Considerations in the Termination of Special Needs Trusts Allison Bren Ferris
Considerations in the Termination of Special Needs Trusts A. Introduction In the world of special needs trusts ( SNT ), termination of a trust usually, and unfortunately, occurs after the death of a beneficiary. The Trustee may have spent years working with the beneficiary and his or her family and winding-up the trust is now the last aspect of that relationship. A trustee should have a clear understanding of the differences in termination procedures for first party and third party SNTs, and adopt best practices around how to address the administrative, fiduciary, tax, legal, and of course, the human aspect of winding up a trust. Reflections on the Human Aspect of Termination Upon the passing of a beneficiary, it can be easy to think of all the administrative and legal items which need to be addressed. The Trustee often has to spring into action to find a copy of the pre-paid funeral plan, call an attorney, call Medicaid, or take care of immediate internal tasks related to an account closing. Although all these items do need to be addressed, it is important to remember that a family has just lost someone whom they loved very much. Sending flowers, cards, food, gifts, 1 or attending a funeral, memorial service, or other traditional remembrance, can be a meaningful gesture from the Trustee during a time which is undoubtedly difficult for the family. It is also important to remember to communicate in a sensitive way with the family in regard to termination activities when sending letters or having conversations. For the family, termination is not just an administrative function, it is the end of their loved one s life. Often, the death of the beneficiary changes the day-to-day routine of family members, especially those who 1 It is important to be aware of the different traditions within various cultures in regard to gifts. For example, in some religious traditions, flowers may not be an appropriate item to send to a funeral. 2
were devoted to daily care giving. Although there isn t one particular way to address family members grieving the loss of a loved one, keeping the emotional aspect of the situation in mind (and acknowledging it), while communicating administrative issues, will usually be appreciated by the family and lead to better conversations about the work that needs to be completed. B. Termination of First Party SNTs The majority of first party SNTs terminate upon the death of the beneficiary. When a beneficiary passes away, there are several issues which need to be addressed. v.9.19.2017 a. The Medicaid Payback 2 Of primary concern is the Medicaid Payback or Medicaid Lien required in any first party SNT drafted on or after August 11, 1993 (sometimes referred to as post-obra SNTs). 3 If the beneficiary received Medicaid at any time during his/her lifetime, then upon the beneficiary s death, there is a requirement that the State Medicaid Agency (or Agencies) be reimbursed for the medical assistance provided, up to the amount remaining in the SNT 4 and 5. If the lien exceeds the balance of the SNT, Medicaid does not have a right to recover funds beyond that amount from the beneficiary s family members. Other benefits such as SSI, SNAP, TANF, and Section 8 Housing Vouchers, and educational expenses related to an IEP, are not subject to any recoupment by the state. 2 For purposes of clarity, it should be noted that in some states, Medicaid is considered a beneficiary rather than a lien holder. 3 See SSA POMS SI 01120.200H 4 See SSA - POMS SI 01120.203B(1)(h) To qualify for the special needs trust exception, the trust must contain specific language that provides that upon the death of the individual, the State(s) will receive all amounts remaining in the trust, up to an amount equal to the total amount of medical assistance paid on behalf of the individual under the State Medicaid plan(s). The State(s) must be listed as the first payee and have priority over payment of other debts and administrative expenses except as listed in SI 01120.203B.3.a. 5 It should be noted that in CA, some of the exceptions to general Medicaid (Medi-Cal) estate recovery have been successfully argued as applicable to SNT recovery (i.e., recovery delayed if SNT beneficiary has surviving spouse, an exception if SNT beneficiary has surviving blind, disabled, or minor child, and an exception if beneficiary was under 55 when services were received). This is due to the court s interpretation in Shewry v Arnold that the remaining trust assets are part of the beneficiary s estate, not trust assets. However, a more recent case, Herting, contradicts this finding. In CA, consultation with trust counsel in regard to whether any exceptions apply after the death of a SNT beneficiary is likely a best practice.
If multiple states provided medical assistance, the trust payback language should provide for a pro-rata share of the funds left in the trust as required by POMS SI 01120.203B(1)(h). If the Trustee has knowledge, or suspects, that the beneficiary has lived in more than one state, the Trustee should contact the state Medicaid agencies for each state to notify them of the death of the beneficiary and confirm (best practice for administration would suggest in written form) whether benefits were received, and, if they were received, request a detailed itemization of expenditures for review. In a SNT funded by a personal injury action, the medical expenses paid by Medicaid between the time of the accident, and the trust funding, are typically negotiated and settled by the personal injury attorney and Medicaid ( the Medicaid lien is resolved ) prior to the remaining funds being deposited into the special needs trust. However, if there are non-injury related medical assistance or services received by the beneficiary prior to the establishment of the trust (e.g. the beneficiary was a Medicaid recipient prior to the injury), that are not related to the personal injury action, the POMS indicates that a trust must not prohibit a claim for those costs by Medicaid at the death of the beneficiary. 6 After receiving notice that a beneficiary has passed away, a Trustee typically notifies the State Medicaid Agency and requests that the Agency submit a claim for reimbursement. The State Medicaid Agency will generally respond with a detailed claim, itemized by treatment date and type. If only a summary is provided by the Medicaid Agency, the Trustee should request a full copy of the claim. While a detail-oriented Trustee might be able to review the claim to determine if duplicate entries appear, or if the claim includes charges which should have been resolved by the initial Medicaid lien pre-trust funding, most Trustees are not trained medical billing professionals and also are not usually privy to each and every treatment received by the 6 See SSA - POMS SI 01120.203B(1)(h) 4
beneficiary. For that reason, it can be useful for the Trustee to submit the claim to a case management firm or other professional for further review (some documents specifically state that the Trustee shall make a submission of the claim for review to a professional). Another best practice is also to send the beneficiary s surviving family members, or guardian of the person, a copy of the claim and ask them to review it as they may be more aware of treatment types, dates, and locations than the Trustee. A professional review, and requesting the family members or guardian confirm (ideally in writing) that they have reviewed the claim can help mitigate any legal disputes which could arise later from a party contesting the lien amount and increases the chance that any error will be identified. However, if necessary, any disputes regarding the amount of the claim may be submitted to a court for final resolution. It may also be wise for the Trustee to request a release from the State Medicaid Agency at the time the payment of the lien is made. b. Post-Death Distributions Another significant area of consideration after the death of the beneficiary relates to which items can be paid by the trust prior to the satisfaction of the payback. SSA POMS SI 01120.203B.3.a specifically addresses which items may be paid prior to Medicaid: 1. Taxes due from the trust to the State(s) or Federal government because of the death of the beneficiary 2. Reasonable fees for administration of the trust estate such as an accounting of the trust to a court, completion and filing of documents, or other required actions associated with termination and wrapping up of the trust. The POMS also provides some examples of prohibited expenses and payments prior to the reimbursement to Medicaid: 1. Taxes due from the estate of the beneficiary other than those arising from inclusion of the trust in the estate; 2. Inheritance taxes due for residual beneficiaries; v.9.19.2017
3. Payment of debts owed to third parties; 4. Funeral expenses; and 5. Payments to residual beneficiaries. Trustee attorney fees, Trustee s fees, the cost of hiring a professional to review the lien documentation, tax preparation fees, fees related to the sale of trust property, and any other costs directly related to winding up the trust are typically allowable prior to the lien reimbursement. In case questions arise from Medicaid surrounding these payments, it is prudent for the Trustee to keep detailed records regarding the funds expended. More difficult to address are requests that come in after the death of the beneficiary for funeral and burial expenses, third party bills, and requests from family members for bills previously paid by the trust (e.g. cell phone bills). If post-death distributions are needed that are not related to winding up the administration of the trust, in many jurisdictions, the Trustee can contact the State Medicaid Agency to obtain a preliminary balance due the Agency. Many Agencies are able to provide this information quickly and if the lien is significantly less than the remaining corpus, the Trustee can usually feel confident in paying any remaining bills and expenses knowing there are ample funds left to reimburse Medicaid. However, if it is unclear that any funds will remain in the trust postpayback, the Trustee can find itself in a more difficult situation. If a pre-paid burial plan 7 was not purchased during the lifetime of the beneficiary (it is highly recommended that the purchase of plan is discussed shortly after the trust is funded), many Medicaid agencies will allow an allocation, pre-reimbursement, for basic burial services. 8 In regard to unpaid bills due third parties, the Trustee has limited options in a situation where the lien balance exceeds the trust value. Most of the strategies for mitigating a situation where 7 Although, the family may need to be made aware that this plan does not cover everything e.g. does not cover food for a reception, cannot cover the cost of a burial clothing for the beneficiary, or extra flowers. 8 The amount allocated by the state is typically only a few thousand dollars and often will not allow for the type of burial desired by the family. There is also no guarantee a state Medicaid agency will allow any amount to be used prior to payback. 6
vendors or others cannot be paid after the death of the beneficiary need to occur prior to death. For example, upon learning a beneficiary is in declining health, the Trustee could contact all third parties involved and request an immediate billing. Some care giving agencies familiar with special needs trusts require a deposit equivalent to one pay cycle for the care givers in order to mitigate a situation where funds are due to employees and most rental situations require a deposit be paid. Given the fragile state of many SNT beneficiaries, general best practice in administration is to promptly process all bills for payment as the health of many beneficiaries can change quickly. Lastly, some of the most challenging termination situations arise when the value of the lien exceeds (or nearly exceeds) the amount remaining in the trust and there are family members who survive the beneficiary living in the trust owned home, or who were receiving a care giving salary for the services they provided the beneficiary. As Trustee, it is very important to set very clear expectations early on in the relationship regarding the realities of the Medicaid lien and the potential that a home, regarded as the family home, might someday need to be sold or that a care giving salary paid for years to a loving parent might abruptly end upon the death of their loved one. 9 It is important to have this conversation from time to time throughout the relationship as well (and to document it in a real estate occupancy agreement and in notes to the trust file). But, even when the information is shared and understood by all parties, the reality of the situation is difficult for all parties to negotiate. c. Tax Issues on Termination of a First Party SNT Assets in a First Party SNT are generally included in the beneficiary s taxable estate for purposes of Federal Estate Taxes, State Estate Taxes and State Inheritance Taxes. For Federal 9 As part of settlement allocation planning, sometimes an allocation can be made to the family in order for them to purchase a home outside of the trust. Additionally, in some states, a family may be able to purchase the remainder interest in real estate the trust owns as a life estate and thus receive the home after the death of the beneficiary. v.9.19.2017
Estate Taxes, if assets in the Trust exceed the Estate Tax Exemption amount ($5.490M for 2017), then a Form 706 (Federal Estate Tax Return) will need to be filed. Certain States may also impose a state estate tax and/or a state inheritance tax. The exemption amount may be much lower in these states, so a state estate and/or inheritance tax return may be due in those states if the assets in the trust exceed that lower exemption amount. It is rare to have a Generation Skipping Transfer ( GST ) tax issue for First Party SNTs, since the assets are included in the beneficiary s estate and generally pass to the parents or siblings of the beneficiary. However, GST issues could arise depending on the value of the residue and the ultimate recipient. Because the assets are included in the beneficiary s estate for purposes of Federal Estate Taxes, the assets in the trust are entitled to a step-up in cost basis to the value on the date of death of the beneficiary. d. Court Accounting Requirements upon Termination of First Party SNT. First Party SNTs are usually court monitored, and often require periodic court accountings. If the SNT was subject to court accountings during administration, then a final accounting will need to be filed. In some instances, the court accounting has to be filed and approved before any assets can be distributed to the remainder beneficiaries. In other instances, the court wants to see all assets distributed out to remainder beneficiaries before the final accounting is filed so that the final accounting reflects a $0 balance. In some instances, no final accounting will be required at all. The selection of trust counsel with experience in the termination of special needs trust in a particular jurisdiction can help guide the Trustee through the process and help ensure adherence with the process required (especially when to distribute assets and to whom). 8
e. Final disposition after Medicaid Payback. Final disposition (after Medicaid Payback) depends on the governing document and local and state law. In some instances, First Party SNTs provide for the trust assets to pass to the personal representative of the beneficiary s probate estate; in those instances, a probate estate must be opened and a personal representative or executor must be appointed. The Trustee then delivers the assets to the personal representative pursuant to a court order. In other instances, the Trust may provide for all assets to pass to certain named individuals, such as the parents of the beneficiary, and, in those instances, opening a probate is not required. In this situation, the Trustee may distribute outright to those individuals, after Medicaid reimbursement, and usually pursuant to a court order. In still other instances, the governing document may provide the beneficiary with a power of appointment via the beneficiary s Last Will and Testament, and if the beneficiary has sufficient mental capacity, the beneficiary may exercise that power of appointment by executing a valid will. In this situation, the will must be submitted to probate, and a probate estate must be opened by the nominated personal representative or executor 10 In still other instances, the governing document may provide for all assets remaining in the trust after death to pass to the beneficiary s heirs at law (AKA intestate heirs) 11. Typically, it depends on the court jurisdiction, state law, and the circumstances as to whether this will 10 If a SNT contains this power, the Trustee should determine if the beneficiary exercised it and, ideally, obtain the will from the family prior to death. 11 It may require significant research to determine the identity of intestate heirs, if those heirs are alive and their legal address. The Trustee may have to request birth certificates, death certificates (if an intestate heir predeceases the SNT beneficiary), or hire a firm to help locate missing heirs. The Trustee may also have disputes arise among the heirs at law due to family dynamics. In some circumstances, the Trustee may have to instruct them to obtain their own counsel to reach an agreement. v.9.19.2017
require an actual heirship proceeding to be filed and pursued by one of the heirs, or whether the Trustee can determine the heirs and distribute accordingly. Another item that requires review are any structured settlements which the SNT has the right to receive. In cases involving Special Needs Trusts, many states require that the trust or the state be named as beneficiary of the Structured Settlement on death of the annuitant, and may require that the commuted value of the annuity be paid into the trust. 12 f. General Trustee Administrative Issues In general, a Trustee should develop a documented administrative process for the termination of special needs trusts. Although the process may vary from Trustee to Trustee, a closing check list might include items such as: 1. Notify State Medicaid Agency of death and request payback amount and full documentation (recommended that actual formal request be sent via letter) 2. Request Step-Up of Cost Basis on Assets (step up to date of death) 3. Review Annuity Contracts and determine remainder beneficiaries 4. Code account as closing for investment purposes and consider liquidation of the account to avoid market fluctuation 5. Work through disposition of any illiquid assets (e.g. new deeds, titling, etc.) 6. Review distributions and stop any automatic payments (consider payment of credit cards, payments for care giving, utility bills etc.) 7. Notify fiduciary tax preparer of death of the beneficiary (may need to change from grantor to complex trust return) 8. If funds will remain after Medicaid Payback, update beneficiary notifications 9. Determine whether a probate estate for beneficiary s estate will need to be established. 10. Make sure known creditors other than Medicaid are provided with notice and publish for unknown creditors 11. Determine if the trust requires a final court accounting 12. Determine whether a Federal form 706 or state inheritance tax return will need to be filed 13. Make sure that the closing letter is received prior to final distributions, and prior to partial distributions obtain release/refunding agreements g. Early Termination 13 12 There are also potential estate planning benefits to the commutation provision as the present value of the future stream is includable in the estate of the beneficiary. If trust funds exceed the estate tax limit, the value of the commuted annuity might be available to pay any tax liability. 13 It is important to note that in June of 2010 (and effective October 1, 2010), SSA via the POMS issued new requirements in regard to early termination language applicable to all trusts established with the assets of an SSI 10
Although termination of a first party special needs trust most typically occurs at the death of the beneficiary, there are other situations in which termination might arise during the lifetime of the beneficiary. Most often, early termination occurs due to a finding that the beneficiary is no longer under a disability. While some SNTs allow for a termination due to the SNT reaching a certain small dollar value, it is rare that a situation would arise that would make termination due to dollar value beneficial to an individual receiving means-tested benefits. In regard to an early termination due to cessation of disability, trust documents often give the Trustee, the trust protector, or the court, the power to determine if the beneficiary no longer needs the special needs trust. When the Trustee or the trust protector is given the power to determine capacity, specific criteria are usually listed in regard to how the determination is to be made such as evaluation by medical professionals, or a set of skills or standards a beneficiary must demonstrate (e.g. supporting themselves for a year, being able to understand currency, no longer meeting disability criteria for public benefits). When the court holds the power, the court also evaluates the beneficiary under a set of criteria established by the trust document such as whether the beneficiary is fully competent, is without any legal disability, and does not meet the criteria for disability under federal statute. Although the Trustee may have the power to determine whether disability has ended, due to the significant ramifications of early termination (requirement to payback Medicaid, loss of protection for means-tested public benefits, and the removal of an objective third party between the beneficiary and requests for funds that may be influenced by others), many Trustees would likely prefer to approach the court for a beneficiary that were created on or after January 1, 2000. A trust which does not comply with the new requirements (e.g. many older documents contained language which directed the Trustee to distribute the funds to a relative of the beneficiary with precatory language that the funds then be used for the benefit of the beneficiary) has a 90 day window for amendment once notification of the deficiency is made. To comply, the early termination provision must state that upon early termination, all Medicaid liens must be satisfied, all remaining funds must be distributed only to the beneficiary, and the power to terminate must be held by someone other than the beneficiary. v.9.19.2017
determination regarding termination or request the beneficiary petition the court. In this situation, the Trustee may consider requesting the beneficiary meet with independent legal counsel to ensure the various aspects of termination are fully understood and communicated to the beneficiary. Additionally, depending on the underlying medical condition which led to the funding of the SNT, the Trustee may want to request the beneficiary confirm with a medical professional that the reoccurrence of the medical condition in the future is unlikely. 14 Trusts which allow for termination due to trust administration being uneconomical, typically when the corpus reaches a stated amount such as $50,000, contemplate a situation where the payment of Trustee fees and costs of administration no longer make sense in light of the size of the trust. However, even when the trust only contains $50,000 and if the beneficiary is receiving means-tested public benefits, it is rarely beneficial to distribute those funds outright and disqualify the beneficiary until their resources are diminished. In this situation, if maintaining the account is not possible, a corporate Trustee or professional fiduciary might consider resignation and the appointment of a pooled special needs trust as Trustee or consider the purchase of exempt assets. C. Termination of 3 rd Party SNTs After the death of the beneficiary of a third party SNT, the Trustee must also address termination. However, no Medicaid lien applies, and the main issues that need to be addressed are usually taxation, final disposition, court accountings, and general administrative issues. a. Taxation Assets in a Third Party SNT are generally not included in the estate of the beneficiary, unless the beneficiary is given a general power of appointment over the assets. A majority of 14 For example, this could be true for beneficiaries who received their settlement due to injuries suffered as a result of e-coli related incidents as they may be healthy after recovering from the initial incident, but potentially could have organ damage that results in issues later in life. 12
SNT beneficiaries are unable to exercise this power, but the holding of such power may require the Trustee to include the assets on a Federal Estate tax return, or on a state estate tax return if the asset values exceed the tax exemptions. 15 Additionally, the current federal estate tax exemption amount of $5.49 million further limits the number of SNTs which would have a tax liability in a situation where the beneficiary holds a general power of appointment. Given that many states have a lower estate tax exemption (e.g. for 2017, Oregon s is $1 million), it is more likely a state estate tax situation could arise if a general power of appointment is held. In regard to GST, it is possible that there could be a taxation issue on a third party SNT if the assets in the trust are passing to a skip person (generally, a person two or more generations below the grantor or donor of the trust assets), and the value of the assets are greater than the current exemption of $5.49MM. In this situation, the skip person is one to the original grantor or donor of the trust assets, not a skip person to the beneficiary. b. Final Disposition A Third Party SNT will likely distribute to remainder beneficiaries or charities named in the document. When determining who will inherit the remaining assets in a SNT, the trust document typically guides the Trustee as to disposition. One of the trickiest aspects for a Trustee can be locating family members who inherit due to being part of a class. Additionally, if a named charity is no longer in existence, the Trustee may need to work with the Attorney General s office in that state to determine a substantially similar organization or petition the court for instruction. 15 Inheritance tax could also be a consideration if the property is inherited from someone who lives in one of the six states which impose this tax on various categories of individuals who inherit from a decedent. v.9.19.2017
c. Court Accountings and Medicaid Payback There is rarely a court accounting requirement in a Third Party SNT after the death of the beneficiary; however, the Trustee, as part of its closing procedures should confirm one is not required. Unless the SNT was improperly drafted no Medicaid Payback will be required on a Third Party SNT. 16 d. Administrative Issues As with First Party SNTs, it is prudent for a Trustee to develop a documented administrative process for the termination of Third Party SNTs. Although the process may vary from Trustee to Trustee, a closing check list might include items such as: 1. Do not step up cost basis on assets unless the assets are includible in the beneficiary s estate 2. Code account as closing for investment purposes and consider liquidating the investment portfolio to avoid market fluctuation 3. Work through disposition of any illiquid assets (e.g. new deeds, titling, etc.) 4. Review distributions and stop any automatic payments (consider payment of credit cards, payments for care giving, utility bills etc.) 5. Analyze the trust to determine whether funds distribute outright to remainder beneficiaries, or remain in trust for remainder beneficiaries, etc. 6. Determine whether the trust is subject to Generation Skipping Taxes on termination 7. Communicate with remainder beneficiaries regarding distributions and collect any necessary administrative documentation, e.g. transfer instructions e. Other issues in 3 rd party termination Although some Third Party SNTs may allow for termination due to trust administration being uneconomical, again, as with First Party SNTs, if the beneficiary is receiving meanstested public benefits, it is rarely beneficial to distribute those funds outright and disqualify the beneficiary until their resources are diminished. The Trustee, again, should consider resignation and the appointment of a pooled special needs trust as Trustee or consider the purchase of exempt assets. 16 If, upon acceptance of a trust, a Trustee realizes there is a Medicaid Payback provision in a 3 rd party SNT, the Trustee may want to engage counsel to explore any legal options available to resolve this issue.. 14
Another challenge that can arise in the termination of a Third Party SNT is the absence of language allowing for the payment of the beneficiary s funeral, burial, and final expenses prior to distribution of the funds to the remainder beneficiaries. If the trust document does not contain language allowing these expenses, the Trustee may consider purchasing a pre-paid funeral plan during the beneficiary s life, so long as it fits with in the distribution standard. If a plan is not purchased, and funds are needed to pay for these expenses, a Trustee will need to obtain approval from the remainder beneficiaries prior to payment for funeral or burial costs. Fortunately, the remainder beneficiaries may be willing to approve reasonable expenses for these costs. D. Conclusion The termination of Special Needs Trusts is an inevitable aspect of trust administration and a Trustee must address termination with a documented and careful administrative process, all the while keeping in mind the human aspect of the situation. This information is provided for educational and informational purposes only and reflects my own views and does not necessarily reflect the views of Wells Fargo Bank, N.A. v.9.19.2017