her Medicaid benefits.

OUTLOOK FOR THE FUTURE

Planning for the elderly and disabled will continue to be done. However, it is becoming increasingly difficult to understand the rules in relation to developing case law. Practitioners should be wary of preparing estate tax planning documents with simple modifications in the hope that the language will comply with the regulatory regime governing trusts for the elderly and disabled.

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(1) U.S. Const., Art. VI, cl. 2; Crosby v. Nat'l Foreign Trade Council, 530 U.S. 363 (S.Ct., 2000).

(2) 42 U.S.C. § 1396a(r)(2)(B).

(3) Anna W. v. Bane, 863 F.Supp. 125, 129 (DC N.Y., 1993).

(4) 526 U.S. 489 (S.Ct., 1999).

(5) F.S. Royster Guano Co. v. Virginia, 253 U.S. 412, 415 (S.Ct., 1920).

(6) 394 U.S. 618 (S.Ct., 1969).

(7) See Ltr. Ruls. 9413045, 9648045, and 9713017; Sections 672, 674, and 675. See also Ltr. Rul. 200240018.

(8) C.D. Ore. Civ. No. 97-256-HA.

(9) HR 3103 now Pub. L. No. 104-191, codified at 48 U.S.C. § 1320a-7b(a)(6).

(10) 999 F. Supp. 710 (DC N.Y., 1998).

(11) 9B-CA-073 (DC R.I.).

(12) Cohen v. Comm'r of Division of Medical Assistance, 423 Mass. 399, 668 N.E.2d 769 (1996).

(13) 423 Mass. 399, 668 N.E.2d 769 (1996).

(14) Cohen, p. 18.

(15) Cohen, p. 10. Also see Lebow v. Comm'r of the Division of Medical Assistance, 433 Mass. 171, 740 N.E.2d 978 (2001).

(16) 561 A.2d 891 (R.I., 1989).

(17) 91 F. Supp.2d 754 (DC N.J., 2000).

(18) See also McNamara v. Ohio Dept. of Human Services, 139 Ohio App.3d 551, 744 N.E.2d 1216 (2000), which reached a similar result involving a spousal annuity trust; Keith v. Rizzuto, 212 F.3d 1190 (CA-10, 2000), involving an invalid income trust.

(19) 561 Pa. 12, 747 A.2d 883 (2000).

(This article was originally published in 30 Estate Planning 233, 2003 WL 1919491 (W.G.&.L.))

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