Can the Trustee of a New Jersey Special Needs Trust Buy Clothing?

Although the federal government clearly changed the rules in 2005 to allow a Trustee of a First Party Special Needs Trust to buy an unlimited amount of clothing for person receiving Medicaid and SSI, there is still a lot of confusion regarding this issue in New Jersey.

New Jersey Administrative Code Section 10:71-4.11, which was enacted in 2001, states that if a Trustee of a Special Needs Trust purchases clothing for someone who has qualified for Medicaid or SSI, it will be considered income to the beneficiary and could reduce the beneficiary's government benefits.  Moreover, if the trust allowed distribution for purchase of clothing, it had the possibility of having the entire trust counted as an asset that may disqualify the beneficiary from benefits.  THIS IS OLD LAW.

To quote from the new law, POMS S.I. 01130.430: "A change in the regulations, effective March 9, 2005, establishes that the resource exclusion for household goods and personal effects no longer has a dollar limit. As a result, beginning with resource determinations for April 2005, SSA no longer counts household goods and personal effects as resources to decide a person’s eligibility to receive Supplemental Security Income (SSI) benefits."  The 2005 law goes on to define "personal effects" to include clothing.

There are several reasons why things are still so confusing:

1. New Jersey has not updated the Administrative Code to reflect the change of law on the federal level by POMS S.I. 01130.430.  The Social Security Regulations clearly override any state rules with respect to eligibility for Medicaid and SSI benefits.  So when Social Security updated its rules in 2005, the NJ rules were automatically updated as well.
2. When looking up the NJ rule online, there is a lot of bad, old information on many websites.
3. When looking up the NJ Administrative Code, which is free on Lexis-Nexis (thank you by the way), unfortunately it has the most recent year next to the Code.  That has the unfortunate side effect of making it look like a new and current law, even if it is not.

So, to be clear - a Trustee of a Special Needs Trust (regardless if it is a first party trust or a third party trust) can buy clothes for the beneficiary and not be concerned that such expenditures will be counted as income or that the beneficiary will lose his or her government benefits.  That being said, if you are spending an excessive amount on clothes, you should probably expect extra scrutiny from the government and potential problems because they could make the argument that the person is just taking the clothes back in exchange for cash, and the fight wouldn't be worth it.

NJ Estate Tax Repeal: How Does This Affect You?

It's official.  According to NJ.com, Governor Christopher Christie has signed a a bill to repeal the New Jersey Estate Tax.  The new law is part of a larger package deal that increases the gas tax, reduces the sales tax slightly, gives the working poor a larger tax credit, gives a tax cut on retirement income and gives a tax exemption for veterans who have been honorably discharged.

Under prior New Jersey law, a person may leave an unlimited amount to a spouse or charity. However, any money going to anyone else above $675,000 (the "exemption amount") is subject to an estate tax. This rule will remain in effect for the rest of 2016.  

For calendar year 2017, the estate tax exemption amount for NJ will increase to $2,000,000.  The tax rate will generally start at about 7.2% and go up to 16% on estates over $10,000,000.

There will be a full repeal of the NJ Estate Tax starting January 1, 2018.  

We have confirmed that New Jersey will NOT be repealing its inheritance tax. Accordingly, money that is left to a non-class A beneficiary will still be subject to a tax.  In other words, there will still be a tax if you leave money to anyone other than a spouse, your descendants, your ancestors or a charity upon your death.

So the big question for many might be how does this affect you.  I will break this down into 5 categories:

1) People who have prepared existing estate planning documents;
2) People with assets between $675,000 to $5,450,000 (for individuals) and married couples with assets less than $10,900,000;
3) Married couples with assets in excess of $10,900,000; 
4) Snowbirds; 
5) Widows and widowers who are the beneficiary of a credit shelter trust; and
6) People who wish to consider Medicaid planning.

1) For people who have already prepared their estate plans, most likely this will not adversely affect your plans.  However, the modification of the tax law likely gives you the opportunity to simplify your documents.  In particular, it is common practice in New Jersey to create a trust for a surviving spouse (often referred to as a Family Trust, Bypass Trust, Credit Shelter Trust or A-B Trust) to double the $675,000 exemption among spouses.  

There still may be other reasons to have a trust for a surviving spouse (such as in second marriage situations), but starting 2018, doubling the NJ exemption amount will no longer be necessary.

2) For New Jersey domiciliaries who have assets above $675,000 (the NJ estate tax exemption limit in 2016) and below the federal estate tax exemption limit ($5,450,000 for individuals and $10,900,000 for married couples in 2016), it was a common part of estate planning for a person to make deathbed gifts to minimize the NJ estate tax liability.  Once the NJ estate tax gets repealed, it will generally be much more beneficial for a person to keep all of their assets until their death rather making substantial gifts during lifetime.

Until 2018, deathbed gifting can be very tax efficient because New Jersey has an estate tax but it does not have a gift tax.  Accordingly, there is the opportunity to substantially minimize the estate tax.  The problem however, is that many people make the mistake of gifting substantially appreciated assets such as stock or real estate. You often want to keep appreciated assets until death to obtain a step-up in basis.   

So before you make a gift, you would need to weigh the potential NJ estate tax consequence of keeping an asset versus the potential capital gains tax if an asset is sold after the gift is made.

Now with the repeal of the NJ estate tax, unless a person is likely to die prior to 2018, you don't need to worry about making the calculation as to whether the NJ estate tax or the capital gains tax will be higher.  It will almost always be better to keep the asset.

3) For married couples with assets in excess of the federal estate tax exemption amount, I have read a number of studies that indicate that a couple can usually transfer wealth in a more tax efficient manner by establishing a credit shelter trust for the surviving spouse rather than relying on portability.  

There are few reasons why wealthier clients may want to continue to use traditional credit shelter trust planning.  The first is that while the estate tax exemption is portable, the generation skipping transfer tax (GST Tax) is NOT portable to a surviving spouse.  Many wealthy clients often wish to make sure the money goes not just to their children, but also to more remote descendants.

Another benefit to traditional credit shelter trust planning is that it acts as freeze for the assets inside the trust.  Specifically, let's assume that we have a married couple with exactly $10,900,000.  If we put half of those assets in trust on the first to die, then regardless of how much that goes up or down, it passes tax free on the surviving spouse's death.  So if the value of the trust goes up at faster rate than the inflation adjustment on the exemption amount, the beneficiaries are basically saving about $0.23 on the dollar because the estate tax is a 40% tax and the capital gains on the appreciation is only taxed at 23%.

While none of this planning will be different after the NJ Estate gets repealed compared to now, it makes the planning much easier to justify because right now we have a dilemma as to "HOW MUCH" we fund the credit shelter trust with.  To avoid any tax on the first to die, a credit shelter trust can only be funded with $675,000.  For some, this hardly makes it worth setting up. However, as the estate tax in NJ goes away, we no longer have this concern.

4) For snowbirds and other people who wish to avoid a "death tax", very simply, starting 2018 the tax incentive to move will be dramatically reduced.  Back in 2009, I wrote a post discussing the tax benefit of relocating to Florida.  Once the NJ estate tax gets repealed, for many it will make little difference from a tax perspective where their domicile is.

That being said, there are still significant differences between being domiciled in New Jersey vs. Florida.  After all, if you own real estate in both places, you still will need to pay property tax in both locations.  The biggest differences that people should be aware of are:

• Florida does not have a state income tax, whereas NJ does.  (Note NJ will start exempting a substantial portion of retirement income from the state income tax); 
• Florida property has homestead protection only if you are a domiciliary of Florida.  This can provide asset protection and it usually stops the property tax from increasing; and
• NJ is keeping its inheritance tax.  So if you plan to leave your assets to nieces, nephews, friends or other non-class A beneficiaries, there could be a substantial tax savings upon your death.

5) If you have a husband or wife who passed away leaving money to you in trust, come 2018 it may be beneficial to consider options for terminating the trust.  Imagine a scenario where husband dies in in 2004 leaving $675,000 in a credit shelter trust (often called a Family Trust or Bypass Trust) for his surviving spouse.  It is likely that these assets in trust have appreciated to over $1,000,000.  If these assets stay in trust until the surviving spouse's death, it will not receive another step-up in basis.  However, if the trust is terminated and assets are distributed to the surviving spouse after 2018, it could be very beneficial from a tax perspective.  

There are many caveats to this plan.  First, you would not want to terminate the trust if the first spouse to die wanted to protect the money in trust for his/her surviving children - so you would not want to terminate the trust in second marriage situations.  Second, you may not want to terminate the trust if the surviving spouse has substantial assets or debts.  It may also not be beneficial to terminate a trust if the value of the trust assets have gone down in value.  

Nevertheless, it would be advisable to consider terminating a trust to make life easier for the surviving spouse and avoid the hassle of having to file an extra income tax return for the trust. 

Please note that a trust can only be terminated if the trust allows it, so you should have the trust looked at to see if the document allows the trust to be terminated.  If the trust does not allow for termination, consider whether it should be modified under the New Jersey Uniform Trust Act.

6) While I don't do Medicaid planning, I do engage in tax planning, and tax planning just got much easier.  The problem with Medicaid planning is that there is so much bad information out in the public sphere.  

I frequently get clients with millions of dollars who want to do Medicaid planning.  They don't realize that to do this type of planning, they actually need to give away most of their assets.  This might work well with someone who has a few hundred thousand dollars.  However, the more money you have, the less sense it usually makes to do this type of planning.

For example, if you have a $500,000 IRA, stock with a basis of $100,000 and worth $400,000, and a house with a basis of $50,000 and now worth $600,000, let's talk about the tax impact of most Medicaid planning.  In order to "give away" everything to qualify for Medicaid (a total of $1.5M here), the person would have to withdraw their entire IRA, causing a federal and state income tax of over $175,000.  Additionally, the transfer of the stock and real estate now would be subject to a built in capital gains of $850,000, resulting in about another $175,000 in capital gains taxes when sold.  

All told, this planning will likely cause about $350,000 in taxes.  This does not even factor in the planning fees and the loss of opportunity to grow the IRA in a tax deferred form.  At $10,000/month in a nursing home, that is about 3 years in a nursing home.  According to the non-profit Life Happens, the average stay in a nursing home is almost 2 and half years and about 70% of the population winds up spending some time in a nursing home.  A $350,000 tax could have paid for 3 years of nursing care home... and in a non-Medicaid facility.  

Prior to the change in the estate tax law, an argument could be made that the increase in income taxes was somewhat offset by a decrease in estate taxes. Until the end of 2016, with an estate of $1.5 million, there was the potential estate tax of over $60,000.  Repeal of the estate tax obviously changes the equation.  Under the new tax law, it is generally more prudent to keep assets in your name rather than giving them away ahead of time.  So while Medicaid planning can certainly be appropriate for some, the larger your estate, the less financial sense it makes to engage in this type of planning.  

A Trust can Qualify for a Section 121 Deduction (For Sale of a Personal Residence)

Typically, people take it for granted that there will not be any tax when they sell their personal residence.  Technically, there is a tax, but the government also offers a limited exclusion under Section 121 of the Internal Revenue Code.

For individuals who sell their primary residence, you can exclude the first $250,000 of gain.  After that, it is subject to a capital gains tax.  For married couples, you can exclude the first $500,000 of gain.

In order to qualify for the exclusion, you must have OWNED and USED the residence as your principal residence for 2 of the last 5 years ending with the date of sale (it does not have to be consecutively). If the home was previously used as a rental property, in a business or for another non-qualified use, there may be longer holding requirements or a reduced exemption amount.

One common estate planning tool that many attorneys create is a revocable living trust.  A revocable living trust, also known as just a Living Trust, is device to manage a person’s assets during life and after death. While the Grantor is alive, the Grantor can manage his or her trust funds as the Grantor wishes. When the Grantor passes, it acts like a Will but with the added benefit of avoiding probate.  If a person sets up a revocable trust, it is highly recommended to transfer all real estate into this trust, including the primary residence.

Another common estate planning tool, particularly for individuals doing Medicaid planning or VA benefit planning, is to move the primary house to an irrevocable trust, which is set up as an intentionally defective grantor trust (IDGT).  An IDGT is a type of trust that is outside a Grantor’s estate for estate tax purposes while simultaneously requiring the Grantor to be taxed on the income earned in the Trust.

Under Internal Revenue Code Treasury Regulation 1.121-1(c)(3)(i), if a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.

So, the long winded answer to the question is, yes, if a trust owns a primary residence and it is set up correctly, it can qualify for the Capital Gains Tax Exclusion under Section 121 of the Code.

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.

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.

Special Needs Planning in NJ - Part 1 of 4

PART I - GOVERNMENT BENEFITS

Many parents of a special needs child have an overwhelming concern: How (and by whom) will their child be taken care of when I die? In this series, I would like to explore the options that exist to ensure that your child will be provided for.

In order to understand the planning options available to your child, you first need to understand the government benefits that might be available to your child. There are 5 types of government benefits commonly available:

1. Supplemental Security Income (SSI) – provides money for low-income individuals who are disabled, blind or elderly and have few assets. SSI eligibility rules form the basis for most other government program rules, and so become the central focus for much special needs trust planning and administration. You must live in the United States or the Northern Mariana Islands to get SSI. Non-citizen residents may be able to get SSI. Once a person qualifies for SSI, he or she is automatically eligible for Medicaid in New Jersey and most other states.

To qualify you must have little or no income and few resources - the value of the things you own must be less than $2,000 if you are single or less than $3,000 if you are married. The value of your home does not count. Usually, the value of your car does not count. And the value of certain other resources, such as a burial plot, may not count either.

To get SSI, you also must apply for any other cash benefits you may be able to get.

The amount a person is entitled to receive in 2009 is:

Person living alone or with others in own household $ 705.25
Person living with spouse who is not eligible for SSI $ 1,018.36
Person living in someone else's household and receiving
support and maintenance $ 493.65
Person living in licensed residential health care facility $ 884.05
Person living in public general hospital or Medicaid
approved long-term health facility $ 40.00
Couple living alone or with others in own household $ 1,036.36
Couple living in someone else's household and receiving
support and maintenance $ 767.09
Couple living in licensed residential health care facility $ 1,730.36

The above includes both federal and state payments.
The benefit is reduced dollar for dollar for any other income the beneficiary may receive. This means that once an SSI beneficiary's income reaches a certain level, his or her SSI benefit will terminate.

2. Social Security Disability Income (SSDI) - provides money for individuals with a disability who qualify for Social Security based upon their own work history or the work history of such person's parents.

The SSDI program pays benefits to adults who have a disability that began before they became 22 years old. The government considers this SSDI benefit as a “child’s” benefit because it is paid on a parent’s Social Security earnings record. For a disabled adult to be entitled to this “child” benefit, one of his or her parents:

• Must be receiving Social Security retirement or disability benefits; or
• Must have died and have worked long enough under Social Security.

SSI v. SSDI

a. SSI is a needs based program and SSDI is an entitlement program. There is no “means” test for SSDI eligibility.

b. SSDI can be a much higher income level than SSI, and with no payback.

c. Under both SSI and SSDI, the child must not be doing any "substantial" work, and must have a medical condition that has lasted or is expected either to last for at least 12 months or to result in death.

d. In order to qualify for SSI, individuals must first apply for SSDI if eligible as SSI is a last benefit of last resort. A person switching to SSDI from SSI can still qualify for Medicaid.

3. Medicaid - is a benefit program available to low-income individuals which makes payments directly to health care providers for medical needs over and above what Medicare will pay. The largest health and long term care program operated and funded by the government – in this case, the federal government. The fixed monthly income cap for Medicaid in 2009 is $2,022.

4. Medicare - is a federal program that makes payments directly to hospitals, doctors and drug companies. People can qualify for benefits if they are 65 and over (and are entitled to receive Social Security benefits, whether or not they have actually retired) and those who have been receiving SSDI for at least two years.

Part A - Covers most medically necessary hospital, skilled nursing facility, home health and hospice care.

Part B - Covers most medically necessary doctors' services, preventative care, durable medical equipment, hospital outpatient services, laboratory tests, x-rays, mental health care, home health care and ambulance services. (There is a monthly premium for Part B based upon a person's income.)

Part D - Covers prescription drugs.

Medicaid v. Medicare

Medicaid differs from Medicare in three important ways:

1) Medicaid is run by state governments (though partially funded by federal payments);

2) it is available to those who meet financial eligibility requirements rather than being based on the age of the recipient, and

3) it covers all necessary medical care (though it is easy to argue that Medicaid’s definition of “necessary” care is too narrow).

Because Medicaid is a “means tested” health care program and Medicare covers a smaller portion of long-term care costs, maintaining continuous Medicaid availability is often the central focus of special needs trust administration.

5. SCHIP - State Children's Health Insurance Program. This program has higher income eligibility limits and provides health insurance for many who earn too much to qualify for other programs.