KEY ISSUES TO BE CONSIDERED IN SELECTING THE PROPER TYPE OF TRUST

by Thomas D. Begley, Jr., Esquire, CELA

            The key issues that must be considered in drafting a trust involving Supplemental Security Income (SSI), Medicaid or other means-tested public benefits are availability, transfer rules and payback requirements.

Availability

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

Transfer of Assets Penalty

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

Is the Asset Available After the Transfer?

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

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

Lookback and Transfer Rules

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

Trust Corpus

Available portion of corpus

            To the extent that a portion of the trust corpus is available to the individual, there has been no transfer and there would be no applicable lookback.  If assets are transferred from the trust to a third party from the available portion, the lookback period and transfer of asset penalty vary with the public benefit program requirements.

Corpus unavailable

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

Calculation of Penalty

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

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

Payback

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

Tax Considerations

• Gift Tax Limit.  Gifts to children are limited by the $19,000 per person per year annual exclusion amount combined with the $15,000,000 lifetime exemption.  A gift to an intentionally defective grantor trust can avoid these limits.
• Step Up in Basis.  If a gift is made to children, the carryover basis applies.  Where there are highly appreciated assets it may make sense to transfer to a trust to obtain step up in basis on the parent’s death.
• I.R.C. § 121 Exclusion.  If a home is transferred to children, carryover basis applies.  If a home is transferred to a properly-drafted trust, the I.R.C. § 121 Exclusion for Capital Gains Tax on the Sale of the Principal Residence can be preserved.
• Income Tax.  If assets are transferred to children, they are responsible for payment of the income tax on any earned income.  The children are usually in a higher tax bracket than the parents.  A trust can be designed so that if assets are transferred to the trust, the parent pays the income tax.