Termination Clause in Special Needs Trust

The Social Security Administration has issued new rules, SI 01120.199, related to the early termination of Self Settled Special Needs Trusts created on or after January 1, 2000. Self Settled Special Needs Trusts, also known as First Party Special Needs Trusts established under Section 1917(d)(4)(A) of the Social Security Act. are designed to avoid being counted as a resource that would affect the trust beneficiary's right to receive Supplemental Security Income (SSI) and Medicaid.

Typically, a Self Settled Special Needs Trust does not terminate until the death of the beneficiary. The new rules provide guidance on how beneficiaries of these trusts can still qualify for government benefits in the event the trusts contain an early termination provision.

An early termination provision is a clause that would allow the trust to terminate before the death of the beneficiary. A termination clause is very important to have in a special needs trust in case the trust beneficiary is no longer disabled, becomes ineligible for SSI and Medicaid, or when the trust fund no longer contains sufficient assets to justify its continued administration.

The most common need for an early termination clause comes when a child wins a very large personal injury settlement. Settlement agreements will routinely require that a special needs trust be established. However, if in twenty years the child is fully functioning and not in need of SSI or Medicaid, a special needs trust will be overly restrictive.

A special needs trust with a termination clause will qualify under the new rules if the trust:

1. has a payback provision on the date of the termination. This means that the trust has to pay to the State all amounts remaining in the trust up to an amount equal to the total medical assistance paid on behalf of the beneficiary by the State;
2. only makes payment of the balance remaining directly to the trust beneficiary (reasonable administration expenses and taxes are allowed to be paid to other parties); and
3. gives the decision on whether or not to terminate the trust to a person other than the trust beneficiary.

In the event you have an existing trust that does not meet the termination standards set forth by this new rule, such trusts will be evaluated under Section 1613(e) of the Social Security Act.

SI 01120.199 also apply to Pooled Trusts established under Section 1917(d)(4)(C) of the Social Security Act. SI 01120.199 will take effect October 1, 2010.

Are Contributions Made to a Non-Profit Organization Tax-Deductible if 501(c)(3) Status Has Not Yet Been Received?

The classic chicken and the egg problem as it relates to charities. You want donors to give money to a non-profit so that you can have money to pay for the legal fees and filing fees associated with forming the non-profit. However, how do you convince people to donate money to the non-profit if they can't get a tax deduction?

IRS Publication 4220 provides the answer. Generally, if the non-profit organization files Form 1023 (an application to be recognized as a tax-exempt entity) within 15 months from the date the non-profit was created will be considered to be a tax exempt organization as of the date of creation.

The practical impact of this is as follows:

1. An organization may have fundraisers prior to receiving proof that it has been declared tax-exempt by the IRS;
2. The non-profit MUST advise potential donors that the 501(c)(3) status is pending.
3. If the tax-exempt status is granted by the IRS, contributions by donors will be tax deductible.
4. If tax-exempt status is denied, contributions made by donors will NOT be tax deductible. Additionally, the organization may be liable for paying taxes on money it has received.
   

Self Settled Special Needs Trusts

There are generally two types of private special needs trusts:

1. 1) Third Part Special Needs Trusts; and
2. 2) Self Settled Special Needs Trusts (also known as First Party Special Needs Trusts or D-4A Trusts).

A person who is receiving (or about to receive) Medicaid and Supplemental Security Income (SSI) may wish to consider establishing a Special Needs Trust just before he or she is about receive a substantial gift, inheritance or personal injury award. By receiving money outright, the person will no longer be eligible to receive SSI and Medicaid.

The Social Security Act (Section 1396p(d)(4)(A)) specifically allows a Special Needs Trust to be created for a person so that the person can continue to qualify for Medicaid and SSI. This particular trust is called a Self Settled Special Needs Trust because it is being funded with the person's own money (as opposed to money given to a trust by a third party).

The prime difference between the terms of a Self Settled Special Needs Trust and a Third Party Special Needs Trust is that when the beneficiary of a Self Settled Special Needs Trusts dies (or the trust terminates), the balance in the trust must pay off any Medicaid liens that have been built up. If there money left in the trust after that, the balance can be paid to the beneficiary's relatives. With a Third Party Special Needs Trust, there is no payback provision necessary.

The reason why a beneficiary of either a Self Settled Special Needs Trust or a Third Party Special Needs Trust can qualify for SSI and Medicaid is because those trusts are limited in what they can pay for. In general, the trust may not pay for food, shelter, electricity, gas or water and it may not pay for anything that can be converted into food, shelter, electricity, gas or water. So cash should almost never be distributed to a beneficiary from the trust. (Note: there are special rules about a trust owning a home)

A Self Settled Special Needs Trust can be created on behalf of the individual who receives the money by the person's guardian, the person's parent or grandparent, or by a court (as often happens in personal injury settlements). The beneficiary must be under the age of 65 when the trust is created and funded and the trust must be for the sole use of the beneficiary.

The costs of creating a Special Needs Trust vary from attorney to attorney, however, hundreds of thousands can be saved by setting up one properly.

The "Gift" of Health Insurance

I frequently come across clients who want to help their children financially, but they do not want to give them money directly. There are numerous ways to do this, including:
1) gifting an interest in a limited liability entity (such as an LLC, an S-Corp or a limited partnership);
2) making gifts to a child via a trust;
3) paying for a child's or grandchild's tuition; and
4) paying for a child or grandchild's medical expenses.

In the first two categories, there is a limit to the amount that can be given tax free. This amount is known as the 2503(b) exemption amount, and it currently stands at $13,000. However, for the third and fourth categories, a parent can pay educational and medical expenses for a child, regardless of amount, and not have to worry about paying a gift tax at all.

When many people consider making a gift for medical purposes, they think that they have to pay the doctor directly on behalf of the child. There is something else that can be done though - they can also pay their child's health insurance premiums. According to Treasury Regulation 25.2503-6(3), "the unlimited exclusion from gift tax includes amounts paid for medical insurance..."

Since insurance premiums have been increasing by double digit percentages almost every year, wealthy parents should take advantage of this option to help out their children and provide piece of mind to themselves. This is particularly true if their child has been laid off in this down economy.

By directly paying the insurance company for their child's health insurance bills, parents can also make an additional $13,000 gift (either in cash or indirectly), to help out their child or minimize their estate for estate tax purposes.