As of January 1, 2019, California is now the 29th state to adopt a Trust Decanting statute, now codified in Probate Code §’s 19501 et. seq. and referred to as the Uniform Decanting Act (SB 909). The Act generally prescribes the scope of the decanting, based in large part upon the degree of discretion given the fiduciary to make distributions. In this regard, the Act distinguishes “limited”, versus “expanded”, distributive discretion, wherein the ability to reform a trust by decanting is greater with expanded discretion, with the following notable exception: in the case of decanting to create a Special Needs Trusts (“SNT”), the fiduciary is deemed to have expanded discretion regardless of the standard set out in the trust instrument.[i]
Upon first read, we might be tempted to view the Act as a panacea to now enable us to fix problem trusts without the traditional court proceeding, especially in the context of Special Needs Trusts (“SNT”), as well as the perennial problem of unwinding outdated “A-B” Credit Shelter Trusts. On reflection, I am not sure that it is. In my view, there are some real problems lurking in the Act with regard to these specific applications, including the following:
1) Reforming Trusts Into Special Needs Trusts: the “Vesting” Issue:
Consider the following example:
A Trust becomes irrevocable because of the death of the Trustor. It requires the trustee to distribute trust principal to C when C attains age 30. Assume C has attained age 31, but the trustee has not yet distributed trust principal to C. C is now a person with a disability and receives, or may receive, means-tested public benefits. The Trustee now desires to decant C’s bequest into a SNT for C, so that it does not undermine his continued receipt of public benefits.
Question: Must the Decanted Trust with SNT provisions contain a “pay-back” provision? Or, put another way, must it now comply with First Party SNT rules, or may it be structured as a Third Party SNT without payback requirements?
Analysis: It seems evident that C’s right to his bequest has already vested, so arguably the funds representing his bequest would now be his own property and he would have legal control of them. On this point, SSI may be stricter than Medi-Cal.
For SSI purposes, if he has the legal right to access the funds, then they are a resource under the POMS.[ii] As such, in order to preserve the beneficiary’s SSI, wouldn’t it now be necessary for the SNT for C to be structured as a First Party SNT with pay-back provisions, as per 42 USC 1396p(d)(4)(A).? If not so structured, would not C’s bequest then be a countable resource and potentially restrict him from public benefits, or at least from SSI?
The Uniform Act is silent on this point. However, this issue was litigated in New York, one of the early states to have a Decanting Statute, albeit not in the form of the Uniform Act adopted in California. Kroll v. New York State Dep’t of Health (39 NYS3d 183, aff’d (Oct. 5, 2016) NY Slip Op 06499).[iii] In Kroll, the older trust was decanted into an SNT for the beneficiary with a disability who was receiving public benefits, including Medicaid. The state objected, contending that the funds were an available resource to the beneficiary, as the decanted SNT did not contain a pay-back clause. On appeal, the court found that the decanting had occurred just days before [iv] the vesting age per terms of the trust, that by reason thereof the funds were not then the property of the beneficiary, and that there was therefore no requirement of a pay-back clause in order to render the SNT protective of his funds and maintain his eligibility for benefits. [v]
Whether this New York case will govern similar proceedings in California is presently unknown. That said, the careful practitioner who desires to decant to a SNT without “payback” provisions would be wise to do so well prior to the time the beneficiary’s interest is deemed to vest. Timing may be critical.
In practice, most efforts to decant to an SNT to preserve public benefits will likely occur only after the death of the trustor. As to these trusts, if the target beneficiary has by then already reached the age for distribution, then the issue litigated in Kroll will continue to present until an appellate court renders a precedential decision, the state issues a definitive regulation or ACWDL, and/or SSA issues a controlling POMS.
In the meantime, California practitioners might argue the point made in Kleinert v Commissioner of Social Security [vi] that, where trust administration is still underway and distributions have not yet been made, vesting has not yet occurred. The Kleinert court also noted the difference in vesting as between a probate case (vesting upon death) and a trust administration (where vesting would be controlled by the express terms of the trust). Although the Federal Court Magistrate’s decision in Kleinert may not carry statewide precedential value, and while it was not a decanting case, per se, its analysis suggests a helpful argument to contend, where the facts warrant, that vesting has not yet occurred.[vii]
Practice Points: A few recommendations:
1) Per the above discussion, if possible, decant prior to the time the interest of the beneficiary is deemed to vest under terms of the trust;
2) Procedurally, handle the decanting pursuant to the Notice provisions of the Act, rather than via the Consent provisions. Doing so might render it less likely that the creation of the SNT will be construed as the volitional act of the target beneficiary (as opposed to that of the original Trustor), and hence a “self-settled” SNT requiring First Party compliance, including the often dreaded “payback” provision.
3) If the amount to be funded into the SNT is relatively modest and/or is likely to be fully expended during the lifetime of the SNT beneficiary, consider biting the bullet: include a payback provision and otherwise structure the SNT as a First Party trust, so as to avoid the issue altogether. Why spend funds litigating the issue (or risking loss of public benefits) where the benefit may well prove illusory?
4) Include a Trust Protector, where the latter is given the specific power to add a payback provision, albeit prospectively [viii].
2) The SNT Problem for Over-Age 65 Beneficiaries:
If the Decanted SNT is characterized by Medi-Cal or SSI as a “First Party Self-Settled SNT”, that could pose a big problem for a beneficiary aged 65 years or older. Reason: a beneficiary over age 65 cannot self-settle a SNT under any circumstance. See, 42 USC 1396p(d)(4)(A). The only option for this beneficiary is to join and fund a Pooled Special Needs Trust, as authorized by 42 USC 1396p(d)(4) (C).
However, even this option has been clouded by a number of decisions in other states [ix], holding that the funding of a Pooled SNT may be a transfer for less than adequate consideration, warranting a Medicaid transfer penalty. The most recent that I have found is the Cox decision out of Iowa. Cox vs. Iowa Dept of Human Services, decided 11/30/2018. [x]
Fortunately –the Cox and other decisions notwithstanding — the rule in California has long been that a person of any age may join and make an initial funding [xi] into a Pooled SNT without jeopardy to his Medi-Cal eligibility. [xii] Indeed, the California Dept. Of Health Care Services acknowledges as much on its own website. See Special Needs Trust Notice, wherein it recites that a person of “any age” may join a Pooled SNT. [xiii] Hopefully, the ‘California rule’ will not change.
However, there still remains concern as to eligibility for SSI for the over-age 65 SNT beneficiary, even if made to a Pooled SNT. The concern is that SSI (unlike Medi-Cal) may impose a transfer penalty of up to 3 years when the aged individual funds a Pooled-SNT. 42 USC § 1382b(c)(1)(A)(ii)(I). [xiv]
(3) Unwinding A-B Credit Shelter Trusts By Decanting; Limited Utility?
Many practitioners were hoping that the Uniform Decanting Act would present a mechanism to unwind unwanted A-B Credit Shelter Trusts without the expense and uncertainty of a formal court proceeding under the usual probate code provisions, including Section 15409. However, I believe that in most cases, use of the Act to decant in this circumstance will not work.
New Probate Code Section 19519(b)(8) [which defines “tax benefit”] is the key section for this application, and actually limits use of the Act to decant in this context. However, that limitation is not immediately apparent from a casual reading of that section, but must be gleaned from a reading of the Official Comments to the Uniform Trust Decanting Act prepared by the National Conference of Commissioners on Uniform State Laws. [xv]
From the Official Comments, I have teased out what I believe to be four conditions precedent to the use of the Act to decant in this context, as follows: (1) the trustee must seemingly be an independent person (i.e., it cannot be the surviving spouse); (2) the independent trustee must have ‘expanded distributive discretion’ (i.e., the trustee’s discretion cannot be limited to only principal distributions for the survivor’s Health, Education, Maintenance and Support [“H.E.M.S”]); (3) the surviving spouse must still be alive; and (4) the proposed decanting must save more in taxes than contemplated by the original Credit Shelter Trust (“CST”). Of these four conditions, numbers (1) and (2) will likely be the key obstacles which will prevent use of the Act to eliminate the CST in many cases.
However, if the original trust provides that the successor trustee of a CST is an independent trustee with expanded distributive discretion, presumably a surviving spouse—who would likely be the initial trustee under a more limited standard – could resign in favor of that independent trustee, and thereby satisfy conditions (1) and (2), above. But, absent this circumstance, most CSTs (at least that I have seen) appoint the surviving spouse as the trustee, usually with limited distributive discretion over principal (i.e. H.E.M.S). Under this circumstance, decanting would apparently not be available. Instead, the remedy would be the traditional approach of seeking reformation by Petition and Court Order under Probate Code § 15409. California courts routinely grant those requests, and the relief is retroactive.
As we begin to use the Act, my hope is that more opportunities, than limitations, will present as we and our courts become familiar with its provisions. In the SNT context, we might also hope for a court decision with statewide precedential value, a clarifying Regulation or ACWDL from the State regarding Medi-Cal, and/or a POMS from SSA regarding SSI, all to affirm the ability of the trustee to decant retroactively, so that the trust bequest in issue is not deemed a resource to the beneficiary with a disability.
* Gene L. Osofsky is a sole practitioner in Hayward, CA. This article appeared in the Legal Network News published on 04/09/2019 by California Advocates for Nursing Home Reform, Spring 2019, Vol 30, No.1.
[i] Probate Code § 19513(b).
[ii] POMS SI 01120.010(B)(2).
[v] The 2nd Circuit has affirmed continuation of Medicaid benefits in a decanting case arising in Connecticut. Simonsen v. Bremby (02/15/2017). The critical fact: the trust had a spendthrift clause, which prevented the SNT beneficiary from accessing the funds at will. The court held that she was “legally restricted from using the trust funds except as disbursed to her in the discretion of the trustee”.
[vii] Under Probate Code § 16061.7, for the 120 days period after notification is served, the trust can be contested. Therefore, the trustee would not normally distribute funds until that notice period has run, and—likewise—the beneficiar(ies) could not insist upon distribution until then. Where the trustee is obliged to prepare an accounting, trust distributions would be further delayed. Probate Code §16062 [duty to account] and §16461 (180 days to Object). During at least these periods, the practitioner might well argue that the funds are not ‘available’ within the meaning of POMS SI 01120.010 (B)(2) [for SSI], and 22 CCR 50402 [for Medi-Cal].
[viii] California courts have held that a court may not modify a prior judgment retroactively to create a SNT to avoid the lien of DDS. Rather, such a nun pro tunc order is limited to an order that merely corrects clerical error so that the judgment conforms to the original court order. See, Hamilton v. Laine, (1st DCA, 1997). 57 Cal. App. 4th 885, 67 Cal. Rptr. 2d 407.
[ix] State decisions holding that funding a Pooled SNT by a person 65 years of age or older may be an uncompensated transfer of assets and will therefore trigger a transfer penalty, include the following: Richardson v. Hamilton (US District Ct in Maine, 02/27/2018) [https://tinyurl.com/yxzchk2c]; Lewis v. Alexander (3rd Cir., 06/20/2012) [https://tinyurl.com/yxzchk2c]; Center for Special Needs Trust Administration, Inc. v. Olson (North Dakota, 04/25/2011) [https://tinyurl.com/yy2ewd5e].
[xi] But the over age 65 individual may not, after the initial funding, later add to or augment his/her initial funding into the Pooled SNT. 22 CCR 50489.9(c).
[xii] 22 Cal Code Regs §50489.9
[xiv] See CEB, Special Needs Trusts, Planning, Drafting and Administration, at §12.10.