What are the key legal issues that legal counsel should consider when reviewing a client’s MTPD’s documents, including the Joinder Agreement application to open an account with the MTPD?
INFORMATION FOR THE LAWYER DISCLAIMER: The information contained below is general in nature and is not intended to be legal advice with regard to any specific situation. Anyone who is interested in establishing a special need trust or an account in a pooled special needs trust should seek the advice of an attorney.
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Why should my client be interested in establishing a Special Needs Trust for a disabled family member?
People with intellectual disabilities have many needs beyond basic medical care, food, clothing and shelter, including recreation, transportation, dental care, telephone and television services, differentials in cost of housing and shelter, supplemental nursing care, private case management, and mobility aids including electric wheel chairs.
To provide for the payment of these needs, federal law permits a person to establish a special needs trust (or “SNT”) to benefit the individual with disabilities. If properly structured, the SNT’s assets will not be considered assets of the disabled beneficiary and therefore will not disqualify him or her from SSI or Medicaid benefits. 42 U.S.C. §1382b, §1396p(d)(4). Parents of a disabled child often are the settlers who fund the SNT, However the individual with disabilities also can fund his or her trust using for example an inherited fund or lawsuit settlement or award.
Does the MTPD qualify as an SNT?
The Maine Trust for People with Disabilities (“MTPD”) offers the opportunity to establish an account in both a third-party SNT (i.e., the “MTPD Trust #1”) and a first-party SNT (i.e., the “MTPD Trust #2”). Both types of accounts have been approved by the Maine Department of Health and Human Services and the Social Security Administration as special needs trust. An account in MTPD Trust #1 can be funded with the assets of a parent or any other person except the disabled beneficiary. By contrast, an account in MTPD Trust #2, can be funded with assets of only the disabled beneficiary. Funds held in an MTPD account are not assets counted for Medicaid or SSI eligibility purposes. In order to qualify an MTPD account as an SNT, the MTPD trust agreement does not require the trustee to use the assets for the support and maintenance of the disabled beneficiary, but rather all distributions are discretionary. See Social Security Administration POMS SI 01120.200.
For a discussion of the other advantages of establishing an MTPD account see FAQ’s.
What is the difference between an MTPD Trust #1 account and an MTPD Trust #2 account?
An MTPD Trust #1 account can be funded with the assets of any person except the individual with disabilities. For example, parents and grandparents of individuals with disabilities can fund an MTPD Trust #1 account. An MTPD Trust #2 account, on the other hand, can be funded only with assets that are owned by the individual with disabilities who will be the beneficiary of the account.
Current law requires that, following the death of the beneficiary, the remaining property in the account (called the “residue”) must be treated differently, depending on which type of MTPD account has been established, as follows:
MTPD Trust #1: Following the death of the beneficiary, the residue can be distributed to any family member, other individual, or to a charity, including MPTD as designated in the Joinder Agreement by the family member who sets up the account.
MTPD Trust #2: Following the death of the beneficiary, the residue must first be used to reimburse the State of Maine for the Medicaid benefits received by the beneficiary. If there are any remaining funds in the residue after repayment to the State of Maine, then the remaining funds can be distributed to any family member, other individual, or charity, including MPTD designated in the Joinder Agreement.
What is the duty of a Maine attorney with respect to establishing an SNT for a client who has a disabled family member?
Maine case law suggests that it may be malpractice for an attorney to allow a client’s disabled family member to be disqualified from Medicaid (i.e., MaineCare) or SSI as the result of drafting an estate plan that leaves assets directly to the disabled family member. In 2000, an attorney was retained to draft a Last Will and Testament that left a significant sum to the testatrix’s sister who resided in a nursing home. Medicaid was paying for the sister’s care. After the testatrix’s death, the sister was disqualified for Medicaid assistance, had to spend down the inheritance, and re-apply for Medicaid assistance. The Maine Supreme Court held that the attorney “could and should have drafted a ‘Supplemental Needs Trust’ for [the sister], thereby avoiding the Medicaid spend down . . ..” On October 25, 2002, the court suspended the drafting attorney’s license to practice law due to his failure, inter-alia, to create the supplemental needs trust. Board of Overseers of the Bar v. Ralph W. Brown, Esq., 2002 Me. LEXIS190 (Me. October 25, 2002).
While this use deals with a nursing home patient, it is possible that similar legal principle could apply to any plan naming a beneficiary who is, or may become entitled to means based public benefits. The MTPD offers pre-approved SNT for such situations.
Consider how to fund an MTPD Trust #1 account.
Parents who establish an MTPD Trust #1 account for a child with a disability often decide to fund the account after the death of both parents. In other words, the account is often funded under the Last Will and Testament of the last parent to die. While this approach works in many cases, it does pose the risk that one or both parents may incur large health or nursing home bills at the end of life, leaving little or nothing to pass to the child’s MTPD account after the parents have died. If it is important to parents to assure that the MTPD account for their child will be funded regardless of what their own medical and other expenses may be, parents can use a number of funding strategies. First, parents can make lifetime gifts to the MTPD account. Second, parents can obtain a paid-up life insurance policy that either names the MTPD account as the beneficiary or that is owned by the MTPD and funded by the parents. Parents often find that a second-to-die policy insuring the lives of both parents is an affordable way to fund an account.
Consider the income tax aspects of funding an MTPD Trust #1 account.
An MTPD Trust #1 account is taxed as a so-called “complex trust”. Any taxable income not distributed to the beneficiary in the year the income is realized will be taxable to the account, which will pay the applicable income taxes from assets of the account. To the extent that taxable income is annually distributed to the beneficiary or to his or her legal representative, a Form K-1 will be issued to the beneficiary or to his or her legal representative, who will be responsible for including such income in the beneficiary’s income tax return reported to the IRS and other taxing authorities, if any such return is required.
Consider the charitable gift aspects of an MTPD Trust #1 account.
An MTPD Trust #1 account does not qualify as a charity. Therefore, the amount that a parent or other relative contributes to an MTPD Trust #1 account will not qualify for a charitable income tax deduction.
The donor may irrevocably designate in the Joinder Agreement that a charity will receive some or all of the residue of an MTPD Trust #1 account following the death of the disabled beneficiary. Possible charitable recipients include, among others, the sponsor of the MTPD (being the Maine Trust for People with Disabilities, Inc.) or any nonprofit social service agency that provides services to the disabled beneficiary. Any portion of the residue left to a charity as a residuary beneficiary will not qualify for an income tax charitable deduction. If the donor wishes to obtain an income tax charitable deduction for the residue that will be payable to a charity, then in connection with funding an MTPD account during his or her lifetime, the donor may wish to also establish a separate charitable remainder trust that pays an annuity to the MTPD account. This technique is described in Revenue Ruling 2002-20. See also http://www.unclefed.com/Tax-Bulls/2002/rr02-20.pdf
Consider the gift tax consequences of funding an MTPD Trust #1 account during the lifetime of the Sponsor.
The MTPD does not contain a so-called “Crummey” power of withdrawal exercisable by the disabled beneficiary or any other person. The presence of a Crummey power would likely result in the amounts donated to the disabled beneficiary’s account being viewed as the beneficiary’s countable asset for Medicaid and SSI eligibility purposes. The absence of a Crummey power in the MTPD results in all amounts given to an MTPD Trust #1 account failing to qualify as a so-called present interest gift under IRC Section 2503(b). Therefore, all amounts given to an MTPD Trust #1 account will result in the donor having made a taxable future interest gift, which will reduce any remaining federal credit shelter amount available to the donor.
Consider the estate tax consequences if your client retains the right to change the residuary beneficiary of the MTPD Trust #1 account.
A person who opens and funds an MTPD account for a disabled beneficiary is called a “Sponsor” in the MTPD Joinder Agreement. Under the Joinder Agreement, the Sponsor can elect to fund the account during his or her lifetime or at death. The Joinder Agreement also allows the Sponsor to name a residuary beneficiary (including family members) who will receive the residue of any MTPD Trust #1 account assets that remain following the death of the disabled primary beneficiary. If the Sponsor completes the Joinder Agreement to indicate that he or she retains the right to change the residuary beneficiary and if the sponsor dies while still holding such right, then the Sponsor will be seen as having a retained power over the account assets, which will result in the value of the assets that remain in the account as of the date of death of the Sponsor being included in his or her taxable estate under IRC Section 2038. If, on the other hand, the Sponsor irrevocably names a residuary beneficiary of the MTPD which he or she cannot change, then the assets in the MTPD account should not be included in the Sponsor’s taxable estate.
Consider how to fund an MTPD Trust #2 account.
Generally ownership of significant assets will immediately disqualify an individual from receipt of Medicaid and SSI benefits until the individual “spends down” the assets to a low level. For this reason, beneficiaries who suddenly are entitled to receive funds—such as an inheritance or insurance settlement—often wish to fund an SNT as soon as possible in order to re-qualify for Medicaid and SSI without having to spend down the newly-acquired assets. In such cases, an individual with disabilities may be most advantaged by transferring assets to an MTPD Trust #2 account as soon as possible after receiving ownership of the assets.
Consider the income tax aspects of funding an MTPD Trust #2 account
An MTPD Trust #2 account is taxed as a so-called “grantor trust”. All taxable income realized by an MTPD Trust #2 account will be considered to be taxable income realized by the beneficiary.
Consider the charitable gift aspects of an MTPD Trust #2 account.
An MTPD Trust #2 account does not qualify as a charity. Therefore, the amount that a disabled beneficiary contributes to an MTPD Trust #2 account will not qualify for a charitable income tax deduction.
Consider the estate tax consequences of an MTPD Trust #2 account.
An MTPD Trust #2 account is a First Party (i.e., self-settled)SNT because it is funded exclusively with the assets of the disabled beneficiary, and further the assets of the account are used exclusively for the benefit of the disabled beneficiary. As a self-settled trust, the residue of an MTPD Trust #2 account is included in the taxable estate of the deceased disabled beneficiary. In almost all cases, however, this does not result in the estate of the deceased beneficiary incurring estate taxes for two reasons: First, required Medicaid repayments to the State of Maine are paid from the residue of the MTPD Trust #2 account, which typically consumes all of the residue and leaves nothing to be included in the deceased beneficiary’s taxable estate. Second, in order to qualify for Medicaid and SSI benefits the disabled beneficiary typically can own liquid and illiquid assets that total no more than $2,000 (under current law). Therefore, adding any remaining residuary assets from an MTPD Trust #2 account to the taxable estate of a deceased beneficiary generally will not result in the total taxable estate exceeding the federal or Maine estate tax exemption amounts.
Consider the gift tax consequences of funding an MTPD Trust #2 account during the lifetime of the sponsor.
An MTPD Trust #2 is a self-settled trust. Therefore there are no gift tax consequences to the disabled beneficiary of funding his or her own MTPD trust account with assets owned by the beneficiary.