New Case Impacts First-Party Special Needs Trusts

By Christopher W. Smith posted 03-09-2015 07:59

  

This week, ICLE will be releasing an on-demand seminar entitled “How and Why to Use Special Needs Trusts” that Art Malisow and I recorded a few weeks ago.  Since that recording, the Eighth Circuit Court of Appeals issued a decision that impacts special needs planners establishing so-called d4A Trusts (also called first-party standalone trusts) in Draper v. Colvin, No. 12-2757 (March 3, 2015)

 

As we discuss in the seminar, if an individual with the disability is establishing a trust and funding it with his or her own money, the trust must comply with the specific provisions of either 42 USC 1396p(d)(4)(A) (d4A standalone trusts) or 42 USC 1396p(d)(4)(C) (d4C pooled trusts) in order for that individual to remain eligible for government benefit programs.  When establishing a d4A standalone trust, federal law clearly states that the disabled individual cannot establish a d4A trust.  Rather, it must be established by a parent, grandparent, guardian, or a court (and not the beneficiary him or herself).  The Draper decision seemingly adds yet another requirement – the person establishing the trust on the individual’s behalf may now need to seed the trust with his or her own funds.    

 

In Draper, Stephany Draper received a personal injury settlement.  (As discussed in the seminar, lawsuit settlements are one of the common reasons why you may need to use a d4A trust.)  Her parents established the trust and used their authority under Stephany’s power of attorney to transfer the settlement funds into the trust.  This would have been considered accepted practice for a parent to establish a d4A trust before this Draper decision.

 

However, in Draper, the Social Security Administration took the strange position that a parent cannot act as both a parent and agent under a power of attorney for purposes of establishing a special needs trust.  The Administration argues that if a parent is acting as an agent under a power of attorney, the parent is not acting as a parent – rather is acting as an extension of the disabled individual himself or herself.   (See POMS SI 01120.203B(1)(g).)  Because the disabled individual cannot establish a d4A trust, neither can his or her agent under a power of attorney even if that person is also a parent.

 

This would make sense if Stephany’s parents were acting as agents under the power of attorney, but they signed the trust in their individual capacities (i.e., as parents).  Further, the Social Security Administration has stated that a trust can be “dry” or “empty” if state law allows it.  (See POMS SI 01120.203B(1)(f).)  Empty trusts are allowed in Michigan and are also apparently allowed in South Dakota (the location of the Draper case).  If a dry trust is allowed, it would seem that the trust was established when the trust was executed – not when it was funded.  Nevertheless, the Eighth Circuit found that because the parents funded the trust with Stephany’s money before “seeding” it with their own money, the trust was not properly “established” under the meaning of 42 USC 1296p(d)(4)(A).          

 

Some attorneys may choose to read the Draper decision narrowly.  Because the Draper trust itself stated that the trust is funded with settlement proceeds, the Eighth Circuit readily dismissed the “empty” trust argument stating that the trust was never empty because of this funding statement in the trust.  An attorney could argue that if the trust makes no mention of how it is being funded, the parent could still act in two separate capacities: as a parent to establish the “empty” trust and as an agent under the power of attorney to fund the “empty” trust.  Indeed, this is a reasonable interpretation of the Draper decision.

 

However, the prudent attorney will now take steps to avoid this issue altogether.  Even though this decision is not binding precedent in Michigan, it is still an opinion of a Federal Circuit Court of Appeals and the Social Security Administration argued for this result.  Unless the Social Security Administration changes the POMS or other courts take a different position, attorneys should have the parent, grandparent, or guardian put some of his or her own money (say $10) to seed the trust before disabled individual’s own funds are put into the trust account.  Better safe than sorry.

 

As a quick aside, does Draper mean judges need to seed d4A standalone trusts in order to establish them?  Presumably no, but one special needs practitioner relayed a story of giving the judge $10 in court to seed the trust.  A ridiculous and probably unnecessary step for sure.  But then again, many of us would have said the same about parents establishing trusts before the Draper decision.

 

You can read the full Draper decision here: http://media.ca8.uscourts.gov/opndir/15/03/132757P.pdf.

 

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