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A (d)(4)(A) Q&A
(Continued - Part 3 of 4)

by Gregory Wilcox, Esq.

Author’s Note: This is the third installment of this article. Two previous parts appeared in the Spring 2002 (Vol. 13, No.1) and Summer 2002 (Vol. 13, No.2) issues of The Legal Network News.

Can the trust pay for closing expenses?

You may notice that this topic was already covered in the second installment of this article. Well, there has been a slight change in the SSI rules that supersedes the language quoted in the earlier installment. The SSI rules still say:

The State must be listed as the first payee and have priority over payment of other debts and administrative expenses. SSA Program Operations Manual System (POMS), SI 01120.203 B.1.f.

But recent POMS revisions now include after the word, “expenses”: “except as listed in SI 01120.203 B.3.a.”. What happened?

The Social Security Administration has deleted the earlier content of SI 01120.203 B.3.a. (unexciting transition rules having to do with reevaluations of trusts under earlier temporary instructions), and replaced it with language allowing payment of certain expenses before reimbursement to Medi-Cal. Specifically, the language now says:

3. Allowable Administrative Expenses

The following instructions apply only to Medicaid special needs trusts and to Medicaid pooled trusts.

a. Allowable Administrative Expenses

The following types of administrative expenses may be paid from the trust prior to reimbursement of medical assistance to the State:

  • Taxes due from the trust to the State or Federal government because of the death of the beneficiary;
  • Reasonable fees for administration of the trust estate such as an accounting of the trust to a court, completion and filing of documents, or other required actions associated with termination and wrapping of the trust.

b. Prohibited Expenses and Payments

The following expenses and payments are examples of some of the types not permitted prior to reimbursement of the State for medical assistance:

  • Payment of debts owed to third parties;
  • Funeral expenses;
  • Payments to residual beneficiaries.

This is all fine and good, and certainly makes it easier and more attractive to administer such a trust. For example, it now appears that the Social Security Administration will actually allow an attorney to charge for his or her time to complete legally required accountings and to comply with other trust termination obligations.

Nevertheless, there is still an inconsistency between the SSI rules and the Medi-Cal rules, and the SSI rules are still harsher. For example, the Medi-Cal rules expressly permit payment of the beneficiary’s outstanding bills and funeral expenses, both expressly barred by the SSI rules. So the conclusion in the earlier installment of this article stands: merely qualifying under the Medi-Cal rules will not make the trust valid under the SSI interpretation of Medicaid law.

How much can a (d)(4)(A) trust distribute?

A. Public law limitations

It is an oddity of the (d)(4)(A) trust rules that they impose no requirements on the amount of distributions other than that they must be “for the benefit” of the disabled person who contributed the funds. 22 Cal Code Regs §50489.9(a)(3)(B), Medi-Cal Eligibility Procedures Manual Letter No. 192, page 9J-74, and SI 01120.203 B.1.d. Does this mean that a (d)(4)(A) trustee could make no distributions at all, or make distributions of the entire trust corpus under (d)(4)(A) rules?

First, let’s look at one extreme: the trustee decides to distribute out the entire trust estate before the beneficiary’s death. Such an exhaustion of the trust is indeed likely to occur naturally where the trust beneficiary is young and/or the trust principal is modest. Of course, exhaustion of the trust before the beneficiary’s death will completely frustrate the provisions for paying back Medi-Cal after the beneficiary’s death.

But suppose that the total distribution is not so natural.For example, suppose the trust beneficiary is a man age 54 who is gravely ill. Suppose it is a virtual medical certainty that he will not last more than a few days. The trust still has $100,000 in it. What happens if the trustee distributes the entire $100,000 to the beneficiary? Technically, he will then lose his Medi-Cal eligibility because he will have assets that exceed $2,000. However, if he dies very soon he may make little additional use of Medi-Cal. When he dies the trust is obligated to repay the Medi-Cal program with any remaining trust assets -- but it has none. Moreover, the trust beneficiary is under the age of 55, so the Medi-Cal program has no right to make a claim against his estate either. Is $100,000 protected for the beneficiary’s beneficiaries? No.

First, Medi-Cal could argue that the distribution of the $100,000 was not really “for the benefit” of the beneficiary. It could argue that the distribution was really for the benefit of his heirs and devisees. Perhaps. But isn’t such a distribution also “for the benefit” the beneficiary? Does the mere disqualification for Medi-Cal arising from the beneficiary’s receipt of the distribution mean that it was not for his or her “benefit”? Why should it mean this?

However, the real reason the answer is “no” is that Medi-Cal regulations have cleaned up a gap in the federal statute. Medi-Cal regulations require that the trust provide for reimbursement “upon the death of the individual or spouse or upon termination of the trust . . ..” 22 Cal Code Regs §40489.9(a)(3)(C) (emphasis added). In contrast, 42 U.S.C. §1396p(d)(4)(A) only requires reimbursement upon the beneficiary’s death.

Assuming that the state’s “clarification” of Congressional intent must be met, it seems pretty clear that a total distribution of the trust estate will result in a “termination”, and therefore trigger a reimbursement requirement. All right, what if the trustee distributes less than the entire trust estate, so that it does not result in a “termination”. Apparently, there would be no reimbursement requirement at that point. How close can the trustee get to a total distribution without amounting to a “termination”? How close do you want to get to a challenge?

What about California Probate Code requirements? California’s Trust Law says that even where:

A trust instrument confers “absolute”, “sole”, or “uncontrolled” discretion on a trustee, the trustee shall act in accordance with fiduciary principles and shall not act in bad faith or in disregard of the purposes of the trust. Probate Code §16081.

If the trustee dumps out almost the entire trust to the beneficiary shortly before his or her death, does the action violate this provision? Certainly, it would be fairly easy to write into the trust a provision that it is a “purpose of the trust” to preserve the trust estate for the remainder beneficiaries and avoid creditors, thereby neutralizing one prong of the statute. Would such an action still amount to a violation of “fiduciary principals” or be in “bad faith”. What is the fiduciary duty of the trustee to protect the Medi-Cal program as a potential creditor of the trust estate? Although I have not researched the issue, I would guess that the fiduciary duty of the trustee is to protect the trust’s beneficiaries from potential creditors.

B. Private law limitations

Never mind what the Probate and Medi-Cal rules say, what does the trust say about the trustee’s rights and obligations to make distributions?

There are a number of alternative formulae for the trustee’s rights and obligations with regard to special needs trust distributions. However, the general debate about which formula to use relates to all special needs trusts, not just (d)(4)(A) trusts, and is beyond the scope of this article. For a detailed commentary on alternative distribution provisions in special needs trusts, see Cynthia L. Barret, “Distribution Standard for the Special Needs Trust”, NAELA Quarterly, Summer 2001, Vol. 14, No. 3.

However, there is one very common special needs trust distribution provision that may limit the right of the trustee to make large distributions from a (d)(4)(A) trust. This is the provision limiting the trustee’s distributions to the beneficiary’s “special needs” and prohibiting the trustee from making any distribution that either eliminates or reduces the beneficiary’s public benefits. Obviously, a large lump sum distribution from a (d)(4)(A) trust would reduce the beneficiary’s public benefits, indeed, probably eliminate them -- and thereby violate the trustee’s duties.

Commentators have criticized this “narrow” or “strict” distribution provision as too restrictive and unnecessary in most cases. Instead, the trust can simply call on the trustee to protect the beneficiary’s public benefits as a general goal:

Unless the trustee has determined in his sole, absolute, and unfettered discretion that the benefit to the beneficiary from the particular trust distribution outweighs the reduction in a particular public benefit program that may be the consequence of the trust distribution.

This is sometimes called an “on/off” or “spigot” provision that grants the trustee with discretionary authority to reduce benefits if the trustee determines that it is in the beneficiary’s best interests. Cynthia Barrett, Id., at 12. In contrast to the “strict” distribution standard, it would not only allow the trustee to make lump sum distributions, but also other sensible distributions, for example payment of the beneficiary’s rent, that would likely reduce public benefits.

How little can a (d)(4)(A) trust distribute?

Sometimes a trustee might want to distribute nothing at all or very little from a (d)(4)(A) trust. Perhaps the trustee wants to preserve the trust estate for later, or maybe the trustee wants the beneficiary to be more self-reliant. Can the trustee stop making distributions?

A. Public law limitations

The trustee’s refusal to make any distribution at all would clearly violate the (d)(4)(A) requirement that the trust be “for the benefit” of the disabled person. What if the trustee makes only minimal distributions “for the benefit” of the beneficiary? This would now appear to comply with (d)(4)(A) law. Indeed, Medi-Cal could not claim that its chances for reimbursement are being prejudiced; preservation of the trust estate would enhance its chances of eventually being repaid.

But there’s still the Probate Code problem. Depending on the language of the trust (see below), tiny distributions might violate the language of Probate Code §16081 quoted above that requires the trustee to exercise his or her “discretion” within fiduciary limits and trust purposes.

B. Private law limitations

How narrowly can (or should) drafters write the distribution language? Can the trust language simply say that the trustee may choose “to make no distributions at all”?

This is tempting language. Indeed, it is a fairly common provision in (d)(4)(A) and other special needs trusts. First, it helps resolve any argument that the trustee is violating “trust purposes”. In addition, it clearly prevents public benefit agencies from arguing that the trustee must provide somehow for the beneficiary. Finally, it also might serve to protect the trustee against an overly demanding beneficiary.

On the other hand, the language may cause the trust to violate the (d)(4)(A) requirement that the trust be “for the benefit” of the beneficiary. There is, therefore, a risk that the trust instrument itself will not comply with (d)(4)(A) requirements, regardless of what the trustee actually does. Second, the trustee must still act according to the fiduciary principals imposed by the Probate Code. Finally, there is the risk that the trustee will abuse his or her authority to make no distributions.

My conclusion is that drafters need to be very careful using language that expressly permits the trustee to make no distributions at all. Perhaps a safer route is to permit the trustee to postpone, or completely withhold payments for periods of time (if one can anticipate that the trustee will not misuse such authority)...


Gregory Wilcox, Esq., is an attorney in private practice in Berkeley, California.