The Treatment of a Trust for the Sole Benefit of a Community Spouse
Date Listed: February 3, 2021
Presented By: Scott Engstrom, J.D.
In episode 12 of our Industry Insights video series, Scott Engstrom, J.D., discusses upcoming changes to Sole Benefit (SBO) rules in Michigan for the community spouse.
Scott details how SBO trusts will be treated as divestments in Michigan to be in line with federal law. Additionally, he describes the differences among states in beneficiary designation rules for Medicaid Compliant Annuities, and why it can be advantageous in states such as Michigan.
Amy: Hi, I’m Amy Beacham, Communications Director for Krause Financial Services. Welcome to Industry Insights. In this series, we discuss news, updates, and hot discussion topics that affect the elder law space and that are relevant to you as an elder law attorney. Working on hundreds of cases per month and working with attorneys from across the country, we see trends that affect this area of planning, and we want to share some of those insights with you today. Today, we have our Corporate Counsel and COO, Scott Engstrom. Scott is a popular guest on Industry Insights, and today, he is going to discuss a hot elder law topic, particularly for our Michigan attorneys–the treatment of a trust for the sole benefit of a community spouse, also known as an SBO trust. Welcome, Scott.
Scott: Thanks for having me, Amy, and thanks for the kind introduction.
Amy: So, to start off, can you tell us what is that SBO rule and who is it intended to protect?
Scott: So, the SBO rule is actually a set of rules that’s found in 42 USC § 1396p(c), and then there’s a subsection within there, subsection 2. And without going into it verbatim, which I know you would make fun of me for at no end, it essentially carves out a set of situations where you can transfer assets for the sole benefit of certain individuals. It allows assets to be transferred without incurring a transfer penalty when they are for the sole benefit of the community spouse, if they’re for a minor or disabled child, or if they’re for somebody who is disabled under the age of 65.
Amy: Okay. So, how does this rule apply to trusts then?
Scott: So, under federal law, there is a distinction. You can go into legislative intent and what Congress actually intended because there are specific carveouts for trusts, that the assets are used to fund a trust for the benefit of a minor or disabled child or for somebody who is disabled under the age of 65. It does not expressly carve out anything for the sole benefit trust for a community spouse. So, this distinction is really what the substance of our conversation is about today.
Amy: Okay. So, you know, looking at the federal rules, a SBO trust for a community spouse would really be looked at as a divestment.
Scott: Yeah, it could be. Absolutely.
Amy: Okay. Now, when it comes to those trusts, you know, Michigan was previously operating under a different set of rules, and they announced that they are going to be changing their policy effective March 1, 2021. Can you tell us a little bit about that?
Scott: Yeah, so the Bridges Eligibility Manual, the BEM in Michigan, which is their eligibility manual, it did not make that distinction that I talked about between, you know, the trusts for somebody who is a minor or disabled child or somebody who is disabled under the age of 65–the distinction between those two and trusts formed for a community spouse. It did permit trusts for the sole benefit of a community spouse. What really happened was this was a challenge because the state had imposed a transfer penalty for an SBO trust for the benefit of a community spouse. Obviously, the attorney challenged that because the BEM had a different set of rules that were essentially broader than what the federal rules allowed, and this is the Hegadorn decision. And you can find all sorts of information about that on our website. And essentially, the Michigan Supreme Court had determined, no, the state can’t impose a transfer here. The manual itself specifically allows this type of trust for a community spouse. Now, ultimately, the state of Michigan, not liking that decision, having clear authority there in the federal law, they announced that they are going to make a rule change. And now they’re bringing their rules in line with what the federal law does say, making that distinction, setting those aside, having that exception, versus community spouse trusts where there is no exception.
Amy: Okay. So now, in Michigan, like the federal rules, an SBO trust for a community spouse is likely to be treated as a divestment. So, with that option no longer available to our Michigan attorneys, what can they do instead in these married couple crisis planning cases?
Scott: There is still an option, and it is the community spouse annuity. So, as long as the annuity has the requirements of the DRA, and even not all of those, which we’ll get into momentarily. As long as it has the requirements from the Deficit Reduction Act, that is not going to be considered a transfer, and you’re not going to run into those eligibility issues.
Amy: So, you just mentioned, you know, there are some different rules with Medicaid Compliant Annuities in Michigan. Can you explain that a little bit?
Scott: Sure. So, in Michigan, they follow what’s definitely the minority rule. This is not broadly accepted across multiple jurisdictions, but they do not require that in a community spouse annuity case, where the community spouse is the annuitant, that they name the state as a beneficiary for it to be Medicaid compliant, and therefore, you know, escaping sort of transfer penalty. So, again, that is the minority rule. It is not widely accepted. But that is the approach that Michigan takes.
Amy: And what’s the benefit of a community spouse not having to name the state as a beneficiary?
Scott: Well, I mean, it protects against estate recovery, so in the event that the community spouse were to pass away, they don’t have to name the state as beneficiary. Those assets are then protected from recovery through the estate recovery process.
Amy: So, you said Michigan is in the minority with that treatment with Medicaid Compliant Annuities. Are there any other states that follow that set of rules?
Scott: So, this actually springs from the Hughes v. McCarthy decision. It’s a Sixth Circuit case. And really, this goes into a lot of statutory interpretation. So, I had mentioned that 42 USC § 1396p(c), and then there’s sub-2, which is where you get into the SBO rules. The Hughes decision made a distinction between that sub-2 and sub-1. And sub-1 goes into a lot of the broader requirements and other requirements relating to annuities and transfer penalties. Notably, in that subsection 1, that’s where the beneficiary requirement comes in. So, in the Hughes decision, because subsection 2 was a carveout and they found it as an exception in finding that the transfer penalty, by reason of subsection 1 did not apply, that beneficiary language did not apply. So, in the Hughes decision–which, again, has not really caught fire, it’s not widely used–essentially, as long as it satisfies that sole benefit rule, then you don’t have to name the state as a beneficiary. And again, this is not widely accepted, but this has caused an issue in the state of Massachusetts–there’s the Dermody decision. That decision has been ongoing for quite some time. I believe there are even some contempt motions for the state for not following through with the court’s order. But ultimately, they did follow a similar analysis as in the Hughes decision, finding that carveout in subsection 2. That litigation is still ongoing. There’s still a lot of fighting to be done on it. But ultimately, it looks like at least for the time being, in Massachusetts, there’s an argument to be made that it’s following that minority rule as well.
Amy: Okay. So, if states do follow that rule–so, really, it’s Michigan and then potentially in Massachusetts, and maybe we’ll see some actual legislative change there in the future. If states do follow that rule, it’s clearly beneficial for the client. Now, we still use Medicaid Compliant Annuities in nearly every other state. Is it still beneficial even with the state as beneficiary?
Scott: Yes, it is definitely useful. You can ultimately do a shorter-term community spouse annuity, so you get that back to the community spouse more quickly. And then, so long as the community spouse does not predecease the end of that annuity, the annuity ceases to exist. There’s no longer anything to recover against. So, a shorter-term community spouse annuity can be very useful in those instances, even where you do have to name the state as a beneficiary.
Amy: Okay, great. So, it sounds like we have some methods that we can rely on to reduce that risk of estate recovery.
Amy: Awesome. Well, thank you very much for joining us today. This was very helpful. For more information on this topic, contact our office at 855-552-5893. Thanks for watching.
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