Posts Tagged ‘self-settled trust’

Section 8 Housing Participant Permitted to Receive Special Needs Trust Benefits

JUNE 27, 2016 VOLUME 23 NUMBER 24
When an individual is receiving Supplemental Security Income (SSI) benefits, or Medicaid (AHCCCS, in Arizona) benefits, he or she may have benefits reduced or eliminated if he or she receives a lump-sum settlement of a personal injury lawsuit or periodic payments from such a lawsuit. That is the usual circumstance giving rise to establishment of what is called a “self-settled” special needs trust. There are a number of specific requirements for establishment and administration of such a trust — but that is not our subject today. What about public benefits programs that are less-known — like Section 8 subsidized housing, for example?

That was the problem facing Kimberly DeCambre, a Massachusetts resident who had received a personal injury settlement. She established a special needs trust, protecting her SSI and Medicaid benefits, but she was also receiving Section 8 rent assistance. Could she maintain those benefits, as well?

One of many oddities in the patchwork of federal/state benefits programs is that the various programs may use “asset” and “income” differently in determining eligibility. For Section 8 housing subsidies, for instance, almost any payments made by any person on behalf of someone else will be counted as income to the beneficiary — unless the payments are “temporary, non-recurring or sporadic.” That is very different from the SSI standard, which permits unlimited payments directly for any goods or services so long as they are not “food or shelter.”

What that meant for Ms. DeCambre was devastating. While she had long paid $435 in rent (the total rent bill was $1,560), the Section 8 administrators determined that all the special needs trust payments on her behalf for previous years should be counted as income, ending her eligibility for the program altogether. Not only would her rent jump by over $1,000, but if her trust was able to pay anything toward her rent, it would reduce her SSI payments by more than $250 per month.

Ms. DeCambre sued, asking the trial court to determine that the trust’s payments of such things as cell and landline telephone payments, automobile expenses and veterinary bills for her cats should not be counted as income for Section 8 purposes. She argued that she needed those services because of her disabilities, that the Section 8 rules were penalizing her for transactions that were permissible under other federal laws, and that the payments were not really being made by someone else at all, since they were being made from her own money, now placed in the special needs trust.

The Federal District Court judge agreed with her, but only to a limited extent. Under the judge’s interpretation, the agency should have conducted a more thorough review of each transaction to determine whether it could be allowed as necessary for her emotional and medical needs. Ms. DeCambre appealed, seeking a more sweeping declaration of the correctness of her position; the Section 8 agency also appealed, arguing that none of the expenses paid by the trust should be excluded from the income determination.

The First Circuit Court of Appeals (with direct jurisdiction over Maine, New Hampsire, Rhode Island, Puerto Rico and Massachusetts) gave Ms. DeCambre her sweeping declaration. According to the three-member panel of appellate judges, the money going into Ms. DeCambre’s special needs trust was her own money. In other words, if the personal injury settlement proceeds had been paid directly to Ms. DeCambre, payments from that lump-sum would not be treated as income to her — and that result should not change just because her proceeds had gone into a special needs trust. With no payments from the trust being treated as income, Ms. DeCambre’s monthly rent cost should drop back to $435 — or even lower, since that figure included some payments that had been made before the final calculation treating all trust payments as income. DeCambre v. Brookline Housing Authority, June 14, 2016.

What does this decision mean for other special needs trust beneficiaries on Section 8 housing subsidy programs? It is potentially a profound shift in the way such participants will be treated. But it is important to recognize that Ms. DeCambre’s situation was different from those of many other trust beneficiaries.

First, it is likely that the logic of the holding will apply only to self-settled trust beneficiaries. If a trust is established, say, by parents of an individual with a disability, and funded with the parents’ own funds, that trust (usually called a “third-party” trust) will not be treated the same as Ms. DeCambre’s trust.

It is also unclear whether some individuals on Section 8 housing might now have the opportunity to establish a special needs trust to maintain just those benefits. Given housing authorities’ interpretation of the regulations before this decision, it has been unproductive to consider such an approach. Now that might be a possibility in individual cases.

It is also odd timing to have this development arrive just as Achieving a Better Life Experience Act (ABLE Act) accounts become available. Those accounts offer new flexibility to pay housing expenses for individuals with disabilities, and as a result there are a handful of new options available to cover such expenses.

A confusing network of public benefits programs just became more confusing — but at the same time, more approachable. It is unclear whether the housing authority involved in Ms. DeCambre’s case might seek Supreme Court review of her decision, or whether other, similar cases might begin to move through other Federal Circuits, but there is likely to be a patchwork of approaches for the next few months or years. The good news, though: housing problems for individuals with disabilities will not be so impenetrable as they have been over the past three or four decades.

Debit Card for Special Needs Trust Creates Eligibility Problem

AUGUST 3, 2015 VOLUME 22 NUMBER 28

As part of Pennsylvanian Sharon Edwards’ (not her real name) divorce settlement, she and her husband agreed to establishment of a special needs trust to hold some of the marital property she would receive. With the trust in place, Sharon would continue to qualify for Supplemental Security Income (SSI), and she would still qualify for Medicaid coverage of her medical needs.

At least that was the plan. It relied on federal law that permits SSI recipients under age 65 to transfer assets to a self-settled special needs trust. This kind of trust must have some specific provisions, including:

  • the trust can not be used for food and shelter costs (although that limitation is not absolute)
  • the beneficiary can not receive cash or items that could be redeemed for cash
  • the trust must pay out to the state Medicaid agency at the death of the beneficiary (at least to the extent of any Medicaid services the beneficiary has received)

That was how Sharon’s trust was constructed. Her father was the initial trustee, and her daughter was the backup trustee if her father became unavailable. The trust terms required a payback to the Pennsylvania Medicaid agency upon Sharon’s death. The terms of the trust prohibited the misuse of trust funds.

What went wrong? When Sharon’s father became ill, Sharon took over a debit card on the trust’s bank account. She used the card to pay doctor’s bills, and to pay her monthly telephone, insurance and electric bills. There was some evidence that she used the card for other (and impermissible) purposes, but ultimately the result was not dependent on whether Sharon herself used the card for other kinds of things.

With online and electronic banking so widespread, debit cards and automatic bill payment arrangements are commonplace. They might seem to be a reasonable approach to handling special needs trusts, too — but they are a dangerous option. The result of Sharon’s use of her trust’s debit card: the Social Security Administration ruled that she had improperly received SSI for over two years, and that she owed the agency $18,137.

Sharon appealed the Social Security Administration’s ruling, but the Federal District Court upheld the agency. Elias v. Colvin, Middle District of Pennsylvania, July 27, 2015. The decision is unsurprising, but it does give us a chance to examine its different elements.

What, precisely, did Sharon and her trust do wrong? Was it the very existence of the debit card, or the specific uses of the card, or the fact that Sharon held it for over two years? Could the problem be solved by tearing up the card, or returning it to the trustee, and stopping the challenged payments? Let’s review some of the principles.

Generally speaking, Sharon’s trustee could have directly paid her doctor’s bills (though most should have been covered by Medicaid, of course), and her telephone bills. Neither of those payments would have been an issue, even if the trust covered all the costs, and/or made monthly payments.

Sharon used the trust to pay for insurance, as well. It is unclear from the reported court decision whether that was auto insurance, health insurance, life insurance or homeowners (or renters) insurance. If her insurance bills were for her automobile, the trustee could have paid those bills without any problem. If health insurance, the same answer applies — except, again, it would be unclear why health insurance was required if she was covered by Medicaid. Life insurance payments would have been permissible, though if Sharon owned a life insurance policy it might have resulted in a loss of SSI and possibly Medicaid coverage. Homeowner’s insurance would be fine, provided that it was not required by the bank holding a mortgage on her home (that would make the homeowner’s insurance look like a housing cost).

Finally, Sharon’s use of the debit card resulted in the trust paying for her electricity. If the trustee had written checks directly to the electric company, that might have been permissible — but it might not, depending on state Medicaid rules and the language of the trust itself. If permissible, it would have resulted in a reduction in her SSI payments.

On balance, if the trustee had paid for everything Sharon admitted using her debit card for, the result should have been (at worst) a slight reduction in her SSI. So why was she found to be ineligible for SSI altogether?

The primary problem for Sharon was that she effectively had access to the entire trust. Even though she did not, she could have gone to the ATM and withdrawn every penny in the trust’s bank account. That fact made the trust an available resource, and its income counted as income to Sharon.

Does that mean that no special needs trust should ever have a debit card, or that no special needs trust beneficiary can ever have access to a debit card? No, it does not — but there are limitations on the use of debit cards that must be observed.

Sharon’s trustee could have had a debit card and arranged for payment of her bills (except, perhaps, for the electricity bill) using the debit card. That would not have caused problems for Sharon’s SSI eligibility.

Sharon herself could have had a debit card, provided that it did not permit her to withdraw funds from the trust’s main account. Her trustee could have set up a small account with Sharon’s SSI money and let her have a debit card on that account. Or her trustee could have arranged for a specialized debit card that could not be used for cash withdrawals or purchase of food or shelter items — one such card is available and marketed by True Link Financial, and we have used their services with excellent results.

It’s also worth noting that Sharon was not given a chance to “fix” the problem by handing back her debit card. For a little more than two years, she had access to her special needs trust’s bank account — and that meant she was ineligible for SSI during that period. It did not mean that her trust was defective, or that she could never get on SSI again, but it did mean that simply giving back the card did not reverse the $18, 137 overpayment notice.

Management of special needs trusts is very complicated and often confusing. We strongly endorse the Special Needs Alliance‘s “Handbook for Trustees,” a very helpful resource for trustees and those interested in understanding how special needs trusts work. Best of all, the “Handbook” is priced right: it’s free.

The “Spendthrift” Trust Explained

JULY 27, 2015 VOLUME 22 NUMBER 27

Lawyers love to name and categorize everything they deal with. It’s a useful way to group similar concepts, but it can lead to confusion and misunderstanding. That’s particularly true when a legal concept is non-exclusive — in other words, when one instrument can go by a number of different names. Let’s see if we can address one good example: the “spendthrift” trust.

You might reasonably ask: “is my trust a spendthrift trust?” It likely does not have the term in its name (no one wants to be a beneficiary of the “John Jones Spendthrift Trust” — not even John Jones). How will you know? Because it will have a paragraph somewhere in the trust that says something like this:

“Trustee shall not recognize any transfer, mortgage, pledge, hypothecation, assignment or order of a beneficiary which anticipates the payment of any part of the income or principal. The income and principal of the trust estate shall not be subject to attachment, garnishment, creditor’s bill or execution to satisfy any debt, obligation or tort of any beneficiary, nor shall any part of the trust estate pass to a trustee or receiver in any bankruptcy or insolvency proceeding initiated by or against any beneficiary.”

It might not read exactly like that (the sample is taken from one of our documents at Fleming & Curti, PLC, and lawyers tend to love tinkering with language like this). It might be identified as “Spendthrift Provision” — or it might not. In Arizona, just calling the trust a “spendthrift trust” is probably sufficient (though we’d never recommend relying solely on the designation).

The point is that the trust’s beneficiary can not sell or transfer their right to receive future distributions from the trust. If there is a provision with similar language, the trust might reasonably be called a “spendthrift” trust. That, in turn, raises other questions:

Does the beneficiary have to be a spendthrift for such a provision to be useful? No. Plenty of very reasonable people, conservative in their financial arrangements and thoughtful about expenditures, get in financial trouble. Or they might be involved in a lawsuit. Or a messy divorce. The spendthrift provision is helpful to keep the beneficiary’s interest in the trust away from those creditors, current or future.

Can I put a spendthrift provision in my own trust? Yes, and we routinely do. But it likely won’t be effective to protect your own assets from your own creditors. The general legal principle is that you can’t shelter your assets from current or future creditors, though there are some exceptions to that rule. This is also one topic on which state laws vary considerably. Ask your lawyer if you are eager to seek protection for your own assets.

Does the spendthrift provision require that someone else be trustee? Wouldn’t it be great if you could set up a trust for your daughter, make her the trustee, and include a spendthrift provision to protect against her creditors? That way she could have complete control of the funds, make decisions about when to distribute money to herself, and still keep her inheritance secure. Turns out you can do just that — at least in most circumstances and in most states.

To keep the protection from slipping away, most of the time lawyers suggest that someone else be trustee of your daughter’s inheritance. It’s not uncommon, though, for your son to be trust of her trust, and for her to be trustee of his trust. That way they can continue to communicate and work with one another, they can help protect one another, and the decisions can stay within the family. Of course, everyone’s situation — assets, family dynamics, family structure — is different, so talk with your estate planning attorney.

Is there anyone who can pierce the spendthrift provision? There might be, depending on state law. Arizona law, for instance, creates a possibility that spendthrift trusts might be reachable for child support payments.

One other possible exception: if the trust requires distributions on a regular schedule, a creditor might be able to collect those future mandatory distributions. But the exceptions are usually very narrow — spendthrift trusts are very effective most of the time.

How likely is it that my trust is not a spendthrift trust? Not very likely. The vast majority of trusts in the U.S. include spendthrift language — or at least the vast majority of lawyer-drafted trusts do.

Should there be a spendthrift provision in my will? It’s a different question for wills, since they usually direct the distribution of all assets outright to beneficiaries in a relatively short period of time. But if your will includes a trust for one or more beneficiaries, you might want spendthrift language in those “testamentary” trusts. Talk with your lawyer about this issue.

We hope this helps. The language can be a little daunting, but lawyers’ categorizations (and labels) are actually understandable and helpful — even by real people.

Managing a Special Needs Trust — The Handbook

APRIL 13, 2015 VOLUME 22 NUMBER 14

Are you named as trustee of a special needs trust? Are you a trust beneficiary, wondering about how the trust should be administered? Or are you a parent or grandparent of an individual with a disability, wondering about what a special needs trust might actually look like in practice? Good news: there is a free resource that will help you understand these unusual trusts, and in some detail.

The Special Needs Alliance, a national organization of lawyers with extensive experience with special needs planning and special needs trust administration, has long maintained (and updated) its Handbook for Trustees (“Administering a Special Needs Trust”) online. There is even a Spanish language version. You can print out the Handbook, or order a printed copy from the Alliance.

(While you’re there, incidentally, you might want to check out the past editions of The Voice, the SNA’s periodic newsletter. There is a lot of really good information, with terrific detail and suggestions. This organization is very willing to share good ideas and explanations.)

What will you learn from “Administering a Special Needs Trust”? A sampling of some of the most important elements:

  • Understand the difference between self-settled special needs trusts and third-party special needs trusts. You might well have that basic understanding already — the former are usually funded with personal injury settlements or unrestricted inheritances received by individuals with disabilities, and the latter are usually funded with family inheritances left, with proper planning, directly to the trust. But the Handbook will help you understand the significant differences in administration between the two types of trusts.
  • Figure out the Social Security Administration’s concept of “In-Kind Support and Maintenance.” What is ISM, and why do you care? It’s the counter-intuitive calculation that determines how much a recipient’s Supplemental Security Income (SSI) payment will be reduced if someone (a trust, a parent or a generous stranger) pays for the recipient’s food and/or shelter. The Handbook gives some examples to help you grasp this odd concept.
  • Learn how taxation of special needs trusts works. Spoiler alert: the self-settled special needs trust is always a “grantor” trust, and that means it is taxed exactly as if there was no trust at all. Third-party trusts are harder to generalize about. OK — that wasn’t much of a spoiler, since you now have to go read the Handbook to figure out what those terms mean.
  • Appreciate the differences (and they are legion) between beneficiaries who receive Supplemental Security Income (SSI) and Social Security Disability Insurance (SSDI) payments. Bonus: you can also learn how an SSI recipient might shift to SSDI payments upon the retirement or death of a parent.
  • Identify which payments will be treated as “housing” for SSI calculation purposes. Rent payments are easy. How about homeowners insurance? Homeowners Association payments? Garbage pickup? Internet, cable, newspaper?
  • One common special needs trust payment is for vehicle operation and maintenance. Can a trust pay for gas? Repairs? Insurance? Read the Handbook and find out. (Spoiler alert: yes.)
  • Get a brief description of trust administration rules. Can the trustee “invest” in their own business? Hire a professional care manager, or a financial planner?

The Special Needs Alliance’s Handbook is less than 20 pages long, so it is not the ultimate authority on special needs trust administration. It is an excellent introduction to the difficult questions, and it provides answers to many of the most common questions. There are also a number of other resources we regularly suggest:

Managing a Special Needs Trust: A Guide for Trustees (2012 Edition) by Jackins, Blank, Macy and Shulman.

Special People, Special Planning: Creating a Safe Legal Haven for Families with Special Needs by Hoyt and Pollock.

Special Needs Trusts: Protect Your Child’s Financial Future by Elias and Fuller.

Income Taxation of the Self-Settled Special Needs Trust

MARCH 16, 2015 VOLUME 22 NUMBER 11

This time of year, we are often asked about income tax issues — especially when a trust is involved. It may take us several newsletters, but let’s see if we can’t demystify the income taxation of trusts. We will start with the type of trust we most often get asked about: self-settled special needs trusts.

We will ask you to imagine that you are the trustee of a special needs trust, set up for the benefit of your sister Allie. This trust was funded with proceeds from a lawsuit settlement. Allie is on AHCCCS (she lives in Arizona, where we renamed Medicaid “the Arizona Health Care Cost Containment System” or AHCCCS), and she receives Supplemental Security Income (SSI) benefits.

[Note: everything we explain here would be the same if Allie was your son, or your aunt, or your husband. It would also be true if the money in the trust came from the probate estate of your grandmother, who left Allie a share of her estate in cash (as opposed to in trust). It would be the same if the court established the trust for Allie, or her mother signed the trust, or if you signed the trust as Allie’s guardian. This advice will probably also be correct if Allie is receiving Social Security Disability Insurance payments — on her own account or on your father’s account — and/or Medicare instead of Medicaid/AHCCCS. If the trust does not include a provision that the Medicaid agency must be paid back upon Allie’s death, the answers we give here might be incorrect — wait until next week to read about that kind of special needs trust.]

Allie never actually signed the trust, but because she was once entitled to receive the trust’s assets outright it is treated (for most purposes) as if she did establish the trust herself. Even though the trust was created or approved by the court, or signed by Allie’s parents, or established by her guardian, it is almost universally referred to as a “self-settled” special needs trust. Those few practitioners who don’t use that term almost all prefer “first-party” special needs trust (though there may be differences regarding whether to hyphenate either descriptive title). We’re going to refer to it as a self-settled special needs trust.

Allie’s self-settled special needs trust has another descriptive name: it is also a “grantor” trust. That term really only has meaning for U.S. federal income tax purposes, but that’s a pretty important purpose and so the term is pervasive. Is it possible that Allie’s trust is not a grantor trust? Yes, barely. The key shorthand way to double-check: look for a provision that says Allie’s Medicaid expenses must be repaid with trust assets upon her death. If that language is in there, either the trust is a grantor trust or someone has created a really peculiar instrument. If that language is not in there, there’s actually a chance the trust is not a grantor trust — before going further with this analysis, go ask a qualified attorney or CPA whether the trust is a grantor trust.

Let’s assume we’ve gotten past this issue, and we can all agree that Allie’s trust is a grantor trust. What does that mean for income tax purposes? Two important things:

  1. Allie’s trust will never pay a separate income tax (well, at least not as long as she’s alive). The trust’s income will always be taxable on her personal, individual, non-trust tax return.
  2. Allie’s trust will also never need to file a separate income tax return. In fact, it will never be allowed to file a separate income tax return.

There is a lot of confusion about Allie’s special needs trust. Does it need to get its own taxpayer identification number (actually, the correct term is Employer Identification Number, or EIN)? No. Then why do accountants, bankers, brokers, even lawyers keep telling you that it does? Because they are wrong, that’s why. Many of them believe that any time a trust has a trustee who is not also a beneficiary the trust must get an EIN. That is not correct.

But just because Allie’s trust doesn’t need an EIN doesn’t mean that it can’t have one. You are permitted to get an EIN for Allie’s trust if you want to.

Let’s assume for a moment that you have not gotten an EIN. In that case, every bank and stockbroker (anyone who pays money to the trust, in fact) should be given Allie’s Social Security number for reporting purposes. The trust’s income will simply be included on Allie’s 1040 (her personal income tax return). Some trust expenses may be legitimate deductions from income, but the Internal Revenue Service effectively ignores Allie’s special needs trust.

That was easy, wasn’t it? Let’s make it just a little more difficult.

Maybe you did get an EIN for Allie’s trust. What kind of tax filings should you make in that case?

Armed with an EIN, you should give that number to banks, stockbrokers and anyone else who holds the trust’s money. The trust’s EIN should not be on Allie’s own bank account (where her SSI gets deposited), even though you might be both trustee and representative payee — and the two funds should not be mixed.

As trustee, you will need to file a fiduciary income tax return — the IRS form number is 1041. It will be easy to file, however. You simply type on the form (there’s no box for this — just type it in the middle of the “Income” section of the form): “This trust is a Grantor Trust under IRC sections 671-679. A statement of items taxable to the grantor is attached.” The exact language is not critical, but that is the sense of what you should tell the IRS. Then attach a summary statement of all items of income and deductible expenses the trust has handled (things paid directly out of Allie’s Social Security account should not be included here).

That’s it. No tax payment. No deductions on the fiduciary income tax return. You are supposed to issue a 1099 (not a K-1, if you are in to those characterizations) for the dividend and interest income received under the trust’s EIN. Those things then get listed on Allie’s personal income tax return (her 1040), and taxed as if they had come directly to Allie — even though they didn’t.

That was pretty easy, wasn’t it? Next week we’ll look at third-party special needs trusts. If you want to get a little preview, you might consider the year-old but still excellent analysis from the Special Needs Alliance about special needs trust taxation.

The ABLE Act — How Will You Be Able to Use It?

DECEMBER 29, 2014 VOLUME 21 NUMBER 47

Last week we told you about the passage of The Achieving a Better Life Experience Act, and tried to spell out some of the important details. But until we can all see actual cases, it might be hard to figure out how to use the new law (and the accounts that it authorizes). This week we’re going to suggest some of the ways that the new ABLE accounts might be useful — and some of the pitfalls for people who use them unwisely.

First, a caveat: we don’t really know what the ABLE accounts will look like yet. That’s because we’re collectively waiting for two things: the federal government needs to adopt regulations implementing the new law, and states need to create ABLE accounts. Neither will be complete for months, at least.

What will the ABLE landscape look like in six or nine months? We predict that there will be federal regulations, and that a number of states will have created ABLE accounts that resemble (in each instance) their existing 529 accounts. But probably not all states will have gotten on board by then. If you (or the family member you want to create an ABLE account to benefit) happens to live in a state that is lagging in implementation, the new accounts will simply be unavailable. Though you might be able to choose among the Section 529 plans of several dozen states when making a contribution, the ABLE Act limits you to the state where the person with a disability lives.

Let’s assume, though, that there is an ABLE account available. Who might set up accounts, and why would they choose an ABLE account over the other alternatives available? Let’s try some examples.

Guillermo

We’ll start with Guillermo. He is 30 years old, and he was born with Cerebral Palsy. He lives with his parents, who provide for most of his daily needs. His grandmother has just died, leaving him a small inheritance of $10,000. She did not create a special needs trust for him; she simply left him the $10,000 in his name directly.

Guillermo was disabled at birth, so he will have no trouble meeting the ABLE Act requirement that his disability had to begin before age 26. Guillermo has the mental capacity to sign a receipt for his inheritance, to open an account in his own name and to sign checks on that account — though his disability makes it impossible for him to actually sign the checks. His Supplemental Security Income (SSI) payments go into an account in joint tenancy with his mother, who makes the actual payments from the account. The bank account now has about $1500 accumulated; it is a regular problem for Guillermo and his mother to figure out ways to spend the money to keep him from losing his SSI — and the Medicaid benefits that flow from it.

Guillermo is the classic ABLE Act candidate. He could put all of his inheritance into an ABLE account, and the savings would not cause him to lose his SSI or Medicaid. He would have control over how the money was spent; he would not have to get approval from a trustee or anyone else before deciding to make a purchase. Of course, he will want to make sure his expenditures do not violate the final regulations limiting the distributions from the ABLE account, but that will probably not be any problem. In fact, Guillermo can contribute future funds to the account, too — as his SSI checking account builds up, he can put funds into his ABLE account to stay below his $2,000 limit. In this way, Guillermo can set aside savings for future expenditures — such as when he is no longer able to live with his parents.

Would Guillermo have other choices? Yes, he would. He could establish a self-settled special needs trust, or participate in a pooled special needs trust. Either of those would likely have more start-up costs than his ABLE account, and the fees charged by either a separate trustee or a pooled trustee would likely exceed the annual administrative costs in the ABLE account. Most importantly, perhaps, the ABLE account would permit Guillermo to directly control his money, which is a terrific advantage.

Guillermo’s Grandmother

Knowing what a good idea the ABLE account looks like for Guillermo, should his grandmother have just set up an ABLE account before her death? Absolutely not. Why not? Because of the ABLE account’s payback requirement.

Looking at the same transaction from Guillermo’s grandmother’s perspective, it looks completely different. It would be simplicity itself for her to modify her will to provide that the $10,000 bequest to Guillermo should be held in a third-party special needs trust — probably naming his parents as trustees, and his sister as successor trustee. The cost? Perhaps an additional few hundred dollars over the cost of her basic will. The advantages? Complete discretion in how to handle Guillermo’s money (admittedly it would be handled by his parents, but there’s nothing that prohibits them from letting Guillermo make many of the decisions for them), no administrative costs, and no payback requirement.

Guillermo’s Grandfather

Meanwhile, Guillermo’s grandfather (from the other side of the family) is planning on leaving a larger bequest to Guillermo — he is going to leave Guillermo a full 1/4 of his estate. Could he utilize the ABLE account? Absolutely not. Why not? Because his gift will be more than the $14,000/year that could be contributed to all ABLE accounts for Guillermo’s benefit, and so ABLE is simply not a choice. He could, of course, make annual contributions of $14,000 until he has put 1/4 of his total estate into the account, but that’s not what he wants to do — and besides, he is in his 80s and might not live long enough to transfer Guillermo’s full inheritance into the account.

Guillermo’s Mother

Guillermo’s family is not wealthy, but his mother thinks she could afford to put as much as $10,000 per year aside for Guillermo’s future needs. Should she utilize an ABLE account? Almost certainly not.

What’s wrong with ABLE accounts for Guillermo’s mother? The payback issue is a real problem, and one that’s easily avoidable by her setting up a third-party special needs trust. Yes, that does mean that she will need to pay the cost of creating a trust, but there will not be any continuing cost for administering the trust. She can consult with an attorney, create a trust, and start contributing funds to the trust right away. She can expressly permit expenditures that the ABLE accounts might preclude. She can invest the trust’s money in any way that seems appropriate to her — not just Guillermo’s state’s ABLE provider. She can look for lower-cost and higher-yield investments if she chooses.

Would the answer be different if Guillermo’s mother only intends to contribute $2,000 per year? Not really. She ought to start with the very small investment of talking with an experienced attorney to figure out whether she really wants to create either a trust or an ABLE account; there might be even smarter, more cost-effective options (like just creating a separate account in her own name and earmarking it for Guillermo’s benefit).

Wendy

Wendy is very much in the same situation as Guillermo, with one important difference: her disability is Down Syndrome, and her ability to make her own decisions is very limited. Her parents have been appointed as guardian (of her person); otherwise, her situation is similar to Guillermo’s. In fact, Wendy’s grandmother has just died, leaving $10,000 in her name. Is her situation the same as Guillermo’s?

Not quite. The cost of an ABLE account will actually be higher for Wendy, since she can not sign a receipt for her grandmother’s estate, or negotiate the check she receives. Her parents will probably need to go back to court to get appointed as her conservator (what is called guardian of the estate in some states) in order to set up the ABLE account. Depending on her local court, they may have to file annual accountings for the ABLE account even after it is set up.

For Wendy, a pooled special needs trust might be more suitable. Yes, there will be a small start-up cost, and there will be a payback requirement at her death. But the administrative expenses are likely to be lower than the cost of a continuing court proceeding. The best answer for Wendy might vary from state to state, from county to county, and even from year to year.

What if Wendy’s SSI bank account builds up to more than the $2,000 she’s permitted to keep? The excess might very well be directed to an ABLE account. The reason the answer is different: her mother, as representative payee, has the authority to set up the account, and the administrative costs are therefore lower than they would be for a pooled special needs trust.

Wendy’s Accident

Unfortunately, Wendy was a passenger in a van that was hit by a negligent driver. The good news: Wendy’s injuries were slight, she has recovered completely, and the negligent driver was insured. His insurance company has offered $5,000 to settle her claim.

Can this money be put in an ABLE account? Yes, and that might be the best choice. Like the small inheritance from her grandmother, there will be some administrative costs (getting the court to approve the settlement and allow the ABLE account), but the ABLE account might be the best alternative. That will especially be true if her grandmother’s inheritance was already put into an ABLE account AND the accident settlement is in the next year.

Guillermo’s Accident

Tragically, Guillermo was also injured in an auto/van accident the year after he received his inheritance from his grandmother. His injuries were more serious: the insurance company is offering $60,000 to settle his claim. Can he use his ABLE account?

If you’re paying attention, you probably think the answer is “no.” But it’s not. There is a two-step way Guillermo can use his ABLE account to receive the lawsuit settlement.

First, he could agree with the driver’s insurance company to make not a single $60,000 lump-sum payment but annual payments of $9,000 for seven years. That means that he would actually get a few more dollars in total settlement. Each year’s $9,000 can be contributed to the ABLE account without running afoul of the $14,000 annual limitation (which will rise to $15,000 within a couple years of Guillermo’s accident, making it even easier).

Of course, Guillermo still will have a payback requirement upon his death. But the language of the ABLE payback is considerably gentler than the payback requirements for special needs trusts — the ABLE account should be available to pay Guillermo’s funeral and burial expenses, for instance, without requiring that he prepay those bills.

Guillermo’s Sister

Guillermo was not alone in the van. His sister Louise was also in the van, and she was horribly injured. She was disabled by the accident; her work history is such that she receives about $500/month from Social Security Disability and another $300/month from SSI. Because she gets SSI, she also gets Medicaid coverage. She was 28 at the time of the accident.

Can Louise’s potential settlement be directed to an ABLE account, in the same way that her brother’s was? Absolutely not. Why not? Because her disability onset was after age 26. That arbitrary (and unfair) limitation, incidentally, is not based on anything but budget considerations; if Louise and people like her had access to ABLE accounts, the anticipated cost to the treasury would mushroom and Congress could not figure out how to pay for it.

Your Situation Here

As you can see, it might be hard to figure out whether an ABLE account is the right way to resolve a particular person’s problem. Some generalizations, though: if you are considering setting aside your money for a family member with a disability, ABLE is probably not your best choice. If the problem is how to handle money belonging to the person with a disability, there are quite a few factors to consider. You should get good legal advice to figure out the best solution in your situation.

Tax Issues for Trusts — Simplified

JULY 29, 2013 VOLUME 20 NUMBER 28

Judging from the questions and comments we get here, taxation of trusts is one of the most confusing issues we regularly write about. We’re going to try to collect the most important rules here for your convenience. Note that we will not try (in this summary) to touch on every exception, every caveat — we want to try to spell out some of the major categories of trusts and of taxation, and see if we can help you figure out what tax issues you have to face. We will try to give very concise answers, a little explanation and a warning about some of the more common or important exceptions in each category.

Do I need to get an EIN for my revocable living trust?

Short answer: no.

More detail: if you created a trust, put your money in it, and retained the right to revoke it — the IRS doesn’t think of it as a trust at all. It is not a separate taxpaying entity. Not only do you not need to get an Employer Identification Number, you can’t get one. A revocable living trust is always a grantor trust, and it does not file its own tax return.

Important exception: if you are trustee of a revocable living trust created by someone else, you can get an EIN but you are not required to do so. Even if you do get an EIN, the trust does not file a separate trust tax return.

I am setting up a special needs trust for my child, who has a disability. I plan on leaving his share of my estate to the trust. Does it need an EIN?

Short answer: probably not — yet.

More detail: while you are still alive you probably will be the “grantor” of the trust for tax purposes — and that may even be true if the trust is irrevocable. Probably you will pay the taxes on any income the trust receives (note: your contributions to the trust are not “income” for tax purposes). But probably this is not important — you really are probably asking about what happens when you die and your estate flows to this trust. THEN it will need an EIN and it will file its own tax returns. Probably it will be what the IRS calls a “complex” trust.

Important exception: if the trust is both irrevocable and immediately funded, it probably does need an EIN even before you die and leave a larger share of your estate to it.

My daughter’s special needs trust was funded with money from a personal injury settlement. Does it need an EIN?

Short answer: almost certainly not.

More detail: even though it is irrevocable, and even though your daughter is not her own trustee, this trust is almost unquestionably going to be a grantor trust for tax purposes. That means it does not need to have a separate EIN; it uses your daughter’s Social Security number as its taxpayer identification number.

Important exception: although it does not have to get an EIN, this kind of trust may get an EIN. But even if it does, the trust does not file a separate income tax return — all the trust’s income gets reported on your daughter’s individual return.

My father established a revocable living trust to avoid probate, and he died earlier this year. Do I need to get an EIN for his trust? Can I just keep using his Social Security number?

Short answer: Yes, you do. No, you can’t.

More detail: With your father’s death his trust became a different entity. It is no longer a “grantor” trust, so should be filing its own income tax returns for the rest of the calendar year of his death and for the future (if the trust continues).

Important exception: While the trust should have its own EIN, it will only have to file a return if it earns $600 in income in any one year after his death. So if the trust gets resolved fairly quickly, and/or does not hold any income-producing property, it may not need a tax return. In that case, and that case only, it may also not need to have a separate EIN.

As a separate exception to the general rule, note that there are some limited circumstances in which your father’s trust may not have to use a calendar year. That can have significant favorable income tax consequences, so be sure to discuss the tax issues with your accountant and/or attorney.

My wife and I created a joint revocable living trust. She died two years ago, and I was simply too busy dealing with everything to do anything about the trust. Are there tax issues I need to resolve, or am I going to get into trouble for not doing anything quickly?

Short answer: You probably are not in any serious trouble, but you should talk with an accountant and/or attorney soon. Don’t continue to put it off, please.

More detail: It may be that nothing needs to be done regarding your trust. It may be that your trust was supposed to be divided into two shares upon the first death. It may be that such a division no longer makes tax sense — but it might still be necessary to deal with it. It’s too hard to generalize about all those possibilities, and your lawyer needs to look at the trust document AND know how assets are titled. Make an appointment and start gathering information. If you don’t do anything before your own death, your children (or whomever you have named as ultimate beneficiaries) will have a much more complicated time dealing with it than you do now. Incidentally, in our experience it is fairly rare that a surviving spouse does not want to make any changes whatsoever — even if all you want to do is to accelerate the pace at which your children receive your estate, it is a good idea to meet with your attorney.

Important exception: If you are certain that your trust does not require division into separate shares on the first spouse’s death, AND you still want the same people to administer your estate, AND you still want everything divided the same way as the original document provides, then it may not be necessary to make any changes. Most lawyers will tell you that it still makes sense to update powers of attorney and your will to remove your late wife’s name (just so your back-up agent doesn’t have to produce a death certificate before banks and doctors will talk with her), but it may not be critical to do so. Still, talking with lawyers is kinda fun, and almost everyone should do it more often.

There you have it. Our most-asked-about trust taxation questions, with simplified answers. Please be careful about this information, though — there is a lot of nuance we have glossed over. Talk to your accountant and your lawyer to confirm what we have told you here before relying on it. Our goal is to give you a bit of a roadmap, not to answer complex legal questions with oversimplified generic answers. But we hope we have helped.

Why You Should Not Create a Special Needs Trust

JANUARY 16, 2012 VOLUME 19 NUMBER 3
Let’s say you have a child with “special needs,” or a sister, brother, mother or other family member. You have not created a special needs trust as part of your own estate plan. Why not?

We know why not. We have heard pretty much all the explanations and excuses. Here are a few, and some thoughts we would like you to consider:

I don’t have enough money to need a special needs trust. Really? You don’t have $2,000? Because that’s all you have to leave to your child outside a special needs trust to mess with their SSI and Medicaid eligibility.

I can’t afford to pay for the special needs trust. We apologize that it can be expensive to get good legal help. But the cost of preparing a special needs trust for your child is likely to be way, way less than the cost of providing a couple month’s worth of care. That is what is likely to happen if you die without having created a special needs trust, since it will take several months of legal maneuvering to get an alternative plan in place. Even if there is no loss of benefits, the cost of fixing the problem after your death will be several times that of getting a good plan in place now.

I’ve already named my child as beneficiary on my life insurance/retirement account/annuity. Ah, yes — our favorite alternative to good planning. If your child is named directly as beneficiary, you may have avoided probate but complicated the eligibility picture. Their loss of benefits will occur immediately on your death, rather than waiting the month or two it would have taken to get the probate process underway. This just might be the worst plan of all.

It’ll all be found money to my kids. I’ll let them take care of it if I die. We have bad news for you: “if” is not the right word here. That aside, you should understand that a failure to plan means you are stuck with what’s called the law of “intestate succession.” That means (in Arizona — if you are not in Arizona you might want to look up your state’s law) that if you die without completing your estate plan, your spouse gets everything unless you have children who are not also your spouse’s children. If you are single, your kids get everything equally. If your child on public benefits gets an equal share of your estate, we will probably need to either (a) spend it all quickly or (b) put it into a “self-settled” special needs trust. That means more restrictions on what it can be used for, and a mandatory provision that the trust pays back their Medicaid costs when they die. All their Medicaid costs. Including anything Medicaid has provided before your death. Wouldn’t you like to avoid that result? It’s simple: just see us (or your lawyer if that’s not us) about a “third-party” special needs trust. The rules are so much more flexible if you plan in advance.

My child gets Social Security Disability (or Dependent Adult Child) Benefits and Medicare. Good argument. Because those programs are not sensitive to assets or income, your child might not need a special needs trust as much as a child who received Supplemental Security Income (SSI) and Medicaid (or AHCCCS or ALTCS, in Arizona). But keep these three things in mind:

  1. Even someone who gets most of their benefits from SSD and Medicare might qualify for some Medicaid benefits, like premium assistance and subsidies for deductibles and co-payments. Failure to set up a special needs trust might affect them, even if not as much as another person who receives, say, SSI and Medicaid.
  2. Even someone receiving Medicare will have some effect from having a higher income. Premium payments are already sensitive to income, and future changes in both Medicare and Social Security might result in reduced benefits for someone who has assets or income outside a special needs trust.
  3. If your child has a disability, it might be that a trust is needed in order to provide management of the inheritance you leave them. If they are unable to manage money themselves the alternative is a court-controlled conservatorship (or, in some states, guardianship). That can be expensive and constraining.

I’m young. We agree. And we agree that it’s not too likely that you will die in the next, say, five years (that’s about the useful life of your estate plan, though your special needs trust will probably be fine for longer than that). But “not too likely” is not the same as “it can’t happen.” You cut down your salt and calories because your doctor told you it’d be a good idea — even though your high blood pressure isn’t too likely to kill you in the next five years, either. We’re here to tell you that it’s time to address the need for a special needs trust.

I’m going to disinherit my child who receives public benefits and leave everything to his older brother. That will probably work. “Probably” is the key word here. Is his older brother married? Does he drive a car? Is he independently wealthy? These questions are important because leaving everything to your older child means you are subjecting the entire inheritance to his spouse, creditors, and whims. And have you thought out what will happen if he dies before his brother, leaving your entire inheritance to his wife or kids? Will they feel the same obligation to take care of your vulnerable child that he does?

I’ll get to it. Soon. OK — when?

I don’t like lawyers. We do understand this objection. Some days we’re not too fond of them, either. But they are in a long list of people we’d rather not have to deal with but do: doctors, auto mechanics, veternarians, pest control people, parking monitors. Some days we think the only other human being we really like is our barista. We understand, though, that if we avoid our doctor when we are sick the result will not be positive. Same for the auto mechanic when our car needs attention. Also for the vet and all the rest. In fact, the only one we probably could avoid altogether is the barista, and we refuse to stay away on principle.

Seriously — lawyers are like other professionals. We listen to your needs, desires and information, and we give you our best advice about what you should do (and how we can help). Most of us really like people. In fact, all of us at Fleming & Curti, PLC, really like people — it’s a job requirement. We want to help, and we have some specialized expertise that we can use to assist you. Give us a chance to show you that is true.

We also know a good barista.

Principles Governing Third-Party Special Needs Trusts

OCTOBER 3, 2011 VOLUME 18 NUMBER 35
Last week we tried to demystify some of the principles of self-settled special needs trusts, and to distinguish them from third-party trusts. This week we continue that education effort, focusing on the rules governing third-party trusts.

Generally speaking, there are two kinds of special needs trusts. Those set up to handle money owned by the beneficiary (like a personal injury settlement, for instance) are usually called “self-settled” special needs trusts. Those set up by someone other than the beneficiary, to handle money not belonging to the beneficiary, are usually called “third-party” special needs trusts. It is the latter kind of trust we want to explain here.

What kind of property can go in to a third-party special needs trust?

Any property someone wants to leave or give to a person with a disability can (and usually should) be placed in a third-party special needs trust. Homes, cash, stock and bonds are all common third-party trust assets.

Are all inheritances properly viewed as third-party trusts, since they come from someone other than the beneficiary?

This is one of the common confusions for those not closely familiar with special needs planning. An inheritance can be left outright to someone, or in a trust for their benefit. In the case of a trust, it can be designated for the “support and maintenance” (or similar language) of the beneficiary, or for their “special” and/or “supplemental” needs (or similar language).

If an inheritance is left outright to a person with a disability, it might be transferable to a trust — but probably only to a self-settled special needs trust, since the beneficiary had an absolute right to possess the property outright. If an inheritance is left in what we might call a “support” trust, it may be a third-party trust but not necessarily a third-party special needs trust. Only if a trust contains money from someone other than the beneficiary and includes language limiting its use to special or supplemental needs will it be considered a third-party special needs trust.

Can an inheritance which is not left to a third-party special needs trust be “fixed”?

Sometimes. State law varies greatly. Fact patterns are very different. This is an important question which should be asked of a qualified attorney. Expect the response to be “let me ask you a few more questions.” The likelihood is high enough, though, that the possibility should definitely be addressed.

Are all third-party trusts funded with inheritances?

Absolutely not. Many people create third-party trusts for their children, loved ones, friends or family members while the person creating the trust is still living. Perhaps a wealthy family is eager to reduce assets in the first generation’s name, but unable to transfer funds outright to a child with a disability. Perhaps friends want to band together to provide assistance to someone who is or has become disabled. Perhaps one generation wants to create a vehicle for other family members — including other generations — to make contributions to the welfare of a person with a disability.

Are all third-party special needs trusts irrevocable?

No. Self-settled special needs trusts must be irrevocable, but the same is not true for third-party trusts. Usually a trust established during the life of the trust’s grantor (rather than in their will) is revocable during the grantor’s life. It is important that the beneficiary not be able to revoke the trust, but there is no reason someone who is not the beneficiary can not be given the authority to terminate it.

Who is the “grantor” of a third-party special needs trust?

“Grantor” is a term that has meaning in the tax code — and that meaning is not always synonymous with the general understanding of the language. A grantor is the person who created a trust and is still liable to pay the income taxes on the trust’s earnings. In the case of a revocable third-party special needs trust, the grantor will usually be the person who (a) contributed the money and (b) has the power to revoke the trust — though even that general statement will not always be true. In the case of an irrevocable third-party special needs trust, the person contributing the money may still be the grantor. This is a question best addressed in individual cases by a qualified attorney and/or Certified Public Accountant.

The income tax definition of a “grantor” is important. The grantor will be taxed on the trust’s income, even though he or she may not receive any benefit from those earnings. Though this sounds ominous, it may well be a desirable result — the tax rates on a trust are usually higher than those on an individual, and a wealthy donor might actually prefer to bear the income tax burden rather than have the trust depleted by having to pay taxes. The income tax filings for a third-party trust created by a living grantor can be very complicated, and almost always require the tax preparation skills of a CPA or other experienced professional.

Can a third-party special needs trust be a “Qualified Disability Trust?”

Yes, it can — but only if it is not a grantor trust, taxed to the person who put the money into the trust in the first place. If a trust is a Qualified Disability Trust, there can be important income tax benefits. Basically, such a trust is permitted to claim an “extra” personal exemption, reducing income tax liability in some (but not all) cases. For more detailed information about Qualified Disability Trusts (or to help educate your tax preparer), consider the Special Needs Alliance article authored by Fleming & Curti partner Robert Fleming and friend Ron Landsman.

What happens to the “grantor” status of a third-party special needs trust when the grantor dies?

The trust is no longer a grantor trust. It is now almost certainly what the Internal Revenue Service calls a “complex” trust, and will need to file a separate income tax return (and pay its own income taxes). One important note, though: distributions for the benefit of the beneficiary — the person with a disability — will be treated as income to him or her, reducing the trust’s income tax liability but possibly creating income tax liability for the beneficiary.

Does a third-party special needs trust need its own tax identification number?

If it is still a “grantor” trust (to the person putting the money into the trust) then it might not need a separate tax number or any income tax filings. Upon the death of the grantor, and earlier in many cases, the trust does need to have an Employer Identification Number (an EIN) and to file separate income tax returns. Even though it may not need an EIN while the grantor is still alive, it is usually permissible for it to obtain one, and to file informational returns (though the tax liability all flows to the grantor, and trust administration costs are probably not deductible). This is one of the areas of greatest confusion, and is yet another good reason for the trustee of any special needs trust to seek out an experienced and qualified tax preparer, usually a CPA who has prepared many returns for special needs trusts.

What kinds of things may a third-party special needs trust pay for?

Though there may be limitations in state law and Medicaid rules about what a self-settled special needs trust can pay for, there are almost no limitations on third-party trust distributions. The trustee must remember this, though: some distributions may have the effect of reducing — or even eliminating — some or all of the beneficiaries public benefits.

That may not always be a bad result. Many times a thoughtful trustee will make distributions that affect public benefits in at least these kinds of scenarios:

  • The effect is to lower, but not eliminate, benefits — and the positive outcome is worth the reduction in benefits (as, for instance, when the trust pays housing expenses and causes a small reduction in Supplemental Security Income payments but improves the beneficiary’s quality of life)
  • The effect is temporary (as, for instance, when the trustee makes cash distributions that allow the beneficiary to pay off old debt that the trust can not tackle directly, or replenish depleted cash reserves, or purchase food or shelter directly — or all of those things)
  • The benefit of distributions outweighs the loss of public benefits (as, for instance, when the special needs trust is very large, the beneficiary’s disability is slight and his or her quality of life is better enhanced by allowing the trust to pay all bills and eliminate public benefits — and the limitations on eligibility — altogether)

Where can I get more information?

One excellent resource is the Special Needs Alliance’s “Handbook for Trustees.” It covers both third-party and self-settled special needs trusts, and provides a wealth of practical information for trustees. It is also available in Spanish.

So what, again, are the differences between third-party and self-settled special needs trusts?

The take-away message: third-party special needs trusts are much more flexible and can be much more beneficial to a person with a disability than the more-restrictive self-settled trust. That means that the trustee of a third-party special needs trust often has a more challenging job, having to weigh intangibles and balance the wishes of the original donor of the funds, the hopes and aspirations of the beneficiary (and family members, friends and supporters) and general trust principles. That is why professional help and advice are so important.

Principles of Self-Settled (“First Party”) Special Needs Trusts

SEPTEMBER 26, 2011 VOLUME 18 NUMBER 34
There is so much confusion about the difference between “self-settled” and “third-party” special needs trusts, that we want to try to explain and simplify some of the key concepts. Here are some of the most common questions (and misunderstandings):

What is the difference between “self-settled” and “third-party” special needs trusts?

This is one of the most perplexing concepts to explain to people, but it is also one of the most important. In general terms, there are two kinds of special needs trusts: “self-settled” and “third-party” trusts. Some people call the former “first-party.” Some make the distinction between “special needs” and “supplemental benefits” trusts. Some talk about “litigation” trusts. But most practitioners use the “self-settled” / “third-party” distinction, and so will we.

“Third-party” special needs trusts (the kind we’re not talking about here) are set up by one person (the third party — sorry about the illogical numbering) for the benefit of another (the first party) who is receiving benefits from the government (the second party in this scenario). Let’s make it simple: if you create a trust for your daughter (who has a developmental disability), and put your own money into the trust, that is a third-party trust. But if your daughter creates her own trust, to hold her money, that is a self-settled trust.

To make things more confusing, most self-settled trusts are not literally self-settled at all. You, for instance, might sign the trust document creating your daughter’s self-settled trust. A judge might authorize you to do so. Your daughter might not be involved at all — in fact, she could theoretically object and still be treated as if she had set up the trust. The key is this: was there a moment in time during which she had the right to receive the money in the trust outright? If so, it is probably a self-settled trust.

Most (but certainly not all) self-settled special needs trusts are set up to receive personal injury settlements or judgments arising from a lawsuit. That may be the easiest way to distinguish self-settled from third-party trusts: if the trust is the result of a personal injury or wrongful death lawsuit, it is almost certainly a self-settled trust.

The second most common circumstance in which a self-settled trust might be created is when a family member leaves money or property outright to an heir who has a disability. Because the recipient had a right to receive the money (or property) outright for at least a moment in time, that kind of trust will usually be a self-settled trust, as well — even though arising from an inheritance.

What difference does it make whether a trust is self-settled or third-party?

All the difference in the world. The former type of trust must have a “payback” provision, returning up to the full value of the trust to any state which provided Medicaid benefits upon the death of the beneficiary (or, in most states, upon the termination of the trust). Third-party trusts do not need to have a payback provision, and it is almost always a blunder to include one.

There are other differences: the self-settled trust will be scrutinized much more closely for types of expenditures (in most states — your experience may vary on this one). Third-party trusts usually fly largely under the radar of public benefits agencies. Self-settled trusts are usually supervised by a court (again, state experience may vary widely); third-party trusts almost never are court-supervised. In Arizona, any self-settled special needs trust must include very restrictive language about how it can be used; third-party trusts need not include that language. In general, if you had a disability or were a trustee you would much rather have your trust be third-party than self-settled.

Who is the “grantor” of a self-settled special needs trust?

This is a particularly fun question. There are at least three different concepts involved here, and they have different language. Everyone — including seasoned practitioners — tends to use the terms interchangeably and the result can be confusing.

Trust law recognizes that someone has to have set up a trust. In trust law that person is usually called the “settlor.” Sometimes you see “trust creator” or some similar language — but the sense is the same. The settlor is the person who said “I hereby create a trust.” Usually they say it in writing, but that is not actually required — or at least not in Arizona. But we digress.

Federal income tax law introduces a different kind of person — the “grantor.” The settlor might not be the grantor. There might be one, two or dozens of grantors for a given trust. But usually, the grantor is the person whose money was transferred into the trust. In the case of a self-settled special needs trust, that will always be the beneficiary — the person with a disability whose public benefits are being protected by establishment of the trust.

Along comes public benefits law and invents another role: the trust “establishor,” if you will. Federal law says every self-settled special needs trust must be “established” by one of the following: the beneficiary’s parent, grandparent, or guardian — or by the court. Notice anyone missing from that list? You’re right — the beneficiary isn’t on the list.

So in many self-settled special needs trusts, there are three different people with three different roles:

  1. The grantor, who is also the beneficiary, who did not sign the trust document
  2. The establishor, who might be a judge and might not sign the document at all, and
  3. The settlor, who signed the trust document — perhaps at the judge’s direction.

Can there be more than one grantor in a self-settled special needs trust?

Technically, yes — but only technically. Some states (not including Arizona, happily) require that the establishor of a self-settled special needs trust put some money or property into a trust in order for it to exist. In those states a parent might sign a special needs trust, and staple a $10 bill to the trust to show that it has been legally created. That makes the parent a grantor for tax purposes — as to the $10 investment. The rest of the money comes from the beneficiary’s personal injury settlement (or inheritance, or savings), which makes the beneficiary the grantor for the bulk of the trust’s assets. So technically the parent and the beneficiary are both grantors. Sound like an absurd distinction? It is.

Does a self-settled special needs trust need a new tax identification number?

No. At least, not usually. The beneficiary’s Social Security number will suffice just fine. Some banks, brokerage houses and accountants may argue otherwise, but there is a special IRS rule for such trusts, even though the grantor/beneficiary is not the trustee. But because the trustee is not the beneficiary, it is permissible for the trust to get a separate number — it is called, incidentally, an Employers Identification Number (or EIN), even if the trust does not have any employees.

What can a self-settled special needs trust pay for?

Ah, that is a great question — and very difficult to answer. It depends on so many factors. One must look at the trust instrument itself, at state law governing self-settled special needs trusts and at the appropriate Social Security and Medicaid rules. Sometimes there are things that the trust could pay for that it should not. Sometimes there are things that the trust ought to be able to pay for, but that it can’t — even though everyone might agree that they would benefit the beneficiary. You might look at the Special Needs Alliance’s “Handbook for Trustees” for better guidance, but at some point you are just going to need to talk to an experienced and capable lawyer. The Special Needs Alliance might be able to help you there, too.

We hope that helps explain what a self-settled special needs trust is. Next week we plan on telling you about third-party trusts, and some of the rules governing them.

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