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Special Needs Trust v. Section 8

by Gregory Wilcox, Esq.


Background


Special needs trusts (SNTs) are written not only to protect the trust beneficiary’s eligibility for welfare benefits but also to allow the trust to make distributions for the benefit of the trust beneficiary. In order to achieve this goal, the SNT must avoid three different potential negative impacts on such welfare benefits: a disqualifying transfer of assets to the trust, continuing availability of the trust assets once transferred, and distributions made on behalf of the trust beneficiary counting as income that reduces or eliminates benefits.

Typically the drafter of a SNT has in mind two major welfare benefits: Supplemental Security Income (SSI) and Medi–Cal (California’s Medicaid program). Fortunately, these two programs have fairly well–established rules that allow a SNT, if properly drafted and established, to avoid all three of the triggers for ineligibility mentioned above. There have been many hundreds of articles on the proper drafting and establishment of SNTs for these two welfare programs, and quite a few in this newsletter alone.(1)

Nevertheless, it is becoming increasingly apparent that most SNTs often overlook a major problem. Frequently a trust beneficiary who receives SSI and Medi–Cal also receives housing assistance. The most common form of this assistance, focusing on persons who have low income and are elderly or disabled, is what almost everyone calls Section 8 housing (formally known as the Housing Choice Voucher Program.)(2) Under Section 8, beneficiaries receive a “voucher” or “subsidy” that they can apply to the rental of the housing unit of their choice – as long as the unit meets the Section 8 program requirements. A local Public Housing Agency (PHA) then delivers the subsidy to the landlord under a contract with the U.S. Department of Housing and Urban Development (HUD). The beneficiary pays a portion of the monthly rent, based on the beneficiary’s adjusted income, and the PHA subsidy pays the remainder.

In contrast to SSI and Medi–Cal, the Section 8 housing assistance program has no language in its rules that expressly recognizes and protects SNTs. As a result, the beneficiary of a new special needs trust who also receives Section 8 assistance can be in for an unpleasant surprise when the time comes around for a review of his or her eligibility or benefit levels.

There are two problems facing a SNT beneficiary of Section 8 assistance: benefit reductions arising from the funding of the trust and benefit reductions arising from distributions from the trust. There are few if any problems that arise as a result of the deemed availability of SNT assets.

Availability of Trust Assets

All the Section 8 eligibility rules relate to the beneficiary’s income. The more income, the less the subsidy, and vice–a–versa. So, strictly speaking, a Section 8 beneficiary does not have to meet any general limitation on the amount and type of assets he or she owns.

Nevertheless, this is not as favorable as it seems. The reason is that the “income” that the PHA counts includes not only normally recognized income, such as employment earnings and public benefits, but also deemed income from assets owned by the beneficiary. Indeed, if the beneficiary’s assets exceed $5,000, the PHA will count the greater of the actual income generated by the assets or the imputed interest income calculated by applying the official HUD passbook savings account rate to the assets.(3)

Fortunately, these rules are not directly relevant to the impact of a SNT because PHAs will not count the SNT assets as “owned” by the beneficiary. It will only count “the cash value of trusts that may be withdrawn by the family.”(4) Further, PHAs will not count “assets not controlled by or accessible to the family and which provide no income to the family.”(5) (On the other hand, the latter phrase requiring “no provision of income” may be difficult to meet, as described below.)

Most SNTs do not specifically address housing assistance programs. However, most SNTs do make it clear that the trust beneficiary has no right to withdraw assets from the trust or to use those assets for his or her support. Accordingly the Section 8 program will not automatically count the assets in a SNT as a source of deemed income.

Funding the Trust

If the SNT is a third party trust funded solely by someone other than the Section 8 beneficiary (not acting at the beneficiary’s direction and not using assets that ever belonged to the beneficiary or to which the beneficiary has a legal right), then the funding should not cause any problem for Section 8 benefits. There are simply no Section 8 rules that address such an event.

However, if the SNT is a first party trust, i.e., one that the beneficiary created with his or her own funds, the rules are quite different. First, the beneficiary will almost always fund such a first party SNT with some kind of lump sum “windfall,” such as an inheritance, insurance payment, or compensation for personal injury or property loss. The PHA will not treat the lump sum receipt itself as a form of income.(6) That’s the good news.

The bad news is that if the beneficiary keeps the windfall, the PHA will treat it as an “asset,” impute an amount of income from it, and the deemed income will then reduce the beneficiary’s housing assistance subsidy. If the beneficiary transfers the windfall to anyone else, including a first party SNT, the PHA will treat the assets as “assets disposed of for less than fair market value.” As such, for a period of two years preceding Section 8 certification or recertification, the PHA will treat them as if the beneficiary still held them. The PHA will then impute additional interest income according to its usual deemed income–from–asset rules by applying the HUD passbook savings account rate to the amount transferred.(7)

Example: Robert is a competent disabled individual who receives Section 8 assistance. His father died and left him $100,000, which he protected from SSI and Medi–Cal by transferring it to an irrevocable (d)(4)(A) “payback” trust established for him by his mother. His mother, acting as trustee, made no distributions to him, but earned $10,000 (i.e., a 10% rate of return) on trust assets in the first year.
The PHA will not count Robert’s $100,000 inheritance as a form of income. Nor will the PHA count the $10,000 in income that the trust principal actually generated. Furthermore, it will not count the initial cash value of the trust, i.e., $100,000. However, the PHA will impute income to Robert at the HUD passbook rate for two years. So, if the passbook rate is 2% (as it is now), the PHA will impute $2,000 per year of additional income, or $167 per month. Because Robert is required to pay about 30% of his income as his share of rent, he will have to pay about $50.10 more each month for his rental unit. This is true even if he does not actually receive a single cent from the trust.(8)

There is an interesting exception to the general rule requiring imputed interest on transferred assets. Buried in an obscure part of the HUD Occupancy Handbook, is the following statement:

Assets placed in nonrevocable trusts are considered as assets disposed of for less than fair market value except when the assets placed in the trust were received through settlements or judgements (sic).(9) (Emphasis added.)

Accordingly, it appears that if the beneficiary originally received the windfall as a result of a personal injury or property loss (or maybe even as the result of a business claim), the funding of the first party SNT would not trigger deemed income at the HUD passbook savings account rate for two years. However, any distributions that such a trust makes will still increase the beneficiary’s countable income, as explained in the next section.

Trust distributions

The burden of having additional imputed income, and a consequent reduction of the housing assistance subsidy, may be made more tolerable by the fact that at least it will all be over in two years. Unfortunately, no such time limit applies to how the PHA treats actual trust distributions, whether from first or third party trusts.

Interestingly, HUD’s published regulations have little to say about trust distributions:

Net Family Assets (2) In cases where a trust fund has been established and the trust is not revocable by, or under the control of, any member of the family or household, the value of the trust fund will not be considered an asset so long as the fund continues to be held in trust. Any income distributed from the trust fund shall be counted when determining annual income under §5.609. 24 CFR §5.603(b).

However, one will look in vain throughout 24 CFR §5.609 for any mention of trusts or trust distributions. One might even take the position that HUD’s rules do not authorize inclusion of trust distributions at all (good luck).

What 24 CFR §5.609(b)(4) does include are “the full amount of periodic amounts received from Social Security, annuities, insurance policies, retirement funds, pensions, disability benefits, and other similar types of periodic receipts.” HUD’s Housing Choice Voucher Program Guidebook repeats this regulation almost word for word,(10) and for good measure adds that annual income also includes in the definition of “income”:

(7) Periodic and determinable allowances, such as alimony and child support payments, and regular contributions or gifts received from persons not residing in the dwelling.

Accordingly, if a first or third party SNT makes any “regular” distribution of either principal or income to a beneficiary, the PHA will count the distribution as part of annual income and reduce its housing assistance subsidy – unless an exclusion applies. So, if the SNT is going to work – that is, if it’s going to make its intended distributions for the special needs of the beneficiary but not to wreck the trust beneficiary’s housing assistance –– the attorney representing the beneficiary or trustee had better find a specific exception that applies.

A Case in Point: Ms. G.

This was the difficult circumstance presented to me in the case of Ms. G. Following my advice, in late 2005 Ms. G’s son filed a petition in the San Mateo County Superior Court to establish a first party (d)(4)(A) SNT. The Court approved the SNT in early 2006, and I notified the Social Security Administration shortly thereafter. Over the ensuing months Ms. G’s son, acting as trustee, made distributions for his mother’s special needs amounting to about $7,500.

Everything went swimmingly until the spring of 2007. In April the Housing Authority for the County of San Mateo (HACSM) asked the trustee for a statement of trust distributions for the last six months. With the information he provided, HACSM sent a “Notice of Change to Lease” to Ms. G. in June informing her of a reduction of her housing assistance subsidy. Her original Total Tenant Payment (TTP) was only $210 per month, and HACSM now more than doubled her obligation to $564 per month. Ms. G. and I promptly filed an appeal, and I went to work trying to figure out why the County had to be wrong.

It turned out after hours of work and exchanges of exhibits, briefs, a hearing, transcript and decision, the key to success was an odd duck indeed: randomness. Under HUD regulations and County guidelines countable “income” does not include “temporary, nonrecurring or sporadic income (including gifts).”(11) I, of course, made the following argument:

The County was not permitted to count any of the distributions from the SNT as income for purposes of her housing assistance because all such distributions were inherently temporary, nonrecurring, and sporadic. The SNT was a discretionary trust in which the trustee has complete discretion to make, or not to make, distributions. Ms. G. had no reasonable expectation of receiving distributions in any amount or at any time, and certainly no expectation that they would be repeated every month.

It didn’t work. But the decision did give Ms. G. and me more than I expected (my expectations were fairly low because the hearing officer was a supervisor in the same department that made the original reduction in subsidy). The decision found that at least “some of the disbursements are sporadic and nonrecurring” and should not be included in the calculation of Ms. G.’s income and subsidy. These included automobile repair and service, legal fees, fraternity dues, and education fees. However, it also found that “some of the disbursements do occur regularly”: auto fuel, cable TV, telephone, and DSL. The decision said that disbursements for medical expenses were protected by specific exemptions and should be treated “differently”: special clothing, dental costs, and medicines. Finally, there were a number of categories of trust distributions that the decision simply did not mention (e.g. entertainment, taxes, postage, and computer service). These were left to the tender mercies of the staff who had made the original adjustment to Ms. G.’s housing subsidy. In Ms. G.’s case we quickly noticed and celebrated the fact that most of the distributions that were found to be sporadic and therefore excludable were the big ones, and the resulting reduction of subsidy fairly slight. Accordingly, the decision could fairly be called a victory for Ms. G.

So the planning lesson from this strange result is this: trustees of SNTs that benefit recipients of Section 8 assistance should make their distributions as randomly and infrequently as possible so the distributions can be characterized as “temporary, nonrecurring or sporadic.” Also, it is particularly important that the larger SNT distributions be “nonrecurring or sporadic” because they will have the larger impact on the subsidy calculation. Fortunately, particularly large distributions may in their nature be “nonrecurring or sporadic,” such as vacation trips or purchases of computer equipment.

Implementation problems

Advocates for SNTs and their beneficiaries need also to be vigilant about how the PHA actually implements the few protections that a housing assistance beneficiary enjoys. For example, in Ms. G.’s case we quickly learned that, in spite of the encouraging words in the decision about treating Ms. G.’s medical expenses “differently,” the County would only allow deduction of unreimbursed medical expenses that exceed three percent of her annual income and also meet Internal Revenue Service requirements for income tax deduction. In fact, HUD’s federal regulations seem a lot more expansive. They exclude from countable income:

(4) Amounts received by the family that are specifically for, or in reimbursement of, the cost of medical expenses for any family member.

HUD’s regulations also define “Medical Expenses” broadly, including “medical insurance premiums, that are anticipated during the period for which annual income is computed, and that are not covered by insurance.”(12) However, HUD’s regulations also impose some limitations on such deductions, including the three percent threshold mentioned above.16 The use of IRS definitions to determine what can be deducted appears to be San Mateo County’s unique invention, and it may violate the intention of the HUD rules. For example, the County would not allow deduction of any nonprescription medications, whether or not directed by a doctor. In Ms. G.’s case, the unreimbursed medical expenses were not particularly significant, so we just gave up on arguing with the County about medical deductions.

In addition to disappointments over the issue of deduction of medical costs, I ended up debating with the County’s eligibility worker about whether a distribution was “sporadic” if made twice a year but “periodic” if made four times a year. This was so silly I’m sure that both of us were rolling our eyes as we talked on the phone (how many angels on the head of a pin?). But the most alarming suggestion made by the County was that it might in the future label “periodic” and count as Ms. G.’s income even trust distributions made only once a year –– if it could show over time that they were made to the same payee every year. I suddenly had a vision of many years of annual disputes ahead of me.

Unanswered questions

Readers may have noticed a major gap in this story about Ms. G. Why didn’t the County impose the two years of deemed interest at the HUD passbook rate described in Funding the Trust above? The original funding was not with an excluded asset from a “settlement or judgment.” I don’t know. I certainly noticed that the County missed this, but my client and I decided not to mention it.

If the County had calculated and imposed imputed interest income for two years after funding the trust, and also counted the trust distributions, it would of course have resulted in double counting. In the example about Robert above, if his mother had distributed the trust’s earnings of $10,000 for his benefit, would the PHA count $2,000 imputed passbook interest and also $10,000, for a total of $12,000 (of which $2,000 was counted twice)? Can the PHA really have it both ways: impute income from the SNT at its passbook rate and also count the very same income when it is actually earned by the trust and distributed for the benefit of the beneficiary? There does not seem to be anything but common sense and logic to prevent this. There is certainly no HUD rule to bar it.

Conclusion

Perhaps the advice advocates should give to SNT trustees for beneficiaries of Section 8 housing assistance is to get a well–balanced coin, flip it to decide on all trust distributions, and then give an affidavit to the PHA every year proving that all distributions were made completely randomly (it creates a whole new definition of fiduciary duty, doesn’t it?). But seriously folks, such SNT trustees should focus on large unique expenditures and let the beneficiary pay regular monthly expenses. If such distributions are inadequate to provide necessary support, trustees should at least make irregular distributions rather than regular ones – and then get ready to argue about the precise definitions of the words, “periodic,” “nonrecurring,” and “sporadic.”

(Greg Wilcox is an attorney in private practice in Berkeley, CA.)


Endnotes

  1. “A (d)(4)(A) Q&A”, Gregory Wilcox, Esq., Spring 2002 (Volume 13, No. 1), Summer, 2002 (Vol 13, No. 2), Fall, 2002 (Volume 13, No. 3), and Spring 2003 (Volume 14, No. 1); “Notes On Special Needs Trusts,” Peter Stern, Esq., Winter 2005 (Vol. 16, No. 4); “Some Frequently Asked Questions About Special Needs Trusts,” Peter Stern, Esq., Spring 2007 (Volume18, No. 1); “Special Needs Trusts in the Courts,” Gregory Wilcox and Polly Levin, Esq., Summer 2007 (Volume 18, No. 2).

  2. When this housing assistance program was first established in 1975, everyone called it “Section 8” after its statutory reference. In the revised federal housing law enacted in 1998, Congress gave the program its formal name, “Housing Choice Voucher Program” (HCVP). Because few have heard of the latter, but almost everyone is familiar with the former, this article uses the term “Section 8” to refer to the “new” existing HCVP.

  3. “The Income and Assets Test for Section 8 Housing,” Jessica Steinberg, Esq., Legal Network News, Winter 2004 (Volume 15, No. 4); 24 CFR §5.609(b)(3).

  4. 24 CFR §5.609(b)(3); HUD Housing Choice Voucher Program
    Guidebook
    , Section 5.4, Determining Income From Assets, and Exhibit 5–3, A.4., at page 5–25.

  5. Ibid., at Exhibit 5–3, B.5.

  6. Steinberg, op. cit., at Endnote No. 3., at page 3; HUD Housing Choice Voucher Program Guidebook, Section 5.3, Annual Income, and Exhibit 5–2, Exclusions (3), at page 5–15.

  7. 24 CFR §5.609(b)(3).

  8. This example was inspired by one in the excellent article, “Special Needs Trusts and Section 8 Housing: Stretching Out the Dollars for Housing,” Kevin Urbatsch, Esq., NAELA Trust SIG News, Fall 2003, pp. 2–4.

  9. HUD Occupancy Handbook for Multifamily Subsidized Housing, Directive No. 4350.3, Chapter 5: Determining Income and Calculating Rent, Paragraph 7. e., at page 5–36.

  10. Section 5.3, Annual Income, Exhibit 5–2, Inclusions, (4), at page 5–24.

  11. 24 CFR §5.609(c)(9), Housing Authority of the County of San Mateo Administrative Plan 2006, Exhibit 6–2: Annual Income Exclusions, page 6–45. See also HUD Housing Choice Voucher Program Guidebook, Section 5.3, Annual Income, and Exhibit 5–2, Income Exclusions, (9), at page 5–15.

  12. 15. 24 CFR §5.603(b).