Use of Trusts in Medicaid Planning in New York

by David Goldfarb Goldfarb Abrandt & Salzman LLP

The use of trusts in Medicaid planning raises a number of issues. The two most important are: (1) How will the transfer of assets into the trust be treated? And (2) How will the assets in the trust and the income from the trust be treated by Medicaid?

In order to fully answer these questions some very important distinctions must be understood. First, is the trust a “third-party” trust where the funds being put into the trust do not belong to the beneficiary or is it a “self-settled” trust where the funds belong to the settlor/beneficiary? And second, is the trust a “Medicaid Trust” where the trustee has no discretion regarding using funds for the beneficiary, or is it an “exception” or Supplemental Needs Trust?

Medicaid Transfers of Asset Rules and Trusts

The first issue involves the treatment of the transfer of a person’s funds into a trust and how it effects his or her eligibility for certain Medicaid services. Transfers into trusts and from trusts are subject to a 60 month look back period (42 U.S.C. § 1396p (c)(1)(B)(i)) and create a penalty period of ineligibility for institutional care (nursing facility services, alternate level of care and waivered programs). 42 U.S.C. § 1396p (c)(1)(C)(i). Exceptions are transfers for the sole benefit of a spouse, into a trust for the sole benefit of a disabled child or a trust established for the sole benefit of a person under the age of 65 who is disabled. 42 U.S.C. § 1396p (c)(2)(A); N.Y. Social Services Law § 366 subd. 5(d)(3)(ii)(C) and (D); 18 NYCRR § 360-4.4(iii)(c). The “sole benefit” provision may provide for reasonable compensation for a trustee. However the funds may not pass to a beneficiary who is not the spouse, blind or disabled child or disabled individual. See Health Care Financing Administration, State Medicaid Manual § 3257 (Transmittal No. 64, November 1994).

What constitutes a person’s own assets was clarified by Congress in 1993 to include income and resources of the individual or his/her spouse, including any income or resources they are entitled to but do not receive because of action by a court or another person acting at the direction of the individual or the spouse. 42 U.S.C. § 1396p (e)(1). An example would be directing the funds from a personal injury settlement into a trust.

Considering Funds in a “Medicaid Trusts” or Income Only Trusts

If a third party creates and funds a trust for the benefit of another, then the Medicaid rules on deeming the asset as available do not apply. This is true whether the trust is discretionary or “income-only” or a combination of the two. Note, any mandatory income to a Medicaid recipient will be income for the purposes of determining “surplus income.” This applies whether the income beneficiary receives “community based Medicaid” or “institutional Medicaid.”

However, to the extent principal may be paid to the “grantor” of a self-settled trust, it is considered or deemed an available resource of the grantor. 42 U.S.C. § 1396p (d)(3)(B); 18 NYCRR § 360-4.5(b)(1)(ii). To the extent discretionary payments are allowed or made to or for the benefit of the grantor from a self-settled trust, they are considered available income. 18 NYCRR § 360-4.5(b)(1)(iii). A transfer into an irrevocable grantor trust that prohibits payment of principal to the grantor is subject to the 60 month look back period and will create a penalty period of ineligibility for institutional Medicaid. 18 NYCRR § 360-4.5(b)(1). Although the terminology may be confusing, self settled trusts, which allow discretion and therefore will be counted by Medicaid, are commonly referred to as “Medicaid Qualifying Trusts.” Trusts which don’t allow discretion (but often have a clause instructing the payment of all income to the grantor) are called Medicaid trusts or income only trusts.

Social Services Law §369(3) provides Medicaid a recovery mechanism against a trust by authorizing it to maintain an action to collect from either a trustee, creator, or creator’s spouse any beneficial interest of either the creator or creator’s spouse in any trust, other than a testamentary trust. It may recover the income and principal to which the creator or creator’s spouse would have been entitled by right or in the discretion of the trustee.

A similar rule (that the assets in a trust are deemed available) was held to apply to the availability of assets to a legally responsible spouse who has put his funds into an irrevocable trust but allowed discretion to the trustees to make distributions to the grantor. Case v. Fargnoli, 182 Misc.2d 996 (Sup. Ct. N.Y. Cty, 1999). Where Medicaid incorrectly granted benefits despite the existence a self-settled discretionary trust, the Court of Appeals allowed recovery against the trust after the beneficiary’s death finding that Medicaid was not “correctly paid” despite the fact that Medicaid made the administrative error and it was not due to misrepresentation or fraud. Oxenhorn v. Fleet Trust Co. and Estate of Judson, ____ N.Y.2d ____, 700 N.Y.S.2d 413 (1999). The Court did not reach the question of whether after death the beneficiary retained a “beneficial interest” permitting recovery under N.Y.Soc. Serv. Law §369(3), if Medicaid had been correctly paid.

Revocable trusts created by a Medicaid applicant/recipient or her spouse are considered available to the extent payment may be made to the applicant or recipient and therefore do not trigger a penalty period. Payments from the revocable trust are however transfers of assets. 18 NYCRR § 360-4.5(b)(2) and (3). Since assets in a revocable trust pass outside the “estate” of an individual, recovery after the grantor’s death may be avoided. New York law currently provides for Medicaid recovery against the probate estate. N.Y.Soc. Serv. Law § 369(2)(b)(i)(B). However, only exempt assets (such as a homestead) could be in a revocable trust while Medicaid was being properly received.

A provision in a self-settled lifetime trust that limits, suspends, or diverts any income, principal, or beneficial interest of the creator or the creator’s spouse, which is “triggered” if they apply for Medicaid or require medical, hospital, nursing, or long term care, is void as against public policy. EPTL 7-3.1(c). The full amount that could be distributed would be considered available.

Trusts as Available Assets

The state agency held in a number of fair hearing decisions that trusts with reserved powers of appointment were available resources. However, a class action in federal court,VERDOW V. SUTKOWY, 2002 U.S. Dist. Lexis 16975 (NDNY, 9/10/02), held that New York’s denial of plaintiffs’ Medicaid benefits because they allegedly are potential beneficiaries of self-settled trusts containing limited powers of appointment exceeds the limits of federal law and specifically is in violation of the “Medicaid Qualifying Trust” statute. New York State’s argument was also rejected by a New York State Supreme Court in Spetz v. New York State Dep’t of Health, 737 N.Y.S.2d 524 (Sup. Ct., Chautauqua Co., Jan. 15, 2002). In Spetz, Medicaid benefits were denied on the basis of the creation of an irrevocable trust containing a limited lifetime power of appointment by petitioner’s husband.

In an unreported decision in Queens County, the court found that the power to make loans did not make the trust an available resource. In Re Newman, Index No. 25783/98 (Sup. Court Queens County, June 17, 2002).

Avoid untested boilerplate trustee powers (such as the power to make loans) which might be construed as a means of benefiting a grantor.

Supplemental Needs Trusts

A supplemental needs trust (“SNT”) enables a person with a disability to maintain eligibility for government benefits (for example, Medicaid and Supplemental Security Income (SSI)). The purpose of the SNT is to enhance the quality of life for a disabled person.

Estate of Escher, 94 Misc. 2d 952, 407 N.Y.S.2d 106 (Surr. Ct. Bronx Cty., 1978), aff’d mem. 75 A.D.2d 531 (1st Dept. 1980), aff’d 52 N.Y. 2d 1006, 438 N.Y.S.2d 2893 (1981), established the right of a parent to create a discretionary trust for a disabled adult child without jeopardizing the child’s eligibility for government benefits. The concept of the supplemental needs trust was later codified in New York at EPTL 7-1.12.

In order for a trust to qualify as a statutory SNT and benefit from the presumptive rules of construction and interpretation set forth in the statute, the beneficiary of the trust must be a “person with a severe and chronic or persistent disability.” The beneficiary of the trust usually receives government benefits, or is expected to need those benefits at some point in the future.

A third party SNT is established and funded by a person who does not have a legal duty to support the person with a disability. The third party SNT can be established by a will or as an inter-vivos or lifetime trust.

A parent may transfer assets to a lifetime trust for the sole benefit of a disabled child without incurring any period of ineligibility for him or herself for Medicaid. 42 U.S.C. § 1396p(c)(2)(B)(iii); N.Y. Soc. Serv. Law § 366 subd. 5(d)((3)(ii)(C). Any person may transfer assets to a trust established for the sole benefit of a disabled individual under the age of 65 without suffering the imposition of a Medicaid penalty period. 42 U.S.C. § 1396p(c)((2)(B)(iv); N.Y. Soc. Serv. Law § 366 subd. 5(d)(3)(ii)(D); 18 NYCRR § 360-4.4(c)(2)(iii)(c)(iv).

Third-Party Supplemental Needs Trusts and Government Benefits

The SNT corpus is not considered “available” for purposes of eligibility for Medicaid. All distributions from the trust are made in the sole discretion of the trustee and are usually paid directly to third parties that provide goods and services to the beneficiary. The trustee may also have discretion to make payments directly to the beneficiary if appropriate, but any money paid directly to the beneficiary may be counted for purposes of eligibility for some means tested government benefits including SSI and Medicaid.

Payments made in the form of in-kind distributions for food, clothing or shelter are considered “unearned income” and will generally reduce SSI payments by a maximum of one-third. 42 U.S.C. § 1382(a)(2)(A); 20 C.F.R. § 416.1130(b); 18 NYCRR § 360-4.3(e); See also, Gordon v. Shalala, 55 F.3rd 101 (2d Cir., 1995); Ruppert v. Bowen, 871 F.2d 1172 (2d Cir., 1989). Payments for goods and services other than food, clothing and shelter will not reduce SSI benefits. 42 U.S.C. § 1382(a)(2)(A); 20 C.F.R. § 416.1130(b). SSI rules on trusts can be found in the Social Security Program Operations Manual System (POMS) at SI 01120.200 (revised by Transmital No.34, August 1999). The new transmittal provides that the trust may own a home where the beneficiary lives without a reduction in his or her SSI.

Medicaid does not have an in-kind income rule, and only income and resources actually available to the Medicaid recipient would be counted for purposes of eligibility.

As long as the SNT was established when the parent (or other third party) no longer had a duty to support the disabled beneficiary and the trust was not funded with any property of the beneficiary, the State has no right of recovery and no right to place a lien against the trust property. Parents can use the SNT to provide for a disabled child for life and are free to direct how any remaining trust property will be distributed upon the child’s death.

The form of SNT’s has become more uniform as a result of the suggested language contained in N.Y. EPTL 7-1.12. The statute sets forth criteria that will afford a supplemental needs trust the benefit of a presumption that the trust is a valid “statutory” supplemental needs trust.

Prohibition Against Court Ordered Invasions of Principal

EPTL 7-1.6(b) authorizes the court with jurisdiction over a trust to give principal to or for the benefit of an income beneficiary whose support or education is not sufficiently provided for. A trust may provide that EPTL 7-1.6(b) shall not apply. For supplemental needs trusts that conform to the statutory criteria there is a presumption that EPTL 7-1.6(b) shall not apply if it would reduce or eliminate the beneficiary’s entitlement to government benefits or assistance. However any trust that anticipates eligibility for government benefits should specify that EPTL 7-1.6(b) shall not apply.

Self Settled SNT’s or “Exception Trusts”

Aside from the third-party SNT’s, Medicaid now provides for the beneficiary to place his or her own funds in an SNT without having the funds counted as income or resources. 42 U.S.C. § 1396p (d)(4). Since these are exceptions to the general rule that the funds are deemed available if the trustee has discretion, these SNT’s are also are referred to as “exception trusts.” In New York there are two “exception trusts” which contain the assets of a person with a disability: an individual “payback” trust established for a disabled person under the age of 65 and a “pooled” trust established for a disabled person of any age. 18 NYCRR § 360-4.5(b)(5). These exception trusts were first authorized by the Omnibus Budget Reconciliation Act of 1993, and are sometimes called “OBRA ’93 supplemental needs trusts.” See 42 U.S.C. § 1396p(d)(4)(A) for individual trusts and 42 U.S.C. § 1396p(d)(4)(C) for pooled trusts. The beneficiary must be disabled as defined in the Social Security Act. These trusts are exempt from the Medicaid rules regarding availability of income and resources. N.Y. Soc. Serv. Law § 366 subd. 2(b)(2)(iii). As previously noted, under separate provisions, a penalty period of ineligibility for Medicaid is not imposed as a result of a transfer of assets into the trust where it is for the “sole benefit” of the disabled person under the age of 65. 42 U.S.C. §1396p(c)(2)(B)(iv); N.Y. Soc. Serv. Law. §366 subd. 5(d)(3)(ii)(D); 18 N.Y.C.R.R. § 360-4.4(c)(2)(iii)(c)(iv).

Individual Payback Trust

An individual “exception” trust must be: (1) established for the benefit of a disabled person under the age of 65; (2) established by a parent, grandparent, guardian or court; (3) funded with the assets of the disabled beneficiary; and (4) require that Medicaid be paid back from the remaining balance, if any, upon the death of the beneficiary. 42 U.S.C. §1396p(d)(4)(A); N.Y. Soc. Serv. Law §366 subd. 2(b)(2)(iii).

Any transfer made into the trust by the disabled person after the age of 65 is treated as a transfer of assets requiring the imposition of a penalty period. 96 ADM-8.

Pooled Trusts

The other kind of exception trust is an OBRA ’93 pooled trust that conforms to the following requirements: It must be “established and managed” by a “nonprofit association;” the assets must be pooled for purposes of investment and management. Each beneficiary has a separate account within the pooled trust. The individual trust account can be funded by the same entities that fund the individual SNT, however the disabled individual himself or herself can also fund the account.

The person creating the account has an election regarding the distribution of the remaining balance (if any) upon the death of the disabled person. If the remaining balance in an account is retained by the pooled trust after the death of the beneficiary, then Medicaid is not entitled to be paid back. Any amounts not retained by the pooled trust must be used to reimburse Medicaid for the cost of medical assistance provided to the beneficiary during his or her lifetime.

Although there is no penalty period for the transfer of a beneficiary’s assets into a pooled trust by a person under the age of 65, there is a penalty period for transfers into pooled trusts if the beneficiary is over 65. 96 ADM-8. In Matter of Banks, Index # 400646/97 (Sup. Ct. N.Y. Cty., June 14, 2000), Justice Parness approved a motion by a guardian to fund a pooled trust with funds discovered to be held by an incapacitated person while she was receiving Medicaid. The transfer to the pooled trust did cause a future disqualification or penalty period for institutional care.

Judicial and Government Supervision of Exception Trusts

When an SNT is established by a guardian or Court with assets of the disabled person, then the court approving the establishment of the trusts will probably impose additional requirements on the trustee. These include an annual accounting, bond, court approval for certain expenditures and proposed budgets. See Matter of Goldblatt, 162 Misc 2d 888, 618 NYS 2d 959 (Surr. Ct. Nassau Cty, 1994) and Matter of Morales, NYLJ, July 28, 1995, p.25. col.1 (Sup.Ct., Kings Cty).

Placing “Income” Into a Supplemental Needs Trust.

It has always been clear that in “income cap” states income could fund a supplemental needs trust. 42 U.S.C. § 1396p (d)(4)(B). New York has no “income cap,” but rather allows a “spend down” to the Medicaid level. However, New York State Department of Health in a Letter from Ann Clemency Kohler, Director of Office Medicaid Management, issued a release amending 96 ADM-8, clarifying the availability in New York to fund a supplemental Needs Trust with an income stream:

On page 8, under Trust, paragraph b., after the first sentence, add the following: “While most exception trusts are created using the individual’s resources, some may be created using the individual’s income, either solely or in conjunction with resources. Income diverted directly to a trust or income received by an individual and then placed into a trust is not counted as income to the individual for Medicaid eligibility purposes. Verification that the income was placed into the trust is required. In order to eliminate the need to verify this on a monthly basis, it is recommended that you advise the recipient to divert the income directly to the exception trust.

A “so ordered” stipulation in Joseph R. K. v. DeBuono, US Dist.Ct. Northern District of NY, 97-CV-0948, February 25, 1998, states that “in determining eligibility for plaintiff… the Albany County Department of Social Services (ACDSS) will recalculate the excess monthly income required to be spent down for medical expenses. In performing such recalculation… ACDSS will not consider income diverted into the…supplemental needs trust, or income received by the plaintiff and then placed into the trust….”

However in In the Matter of Lynch, 703 N.Y.S. 2d 653 (Surr. Ct, Onondaga County, 1999), the court held that it would not allow SSI income to be put into an SNT, stating that it was “troubled by the concept of funding a supplemental needs trust with benefits received from governmental entitlements….”

New SSI Provisions Regarding Transfer of Assets and Trusts

At the end of 1999 Congress adopted and the President signed the “Foster Care Independence Act of 1999.” Foster Care Independence Act of 1999, §§ 205 & 206, Pub. L. No. 106-169 (1999) (codified at 42 U.S.C. §§ 1382a(a)(2)(G), 1382b(c) and 1382b(e)). This bill included two important provisions affecting SSI recipients.

Transfer of assets will effect eligibility for SSI (as had been the rule prior to 1988). There will be a 36-month look-back, similar to Medicaid, and a penalty period calculated by dividing the amount transferred by the SSI rate (including the state supplement). Unlike Medicaid there is a 36-month “cap” on any penalty. The penalty begins on the first day of the month “in or after” the transfer occurred. The law provides for transfer exceptions for the home and other resources similar to those in the Medicaid law. This provision applies on or after December 14, 1999.

Both revocable and irrevocable trusts will be considered resources (and earnings considered income) if they are “self settled,” that is, they contain the assets of an individual or an individual’s spouse (unless funded by the spouse’s will). The trust will be counted as a resource (and earnings considered income) if it is revocable or in the case of an irrevocable trust if there are any circumstances (that is, “discretion”) where the trustee can pay corpus (or earnings) to or for the benefit of the grantor or the grantor’s spouse. There are exceptions for supplemental needs trusts established pursuant to 42 U.S.C. §1396p(d)(4)(A) [payback trusts] or (d)(4)(C) [pooled trusts]. This provision became effective on or after January 1, 2000.