LESSER-KNOWN TRUSTS FOR THE SNT PRACTITIONER
2016 National Conference on Special Needs Trusts and Special Needs Planning Stetson University College of Law Vinoy Renaissance Resort & Golf Club St. Petersburg, Florida October 19-21, 2016
BRYN POLAND and PI-YI MAYO* 5523 Garth Road Baytown, Texas 77521 281.421.5774
*Certified Elder Law Attorney by the National Elder Law Foundation
Nothing in this paper is to be construed as the rendering of legal advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. This publication is intended for educational and informational purposes only. © 2016 Copyright, Bryn Poland, All Rights Reserved.
Stetson College of Law Lesser-Known Trusts for the SNT Practitioner
Copyright 2016 Law Office of Pi-Yi Mayo
Lesser-Known Trusts for the SNT Practitioner Table of Contents I.
Introduction……………………………………………………………………………..2
II.
Qualified Disability Trusts……………………………………………………………2 A. Elements………………………………………………………………………………...3 B. Analysis………………………………………………………………………………….5
III.
Sole Benefit Trusts…………………………………………………………………….5 A. Elements………………………………………………………………………………...6 B. Analysis………………………………………………………………………………….8
IV.
Qualified Settlement Funds………………………………………………………….9 A. Elements……………………………………………………………………………….10 B. Analysis………………………………………………………………………………..12
V.
Conclusion……………………………………………………………….……………15
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Introduction The area of Special Needs Trusts law is a complex one. Attorneys specializing in special needs trusts must be experts in public benefits, trust law, and tax law. Knowledge in these areas provides the perfect backdrop for a special needs trust attorney to add other, lesser-known trusts to his or her repertoire. By doing so, an attorney can increase the bottom line by attracting clients for whom a special needs trust may not be the best solution. Additionally, some special needs trusts clients may benefit by adding these other services, allowing an attorney to provide clients with more complete representation. While these lesser-known trusts may not be able to sustain a law practice on their own, when added to an existing special needs trust practice, they can be useful and complementary. This paper will cover three lesser-known trusts that may complement a special needs trust practice. Those trusts are qualified disability trusts, sole benefit trusts, and qualified settlement funds. The discussion will include an overview of each trust and the elements of each. Additionally, the paper discusses examples of each type of trust and how a special needs trust practitioner may be able to add value to clients by incorporating these lesser-known trusts into his or her practice, when appropriate. Qualified Disability Trusts As a general rule, trusts are required to pay income tax on income the trust receives annually. The trust tax rates are compressed compared to the personal tax rates. An irrevocable, non-grantor trust reaches the maximum tax bracket (39.6% in 2016) at only $12,400.00 of income annually.1 Not only is the tax rate for trusts compressed when compared to the personal tax rates, but the exemption amount is much lower for trusts than for individuals. The Internal Revenue Code provides for a personal or dependency exemption2 of $4,050.00 in 2016.3 This means that an individual gets to exempt the first $4,000.00 of income each year. For non-grantor trusts, however, the exemption amount is between $100-$300.4 Historically, if a person wanted to avail herself of the personal tax exemption and avoid the compressed tax rates for trusts, she would create a grantor trust. A grantor trust 1
Rev. Proc. 2014-61, available at https://www.irs.gov/pub/irs-drop/rp-14-61.pdf. I.R.C. § 151. 3 Supra note 1. See also https://ww w.irs.gov/uac/newsroom/in-2016-some-tax-benefits-increase-slightly-due-to-inflation-adjustments-othersare-unchanged (discussing changes to tax rates in 2016). 4 The amount depends on whether the trust is a “simple” trust ($300 exemption) or a “complex” trust ($100 exemption). I.R.C. §642(b)(2). 2
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passes all income of the trust through to the “grantor,” who can then apply her personal tax exemption and will pay taxes at her own personal tax rate, rather than the compressed tax rates imposed on trusts.5 Historically, if a trust could not avail itself of grantor trust status, however, it was subject to the compressed tax rates and minimal exemption amounts. The Internal Revenue Code allows for certain types of disability trusts to qualify for a special personal exemption. Trusts that meet the requirements of IRC § 642(b)(2)(C) are referred to as qualified disability trusts. A Qualified Disability Trust (“QDT”) receives an exemption equal to the personal/dependent exemption. Thus, if a trust has QDT status, no income tax will be due on the first $4,050.00 (in 2016) of income the trust generates. The IRC definition of a qualified disability trust is somewhat confusing because it references public benefit rules, rather than giving an out-right definition.6 As a general rule, the provision will apply to most non-grantor trusts created for the benefit of a disabled individual who receives Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI) benefits. Elements The statutory definition of a QDT is a trust that is “a disability trust described in subsection (c)(2)(B)(iv) of section 1917 of the Social Security Act (42 USC § 1396p),”7 and all of whose beneficiaries are “determined by the Commissioner of Social Security to have been disabled (within the meaning of §1614(a)(3) of the Social Security Act, 42
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Id. at §671. “(C) Disability trusts (i) In general. A qualified disability trust shall be allowed a deduction equal to the exemption amount under section 151(d), determined— (I) by treating such trust as an individual described in section 68(b)(1)(C), and (II) by applying section 67(e) (without the reference to section 642(b)) for purposes of determining the adjusted gross income of the trust. (ii)Qualified disability trust. For purposes of clause (i), the term “qualified disability trust” means any trust if— (I) such trust is a disability trust described in subsection (c)(2)(B)(iv) of section 1917 of the Social Security Act (42 U.S.C. 1396p), and (II) all of the beneficiaries of the trust as of the close of the taxable year are determined by the Commissioner of Social Security to have been disabled (within the meaning of section 1614(a)(3) of the Social Security Act, 42 U.S.C. 1382c(a)(3)) for some portion of such year. A trust shall not fail to meet the requirements of sub clause (II) merely because the corpus of the trust may revert to a person who is not so disabled after the trust ceases to have any beneficiary who is so disabled.” Id. § 642(b)(2)(C). 7 Id. § 642(b)(2)(c)(ii)(I). 6
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USC 1382c(a)(3)) for some portion of such year.”8 The code continues that: “a trust shall not fail to meet the requirements of sub clause (II)--that all of the beneficiaries must be disabled--merely because the corpus of the trust may revert to a person who is not so disabled after the trust ceases to have any beneficiary who is so disabled.” To qualify as a QDT, all of the beneficiaries must receive benefits under SSI or SSDI. This is not true of all trusts qualified as a Special Needs Trust under § 1396p(c)(2)(B)(iv), which can be established without a finding of disability so long as the person could meet the disability standard as prescribed by the Social Security Administration.9 Thus, a trust for a disabled federal retiree who is not qualified for SSA benefits could not qualify as a QDT, but the trust might meet the definition of a special needs trust as prescribed by 42 USC §1396p. A QDT cannot be a grantor trust. The trust entity must be a taxpaying entity; because a grantor trust does not file a separate return, it will not qualify as a QDT. Most selfsettled special needs trusts are grantor trusts because the trustee has ability to use all trust income and principal for the benefit of the beneficiary.10 Grantor trust treatment can sometimes also apply to third-party special needs trusts. If the beneficiary is a disabled person and not the original funding source, the grantor trust rules may still cause treatment of the trust as a grantor trust to the original trust creator.11 In such a case, QDT treatment will not be available to the trust because it is not the taxable entity. The trust must be established for the benefit of disabled individuals under age 65 at the time of the trust creation. Under section §1396p(c)(2)(B)(iv), a trust must be established for the benefit of only one trust beneficiary. Thus, a grandparent with more than one disabled grandchild could not establish a single special needs trust for the benefit of the group of disabled grandchildren and still receive the benefits of §1396p(c)(2)(B)(iv). The IRC provision, however, requires that “all of the beneficiaries” be determined to be disabled. The sole benefit rule, then, appears to not be applicable to QDTs.
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Id. § 642(b)(2)(c)(ii)(II). The Administration makes disability determinations only when a person seeks benefits because he or she is disabled and meets the other program requirements for SSI or SSDI. 20 C.F.R. §404.1520. 10 IRC § 673 gives grantor trust status to any portion of a trust in which there is a reversionary interest of as much as 5% of the value of the trust. Because the value of the reversionary share is calculated by “assuming the maximum exercise of discretion in favor of the grantor,” most self-settled SNTs are grantor trusts. IRC § 673(c). 11 Id. at §§671-678. 9
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Analysis Using the QDT tax provisions will generally always be a good idea for third-party nongrantor special needs trusts. There may be, however, good uses for the QDT tax provisions even when a special needs trust is not the appropriate tool. In a typical special needs trust, one disabled individual is named as the beneficiary for the duration of life. Consider a situation where grandparents have a two-year-old grandchild receiving SSI because she has a total disability, but the disability can be cured with a major surgery. The surgery cannot be performed until the child reaches age ten when her body is more able to recover from such a major surgery. The grandparents have three other grandchildren for whom they would like to provide. A trust that provides for the disabled grandchild until she is age eighteen, and then provides for all grandchildren could receive QDT status so long as the first beneficiary receives SSI. Unlike the “sole benefit” requirement in the public benefits provision, which requires that the disabled beneficiary’s interest terminate only at death, the QDT provision permits reversion after the trust ceases to have any disabled beneficiary. Next consider a family with four adult children; three of the children receive SSDI benefits. The three children receiving SSDI benefits do not need to adhere to the special needs trust rules because they are not receiving means-tested benefits. The child who is not receiving SSDI benefits has agreed to serve as trustee for a trust established for her siblings, but would prefer to manage only one trust for the whole--not three separate trusts. The parents establish a single trust for the benefit of their three children that meets the QDT tax provisions because the IRC provision permits multiple beneficiaries so long as each has a disability determination by the Social Security Administration. Sole Benefit Trusts A Sole Benefit Trust (SBT) is a trust that, when properly drafted, does not create a transfer penalty for the Settlor under the Long-Term Medicaid rules. It can be the perfect planning tool for a Medicaid Spend Down when trying to qualify an applicant for long-term Medicaid, in certain circumstances. If correctly drafted, transfers of the applicant’s assets to a sole benefit trust could allow Medicaid eligibility (without a transfer penalty) while also maintaining eligibility for means-tested benefits for the trust beneficiary. As a general rule, an individual must have less than $2,000.00 in countable assets to be eligible for Medicaid. Medicaid imposes a five-year “look back” period wherein the applicant is penalized for transfers made when the applicant received less than fair
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market value in return. Some transfers are exempt from this penalty: transfers to the applicant’s spouse and transfers to a child who is under age 21 and transfers to a child who is blind or has a disability are all exempt. An often lesser used transfer exemption is a transfer to a trust for the sole benefit of any individual who is under age 65 and who does or would meet the Social Security Administration’s criteria for total and permanent disability. This may sound like a hidden loophole that allows two people to qualify for benefits with just one trust. But, there are some pitfalls to avoid for beneficiaries who receive certain types of government benefits. A sole benefit trust for this purpose combines the aspects of both first and third party special needs trusts. It is established with the funds of someone other than the beneficiary (third-party). The beneficiary must be under the age of 65 and the trust must be for the “sole benefit” of the beneficiary (first-party). It is important to note that the term Sole Benefit Trust is merely descriptive: many trusts that contain the provisions that allow them to qualify as SBTs are considered standard special needs trusts--however--not all special needs trusts are SBTs. The statute12 exempts from sanctions any transfer “to a trust (including a trust described in subsection (d)(4) of this section) established solely for the benefit of” a disabled person who is either under age 65 or the transferor’s child of any age. While the statute clearly articulates the requirements of a D4A trust--including the payback requirement--it is silent as to what requirements apply to the other types of trusts that might qualify as “solely for the benefit of.” Elements The Centers for Medicare and Medicaid Services (CMS) State Medicaid Manual defines Sole Benefit. “A transfer is considered to be for the sole benefit . . . if the transfer is arranged in such a way that no individual or entity except the spouse, blind or disabled child, or disabled individual can benefit from the assets transferred in any way, whether at the time of the transfer or at any time in the future.”13 A sole benefit trust could be established by a Medicaid applicant for the sole benefit of the community spouse without incurring a penalty. An SBT can also be created for a child--of any age--who is blind or who meets the disability criteria as established by the Social Security Administration (SSA). The Administration defines disability as the inability to engage in substantial gainful activity by reason of a “medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be
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42 U.S.C. §1396p(c)(2)(B). CMS State Medicaid Manual, Chapter 3, Section 3257, available for download at https://www.cms.gov/Regulations-and-Guidance/guidance/Manuals/Paper-Based-ManualsItems/CMS021927.html. 13
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expected to last for a continuous period” of at least twelve months.14 The individual’s impairment(s) must be severe enough to prevent him from performing not only his previous job but, considering his age, education and experience, any other job that exists in the national economy. Lastly, a Medicaid applicant can establish an SBT for any individual under age sixty-five (65) who is disabled. To be considered “for the sole benefit of” an individual, the trust must require distributions to be actuarially sound based on the life expectancy of the beneficiary.15 To be actuarially sound, the minimum distribution standard must provide for the complete distribution of the trust principal within the beneficiary’s anticipated life expectancy.16 The trustee can deplete the trust more rapidly, but the trust document must provide for minimum payments that are actuarially sound. One possible distribution standard would be to include minimum required distributions that are based on the beneficiary’s life expectancy with trustee discretion to exceed the minimum standard. This would allow the trustee some flexibility in the event the beneficiary would be better served with larger distributions. Some state Medicaid authorities have placed additional requirements on SBTs. Some states also require a payback provision to be included. Additionally, some states require the beneficiary’s estate to be the sole remainder beneficiary.17 These requirements are absent from the federal statute and the CMS manual. Ostensibly, these requirements ensure that the trust is solely for the benefit of the beneficiary, but appear to be more restrictive than the federal law. In States without these extra hurdles, a sole benefit trust may be a solution for a penalty-free Medicaid spend down while also benefiting a disabled individual. Analysis An obvious use of the Sole Benefit Trust is when a would-be beneficiary only receives Social Security Disability Insurance (SSDI). SSDI is federal benefit program without income and asset restrictions. If a person with disabilities is receiving SSDI and will never qualify for SSI because the monthly payments she receives exceed the SSI limits, she could easily be the beneficiary of a Sole Benefit Trust because the mandatory actuarially sound distributions will not negatively impact her SSDI benefits. In this 14
42 U.S.C. §1382c(a)(3)(A). Texas, where the author resides, requires the trust to make distributions that are actuarially sound. Medicaid for the Elderly and People with Disabilities Handbook, I-3300, available at http://www.dads.state.tx.us/handbooks/mepd/. 16 Supra, note 13 at §3258.9B. 17 See 18 NYCRR § 360-4.4(C)(2)(iii)(d)(V). 15
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circumstance, an applicant for Long-Term Medicaid could transfer assets--penalty free-to a sole benefit trust for the SSDI recipient with no negative impact on the SSDI recipient’s benefits. A true win-win. The scenario is more complicated when the would-be beneficiary is a Supplemental Security Income (SSI) recipient. Cash received from the trust will reduce SSI benefits dollar-for-dollar.18 Therefore, it will be necessary to structure the minimum distributions so that they will not be income (under the SSI rules) to the beneficiary. A sole benefit trust for an SSI recipient could require the Trustee to satisfy the minimum distribution requirements first with distributions that do not constitute income (for SSI eligibility purposes) to the beneficiary. If the minimum required distribution cannot be satisfied under the first requirement, the Trustee would next be required to make distributions that constitute In-Kind Support and Maintenance (ISM). The receipt, or right to receive, food or shelter is known technically as In-Kind Support and Maintenance. The trust beneficiary's SSI benefits will be reduced if she receives ISM because SSI benefits are specifically intended to pay for a person's food and shelter; if an SSI recipient receives those goods or services from another source, then theoretically, less SSI income is needed.19 When a Trustee distributes ISM to the beneficiary, SSI benefits will be reduced, but not on a dollar-for-dollar basis as with cash.20 If a potential Medicaid applicant owns a brokerage account with a balance of $500,000.00, the applicant could fund an irrevocable trust for the sole benefit of her 52year-old son who is disabled and receives SSDI benefits. According to the Administration’s actuarial tables, a 52-year-old male has a life expectancy of 27.66 years of remaining life (age 79.66).21 Thus, the SBT must provide for minimum annual payments of $18,076.65 ($500,000.00÷27.66=$18,076.65). The trust is irrevocable and not a countable asset to the applicant. The trust requires minimum annual distributions of $18,076.65, and thus, is actuarially sound. Because SSDI is not a means-tested program, monthly trust disbursements to (or for the benefit of) the applicant’s son do not
18
Social Security Administration Programs Operations Manual (POMS) SI 01120.200E1.a, available at https://secure.ssa.gov/apps10/poms.nsf/lnx/0500815001. 19 There are sometimes rather fine distinctions between allowable in-kind income and countable ISM. For example, you can pay for some travel arrangements but not others: a plane ticket (in-kind income) --but not a hotel room because that is shelter (ISM). You can pay for some entertainment expenses but not others: a movie pass (in-kind income) but not a restaurant meal because that is food (ISM). See Id. at SI 00815.001(C) and (D). 20 Instead, the formula Social Security uses to reduce the SSI benefits for a person who receives ISM depends on two further factors: the household and living arrangement of the SSI recipient. The formula will either be the Presumed Maximum Value or the One-Third Reduction rule. Id. at SI 00835.300. 21 Social Security Administration Actuarial Life Table, 2013, available at https://www.ssa.gov/oact/STATS/table4c6.html.
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affect his benefits. Because the trust meets the requirements of an SBT, the applicant will not receive a transfer penalty for the trust funding. Now consider a Medicaid applicant who owns $100,000.00 in real property and a bank account with $100,000.00. She creates an irrevocable trust for her 31-year-old granddaughter who receives SSI benefits. According to the actuarial tables, a 35-yearold female is 47.19 years of remaining life (age 82.19). The trust provides that the Trustee make minimum annual distributions of $4,370.63 ($200,000.00÷47.19=$4,370.63). The trust is irrevocable and does not result in a transfer penalty for the applicant because the minimum distributions are actuarially sound. Any cash received by the granddaughter will reduce her SSI payment dollar-fordollar. So long as the applicant’s granddaughter continues to receive an SSI check of at least $1.00 per month, she remains eligible for Medicaid. Qualified Settlement Funds Qualified Settlement Funds, often called Section 468B settlement funds, have recently developed as an important dispute resolution tool that possesses incredible tax benefits to both Plaintiffs and Defendants. To those familiar with them, the benefits of a QSF make them seem like a gift directly from the Internal Revenue Service, itself. These generally simple trusts, specifically authorized by Section 468B of the Internal Revenue Code, establish a mechanism wherein the concepts of constructive receipt and economic benefit do not apply. These Funds were created under the tax regulations with a very specific purpose in mind: encouraging the timely and efficient conclusion of litigation. Despite the enormous benefits to all parties in a dispute, Qualified Settlement Funds are still grossly underutilized. There is little guidance as to how and when to form them, how to draft the agreements, and how to serve as administrator or trustee. While the setup of a QSF is fairly simple, there are some considerations and some issues that must be resolved for a Fund to run efficiently and smoothly. Generally speaking, 468B funds act as an intermediary party to a lawsuit. These funds allow defendants and their insurers to make payments to a court-created trust fund. The fund is subject to the court's continued oversight. The payments to the fund made by the defendants are tax-deductible to the defendants at the time payment is made–no matter when the plaintiff actually receives payment from the fund. In addition, the defendants are released from liability at the time they make the payments to the fund. The fund administrator then works to make proper allocations among plaintiffs and claims. The administrator has the flexibility to arrange payments in a number of ways including cash payments, periodic payments, or through a special needs trust.
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These 468B funds get their name from the Internal Revenue Code section under which they are created. In the 1980s, congress passed Section 468B of the Internal Revenue Code, thereby creating Designated Settlement Funds. These funds were limited in the way they could be used. In 1994, however, the Treasury Department added regulations under Section 468B that expanded the use of these funds and created a new type of fund entitled “Qualified Settlement Funds.” The added regulations expanded the range of claims in which the funds can be used, and now these funds are available in personal injury, breach-of-contract, and environmental claims.22 Elements To establish a valid QSF, there are three requirements.23 First, it must be established or approved by governmental authority and must be subject to the continuing jurisdiction of that authority.24 This requirement is met when the government authority issues a preliminary order to establish the fund. An order from the court approving the fund, or even an award granted by an arbitration panel is sufficient to meet this standard so long as the award is judicially enforceable and the fund is subject to the panel's continued jurisdiction. Secondly, the fund must be established to resolve contested or uncontested claims asserting liability for a tort, breach of contract, or violation of law.25 A QSF cannot be used to provide restitution. It is only available in those cases in which the fund can be used to satisfy a requisite claim. Finally, the fund must meet the requirements of a trust under applicable state law. Alternatively, the monies placed in the fund must be kept separate and apart from the assets of the defendant, the defendant's insurance carrier, or other related parties. A Qualified Settlement Fund can be established by any court–there is no requirement that the QSF be created in the same court and by the same judge who has considered the underlying case. A local probate court can create a QSF for funds in a case resolved by a federal court, and vice versa. There is often a fear that an establishing court will be more intrusive than desired, but generally, a court will be as involved as the administrator wants. Unless the trust 22 468B funds are not available for liabilities under the worker's compensation act. Treas. Reg. §1.468B1(g). 23 Id. at §1.468B-1(c). 24 Id. at §1.468B-1(c)(1). 25 Id. at §1.468B-1(c)(2).
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document requires it, QSFs need not seek court approval to make distributions. There are some instances where more court oversight is required or encouraged. If a case involves a minor or incompetent person, the QSF Administrator will likely require court approval to make a disbursement to or on behalf of that person. It is up to the scrivener to be sure that court involvement is fully described in the trust document. The court establishing the fund can, of course, require more oversight, but as a general rule, the establishing court will follow the terms of the QSF agreement as to Court approval of disbursements. When drafting a QSF Agreement, it is necessary to choose a QSF administrator and/or a trustee. The treasury regulations require that the Fund have an administrator and if the Fund is a trust (rather than being merely a segregated account), it will also have a trustee. In most cases, the same person or entity will serve both roles. However, there may be cases where naming different people or entities to serve as trustee and administrator may be preferable.26 When selecting a trustee, it is best for the trustee to be independent of the transferor and beneficiaries, therefore, it is best to avoid appointing a beneficiary, a transferor, or an attorney that represents a beneficiary or transferor as trustee of the QSF. The regulations state that a QSF must have an administrator who shall obtain the employer identification number, file the tax returns, and receive documents from the defendant.27 The fact that the administrator has specific duties does not relieve the trustee of fiduciary responsibilities to the beneficiaries. If the trust document appoints separate trustee and administrator, it should fully describe the duties of both. The QSF Agreement should fully describe all the duties and responsibilities of all parties. It may be necessary to incorporate specific provisions of a settlement agreement into the QSF document when the settlement agreement gives specific duties to the plaintiffs, attorneys, or even the QSF administrator. The document should be clear as to who shall handle the lien resolution and subrogation claims. Often, duties such as allocation amongst plaintiffs and drafting of any additional documents--such as trusts, Medicare set-asides and additional releases--are assigned to the administrator, but the plaintiffs and defendants may have contemplated that some or all of these would be handled by third-parties. If the administrator is an attorney, the QSF agreement 26
If the administrator is not also the trustee, the administrator may be any of the following persons, according to the following priority: 1. The person designated or approved by the governmental authority that approved the QSF; 2. The person designated in the escrow agreement, settlement agreement, or other similar agreement that governs the Fund; 3. The person in control of the Fund’s assets; 4. A single transferor or all of the multiple transferors to a QSF. Treas. Reg. § 1.468B-2(k)(3); see also Ltr. Rul. 200216013 (Jan. 16, 2002). 27Id. at § 1.468B-2(k)(3).
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should specify whether attorney work done by the administrator is considered an administrative duty, or whether the administrator will bill separately for those services. When drafting a QSF agreement, it is better to err on the side of caution and describe in as much detail as possible, who will be assigned duties and responsibilities and how those duties and responsibilities should be carried out. Analysis Although originally created to handle mass tort cases, today, 468B funds are being used in a cases big and small and for a variety of reasons. Establishing a QSF has many advantages to plaintiffs, defendants, and the attorneys involved, but it may not be the right choice in every case. When deciding whether a QSF is appropriate, it is good to evaluate the advantages and disadvantages discussed below. Although the Treasury Regulations state that a QSF can be established to resolve one or more claims,28 there has been much discussion about the use of a single-claimant QSF. Some argue that if there is only one QSF beneficiary, then payment to the QSF will constitute constructive receipt. Although many have requested private letter rulings on the issue, the IRS has declined to address the single-claimant QSF issue. This leads many commentators to believe that if it was constructive receipt, the IRS would be quick to address the issue and resolve the confusion. Many insurance companies who issue qualified structures, however, will refuse to issue structures for single-claimant QSFs, because of the perceived conflict with constructive receipt. If your case has only one claimant and purchasing a structure is a strong desire of the plaintiff, using a QSF could limit the market for purchasing the annuity. In these circumstances, it is best to thoroughly evaluate the situation before moving forward with the QSF. There are some financial costs in establishing a QSF. If the settlement amount is small, it may not warrant establishing a QSF. Depending on the fee structure of the Trustee/Administrator, it may not always be cost effective to establish a QSF. Generally, the costs associated with a QSF include a drafting fee, filing fees and either a monthly administrative fee or an hourly rate for the administrator. The fund is required to file a tax return each year, so there may also be fees associated with tax preparation and general expenses. QSFs can be used for cases other than just mass torts. A QSF can be established for any breach of contract, or Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) claims.29 They can be used to collect settlement
28 29
Id. at §1.468B-1(c)(2). Id. at §1.468B-1(c)(2)(i); I.R.C. §468B(d).
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proceeds from defendants outside the country. The reverse is also true–a QSF can be used to collect proceeds from a defendant for plaintiffs who reside outside the United States. The funds are being used more and more when plaintiffs are on public benefits or there are subrogation claims that must be resolved. Using a QSF has great advantages to a plaintiff and to plaintiff's counsel. The first advantage is breathing space. Many times, settlements occur so quickly that there is not enough time to truly evaluate the advantages and disadvantages of alternative forms of distribution, such as structured settlements. Using a QSF allows for the settlement to move forward while preserving all distribution options for each claimant. This allows each claimant time to decide on the form of distribution that best suits his or her needs. A QSF allows time for plaintiffs to resolve subrogation claims, protect public benefits, and reach allocation agreements. One of the more important advantages of a QSF is that it allows the administrator to make a qualified assignment under I.R.C. §130. This section of the code allows a recipient of payments from a structure to receive the stream of payments tax free if the payment from the settling entity would have been tax free if paid directly from the defendant and certain other requirements are met.30 Such a structure can provide a lifetime of tax-free guaranteed payments to a plaintiff.31 In some instances, using a QSF also allows for easier apportionment of shares. Often times, individuals within a group of claimants cannot agree on how to apportion the proceeds of a settlement amongst themselves. Using a QSF may help solve that problem because the Fund Administrator is able to negotiate with individual claimants or their counsel to resolve these issues. Establishing a QSF also helps eliminate the risk of insolvency by the defendant or its insurer. If the plaintiff is aware that the defendant's financial status is unstable, establishing a QSF allows for quick transfer of funds to protect the plaintiff's interest while the remaining issues are being settled. This can be a great protection for the plaintiff in any case where the defendant's financial situation is unstable. Although QSFs provide many advantages to plaintiffs and plaintiffs' counsel, Qualified Settlement Funds are not without advantages to defendants. Establishing a QSF allows a defendant to disengage from litigation. After a QSF is created, the plaintiffs execute a release of liability and economic performance takes place immediately upon payment 30
A discussion of the intricacies of an I.R.C. §130 qualified assignment is beyond the scope of this article; but in many cases, the purchase of a qualified structure will be one of the main attractions of using a QSF for the plaintiff. See I.R.C. §130. 31 Id.
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Stetson College of Law Lesser-Known Trusts for the SNT Practitioner
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into the fund. Upon payment of the settlement funds into the QSF, the defendant is able to obtain an immediate tax deduction as economic performance has occurred. Defendants can be dismissed from the suit without being bothered by allocation issues or waiting on the Medicare or Medicaid claims to be settled. Although QSFs can be valuable in handling settlements in smaller cases, there are distinct advantages to using them in cases involving a large number of claimants. One of these areas involves the requirements of the Health Insurance Portability and Accountability Act of 1996 (HIPAA).32 The HIPAA controls the release and access of individually identifiable health information known as Protected Health Information (PHI).33 In cases involving large numbers of claimants, the effort to obtain specific HIPAA releases from each settling claimant may be a burdensome task. But these releases are necessary for negotiating subrogation claims in personal injury cases. If a third party vendor is engaged to handle subrogation claims and potential Medicare or Medicaid claims, the vendor may be required to disclose PHI to many different parties in order to secure release or payment requirements to settle these claims. An administrator of a QSF can obtain a qualified protective order (QPO) that complies with the requirements of the law and allows for the limited use of PHI.34 A QPO with respect to protected health information is defined as an order of a court or of an administrative tribunal or a stipulation by the parties to the litigation or administrative proceeding that prohibits the parties from using or disclosing the protected health information for any purpose other than the litigation or proceeding for which such information was requested.35 The regulation further requires the return to the covered entity or destruction of the protected health information (including all copies made) at the end of the litigation or proceeding.36 The order of a court or administrative tribunal, must specifically describe the PHI sought from the covered entity and only that specific protected health information may be disclosed. The administrator of the QSF is wellsuited to obtain such a QPO to allow the third party vendor to obtain the necessary PHI to settle subrogation claims of medical payment providers. Conclusion While these lesser-known trusts may not be able to sustain an entire law practice, they can definitely add value and compliment a thriving special needs trust practice. Understanding their risks and benefits allows an attorney to better meet client needs 32
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) P.L. No. 104-191, 110 Stat. 1938 (1996). 33 45 C.F.R. §160.103. 34 Id. §164.512(e)(v). 35 Id. §164.512(e)(v). 36 Id. §164.512(e)(v).
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Stetson College of Law Lesser-Known Trusts for the SNT Practitioner
Copyright 2016 Law Office of Pi-Yi Mayo
and provide a complete representation for each client. If your special needs trust practice makeup is primarily third-party trusts, knowing how to properly draft a trust that meets the QDT tax provisions will ensure your clients are receiving the greatest tax benefits possible. A QDT might be an alternative when a special needs trust is not the right fit. If your practice is made of primarily long-term care planning, then understanding the sole benefit trust rules will allow you to assist clients with Medicaid qualification while also transferring assets to a trust without incurring a Medicaid penalty. And finally, if your practice is primarily court-created special needs trusts, adding qualified settlement funds to your practice will allow you to further assist the personal injury attorneys with whom you work by establishing a QSF that allows them to resolve any issues surrounding settlement while also preserving public benefits for your ultimate SNT beneficiaries.
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