By Gene L. Osofsky, Esq. * An Earlier draft of this article was first published in the Legal Network News of the California Advocates For Nursing Home Reform, Volume 23 No. 2, Summer 2012. It was designed for Elder Law attorneys practicing in California. ————
Bypass Trusts Pose Special Problems for Medi-Cal Planning
By Gene L. Osofsky, Esq. *
(Numbers in Parentheses Refer to Endnotes)
Bypass Trusts (1), created by married couples as part of their joint revocable trust, pose a special quandary in the context of Medi-Cal planning. These trusts were typically created years ago in a tax climate where the applicable estate tax exemption was much less generous than it is today, and were usually driven by the goal of estate tax savings to a marital estate following the death of both husband and wife. Aside from the tax and administrative problems these older trusts often present during trust administration, they are particularly troublesome when the need for a Medi-Cal subsidy to help with the cost of nursing home care for the survivor later arises.
This article sounds an alert that the creation of an estate plan for low to mid-net worth married couples which requires mandatory funding into a Bypass Sub Trust upon the first death, may actually inhibit the ability of the survivor to qualify for a Medi-Cal subsidy at the time of need. It also suggests that estate planners who have previously drafted such trusts, or who have been asked to review trusts prepared by others, may now wish to revise them to eliminate the sub trust mandate unless there are compelling reasons to retain it. In appropriate cases, the general estate planner may wish to consult an Elder Law attorney with experience in Medi-Cal planning to help with the plan design or plan revision.
WHAT IS MEDI-CAL AND WHY IS IT IMPORTANT?
Estate planners often focus on probate avoidance and the desire to minimize or avoid estate tax in the transmission of assets from one generation to the next. Often overlooked, however, is the need to plan for long-term care expense, especially the cost of care in a nursing facility. Without incorporating this risk into estate planning, the individual or couple of modest to mid-net worth means is at risk of depleting an estate which required a lifetime to accumulate. Indeed, for these persons, the cost of long-term care can be far more financially devastating than the cost of probate and – with the current generous exemption from estate tax, coupled with portability – of far greater importance than planning to avoid the estate tax. This is where Medi-Cal planning enters the picture, as the Medi-Cal Long-Term Care (“LTC”) program is designed to subsidize the cost of nursing home care for those who meet the financial eligibility criteria. While incorporating long term care insurance into an estate plan might be ideal, many individuals or couples cannot afford the LTC premium cost, or cannot medically qualify for coverage. For them, planning their affairs to permit later access to a Medi-Cal LTC subsidy becomes critically important, as the cost of LTC nursing home care is significant. In California, the cost of a nursing home bed typically runs between $7,500 and $10,000 per month, depending upon geographic region and the choice of private or semi-private room. Indeed, for some individuals, the cost of care can approach $25,000 per month, e.g. where the individual needs more intensive nursing care due to insertion of a tracheotomy tube, a condition not all that uncommon for a nursing home resident. For most mid-net worth individuals and couples, this cost is much more than they can afford for more than a few months, and certainly more than they can handle long term without depleting a lifetime of savings. For these individuals, the California Medi-Cal Long Term Care program (known as Medicaid in other states) may afford some relief by providing a subsidy to help with that cost, providing the individual meets the financial eligibility requirements. For these individuals and their dependents, a Medi-Cal LTC subsidy can be a life-saver and planning to accelerate Medi-Cal eligibility then becomes a high priority.(2)
Two Aspects of Medi-Cal planning: “Eligibility” and “Recovery”
This article deals with Medi-Cal planning in two contexts: (1) eligibility and (2) recovery. Eligibility refers to qualifying the individual for a nursing home subsidy under the California Medi-Cal program and depends upon meeting financial eligibility requirements. Recovery refers to the right of the California Department Of Health Care Services (the “Department”) to later recover the value of benefits paid on behalf of the beneficiary, albeit following the death of the beneficiary and his or her surviving spouse and/or other qualified dependent(s). Successful Medi-Cal planning embraces both aspects.
Eligibility: Some Basic Medi-Cal Rules
To qualify for a Medi-Cal Long-Term Care (“LTC”) subsidy, an individual must generally need care in a skilled nursing facility (“nursing home”) (3) and cannot own more than $2,000 in nonexempt resources ( e.g. savings). If the individual has a married spouse at home, the spouse at home can retain an additional amount of otherwise nonexempt resources (i.e. savings), called the Community Spouse Resource Allowance (“CSRA”). (4) In addition, the individual in either situation may retain certain exempt resources, such as a home and limited other assets, without undermining Medi-Cal eligibility.(5) However, if this individual is the surviving spouse of a couple who together previously created a “revocable “living” trust (RLT) which contained a Bypass sub-trust funding mandate on the first death, that funding mandate may impair the survivor’s eligibility for a Medi-Cal subsidy even though the survivor’s access to trust corpus is restricted. In a word, all trust assets funded into the mandatory Bypass Sub Trust may be counted as “available” to the survivor. Assuming that the combined value of the assets in both the Bypass Trust and the Survivor’s Trust were then greater than $2000, he or she would then likely be deemed to be “over-resourced” and ineligible for a Medi-Cal LTC subsidy. The conundrum addressed in this article is the survivor’s potential ineligibility for a Medi-Cal LTC subsidy where a married couple previously created a RLT with a Bypass Sub Trust funding mandate upon the first death. In a word, the Bypass Sub Trust potentially becomes the “poison pill” for the survivor.
ELIGIBILITY ISSUE: THE INITIAL PROBLEM
The first question in establishing eligibility for a Medi-Cal LTC subsidy is whether the individual’s available non-exempt resources are within the Medi-Cal $2,000 resource ceiling. In this regard, resources are essentially divided into two categories: those that are exempt (e.g. the home) and those that are nonexempt (e.g. savings, stocks and bonds, and the like). The nonexempt resources must also be “available” in order to be counted as part of the individual’s resource allowance, and here is the heart of the problem: assets held in a Bypass Trust may, in the Medi-Cal context, be deemed fully available to the surviving spouse and thereby potentially disqualify him or her from a Medi-Cal subsidy. This is so even if the Bypass Trust, itself, provides that the survivor’s access to principal is restricted or even totally precluded. Let’s take the situation where a couple created a joint revocable trust in the late 1990s, which provided that, upon the death of the first spouse, the trust estate would be divided between a Survivor’s Sub-Trust and a Bypass Sub-Trust. The husband became a nursing home resident, qualified for a Medi-Cal Long Term Care subsidy, and received Medi-Cal benefits for several years before his death. Pursuant to the terms of their trust, upon the husband’s demise his share of marital assets was allocated into a Bypass Sub-Trust and the wife’s share into the Survivor’s Sub-Trust. Advance the clock to the present: the wife is now on the threshold of moving into a nursing facility and also needs a Medi-Cal LTC subsidy. Query: Can the wife now qualify for a Medi-Cal LTC subsidy? Remember, under the rules, the surviving spouse, who is now a single individual, cannot have more than $2,000 in savings or other nonexempt resources available to her in order to qualify. The threshold question: What trust assets are now deemed available to the wife under the Medi-Cal rules? Answer: All of the assets in the Bypass Trust would be available to the wife. As a result, she would likely not qualify for a Medi-Cal LTC subsidy, for the following reasons:
The Relevant Law
(1) Resources Deemed Available: Not Established by Will: Under relevant federal law, assets placed into a trust by an individual or spouse are treated as resources available to the individual. . . . unless the trust was “established by will”.6 T hreshold Question: Was the Bypass Trust “established by will”? Answer: No, it was established by the terms of an inter vivos trust instrument. Hence, the assets forming part of the Bypass Trust would now be resources available to the surviving spouse, and would potentially disqualify her from receiving a Medi-Cal subsidy. This result assumes, of course, that the combined value of nonexempt resources in both the Bypass and Survivor’s Trust amounts to more than $2,000, a likely scenario.
(2) Resources Deemed Available: “Under Any Circumstances” Test: But there is an additional reason that the Bypass Trust assets are available to the survivor. Since the typical Bypass Trust permits the survivor to invade corpus, albeit under a “health, education, maintenance and support” (“HEMS”) standard, she has at least theoretical access to the entire trust corpus, the actual amount depending upon the extent of her need for “health, education, maintenance and support”. For this separate reason, the assets in the Bypass Trust would be deemed available to her under the following state regulation: ” In the case of an irrevocable OBRA 93 trust [e.g., an irrevocable ByPass Trust]: (1) if payments can be made from the trust to, or for the benefit of, the individual or spouse at any time or under any circumstances, the portion of the trust income or principal from which payments to the individual or spouse could be made shall be considered property available to that individual or spouse. . ” [Emphasis added] 22 CCR § 50489.5(f).
( 7 ) While the surviving spouse’s access to principal would likely be limited to a HEMS standard under terms of the trust, perhaps with an accompanying “Five or 5″ annual invasion power” (8), nevertheless she could – depending upon her need – theoretically access the entire trust corpus. That theoretical possibility is the rub. Applying the “under any circumstances” test of the regulation, the entire Bypass Trust corpus would then be deemed “available” to her and would likely preclude her eligibility for a Medi-Cal subsidy, as she would then be deemed to have excess nonexempt resources above the $2,000 ceiling for a single individual. Federal rules are in accord. In essence, under the Medi-Cal rules limited access is tantamount to full access. To illustrate the point, in both the federal and state regulations attention is invited to the notorious example of the hypothetical Mr. Baker, who could only access $50,000 placed into an irrevocable trust for his benefit in the event he needed a heart transplant. Notwithstanding that limitation, the entire $50,000 would nevertheless be deemed available to him regardless of whether he needed a heart transplant. (9)
(3) Gifting / Spend Down Precluded By Terms of Bypass Trust: But wait! Elder Law attorneys deal with the problem of excess available resources all the time, often by creating appropriate “spend down” plans, e.g. a plan involving a series of carefully designed gifts of excess resources to trusted family members in a manner which is compliant with the Medi-Cal rules. Question: So why do we have a problem now? Answer: because the Bypass Trust is, by its express terms, irrevocable and the surviving spouse’s actual access to trust corpus is usually limited by an ascertainable standard (i.e. “HEMS”) (10) .
Query: Under the HEMS limitation, can the survivor freely access the nonexempt Bypass Trust assets in order to include them as part of any gifting program? Answer: She probably cannot. They are locked in. (11) Thus, the assets in the Bypass Trust are, on the one hand, deemed fully available to her when applying for Medi-Cal LTC, but, on the other hand, are not fully accessible to her for purposes of implementing an appropriate spend down (12) . In the author’s view, this is the conundrum presented by the typical Bypass Trust when attempting to qualify the survivor for a Medi-Cal LTC subsidy.(13)
RECOVERY ISSUE: ANOTHER PROBLEM
Legal Authority The federal Omnibus Budget Reconciliation Act of 1993 (“OBRA 1993) provides the basic authority for the Medi-Cal estate recovery program. 42 USC § 1396p(a)–(b). The California recovery statute is found at Welfare and Institutions Code Section 14009.5, and the state regulations at 22 CCR § 50961–50966. Under the California recovery scheme, when a married Medi-Cal recipient dies but is survived by his spouse, the Department’s right of recovery does not expire, but is only suspended during the lifetime of the survivor. 14 It would seem that this temporary suspension is a matter of public policy, apparently designed to avoid depriving the surviving spouse of a home or other means of support during his/her own lifetime, thereby preventing the survivor from becoming a public charge. However, upon the death of the survivor the claim is revived, but here is where the state statute and the state regulation part company:
The State Statute: Only Against Survivor’s Estate W&I Code § 14009.5 limits the state’s claim to the estate of the surviving spouse and then only to the extent that the surviving spouse has received the decedent’s property by “distribution or survival.” It provides as follows: “. . . However, upon the death of the surviving spouse, the department shall make a claim against the estate of the surviving spouse, or against any recipient of property from the surviving spouse obtained by distribution or survival, for either the amount paid for the medical assistance given to the decedent or the value of any of the decedent’s property received by the surviving spouse through distribution or survival, whichever is less…” W&I § 14009.5(b)(2)(A). [Emphasis added]
The State Regulation: Against “Any Recipient” of the Decedent’s Property However, the recovery regulation broadens the recovery statute by permitting the Department to claim “against any recipient of the decedent’s property by distribution or survival”. 22 CCR § 50961(a). It provides as follows: “(a) the Department shall claim against the estate of the decedent, or against any recipient of the decedent’s property by distribution or survival, an amount equal to the lesser of: (1) all payments made by the Medi-Cal program on behalf of the decedent. . . . ; or (2) the decedent’s equity interest in the property at the time of death (to the extent of such interest).” [Emphasis added] The regulation therefore seemingly allows the Department to claim against a third-party recipient of the decedent’s property (e.g., the couple’s children) after the death of the surviving spouse, even in the case where the property has not passed through the estate of the survivor.(15) By comparison, the statute requires that the property pass through the estate of the surviving spouse before the Department can initiate recovery.
The Statute Versus the Regulation
Assume, once again, that the predeceased husband was a Medi-Cal recipient. The difference between the scope of recovery permitted by the statute, as compared with the larger scope ostensibly permitted by the regulation, has implications with regard to recovery from the assets remaining in the Bypass Trust upon the death of the survivor. Typically, assets remaining in the Bypass Trust upon the death of the surviving spouse would go directly to the couple’s children or other designated non-spouse beneficiaries; nothing would go to the survivor nor flow through the survivor’s estate. Indeed, that is the essence of the “bypass” feature. So, here is what we have:
A) Under the more limiting statute, recovery against the remaining Bypass Trust assets for the husband’s Medi-Cal benefits would seemingly not be permitted because – upon the death of the survivor – remaining Bypass Trust assets would typically go directly to the couple’s children or other designated non-spouse beneficiaries; nothing would flow through the survivor’s estate;
B) By contrast, under the regulation, the remaining Bypass Trust assets would seemingly be exposed to recovery for the husband’s Medi-Cal benefits, as the children would qualify as “any recipient” and they would succeed to the remaining Bypass Trust assets by “distribution or survival.”
In short, whether assets remaining in a Bypass Trust are subject to recovery after the death of the surviving spouse for benefits received by the predeceased spouse, depends upon whether the state statute governs, on the one hand, or the regulation governs, on the other. Advocates would certainly argue the former in every case and would contend that the broader regulation impermissibly exceeds the scope of the state statute.(16) In this author’s experience, the good news is that the Department has thus far abided by the more limited right of recovery prescribed by the statute, at least when cited by advocates. Indeed, this author is unaware of any actual situations where the Department has actually pursued recovery, for Medi-Cal benefits paid on behalf of a predeceased spouse, against assets remaining in a Bypass Trust after the death of the survivor.
Query: What if, instead, it was the surviving spouse who was the Medi-Cal recipient? Answer: It would seem that assets in the Bypass Trust would not be subject to recovery after her death, under either the statute or the regulation, as the survivor would technically not own “legal title” to the assets in the Bypass Trust (22 CCR 50404(a)), nor would they form part of the survivor’s “estate”. 22 CCR 50960.12(a).
The Five or 5 Power Even under the more limiting statute, there is some uncertainty as to whether recovery for a survivor’s Medi-Cal benefits might be permissible as to that portion of a Bypass Trust subject to a “Five or 5 Power”.(17) Query: if the survivor has been given — but fails to exercise — this “Five or 5 power”, what are the implications for recovery against the estate of the surviving spouse for benefits she, herself, received? The answer is unclear. Arguably, even under the more limiting statute, the answer might depend – as it does for estate tax purposes – upon whether the survivor died during that portion of the year when the power was exercisable. But, caveat: this author is unaware of any legal authority which would allow the Recovery Unit of the Department of Health Care Services to analogize to estate tax rules to support its claim for estate recovery in the Medi-Cal context.
Because of the problems discussed above, in terms of Medi-Cal planning it would seem that the goal would be to eliminate the Bypass Trust, whether funded or unfunded. How do we accomplish this?
Should We Just Ignore the Bypass Trust Requirement?
A common scenario is where the surviving spouse presents the practitioner with a joint revocable trust wherein the Bypass Trust funding mandate has been ignored. This discovery might come to the practitioner’s attention in the context of the survivor wishing to modify the dispositive plan or perhaps needing to assist the survivor to engage in Medi-Cal planning. Aside from emitting a silent groan, what does the practitioner do? Does he advise the client to ignore the funding mandate? While some attorneys feel comfortable ignoring the bypass trust funding mandate where all living beneficiaries consent, this approach appears perilous and exposes the practitioner and the successor trustee to claims from disgruntled downstream beneficiaries, especially minor, unborn or unascertained beneficiaries. There may also be breach of fiduciary duties and ethical issues in ignoring the funding mandate. Simply ignoring the Bypass Trust may also expose the practitioner and the successor trustee to claims from the IRS that the funding mandate was inappropriately ignored. Indeed, it might be helpful to think of the IRS as a “silent partner” to these decisions, as the choice to ignore a funding mandate does have tax implications (18). For example: (a) assets channeled into a Bypass Trust typically would not enjoy a second date of death adjustment in basis upon the death of the survivor, which would otherwise expose them to a greater capital gains tax upon a later sale (19) and thus more tax revenue to the IRS downstream; and (b) the delayed allocation of appreciating assets to a Bypass Trust to satisfy a pecuniary formula would usually trigger taxable capital gain (20) . Thus, a decision to ignore the Bypass Trust funding mandate would arguably “short” the IRS of potential tax revenue. In view of these concerns, it is suggested that the decision to ignore a funding mandate and rely upon beneficiary consents should be used sparingly, if at all. Indeed, there appears to be no clear legal authority to simply ignore the Bypass Trust funding mandate.
Terminate: Uneconomical To Administer:
Under Probate Code Section 15408, a trust may be terminated where the value of the principal renders the trust uneconomical to administer. Per Section 15408, if the value of the trust is below $40,000, the trustee may terminate the trust without court order. Otherwise, the trust may be terminated upon petition to the court made by a trustee or beneficiary (21). Many trusts also authorize termination in the situation, often without the requirement of a specific value of trust corpus, leaving the decision to the discretion of the trustee. Presumably, a trustee given discretion to terminate in the trust instrument, itself, could do so without court order even where the trust corpus is greater than $40,000. If terminated without court order, it is recommended that the trustee secure the consent of the remainder beneficiaries and, perhaps, the contingent remainder beneficiaries. Upon termination, the trust property would be distributed in the manner described in the trust instrument or to the living beneficiaries on an actuarial basis. (22). For Medi-Cal planning purposes, such a distribution would presumably permit access to the Bypass Trust assets sufficient to initiate an appropriate “spend down” to qualify the survivor for a Medi-Cal LTC subsidy. This approach to terminating the bypass trust would seem to work both as to funded and unfunded Bypass Trusts.
Terminate: Petition Under Probate Code § 15409: Changed Circumstances
A Bypass Trust may also be terminated upon petition to the court based upon changed circumstances “not known to the settlor and not anticipated by the settlor”. Probate Code §15409. Circumstances which support termination under this section might include some or all of the following: (a) a change in the tax law would render the sub-trust division unnecessary in order to achieve the desired estate tax savings, (b) the need for a Medi-Cal subsidy for the survivor, and/or ( c) the survivor’s need for unfettered access to the marital residence in order to arrange a reverse mortgage or other loan. It would seem that a judge would be more receptive to a petition under Probate Code §15409 if brought shortly after the death of the first spouse and prior to the funding of the Bypass Trust. Before initiating such a petition, however, the careful consideration should be given to whether doing so might trigger the “no contest” provisions in the trust instrument.(23) One note of caution: With respect to all trust modifications, even though made in compliance with state law, the IRS is not necessarily obliged to honor them.24
Disclaim and Fold
Another approach, as yet untested to this author’s knowledge (25), might involve a “disclaim and fold” approach. Here’s how it might work, at least theoretically: a surviving spouse might disclaim (26) her entire interest in the Bypass Trust. The Bypass Trust would then have no res and therefore no further reason to exist.(27) The trustee could, upon the first death, theoretically then distribute the trust corpus directly to the remainder beneficiaries (e.g. the children) and thereby effectively eliminate the Bypass Trust. Caveat: a disclaimer in the tax world is treated differently from a disclaimer in the Medi-Cal world. In the former, a qualified disclaimer effectively removes the disclaimed assets from the taxable estate of the disclaiming beneficiary. However, in the Medi-Cal context, a disclaimer is considered a prohibited transfer, which would potentially disqualify the disclaiming individual from a Medi-Cal subsidy. For the practitioner wishing to test this approach, but also wishing to avoid a period of ineligibility for a Medi-Cal subsidy (28) which might otherwise be triggered by a large, lump sum disclaimer, perhaps he or she could counsel the survivor to make a series of smaller fractional interest disclaimers, each in an amount designed to generate little or no period of Medi-Cal disqualification. (29) To be safe, this author strongly recommends that the general estate planning attorney considering a disclaimer associate an Elder Law attorney familiar with Medi-Cal planning before attempting to implement this strategy, as the Medi-Cal rules associated with divestment strategies are tricky. Also, before attempting this approach with respect to real property trust assets, the careful practitioner might first consider running it by his/her favorite title company, so that there are no unresolved title issues down the road. Although as yet apparently untested, this strategy would seemingly apply to both the funded as well as the unfunded Bypass Trust.
Other Modification Options?
The practitioner should examine other provisions of the Probate Code which permit modifications to determine whether any other approaches might apply. 30 Of interest is the authority under Probate Code § 15411 for a court to combine two or more trusts which are “substantially similar”.
The threshold concern in these cases is eligibility: the assets allocable to the Bypass Trust are deemed available to the survivor, but are not fully accessible to the survivor for purposes of initiating an appropriate “spend down” to qualify for Medi-Cal. Perhaps planners should consider eliminating the Bypass Trust in favor of other estate planning devices, e.g. an optional Disclaimer Trust. A revocable trust with an optional Disclaimer Trust would permit postmortem planning after the death of the first spouse, when the long-term care needs of the survivor would likely be more apparent. For example, if the survivor then had a present or foreseeable need for a Medi-Cal LTC subsidy, the survivor could forgo the optional disclaimer and permit the entire trust estate to go into the Survivor’s Trust, so that all of the trust assets would then be fully accessible for an appropriate “spend down” plan designed to qualify the survivor for Medi-Cal. In terms of the Department’s right of recovery, this would depend upon which spouse was the Medi-Cal spouse and whether the state statute, on the one hand, or the state regulation, on the other hand, governed its claim: a) If the first spouse to die were the Medi-Cal beneficiary, there would be no recovery under the statute against assets remaining in the Bypass Trust upon the death of the survivor, but those assets would be exposed to recovery under the regulation; b) If only the survivor were the Medi-Cal beneficiary, presumably only the assets in the Survivor’s Trust would be subject to recovery under either the statute or the regulation, and there would be no recovery against the assets remaining in the Bypass Trust upon the survivor’s death. With regard to at least the matter of recovery, perhaps the Department will one day bring its regulation into line with the enabling state statute and thereby eliminate the confusion. One can only hope. (31)
1 Bypass Trusts are irrevocable sub-trusts created upon the death of the first spouse and typically designed to hold the decedent’s property — up to the amount of the applicable estate tax exemption — until the death of the surviving spouse, whereupon the remainder is distributed out to the designated beneficiaries, usually the children. During the lifetime of the survivor, all income is typically distributed to the survivor and the survivor has limited access to principal. It is so named because it “bypasses” the estate of the survivor. It is sometimes known as the “B” trust, the “Credit-Shelter Trust” and/or the “Exemption Trust”.
2 In this author’s view, Medi-Cal planning is akin to tax planning for the wealthy: each impacts the public treasury. Indeed, it is suggested that tax planning has a far greater impact upon the treasury than public benefits planning. So long as both types of planning are practiced ethically and within the law, it would seem that we, as attorneys, have the same duty in each discipline to advocate effectively for our clients. For more, see the author’s monograph entitled “Asset Preservation and Medi-Cal Planning” at www.LawyerForSeniors.com.
3 This article addresses only the Medi-Cal Long Term Care program, which is generally only available only to those persons receiving care in skilled nursing facilities (“nursing homes”) and for those relatively few individuals who have (1) qualified for equivalent home care under a Medi-Cal In-Home Care Waiver, which is usually difficult to secure and is limited to only a few hundred individuals in the entire state; (2) live in a geographic region where an Assisted Living Waiver is available, which again is very limited, or (3) qualify for semi-institutional day care while residing at home under an available Program For All Inclusive Care of the Elderly (“PACE”). Except as noted, the Medi-Cal LTC Program does not generally cover persons residing at home, in Residential Care Facilities for the Elderly, or in Assisted Living facilities. In short, nursing home residence is generally a prerequisite to qualifying for the Medi-Cal LTC program, and is then only available to persons who meet the financial eligibility criteria.
4 A married individual, however, is treated differently. Back in 1988, Congress adopted the Medicare Catastrophic Coverage Act, designed in part to avoid impoverishing the “at home” spouse when the other spouse needed nursing home care. Congress did so by carving out an exemption, applicable to married couples only, which provided that the spouse at home could retain a certain amount of otherwise nonexempt resources (i.e. savings), even while the ill spouse was obliged to seek a Medi-Cal subsidy to help with the cost of nursing home care. This carve-out or “nest egg” was named the Community Spouse Resource Allowance (“CSRA”). The amount of this CSRA is indexed to inflation and changes every year. There is also some variation among the states in the amount and application of this exemption. In the year 2013, the amount of the CSRA in California has been set at $115,970. Thus, for a California couple where one spouse is in need of nursing home care, the spouse at home can retain $115,970 in savings or other nonexempt resources, and the nursing-home spouse can retain up to $2,000 in his/her own name, for a combined total of $117,970 between them, while still qualifying the ill spouse for a Medi-Cal LTC subsidy. In addition, the individual or couple can retain exempt assets, such as a home, furnishings, one automobile, and other assets.
5 Other exempt assets would include the following: IRA’s and other retirement assets if in the name of the “well spouse”; IRA’s in the name of the ill spouse if making distributions under IRS Required Minimum Distribution rules or making payments of at least some principal and interest; certain immediate annuities if compliant with Medi-Cal rules; burial plot and irrevocable burial fund; up to $1500 earmarked for additional burial expenses, and other assets 6 42 USC 1396p(d)(2)(A) and 1396p(d)(3)(A)(I); 22 CCR 50489.5(a)(1), i.e., an OBRA 93 trust. Note: this author has never been able to discern why Congress decided to treat wills differently from inter vivos trusts. One hypothesis, only, which he sometimes suggests to clients is the following: perhaps Congress associated wills with death, while trusts were perceived as clever devices created during lifetime to obtain tax and other advantages, and perhaps Congress felt that persons would not try to avoid recovery by dying.
7 Health Care Financing Administration (“HCFA”) Transmittal No. 64, §3259.6(B) and example at subsection (E); Medi-Cal Eligibility Procedures Manual, Treatment of Trusts, Manual Letter 159, Page 9J-53; Manual Letter 179 at Page 9J-57 [example];
8 Bypass Trusts are often drafted to give the surviving spouse the power to withdraw from the trust corpus, usually once during any calendar year, an amount not greater than either $5,000 or 5% of the aggregate value of the trust property. IRC section 2041(b)(2), 2514(e). This power of invasion is considered a safe harbor which allows the surviving spouse some access to assets without jeopardy to the estate tax benefit of a Bypass Trust (i.e. without undermining the ascertainable standard limitations of HEMS and without creating a general power of appointment in the surviving spouse). These powers of invasion are typically exercisable only during a very limited number of days each year, so as to minimize the risk that the survivor would die at a time when the power is exercisable and thereby Endnotes result in the inclusion of that portion of the Bypass Trust in her taxable estate. See, CEB, Drafting California Revocable Trusts, § 7.90.
9 Healthcare Administration Financing (“HCFA”) Transmittal No. 64 (aka “HCFA 64”), §3259.6(B) and example at subsection (E); Accord: Medi-Cal Eligibility Procedures Manual, Treatment of Trusts, Manual Letter 159, Page 9J-53; Manual Letter 179 at Page 9J-57 [example]
10 Sometimes there is an exhaustion clause, requiring that the assets in the Survivor’s Trust be first exhausted before the survivor can access the principal in the Bypass Trust, even for HEMS.
11 Some advocates take the view that the Bypass Trust assets may be fully accessed by distribution to the survivor through the HEMS “window”. Others take the more conservative view that any attempt to do so raises fiduciary, tax and even ethical issues.
12. Of course, to the extent that exempt assets were allocated to the Bypass Trust, they would continue to be exempt and therefore not present an eligibility problem for the surviving spouse. 22 CCR 50489.5. However, for tax reasons, it is unusual for the home – typically the largest exempt asset for any couple – to be allocated to the Bypass Trust, as doing so would (1) cause the survivor to lose the full benefit of the IRC §121 exclusion of capital gain in the event of sale and (2) (typically) result in the home losing a second date of death adjustment in basis upon the death of the survivor [IRC §1014]. CEB, Drafting California Revocable Trusts, §14.23. Note, however, although not typically done, it is possible to create a “QTIPable” Bypass Trust which can result in a second adjustment upon the survivor’s death. CEB, supra, §14.24 – 14.27B. Further, in regard to recovery, even exempt assets such as the home may be exposed after the death of the surviving spouse and qualified dependents.
13 Notwithstanding the comments above, if the Medi-Cal folks in any particular case take a more kindly view and opt not to treat Bypass Trust assets as being “available” to the surviving spouse, so much the better. However, the possibility that they will do so in any particular case is not something upon which we should rely. On this point, if the trustee of the Bypass Trust were someone other than the surviving spouse, e.g. a child or independent fiduciary, this author wonders if the Medi-Cal folks would overlook the “availability” issue on the ground that the surviving spouse is not the owner of the Bypass Trust assets? See 22 CCR § 50404(a), defining ownership of property as based upon legal title.
14 Recovery during the lifetime of a surviving spouse is expressly barred by federal law (42 USC 1306p(b)(2), and by state law (Welf. & Institutions Code § 14009.5(b)(2)(A); 22 Cal. Code Regs § 50961(d)(2)).
15 See, CEB, California Elder Law, Resources, Benefits and Planning, at §12.37 (Wilcox), [hereinafter shortened to “CEB, Elder Law“.]
16 The federal statute does not resolve the question, as it permits California to define “estate” broadly, 42 USC 1396p (b)(3)(4)(B), and California has done so by regulation. 22 CCR 50960.12(a).
17 Bypass Trusts are often drafted to give the surviving spouse the power to withdraw from the trust corpus, usually once during any calendar year, an amount not greater than either $5,000 or 5% of the aggregate value of the trust property. IRC §s 2041(b)(2), 2514(e). This power of invasion is considered a safe harbor which allows the surviving spouse some access to assets without jeopardizing the estate tax benefit of a Bypass Trust (i.e., without undermining the ascertainable standard limitations of HEMS and without creating a general power of appointment in the surviving spouse). These powers of invasion are typically exercisable only during a very limited number of days each year, so as to minimize the risk that the survivor would die at a time when the power is exercisable and thereby result in the inclusion of that portion of the Bypass Trust in her taxable estate. See, CEB, Drafting California Revocable Trusts, § 7.90.
18 Delayed funding of trusts raises significant questions with regard to capital gain and implications from the failure to file fiduciary income tax returns, taxes, interest and penalties, discussion of which is beyond the scope of this article. See, Lamping, “Revitalizing a Stale Trust: Improvement, If Not Perfection”, in California Trusts and Estates Quarterly, Winter 2010; CEB, California Trust Administration, 14A.17, “Funding Stale Trusts” (Gaw & Lamping); Hartog, John, “Stale Trusts: How Can We Freshen Them Up”, unpublished article available on his website, www.HartogBaer.com under the “Trusts & Estates” tab.
19 CEB, Drafting California Revocable Trusts, §14.23.
20 Sometimes called “Kenan gain”. Kenan v. Commissioner 114 F.2d 217 (2d Cir. 1940).
21 Probate Code § 15409, discussed infra.
22 Probate Code § 15410.
23 See, CEB, California Trust Administration, §16.3A, “Will Modification Trigger No-Contest Clause” (Stern, Tippett). This concern would appear to apply primarily to trusts which became irrevocable prior to 2001.
24 CEB, California Trust Administration, §16.3B
25 This approach was essentially suggested by attorney Michael Young of Walnut Creek in a post on an elder law attorney’s ListServ.
26 To be effective, the disclaimers must be made “within a reasonable time” (Probate Code § 279), but to be qualified disclaimers for estate tax purposes under IRC § 2518, they would all need to be executed within 9 months of the death of the first spouse. Of interest is that mere continued occupancy of the home by the survivor having an interest in the home may not, itself, preclude the making of a qualified disclaimer for estate tax purposes. Treas. Reg.§ 25.2518-2(d)(I); PLR 9733008 [surviving spouse with joint tenancy interest in home permitted to make qualified disclaimer, notwithstanding continued residence after the death of her spouse].
27. See Probate Code § 15202.
28 Even if an interest in a home is the primary asset in the Bypass Trust, the interest the surviving spouse would disclaim would arguably be the disclaimer of an “income and principal interest in an irrevocable trust. So, there is some uncertainty as to whether the disclaimer would be deemed that of an exempt resource (home) or that of a non-exempt resource. The prudent practitioner might best take the conservative view, treat it as the latter for planning, and do fractional interest disclaimers as per the next Note.
29 To the extent that the value of each disclaimer is less than the Average Private Pay Rate (“APPR”), currently $7,549 in year 2013, the resulting period of ineligibility associated with each disclaimer would be “0”. The APPR is the average monthly cost of a nursing home in California and this number is used by Medi-Cal as the divisor to determine the number of months the dollar value of a gift transfer could have been used to purchase nursing home care on a private-pay basis, which number then becomes the number of months of Medi-Cal disqualification or “penalty” associated with each prohibited gift. Currently, Medi-Cal rounds down, so a gift in an amount less than the APPR results in “0” months of ineligibility for each such gift transfer, and the calculated penalties on a series of separate gifts made on different days are not aggregated. Variations on that strategy, involving the “bunching” of such disclaimers, would likewise be currently available. CEB, Elder Law, supra, § 11.60 (Wilcox). However, such strategies will only work until the state fully implements the federal Deficit Reduction Act of 2005 [Pub L 109-171, 120 Stat 4], a federal law designed to limit the use of many traditional Medi-Cal planning techniques, such as gift transfers to accelerate eligibility.
30 However, Probate Code §15403 cannot be used where the trust contains a spendthrift clause, which most do, and Probate Code §15404 would seem to require the consent of the now predeceased settlor.
31 The author wishes to thank attorneys F. Michael Hanson of Pleasant Hill for reviewing an early draft of this article and for his helpful comments.