Published in the New York Law Journal
Monday, July 26, 2004
First-Party Supplemental Needs Trusts: The Second Decade
BY JAY J. SANGERMAN
THE NEW YORK STATE enacting law for first-party supplemental needs trusts is at the beginning of its second decade.1 The past decade demonstrated the extraordinary importance of such trusts for the protection of the entitlements for the disabled of our state. Although such trusts are utilized for the placement of any assets belonging to a disabled person, including inheritances, to maintain, or obtain, Medicaid and/or Supplemental Security Income (SSI) eligibility, these trusts are generally utilized for the placement of medical malpractice and personal injury awards. In 1993, New York State enacted Estates Powers and Trusts Law §7-1.12 and, in 1994, Social Services Law §366(2)(b)(iii), two statutes pertaining to supplemental needs trusts. As a result of the elder law attorney’s experience with Medicaid planning for seniors, elder law has evolved to include the planning for, and drafting of, supplemental needs trusts, even though many of the beneficiaries of such trusts are the disabled young, rather than the elderly.
Elder law attorneys draft estate planning supplemental needs trusts (EPTL §7-1.12), generally referred to as third-party trusts which are funded with assets from someone other than the beneficiary, and asset protection supplemental needs trusts (SSL §366(2)(b)(iii)), generally referred to as first party supplemental needs trusts, which are funded with the beneficiary’s own funds. The supplemental needs trusts discussed in this article are first party or “pay-back” trusts. There are approximately 200 reported “first party” supplemental needs trust decisions nationally, with the greatest concentration of such decisions in New York State. The single most significant issue over the past decade has been whether the Medicaid lien against the proceeds of medical malpractice/personal injury settlements must be paid prior to the placement of the settlement funds into the trusts, or whether payments to satisfy the Medicaid lien only need to be paid upon termination of the trusts. This issue has been resolved in favor of Medicaid. 2 The issues expected during this second decade, and which are presently developing, pertain to the drafting and the administration of these trusts.
Administration of Trusts
For a disabled minor, the choice for the placement of medical malpractice and personal injury settlement proceeds is either into a supplemental needs trust, as discussed in this article, or into numerous bank accounts (each of which will be limited to a maximum of $100,000, including anticipated interest) until the child reaches the age of majority. The use of funds in these accounts is subject to court order. Alternatively, the funds can be placed into a guardianship account. Only the placement of the award into a supplemental needs trust can assure the continuation of Medicaid and SSI benefits. Furthermore, the trust vehicle permits diversity of investments unlike a bank account. The trustee of the supplemental needs trust generally has discretion over distributions, other than, perhaps, for a house and a motor vehicle, which may require court approval. If funds are in bank accounts, it is generally necessary to apply to the court for each withdrawal. Therefore, asset management and asset distributions are much more flexible with the use of a trust vehicle. For an adult, the choice is either placement into a guardianship account if the adult is mentally incapacitated, resulting in the loss of Medicaid benefits, or into a supplemental needs trust. If the adult has mental capacity, then the adult needs to consider whether he or she wishes to have control over the funds and lose Medicaid benefits, or wishes to retain entitlement benefits. The competent adult must realize that he or she will have no authority over the administration of the supplemental needs trust, if created. Therefore, the mentally competent adult needs to consider whether the benefit derived from Medicaid is significant enough to give up control over the assets. Such individual should consider whether he or she can be appropriately covered by private insurance without the provision of Medicaid benefits. In New York State, if an individual applies for private insurance within 63 days of going off of Medicaid, such individual can receive private health insurance without pre-existent conditions. If the adult determines not to have his or her assets placed into a supplemental needs trust, then he or she should still consider the placement of assets into a trust (which is not Medicaid protective), naming a trusted family member or friend or a bank trust department as trustee, for the ease of asset management, as set forth above. Supplemental needs trusts can be extraordinarily difficult to administer. Trustees are subject to significant liability, not only from the beneficiary and the trust remaindermen, but also from Medicaid and the courts. The trustee is under pressure from the disabled trust beneficiary or the beneficiary’s family to obtain funds or to make purchases. The trustee can be subject to surcharge for the manner in which payments are made, paying for items that otherwise could be available through the Medicaid program, making payments that the Medicaid district considers unnecessary, reducing Medicaid’s remainder interest and/or making payments which were not for the benefit of the beneficiary him or herself. Even following a court order can cause trustee liability. On the West Coast, a bank trustee followed a court order to pay parents hourly for taking care of their disabled child. After three years of such payments, the guardian ad litem for the disabled child alleged that the bank made excessive annual payments to the parents, which the bank, ultimately, settled for a significant sum. The above example emphasizes the importance of a properly drafted trust which provides clarity for the obligations and limitations upon trustee discretion, including when the trustee must, or should, obtain court approval prior to certain expenditures, and whether such request be on notice to the Medicaid district. The well-drafted trust protects the beneficiary’s entitlements and best assures the provision of the beneficiary’s needs. Liability can also fall upon the plaintiff attorney for either not recommending a supplemental needs trust, or for facilitating a trust that does not appropriately provide for the plaintiff’s present and future needs. Many issues pertaining to supplemental needs trusts are resolved out of court and, therefore, are not reported decisions. Under the federal and state laws, a first-party supplemental needs trust must satisfy the following requirements: It may be established only for a person under the age of 65 years. The intended trust beneficiary must be disabled pursuant to §1614(a)(3) of the federal social security act, i.e., unable to engage in gainful employment, or will be unable upon achieving the age of majority. The trust must be created by a parent, grandparent, legal guardian, or court. The individual cannot create the trust for him/herself, nor can the prospective trust beneficiary’s attorney in-fact create the trust for the beneficiary. 3
There can be no additional payments to the trust once the individual reaches age 65. Upon termination of the supplemental needs trust, the state will receive all amounts remaining in the trust up to the total value of all medical assistance paid on behalf of such individual. Many medical malpractice and personal injury actions are settled by a combination of cash and a structured settlement annuity. The structured settlement provides for income tax free benefits (including the earnings in the annuity) to the beneficiary, 4 as well as protection from dissipation of the settlement funds. However, to protect Medicaid and SSI benefits, it is important that the settlement documents be properly drafted. This was an issue in a recent supplemental needs trust matter in the Atlanta region of the Social Security Administration. The Social Security Administration denied SSI benefits on the grounds that, although settlement of the medical malpractice action with a structured settlement was appropriate, it appeared that the manner in which the payments were made was not in conformity with SSI rules. Medicaid follows the Social Security rules and, therefore, the issue in the Atlanta region of SSA may also arise in Medicaid eligibility issues.
Legal Malpractice Claim?
Should a supplemental needs trust be created for the placement of the settlement proceeds? Not settling a matter with the placement of settlement proceeds into a supplemental needs trust has resulted in a successful legal malpractice claim against the plaintiff attorney and the court-appointed fiduciary who made the recommendation to the court that there be neither a supplemental needs trust nor a structured settlement. 5 Plaintiff attorneys need to give appropriate consideration for when a supplemental needs trust for the placement of settlement proceeds should be used. Not only should plaintiff attorneys explain to the client the function of a supplemental needs trust and a structured settlement, but, should the client, or the parent/guardian, state that he/she does not wish a supplemental needs trust and/or a structured settlement, it would be advisable to document the discussion.
Joint accounts and custody accounts do not necessarily permit the plaintiff to retain entitlements. Many plaintiff attorneys settle infant cases by having the settlement proceeds placed into a joint account or custody account until either further order of the court, or upon the plaintiff’s reaching the age of majority. The analysis is the belief that the child will maintain Medicaid and/or SSI eligibility. The issue with such placement is twofold: on the one hand, the account may cause the child to lose his/her Medicaid and/or SSI eligibility. 6 Secondly, years after the settlement, but prior to the creation of the supplemental needs trust, if the plaintiff maintained Medicaid eligibility, then Medicaid may be able to require repayment from the date of the settlement through the date the supplemental needs trust is established for causally related Medicaid expenditures. Therefore, reimbursements to Medicaid that would not have had to be made until the death of the plaintiff had a supplemental needs trust been created at the time of the settlement would need to be reimbursed years earlier. This was the issue in a California case 7 in which the court held that the Medicaid lien which accrued after the settlement had to be paid prior to the establishment of the supplemental needs trust.
Medicaid Remainder Interest
Creation of a supplemental needs trust could cause a significant Medicaid collection upon the death of the plaintiff far beyond the advantages of the trust. Medicaid has a remainder interest in the supplemental needs trust upon the death of the beneficiary. N.Y.. Soc. Serv. Law §366(2)(b)(iii), which follows the federal law, states that “upon the death of such individual the state will receive all amounts remaining in the trust up to the total value of all medical assistance paid on behalf of such individual.” The issue is to what “all medical assistance paid” refers. This author can find no reported decision in any state or federal court in which this issue had been before the court. The congressional record is silent on this issue inasmuch as there were no committee hearings on this law, and New York State merely reiterates the federal law. In speaking with Medicaid officials in various states, as well as in various counties of New York State, there are differing opinions. All but one Medicaid district with whom this author has spoken assert the Medicaid remainder interest to be solely as of the date of the creation of the trust. However, at least one Medicaid district in New York State asserts that it has the statutory right to be paid for all Medicaid paid during lifetime, including any reduction in the compromised amount of the Medicaid lien against the settlement proceeds. As a result of this uncertainty and if the beneficiary is receiving benefits in a Medicaid district which requires all Medicaid provided during lifetime to be reimbursed, there needs to be a determination as to whether the creation of the trust could create a major financial liability otherwise not present. For instance, if the trust beneficiary has received a significant amount of Medicaid prior to the creation of the supplemental needs trust, which was not causally related to the receipt of the funds, should there be a trust created at all. In the absence of the supplemental needs trust, the past Medicaid may never need to be repaid.
New York State has no regulations for how the supplemental needs trust is to be drafted or administered. The sole regulation, which need not be drafted into the trust, pertains to notice requirements to the local Medicaid district upon the creation and funding of the trust and prior to major disbursements from the trust. 8 Therefore, each Medicaid district has its own “requirements” for the provisions of a supplemental needs trust. That which is required in one Medicaid district is prohibited in another Medicaid district, causing the threat of the loss of Medicaid benefits should a beneficiary move from one Medicaid district to another. The issue becomes compounded when the disabled beneficiary moves from New York State to another state. Some states have published rules, regulations and/or statutes pertaining to the provisions requisite in a supplemental needs trust. Trust beneficiaries and their families are highly mobile. Therefore, a properly drafted supplemental needs trust should provide for the portability of the trust from one Medicaid district to another. Because of this mobility, consideration should be given as to whether the supplemental needs trust can be amended in order to provide for Medicaid eligibility in whatever Medicaid district the beneficiary shall reside. The issue, in which Medicaid districts differ, is whether a supplemental needs trust can include provisions for amendments other than pursuant to EPTL 7-1.9 (a), wherein a trust can be amended only if initiated by the “creator” of the trust upon consent of all interested parties. However, if a trust only can be amended if initiated by the settlor of the trust, then, if the settlor becomes incompetent or deceased, it would appear that the trust cannot be amended.
Until recently, most courts have not exercised oversight over supplemental needs trusts. Most courts did not require annual accountings. Nor did most courts require a court order for the purchase of the “big ticket” items, e.g., houses and vehicles: these decisions were left to the discretion of the trustee, reviewed solely by the Medicaid district. Justice Bertram Katz of the Supreme Court, Bronx County, this month issued an order and decision pertaining to the drafting of supplemental needs trusts. The author represented the plaintiff in Cano v. Shmonie Corp., et. al., signed on July 12. In the order and decision, Justice Katz stated, inter alia, that there must be court supervision over such trusts and that the trusts should be drafted to be amendable. (The decision in Cano was published in the Law Journal on July 22, p. 19, col. 1.) New York State Medicaid districts differ as to the degree of court involvement which can be exercised over the trust administration. Medicaid district policies range from requiring trust provisions for court involvement to not approving a supplemental needs trust which contains any provision for court involvement.
Income and Estate Tax Issues
Incorrectly drafted and administered supplemental needs trusts can cause significant income and estate tax problems. In trusts, other than supplemental needs trusts, it is the settlor/creator who places the consideration into the trust. In a supplemental needs trust, it is the disabled beneficiary who provides the consideration. 9 Therefore, to avoid income and estate tax problems, such trusts should be drafted so that the trust income does not become recognized by the named settlor/creator, but only by the disabled beneficiary on his/her income tax return. Additionally, care should be given so that it is the estate of the disabled beneficiary and not the estate of the named settlor/creator of the trust which pays any estate taxes.
Distributions to Beneficiary
The trust provisions for distributions need to take into consideration SSI and Medicaid rules. A trust that provides for distributions to the parent or guardian of the trust beneficiary may cause such distributions to be countable as income to the disabled person, thereby disqualifying the beneficiary from SSI benefits and/or Medicaid benefits. 10
Supplemental needs trusts can provide enormous benefit to disabled people. However, such trusts also carry great potential liability for the plaintiff attorneys and the drafting attorneys, who are often elder law attorneys, as well as the trustee. It is anticipated that this second decade of supplemental needs trusts will see both the development of rules and regulations for the drafting and administration of such trusts, as well as court decisions on these issues.
1. N.Y.. Soc. Serv. Law §366(2)(b)(iii) (McKinney 1992 & Supp. 2002), which follows 42 U.S.C.A. §1396p(d)(4)(A) (West Supp. 2002).
2. See, e.g., Cricchio v. Pennisi, 90 N.Y.2d 296, amended sub nom. Link v. Town of Smithtown, 1997 N.Y. LEXIS 2309 (N.Y., July 1, 1997); Robin K. Calvanese v. Anthony J. Calvanese et. al., 93 N.Y.2d 111 (1999); Abraham Gold, et. al. v. United Health Services Hospitals, Inc., et. al., 95 N.Y.2d 683 (2001).
3. See “Establishment of First Party Supplemental Needs Trust,” NYLJ, June 2, 2003, by Jay J. Sangerman.
4. IRC 104(a)(2).
5. Out-of-court settlement in Texas.
6. See, e.g., SI 01140.215; Robin Horowitz, v. JoAnne B. Barnhart, (March 2, 2002, 2d Cir.); Frerks v. Shalala, 52 F.3d 412, 414 (2d Cir. 1995), aff’d 848 F.Supp. 340 (E.D.N.Y. 1994), aff’d 52 F.3d 412 (1995).
7. Hamilton v. Laine (Dep’t of Dev. Services), 57 Cal. App. 4th 885 (Ct. App. Cal. 1997).
8. See Matter of Regina, NYLJ Nov. 2, 2001, page 17, Surr. Ct. Queens County, referring to 18 NYCRR 360-4.5(b)(5)(iii).
9. See, e.g., In re Estate of John Hickey, 635 N.E.2d 853 (Ill. App. 1994); Stewart v. Merchants National Bank of Aurora, 278 N.E.2d 10 (Ill. App. 1972); In re Barbara Hertsberg Inter VivosTrust, v. Department of Health, et. al., 578 N.W.2d 289 (Sup. Ct. MI 1998); Guarantee Trust Co. of New York v. New York Trust Co., 297 N.Y. 45 (1947); SI 01120.201.
10. Hecht v. Barnhart, 68 Fed. Appx. 244 (2d Cir. 2003); SI 01120.201D.3.a.
Jay J. Sangerman is the principal of Jay J. Sangerman, PLLC, a boutique law firm with a concentration in the planning for, and drafting of supplemental needs trusts. His firm represented the plaintiff in Cano v. Shmonie Corp., mentioned in this article, for purposes of establishing the supplemental needs trust by order of the court.
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JAY J. SANGERMAN, ESQ.
JAY J. SANGERMAN, PLLC
171 East 84th Street, Unit 21B
New York, New York 10028
Telephone (212) 922-0711
Facsimile (212) 439-0056