The following article first appeared in 25 The Colorado Lawyer 49 (May, 1996) and is reprinted here by permission of the Colorado Bar Association.
Preserving the Disabled Plaintiffs Access to Public Benefits With The Special Needs Trust
By Jersey M. Green and Marilyn W. McWilliams
A personal injury settlement or judgment provides welcome relief to a disabled plaintiff. What is not so welcome is a notice from the Social Security Administration and the Colorado Department of Health Care Policy and Financing (Department) that, because of receipt of the lawsuit recovery, the injured person has lost both his or her monthly Supplemental Security Income (SSI) and Medicaid eligibility. This foreseeable and unfortunate result is preventable by the use of a special needs trust.
A special needs trust is a vehicle for ensuring that personal injury or medical malpractice proceeds from a settlement or a judgment do not work to disqualify the disabled plaintiff from receiving SSI income and benefits under the accompanying Colorado Medicaid program. This article discusses how a plaintiff can be disqualified from both SSI and Medicaid because of a settlement or judgment and how practitioners can shield their disabled clients from such a result by use of the special needs trust.
Government Benefits Program
Unlike retirement benefits under Social Security, which are earned through employment, and Medicare, which is an entitlement program for Americans age sixty-five and over, SSI and Medicaid are needs-based welfare programs. Disabled persons under the age of sixty-five are eligible for monthly income and payment of medical expenses by these programs if they are both income eligible and resource eligible. Without proper planning, proceeds from settlements or judgments can be deemed countable resources, rendering the disabled plaintiff ineligible for SSI and Medicaid.
Qualification for Benefits
To achieve and maintain eligibility for SSI and Medicaid, the claimants countable resources must be less than $2,000. Countable resources are all resources that are not exempt. Exempt resources are a home of any value and its furnishings; one automobile; wedding rings; a burial plot; an irrevocable burial insurance policy of any value or a revocable policy valued at $1,500 or less; and cash value of life insurance of $1,500 or less.
The claimants income also must fall at or below the allowable maximum, a figure that is adjusted annually. In 1996, the monthly maximum is $470. If income or countable resources exceed these limits, the claimant loses eligibility for SSI and Medicaid for a period of time based on the amount of income or value of resources received.
Effect of Disqualification
Disqualification from receipt of such public benefits can have profound, adverse economic consequences to the disabled plaintiff. In fact, in some circumstances, the economic loss of such public benefits can be greater than the value of the settlement or judgment proceeds.
For example, suppose a disabled person is receiving tax-free SSI disability income of $5,640 per year. Assume also that he requires the expenditure of $15,000 per year for medical care because of his disability, which is being provided by Medicaid. He is injured further in an automobile collision and files a lawsuit. From the lawsuit, he obtains a net settlement of $30,000, after payment of attorney fees and costs, but no provision is made for the award to go into a special needs trust.
The failure to place the award in a special needs trust means that the $30,000 settlement will be counted as a resource, thus disqualifying the plaintiff from receiving further assistance through SSI and Medicaid for a significant period of time. In this example, the plaintiff both loses his tax-free SSI benefits and exhausts his $30,000 settlement award within two years to pay for his pre-existing medical problem which, with proper planning, would have been paid for through Medicaid. Under these circumstances, the failure to establish a special needs trust actually costs the plaintiff more than he receives from the settlement.
Special needs trusts were authorized under the Omnibus Budget Reconciliation Act of 1993 (OBRA-93), which was signed into law by President Clinton in August 1993. This legislation amended the section of the Social Security Act governing Medicaid and permits the courts and certain other parties to place proceeds from personal injury and medical malpractice lawsuits for disabled children and adults into a trust instrument so the funds will not be considered a countable resource.
The Colorado legislature also authorized the creation of such trusts for the purpose of allowing disabled persons to become or remain eligible for the state Medicaid program. In Colorado, special needs trusts are governed by federal and state statutes and regulations. In addition, counsel should refer to the staff manuals for the administering agencies, the Social Security Administration and the county Department of Social Services.
How a Special Needs Trust Works
The underlying purpose of the statutes and regulations governing the special needs trust is to ensure that the disabled SSI and Medicaid recipient is not penalized for the successful prosecution of a personal injury or medical malpractice claim. This is accomplished by allowing a disabled plaintiff to continue to be eligible for SSI and Medicaid if he or she uses the funds recovered in the suit in accordance with applicable laws and regulations.
The benefits attainable through a special needs trust are not necessarily achieved at the expense of the taxpayers. Under OBRA-93, Medicaid has a lien on the proceeds in the special needs trust for medical expenses paid for by Medicaid. The lien is not enforced during the plaintiffs lifetime. When the plaintiff dies, the lien is satisfied from the remaining trust funds, if any, to the extent of the actual dollars expended by Medicaid. No interest accrues on the lien during the plaintiffs lifetime.
After Medicaid enforces its lien following the death of the plaintiff, any balance left over can then be distributed to the plaintiffs beneficiaries. For example, if Medicaid provided medical services totaling $30,000 during the lifetime of an injured plaintiff, Medicaid could recover only $30,000 from the balance left in the trust after his or her death. If the trust held a total of $50,000 on the plaintiffs death, the $20,000 remaining after the Medicaid lien is satisfied may pass to the beneficiaries of the deceased plaintiff.
In establishing a special needs trust, it is necessary to have a trustee, oftentimes a family member, who is willing to serve as the purchaser for goods and services bought with trust funds. Funds from the trust, by statute, are to be used for supplemental needs, which means the funds cannot be used to purchase basic support items such as food, clothing and shelter.
Funds from the trust can be used to purchase medical services not provided through Medicaid. The funds can be used for many purposes, including but not limited to transportation, travel, home companions, nurses, private rehabilitation services, sophisticated diagnostic services not provided by public programs, medical equipment not provided by Medicaid and recreation. The permitted uses of the funds are governed by detailed regulations that are subject to change and should be consulted periodically.
The trust funds are to be used only for the benefit of the injured person and not for his or her family members. The Colorado statute prohibits the funds from being transferred for less than fair consideration, and thus denies the plaintiff the freedom to make gifts. Reasonably, this prohibition can be construed to prohibit the use of the trust funds, for example, for the plaintiffs childrens college tuition. The federal regulations impose a penalty waiting period of twenty-four months for transfers of assets for less than fair market value.
Although the funds in a special needs trust are excluded as a countable resource to the SSI recipient, actual cash disbursements to the SSI recipient will be deemed as income to the SSI recipient and can result in income ineligibility for that month. The claimants income is determined on a monthly basis. Ineligibility also can result if the trust funds are used for food, clothing or shelter because disbursements for such expenditures will be regarded as income.
The amount of income the disabled plaintiff receives during a month affects the amount of SSI benefits the claimant may receive in that month. If the income is not fully expended and is held over to the following month, the income is treated as a resource in the second month. Therefore, the timing and amounts of disbursements are important.
The Department offers pre-approved pattern special needs trust documents at no expense. These can be obtained by calling the Department in Denver at (303) 866-5410. A pattern special needs trust may be created at nominal expense to the client.
There are certain other considerations not dealt with in the enabling legislation or in the Departments pattern trust that can forestall potential problems or provide additional benefits under the special needs trust to the disabled beneficiary. Counsel also may fashion the special needs trust to qualify as a grantor trust under the Internal Revenue Code (Code) rules to lower the income tax liability of the trust.
The Code classifies trusts as either complex trusts (subject to special income tax rates) or simple or grantor trusts. Income from grantor trusts is taxed at the rates for individuals. In contrast, the tax rate brackets for complex trusts are greatly compressed. For example, the first $24,000 of ordinary income earned by individuals and grantor trusts is taxed at a rate of 15 percent. The current highest individual tax rate, 39.6 percent, is not imposed until the taxpayers income exceeds $263,750. In contrast, the 1996 income tax rates for complex trusts begins at 15 percent of the first $1,600 of taxable income and reaches the 39.6 percent rate at $7,900.
The complex trust tax rates are so much higher than those applied to grantor trusts that the tax impact of classifying a trust as complex or grantor is dramatic. Despite the names complex and grantor, the length or intricacy of the trust document and the difficulty of interpretation are not determinative of Internal Revenue Service designation of a trust as complex. A thorough discussion of how to create a trust that qualifies for grantor trust income tax treatment is beyond the scope of this article but should be examined by those who undertake the task of establishing a special needs trust. There also may be gift tax issues that should be considered at the time of the funding of the trust.
When to Consider a Special Needs Trust
The threshold eligibility requirement for a special needs trust is that the claimant be disabled. Disability is defined as the inability to do any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than twelve months.
The claimant must have a severe impairment, which makes the claimant unable to do his or her previous work or any other substantial gainful activity that exists in the national economy. The process of determining whether the claimant is disabled takes into consideration whether he or she is able to do any other work; his or her residual functional capacity; and his or her age, education and work experience.
A special needs trust should be considered for anyone currently eligible to receive SSI and Medicaid or anyone who could qualify for such benefits in the foreseeable future. For example, a disabled minor who is about to attain the age of majority may be a good candidate for a special needs trust. It would be incorrect to assume that a special needs trust is only for the currently impoverished. The authors of this article are aware of a multi-million-dollar medical malpractice case in which the settlement was more than adequate to provide for the life-care needs of the catastrophically injured client, who had attained the age of eighteen years. Because the client met the definition of being disabled and did not have income or countable resources that would disqualify her from public benefits, a special needs trust was established that included spendthrift provisions to protect the client from unscrupulous suitors, provisions to qualify the trust as a grantor trust for income tax purposes, and provisions to avoid gift tax problems.
When in doubt concerning a clients eligibility for SSI and Medicaid, counsel should have the client apply by calling the Social Security Administrations toll-free information: (800) 772-1213. A separate Medicaid application also can be filed with a county service center of the Colorado Department of Human Services. The process of determining whether a claimant is eligible for SSI and Medicaid can be involved. Processing and appeal procedures can take several months. Consequently, the process of determining whether the client is eligible for such public benefits should be commenced early in the attorney-client relationship.
Timing the Creation of the Trust
If the plaintiff receives funds from a settlement or judgment in his or her own name, the regulations may render the plaintiff disqualified from public benefits for a period of time based on the size of the award. For example, assume a plaintiff receives a cash settlement of $30,000 and has no other nonexempt assets. The first $2,000 is considered exempt. Consequently, the plaintiff would be deemed to possess $28,000 of nonexempt assets, thus rendering him ineligible for SSI and Medicaid. Even if he gave these assets away, the plaintiff would still be ineligible for SSI and Medicaid for twenty-four months. If he used the funds to purchase nonexempt assets, he would continue to be ineligible.
The special needs trust should be created before settlement or trial to receive the settlement or judgment. A special needs trust must be approved by the Department, which can generally be accomplished within a short period of time (less than two weeks) after submission.
Of course, whether a case will settle and when is usually unpredictable, as is the amount of the ultimate settlement. If the special needs trust has not yet been approved by the Department at the time of the settlement, execution of the settlement documents and receipt of the funds should be postponed until the Department has approved the trust. If the defendant is willing to do so, counsel may request the settlement proceeds be placed in escrow in an interest-bearing account while awaiting the drafting and approval of the special needs trust.
Except for the effort of creating a special needs trust, the inclusion of the trust does not otherwise complicate the settlement process. Even structured settlements can be placed in a special needs trust. Moreover, the creation of such a trust does not hinder counsel from collecting his or her attorney fee.
In settlement documents, the trustee of the special needs trust is the person to be identified as the recipient of the settlement proceeds: John Doe, as Trustee of the Jane Roe Irrevocable Special Needs Trust. Whether the settlement proceeds are tendered to the trustee of a special needs trust or to the plaintiff, individually, should be of no concern to the defendant. Of course, the plaintiff may execute the settlement agreement and release, individually.
When everything is ready, a motion to approve the special needs trust should be presented to the court along with the motion for dismissal of the case. If the case goes to trial, the trust should be submitted to the court prior to trial for the courts approval in expectation of a judgment in favor of the plaintiff.
Disadvantages of the Special Needs Trust
As with many other estate planning devices, the special needs trust is a tool of conservation and requires a willingness on the part of the trust beneficiary to conserve. Plaintiffs receiving a substantial settlement or judgment may be unwilling to live with the fiscal restraint required to maintain such eligibility.
Additionally, administration of the trust can prove burdensome. The trustee must be conscientious and willing to take the time necessary to administer the trust properly, preferably without a fee. In the absence of a suitable family member or friend willing to serve as an uncompensated trustee, the only other alternative is to appoint a trustee on a fee-for-service basis. If the trust funds are invested appropriately, the returns on investment should be more than sufficient to cover such fees. However, the smaller the settlement or judgment, the less desirable a special needs trust may be because of the expense involved in establishing and administering the trust.
The special needs trust preserves the disabled plaintiffs access to public benefits and may include many tax and asset protection provisions to assure that settlement or judgment proceeds are available to the plaintiff when needed in the future. The principal drawback is that the trust must be administered in compliance with statutes and changing regulations. Administering a special needs trust requires attention to detail that must be measured against the value to be gained by maintaining access to public benefits.
The availability and advisability of special needs trusts should be discussed with a client in the early stages of the case. Counsel should explain to the client the significance of living with a special needs trust. If the disabled plaintiff elects not to have the proceeds placed in a special needs trust, counsel probably should have this election manifested by an informed, written waiver signed by the client.
 Title XVI, Social Security Act, 42 U.S.C. 1381 et seq.
 CRS 26-4-101 et seq.
 Social Security Act, 42 U.S.C. 401 et seq.
 Title XVIII, Social Security Act, 42 U.S.C. 1395 et seq.
 20 C.F.R. 416.1201.
 20 C.F.R. 416.1210 et seq.
 20 C.F.R. 416.1100 et seq..
 42 U.S.C. 1396p(d)(4), as amended Aug. 10, 1993, P.L. 103-66, Title XIII, Ch. 2, Subch. B, Part II. 13611(a)-(c), 13612(a)-(c), 107 Stat. 622, 627.
 CRS 15-14-409.8.
 20 C.F.R. 416.1246.
 See Rev. Rul. 83-25, 1983-1 C.B. 116.
 I.R.C. 1(e) and 3(b)(2).
 42 U.S.C. 1382c(a)(3); 20 C.F.R. 404.1505.
 20 C.F.R. 416.1324.
 20 C.F.R. 416.1246.
 CRS 15-14-409.8(4).