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KANSAS BAR ASSOCIATION

“Hot Topics in Elder Law”

Using Trusts in Medicaid Planning: Avoiding Hazards and Maximizing Benefits

Community Foundation of Southeast Kansas

June 6, 2013

Timothy P. O’Sullivan Foulston Siefkin LLP

1551 N. Waterfront Parkway Suite 100

Wichita Kansas 67206 316-267-6371

[email protected]

TABLE OF CONTENTS

Page Use of Trusts in Maximizing Medicaid Eligibility and Minimizing Estate Recovery ............ 1 I. Drafting of “Supplemental Needs” Trusts .............................................................. 1 a. Support Trusts ............................................................................................. 2 b. Discretionary Trusts .................................................................................... 3 c. Hybrid Trusts ............................................................................................... 5 d. Kansas Statutory Repeal of Common Law Position .................................. 13 e. Suggested Trust Provision ......................................................................... 14 II. Avoiding Estate Recovery ..................................................................................... 16 a. Interest Terminating at Death of Medicaid Recipient .............................. 17 b. Potential for Estate Recovery Expansion to Interests Created by Third Persons ...................................................................................................... 23 III. Spousal Revocable Trust Planning ........................................................................ 25 a. Impact of the “Miller decision” ................................................................. 26 b. Federal Statutory Authority Favoring Wills Over Revocable Trusts ......... 27 c. Ensuring Most Marital Assets Held in Predeceased Spouse’s RT ............. 29 IV. Transfer of Assets in Trust for Purposes of the Five Year “Look Back” Rule ........ 31 a. Principal a Resource to Grantor if Grantor a Principal Beneficiary .......... 32 b. Provisions Providing Flexibility and Indirect Grantor Control .................. 32 c. Benefits of “Grantor Trust Status” ............................................................ 33 d. Benefits of Inclusion in Grantor’s Taxable Estate ..................................... 34 e. Use of Strategy by Surviving Spouse When Predeceased Spouse Received Medicaid Benefits ...................................................................... 34 f. Include Savings Clause in Trust Instrument .............................................. 35

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© 2012 Foulston Siefkin LLP Timothy P. O’Sullivan

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Use of Trusts in Maximizing Medicaid Eligibility and Minimizing Estate Recovery

Beyond utilizing asset transfer and asset structuring strategies (e.g., conversion of non‐

exempt resources to exempt resources or income) which accelerate the qualification for

Medicaid benefits, it is the proper usage of trusts which serves to protect beneficiaries who

would otherwise qualify for such benefits from having such governmental resource benefits

reduced by the availability, or deemed availability, of assets left by others for their benefit (in

so‐called “third party trusts”) or being an asset subject to estate recovery for governmental

benefits paid to such beneficiary. This outline addresses strategies for the structuring of such

trusts to maximize the achievement of both such goals. Not addressed will be so‐called “self‐

settled trusts” created by a beneficiary for the benefit of such beneficiary. Except for trusts

termed as “d4A trusts,” such trusts are statutorily deemed to be a resource to the full extent

the trustee is authorized to distribute assets to the grantor/beneficiary.

The first segment of this outline will address the fundamentals necessary to ensure both

that the trust estate of “third party trusts” is not deemed to be an available resource to trust

beneficiaries for Medicaid purposes. The second segment will focus on drafting of such trusts

to minimize the exposure of such trusts to estate recovery for Medicaid benefits paid to the

trust beneficiary. The third segment will discuss the structuring of revocable trusts to minimize

the amount of “spend down” by the surviving spouse should the surviving spouse either be on

Medicaid or seek Medicaid benefits subsequent to the death of the predeceased spouse. The

fourth and final segment of the outline will involve the strategy of transferring assets to a trust

for the purpose of either being outside of the “five year look back” period with respect to the

grantor’s qualification for Medicaid benefits or by a surviving spouse to avoid estate recovery

for governmental resource benefits paid to the predeceased spouse.

I. Drafting of “Supplemental Needs” Trusts

Choosing a distribution standard is critical when a trust beneficiary may be receiving, or

become eligible to receive, Medicaid or other government benefits. Without question any

mandatory distribution will automatically considered a resource for such purposes. Kansas

Economic and Employment Support Manual §5620(4). An example would be a trust which

requires all of its income to be distributed annually to the trust beneficiary.

There are three basic types of trusts which do not have mandatory distributions and

thus repose some degree of discretion in the trustee with regard to such distributions: support

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trusts, discretionary trusts and hybrid trusts. An understanding of these types is essential in

employing Medicaid planning strategies through trusts.

a. Support Trusts

Support trusts are created by a grantor or testator to provide for the support of one or

more beneficiaries. Typically, the support standard will relate to the health, education,

maintenance and support needs (sometime broadened beyond an ascertainable standard to

include “welfare,” “comfort” or “care”) of a given beneficiary or beneficiaries. The trustee of a

support trust is directed by the grantor to make distributions of trust income and/or principal

pursuant to a standard that relates to a support need of trust beneficiaries. See, Restatement

(Second) of Trusts, § 154; First National Bank of Maryland v. Dept. of Health and Mental

Hygiene, 399 A.2d 891 (Md. 1979). Being commanded to make such distributions, the trustee’s

discretion is limited to the timing, manner and amount of such distributions to satisfy the

support standard. Eckes v. Richland County Social Services, 621 N.W.2d 851 (N.D. 2001).

In Godfrey v. Chandley, 248 Kan. 975, 811 P.2d 1248 (1991), the Trust provided that the

trustee “shall pay . . . such portion of the net income from the trust as may be necessary for

[my wife’s] support, health, and maintenance.” Id. at 978. The Kansas Supreme Court held that

such language required the trustee to make income payments to the surviving spouse, if such

payments were necessary for her support, health and maintenance. The trustee had no

discretion whether to make such distributions; instead, the trustee only had discretion to

determine whether the contemplated distributions met the standard. However, the

compulsory support distribution standard may also delineate, as was implied in the “as may be

necessary” language in Godfrey, that the trustee may or shall consider all other resources

available to the beneficiary prior to being compelled to make a distribution.

With a support trust, the beneficiary can compel the trustee to make distributions under

circumstances dictated by the standard of distribution. Restatement (Second) of Trusts, § 128,

comments d and e. As more fully discussed below, this also means that absent a spendthrift

clause or a statutory provision to the contrary, a creditor under common law could compel a

distribution for the beneficiary’s support in circumstances where the debtor/beneficiary could

have compelled such a distribution.

Due to limitations in the trustee’s discretion imposed by the terms of the trust

instrument, the trustee’s decision‐making with regard to non‐mandatory (i.e., discretionary)

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distributions to be made in a support trust is much more circumspect under a judicial review

than in a pure discretionary trust context discussed below. The singular issue before the court

in such former circumstance is whether the trustee abused the trustee’s more limited

discretion in either making, or failing to make, a distribution required to be made for the

delineated support needs of a beneficiary, subject to any definitions in the trust instrument as

to such support needs and after considering any other factors specified in the trust instrument

for the trustee to consider in either making such distribution or the amount thereof. However,

courts are understandably averse to substituting their judgment in such regard for that of the

trustee. Instead, a court will not interfere with a trustee’s determination unless it is so far

outside the bounds of reasonableness given the support standard so as to be patently

unreasonable or arbitrary.

A support trust is normally considered a countable resource of someone who is

receiving or applying for Medicaid benefits. Because the trustee of a support trust has a legal

responsibility to make distributions of income and/or principal to or for the benefit of the

beneficiary for support or maintenance needs, such assets are deemed to be available to the

beneficiary and are counted when a beneficiary makes application for Medicaid or a similar

program. In Miller v. Kansas Dept. of Social and Rehabilitation Services, 275 Kan. 349, 64 P.3d

395 (2003), the Kansas Supreme Court observed:

“A support trust exists when the trustee is required to inquire into the basic

support needs of the beneficiary and to provide for those needs. . . . Eligibility for

Medicaid depends on the assets ‘available’ to the applicant, and the support

trust is always considered such an available asset.”

Id. at 354.

b. Discretionary Trusts

Pure discretionary trusts, on the other hand, are usually couched in terms of authorizing

a trustee, in non‐compulsory language, such as “is authorized” or “may,” to make distributions

using broad discretionary language, such as in the trustee’s “sole,” “absolute,” or

“uncontrolled” discretion. They thereby repose almost untrammeled authority in the trustee

regarding the timing of trust distributions, the purposes for which distributions will be made,

the amount of such distributions, and in circumstances where there are multiple current

beneficiaries, i.e., a blended trust, the beneficiaries who are to receive such distributions.

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Kansas’ common law recognition of such discretionary trusts is of more than 65 years’

duration. Watts v. McKay, 160 Kan. 377, 162 P.2d 82 (1945). In Watts, the Kansas Supreme

Court determined a discretionary trust was created such that the beneficiary’s ex‐wife could

not “stand in the shoes” of the beneficiary and compel a trust distribution to satisfy the

beneficiary’s alimony obligation due to the trustee’s discretion being absolute as to the making

and amounts of any such trust distributions.

Distributions from pure discretionary trusts are not based on any support standard or

beneficiary need. They are based solely on whether a trustee believes such distribution is

appropriate. In Simpson v. State Department of Social and Rehabilitation Services, 21 Kan. App.

2d 680, 906 P.2d 174 (1995), a case where the central issue was whether the trust was a pure

discretionary trust such that the beneficiary could not compel a distribution so as to preclude

the trust estate from being a resource for Medicaid qualification purposes, the trust provided:

“The Trustees shall have the absolute discretion, at any time and from time to

time, to make unequal payments or distributions to or among any one or more

of said group [of beneficiaries] and to exclude any one or more of them from any

such payment or distribution.”

Id. at 684.

Regarding this distribution standard, the Court stated:

“We cannot imagine a better example of a discretionary trust. No one

beneficiary of the Trust has the right to any distribution. The trustees have

absolute discretion as to whom they will make distributions and may exclude any

one or more of the beneficiaries from any payment or distribution. The

discretion placed in the trustees is total and absolute.”

Id.

The beneficiaries in Simpson consisted of the subject beneficiary, Margaret, (who was applying

for Medicaid benefits), Margaret’s spouse, Margaret’s issue, and spouses of such issue. There

was no distribution standard in the trust instrument. Instead, the trust provisions expressly

provided that the trustee could exclude any one or more of such beneficiaries from receiving

any distributions, thereby giving an incredible amount of control to the trustee. Indeed, the

foregoing language utilized by the Court in defining the subject distribution standard would

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tend to indicate that the trustee’s discretion in making distributions to the trust beneficiaries

was unfettered. Thus, the Court concluded the trust estate was not a resource to Margaret for

Medicaid qualification purposes.

In a pure discretionary trust, a beneficiary cannot compel the trustee to distribute trust

funds absent a showing that the trustee abused the trustee’s discretion in failing to make a

distribution (which is difficult to do in a pure discretionary trust devoid of distribution

standards), i.e., the trustee acted dishonestly or with an improper motive in failing to make

such distribution. Restatement (Second) of Trusts, § 187, comment e; Ridgell v. Ridgell, 960

S.W.2d 144 (Tex. App. 1997); State Street Bank and Trust Company v. Reiser, 389 N.E.2d 768

(Mass. 1979); Brent v. State of Maryland Central Collection Unit, 537 A.2d 227 (Md. 1988). The

Court in State Street Bank, supra, cited Restatement (Second) of Trusts, § 187 (1959), comment

j, which provides that where such adjectives as “absolute” or “unlimited” or “uncontrolled”

modify the term “discretion,” the trustees may act unreasonably, so long as not dishonestly,

from a motive divorced from the purposes of the trust, or from a failure to use the trustee’s

judgment.

c. Hybrid Trusts

Hybrid trusts represent a conflation of the aspects of the two traditional types of non‐

mandatory distribution trusts, support trusts and pure discretionary trusts. They provide for

distributions pursuant to a “support standard,” but also contain language indicating the trustee

has at least some degree of discretion in the making of distributions to satisfy that standard.

For example, such discretion may be indicated by substituting the permissive word or

words “may” or “the trustee is authorized to” for the more compulsory “shall” regarding the

making of such distributions pursuant to a standard. It also might be indicated by including

discretionary language with the compulsory wording found in a support trust, such as “in the

trustee’s discretion” or “in the trustee’s sole discretion.” Finally, it may be implied by

subjecting the compulsory wording to accompanying language that would appear to detract in

varying degrees from the compulsory mandate, such as “as the trustee deems reasonable and

necessary” or “as the trustee may deem appropriate.”

Being both heterodox in nature and far from trenchant in phraseology, hybrid trusts

pose significant problems both in their construction and efficacy in implementing the grantor’s

or testator’s intent as to the discretion to be accorded the trustee. The central issue in hybrid

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trusts is whether they are to be construed as to the discretion of the trustee as a discretionary

trust with respect to the making of distributions for the stated support purposes, a support

trust, or a truly hybrid discretionary standard between the two basic types of trusts.

The resolution of this question has had particularly acute consequences historically, due

to fact that the Restatement (Second) of Trusts does not recognize that the degree of discretion

accorded in trustees of hybrid trusts can be hybrid in nature, i.e., between the broad degree of

discretion accorded the trustee in a pure discretionary trust and the more limited discretion of

the trustee in a support trust context. Thus, absent language in the trust instrument clearly

delineating the degree of such discretion in a hybrid trust context, the position of courts that

follow such Restatement position is that such discretion of the trustee is either that accorded

by a pure discretionary trust or that accorded by a support trust, with the courts having to

resolve the intent of the grantor or testator in that regard.

In the circumstance where very broad discretionary authority accompanies the support

standard, such as “absolute,” “unlimited” or “uncontrolled” discretion, following the position of

Restatement (Second) of Trusts, Section 187, comment j, the courts will tend to conclude that

such discretion need not be exercised reasonably in satisfying the distribution standard, i.e., the

discretion is the same as in a pure discretionary trust. However, more limiting discretionary

language, being inherently ambiguous, creates the issue of whether the grantor simply

intended for the trustee to have fiduciary discretion in interpreting the standard and making

the distribution (the degree of discretion being that accorded the trustee of a support trust or

perhaps somewhat greater should the court digress from the Restatement (Second) of Trusts’

position on the issue) or, alternatively, that distributions were limited to such purposes but the

trustee had absolute discretion (to the same degree as in a discretionary trust) in deciding

whether to make any such distributions.

Consequently, as one might expect, courts across the country have been quite

inconsistent in interpreting the discretionary authority reposed in trustees under the provisions

of hybrid trusts, even sometimes in interpreting very similar provisions within the same trust

instrument. For example, in Kryzsko v Ramsey County Social Services, 607 N.W.2d 237 (N.D.

2000), the trustee was given “sole discretion” to make distributions of trust principal for the

beneficiary’s “proper care, maintenance, support, and education.” The North Dakota Court held

that such terminology created a support trust. In First of America Trust Company v. United

States, 93‐2 USTC Para. 50,507 (D.C.C.D. Ill. 1993), the Court paradoxically held that a trust

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distribution standard that “the Trustee shall pay or apply the net income and so much of the

principal as the Trustee may in its sole discretion deem necessary or appropriate for the

support, comfort and welfare of such of [the beneficiaries] as shall be living from time to time”

created a support trust as to the income (all income of the trust being interpreted to be

required to be distributed for the support of the beneficiaries) but a discretionary trust as to

principal distributions.

Other courts have held that hybrid distribution standards create a support trust, but

departing from the position of the Restatement (Second) of Trusts, have held that the trustee is

given broader discretion in determining the propriety, timing and amount of such distributions

than would otherwise have been the case in the absence of such language. See, e.g., Bureau of

Support in Department of Mental Hygiene & Correction v. Kreitzer, 243 N.E.2d 83 (Ohio 1983);

Strojek ex re. Mills v. Hardin County Board of Supervisors, 602 N.W.2d 566 (Iowa App. 1999);

Smith v. Smith, 517 N.W.2d 394 (Neb. 1994). In Kreitzer, the court held that the trustee’s

discretion was subject to the rather amorphous standard of “reasonableness.”

Still other courts have indicated that the terminology is inherently ambiguous so as to

permit the resolution of the grantor’s intent through parol evidence. See, e.g., Bohac v.

Graham, 424 N.W.2d at 144 (N.D. 1988), in which the trustee was authorized to distribute

principal as the trustee “may deem necessary” for the beneficiary’s “support, maintenance,

medical expenses, care, comfort and general welfare.”

Kansas appellate courts have followed the position of the Restatement (Second) of

Trusts in finding that hybrid trusts do not create a hybrid discretionary authority. However, in

resolving the issue as to whether the trustee in a hybrid trust context has the discretion

accorded the trustee in a pure discretionary trust or a support trust, the Kansas appellate

courts have demonstrated a strong proclivity to find hybrid trusts, which in the absence of the

inclusion of a distribution standard such as “maintenance and support” would have been

considered to create a pure discretionary trust, to remain a pure discretionary trust despite the

inclusion of a support distribution standard, with distributions being limited to the purpose of

satisfying the delineated support standard. This conclusion carries over as to how Kansas

appellate courts view hybrid trusts in a Medicaid context.

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In State ex. rel. Secretary of SRS v. Jackson, 249 Kan. 635, 822 P.2d 1033 (1991), the trust

provided, in relevant part:

“During the lifetime of Carrie Conner Jackson, the Trustees, in their uncontrolled

discretion, shall pay to Carrie Conner Jackson the net income of the Trust. In

addition, the Trustees may pay to Carrie Conner Jackson, from the principal of

the Trust from time to time, such amount or amounts as the Trustees in their

uncontrolled discretion, may determine is necessary for the purposes of her

health, education, support and maintenance. The Trustees are not prohibited

from invading the principal of the trust for my granddaughter, Carrie Conner

Jackson, before she has exhausted her own funds.”

Id. at 639.

The Jackson Court analyzed this provision as follows:

“Stripped down, the provision states the Trustees shall pay the net income and,

in addition, may pay from the principal. The payment of the net income is not

tied to any determination of need as are payments from the principal.”

Id. at 641.

Even though the income distribution standard was phrased in terms of the trustee’s

“uncontrolled discretion,” the use of the word “shall” was construed by the Court to have

negated the trustee’s ability to use discretion about whether to distribute income. Perhaps the

Court gave limited applicability to the words “in their uncontrolled discretion” due to the

Court’s unabashed distaste, as expressed in its opinion, for estate planning strategies designed

to protect the trust estate from being a resource for Medicaid purposes. In a divided opinion,

the majority had to strain to resolve this palpable inconsistency in the language by construing

the term “uncontrolled discretion” in a manner that ascribed such discretion only to the timing

of such distribution of income, not the amount. The dissent opined that such language created

an obvious ambiguity that should have been resolved by remanding the case back to the district

court for the purpose of determining the grantor’s intent.

Had the trust used the word “may” instead of “shall,” it is likely the Court would have

held there was no requirement that the trustee make distributions of income. With respect to

distribution of principal, it was conceded by both parties that the trustee was deemed to have

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absolute discretion (due to the use of the word “may” in conjunction with the term

“uncontrolled discretion”) to determine what amounts were necessary to provide for the

beneficiary’s health, education, support, and maintenance. Consequently, the principal was

deemed not to be a resource to the beneficiary for Medicaid qualification purposes.

Despite the Court’s judicial constraints imposed on the broad discretionary authority in

the trust instrument relating to the trustee’s distribution of income, this decision should be

considered anomalous, if not clearly inapposite, to the issue of the degree of discretion legally

afforded a trustee in a hybrid trust. First of all, with respect to income distributions the subject

trust was not a hybrid trust, because distributions were not related to a support standard.

Instead, the sole issue was whether the trust provisions mandated that income be distributed

when there was inconsistent language in that regard. Second, the Court’s decision was

probably attributable to both its Medicaid context and the palpable inconsistency with the

word “shall” being related to making such distribution and the later inconsistent broad

discretionary authority which belied its compulsory nature. The dissenting position that such

language created an ambiguity would appear to be better reasoned. The majority simply may

have been reticent to acknowledge such ambiguity by virtue of a predilection to find the trust

to be a resource for Medicaid purposes.

In any event, in other subsequent contexts the Kansas appellate courts have found

discretionary language to take precedence in hybrid trust situations having a prescribed

support distribution standard, even if the support standard includes compulsory wording.

For example, in Myers v. Kansas Dept. of Social and Rehabilitation Services, 254 Kan.

467, 866 P.2d 1052 (1994), involving the same issue that was presented in Jackson as to

whether the trust estate was an available resource for Medicaid purposes, the Trust provided:

“During my son’s lifetime, my trustee shall hold, manage, invest and reinvest,

collect the income there from [sic] any [sic] pay over so much or all the net

income and principal to my son as my trustee deems advisable for his care,

support, maintenance, emergencies, and welfare.”

In construing the foregoing terms of distribution, the Court in Myers, in contrast to its

position in Jackson, held that the use of the word “shall” in this different context pertained only

to management and investment functions of the trust, not to the distribution standard. Then,

in looking at the discretion imposed by the distribution standard, the Court held that because

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the trust provisions gave the trustees authority to make distributions for care, support,

maintenance, emergencies and welfare in terms of “so much or all the net income and principal

to [the beneficiary] as my trustee deems advisable,” the trust was a pure discretionary trust as

it related to the distribution standard. The Court further held that neither the beneficiary nor a

creditor of the beneficiary could compel a distribution from the trust if such distribution was

not deemed advisable by the trustee. As a consequence, the trust estate was held not to be a

resource for Medicaid purposes.

In recognition of this reality and the failure of some courts to follow the dichotomy of

the Restatement (Second) of Trusts on this issue, the Restatement (Third) of Trusts abandoned

the position of the prior Restatements as to any strict adherence to a “bright line” distinction

between “support” and “discretionary” trusts in a hybrid trust context. The Comments to the

Restatement (Third) of Trusts § 50 (trustee discretion), § 58 (spendthrift provisions), and § 60

(ability of a creditor to “stand in the shoes” of a beneficiary and compel a distribution in the

absence of a spendthrift clause) indicate that such a distinction is artificial. Comment b to § 50

first reaffirms the general common law view that “judicial intervention is not warranted merely

because the court would have differently exercised its discretion.”

However, the comment goes on to provide a “reasonableness” test, stating that a court

“will not interfere with the trustee’s exercise of a trustee’s discretionary power when that

exercise is reasonable and not based upon an improper interpretation of the terms of the

trust.” The Commissioners make particular note that this illogical demarcation poses particular

problems in the area of determining whether the assets of a trust in which a trustee is given

discretion to make distributions to a beneficiary who is on or applying for government benefits,

such as Medicaid, should be considered a “support trust,” the assets of which should be

deemed available to a beneficiary, versus a “discretionary trust” where they are not. Instead,

the Comments state that distribution standards should be treated as a continuum from being

purely discretionary to providing for support‐type needs, with varying degrees of discretion

accorded to the trustee dependent upon the evinced intent of the grantor as gleaned first from

the provisions of the trust instrument and secondarily from parol evidence in the event such

provisions are deemed to be ambiguous. In essence, the Third Restatement strives to

amalgamate all of the various positions jurisdictions across the country have taken on this

issue, albeit it under a somewhat amorphous standard of review.

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Although the Kansas Court of Appeals has cited with approval the Restatement (Third) of

Trusts in other contexts (See, e.g., In re Breeding Trust, 21 Kan.App.2d 351, 899 P.2d 511 (1995),

in which it was cited with respect to a trustee’s duty to successive beneficiaries), neither it nor

the Kansas Supreme Court has done so to date in the context of the difference between

discretionary and support trusts. Consequently, there is no indication to date that Kansas will

depart from the foregoing precedents, which have uniformly found a clear demarcation

between both types of trusts and a proclivity to resolving such demarcation in a hybrid trust

context in favor of finding such trusts to be discretionary, rather than support, trusts. Even if a

Kansas appellate court should decide to adopt such Third Restatement position, due to the

largely “facts and circumstances” approach that is implicit thereunder in resolving the degree of

discretion accorded the trustee in any particular situation, there is little certainty as to the

outcome in any given circumstance.

Also, interestingly enough, K.S.A, 58a‐814, enacted in 2002 along with other provisions

of the Kansas Uniform Trust Code, provides for a “good faith” standard in reviewing

discretionary language either in a pure discretionary or hybrid trust context. Such subsection

provides that “[n]otwithstanding the breadth of discretion granted to a trustee in the terms of

the trust, including the use of such term “absolute,” “sole” or “uncontrolled,” the trustee shall

exercise a discretionary power in good faith in accordance with the terms and purposes of the

trust and the interests of the beneficiaries.” [Emphasis supplied.] Such terminology has been

criticized by some commentators. They assert it gives too much control to beneficiaries (with an

asserted consequential exposure of the trust estate to third party claims and potential

governmental resource disqualification), requiring a much more circumspect test than simply

inquiring whether a trustee has acted dishonestly or with improper motive under the position

of the Restatement (Second) of Trusts to the extent the trust would have otherwise have been

construed as a discretionary trust. In essence, such commentators posit that a “good faith”

standard is higher than simply requiring that the trustee not have acted in bad faith. Obviously,

if such was the case, there would have to be a third alternative in between. If any such

distinction can be made, the authors believe it is primarily gossamer in nature.

In a subsequent hybrid trust context case, Kershenbaum v. Fasbinder, 170 P.3d 922,

2007 Kan.App. Unpub. LEXIS 388 (2007), which was decided in 2007 after the passage of such

provision and applicable in construing the subject trust terms, the Kansas Court of Appeals did

not mention this KUTC provision in continuing to adhere to the position of the Restatement

(Second) of Trusts position on the issue. The Court was called upon to construe a trust provision

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which provided that “the testamentary trustee(s) shall pay to the beneficiaries or for their

benefit, from the income or principal of that beneficiary’s trust, such sum or sums, as the

testamentary trustee(s) shall deem necessary or proper to provide for the beneficiary’s suitable

support, health and maintenance, adding any unused income to the principal at the end of each

year.” The Court determined that the language “as the testamentary trustee(s) shall deem

necessary or proper,” despite the words “shall pay” and “suitable support, health and

maintenance,” nonetheless created a discretionary trust.

In short, the Kansas appellate courts, in following the Second Restatement’s position

that a hybrid trust is either to be construed as a support trust or a pure discretionary trust with

distributions being limited to the delineated support purposes, has found that almost any

discretionary wording in a hybrid trust context will result in the trust being construed as a

discretionary trust, not a support trust.

From a general drafting standpoint, except where necessary or desirable to do so in

circumstances in which a beneficiary is suffering from a disability and is seeking or receiving

governmental resource benefits, it is best not to draft pure discretionary or hybrid trusts given

the Kansas appellate courts’ adherence to the Second Restatement’s position. Such

distribution standard reposes far too much discretion in the trustee and provides precious little

recourse to a beneficiary to be able to compel a distribution in circumstances the grantor or

testator would have intended.

Instead, the following clause is suggested to ensure that in a hybrid trust context, in

which discretionary language is included so as to avoid a beneficiary considering access to the

trust estate to be an entitlement, that such discretion is not to be unbridled, but in the nature

of a support trust in which the trustee’s decision will not be subject to being “second guessed”

by a court unless it is clearly beyond the discretion accorded a trustee, i.e., the trustee’s action

or inaction with regard to the distribution standard is outside the parameters in which

reasonable persons might differ as to whether a distribution should be, or should not be, made

under the particular support standard and circumstances:

Trustee’s Discretionary Authority Regarding Trust Distributions. Under the

provisions of this Trust Agreement, I have both authorized and provided for the

Trustee to make trust distributions for the health, education, maintenance and

support needs of trust beneficiaries. To the extent such distributions are made

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subject to additional qualifying language, such as “in the Trustee’s discretion” or

in amounts the Trustee “determines to be necessary or advisable,” unless a

Priority Beneficiary is serving as Trustee and such discretionary authority relates

to such Trustee/beneficiary’s descendants, or a beneficiary who is otherwise

qualified to receive governmental benefits such as Medicaid and SSI is not

serving as a Trustee and such interpretation (as provided herein) is necessary for

such beneficiary to qualify for such governmental benefits, it is not my intent by

the inclusion of such qualifying language to create a purely discretionary trust

whereby the Trustee is unfettered by normally applicable fiduciary constraints

and responsibilities regarding the Trustee’s determination whether to make a

distribution to a trust beneficiary pursuant to such distribution standard or the

amount of such distribution, to be limited only in circumstances of dishonesty or

bad faith.

To the contrary, despite the inclusion of such qualifying language, the exercise of

such Trustee authority shall be subject to reasonable fiduciary constraints and

principles. However, it is not my intent that a court of competent jurisdiction

shall be free to simply substitute its determination for that of the Trustee in the

exercise of such authority. Rather, I intend by the inclusion of such qualifying

language that the Trustee be afforded a reasonable degree of discretion

regarding whether to exercise such authority, as well as the amounts to be

distributed to a trust beneficiary in satisfaction of such distribution standard,

such that a court of competent jurisdiction would not substitute its judgment for

that of the Trustee unless the court has found that the admissible evidence

demonstrates that there was an abuse of the exercise or non‐exercise of such

Trustee’s discretionary authority such that such Trustee’s action or inaction in

that regard was clearly unreasonable (i.e., beyond the realm of reasonable

debate) or arbitrary after applying the applicable distribution standard, the

beneficiary’s circumstances, and all other provisions of this Trust Agreement

which are intended to impact such Trustee determination.

d. Kansas Statutory Repeal of Common Law Position

The foregoing common law Kansas position that the trust estate of a discretionary or

hybrid trust construed as a discretionary trust is not a resource for Medicaid purposes due to

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the inability of a beneficiary to compel a distribution, was statutorily repealed in 2004 with the

enactment of K.S.A. 39‐709(e)(3). This statute, in the absence of prescribed supplemental

language delineated therein, literally makes assets of a discretionary trust a countable resource

of a Medicaid applicant, to the extent that, using the full extent of his discretion, a trustee may

make distributions to or for the benefit of the beneficiary. The statute provides:

“(e)(3) . . . (A) Resources from trusts shall be considered when determining

eligibility of a trust beneficiary for medical assistance. Medical assistance is to be

secondary to all resources, including trusts, that may be available to an applicant

or recipient of medical assistance.

(B) If a trust has discretionary language, the trust shall be considered to be an

available resource to the extent, using the full extent of discretion, the trustee

may make any of the income or principal available to the applicant or recipient

of medical assistance. Any such discretionary trust shall be considered an

available resource unless: (i) At the time of creation or amendment of the trust,

the trust states a clear intent that the trust is supplemental to public assistance;

and (ii) the trust: (a) Is funded from resources of a person who, at the time of

such funding, owed no duty of support to the applicant or recipient of medical

assistance; or (b) is funded not more than nominally from resources of a person

while that person owed a duty of support to the applicant or recipient of medical

assistance.

(C) For the purposes of this paragraph, "public assistance" includes, but is not

limited to, Medicaid, medical assistance or title XIX of the social security act.”

e. Suggested Trust Provision

In light of the foregoing statute, it has become critical to include additional language

heretofore not required in Kansas in a discretionary trust, comporting with that in

subparagraph (B) above, stating that it is the intent of the grantor or testator that the trust be

considered supplemental to benefits that may be available to a trust beneficiary from public

assistance such as Medicaid or a similar program. It is important to note that the foregoing

statutory requirement does not appear to require that the trust be a “pure discretionary trust”

with respect to the discretionary language, only that the language indicate there is discretion in

the trustee with respect to the making of a distribution.

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Such intent might be best expressed as follows:

Supplemental to Governmental Resources. To the extent the Trustee is given

the discretion to make a distribution of income or principal from a trust created

hereunder for any beneficiary’s health, education, maintenance, or support,

such trust income or principal shall be supplemental to any resources available

for such needs from any local, regional, state or federal government or agency

(including, but not limited to, the Veterans Administration, Supplemental

Security Income “SSI,” Medicaid, medical assistance, Title XIX of the Social

Security Act or any other similar current or future governmental program,) or

from private agencies, it being my express purpose and intent that such trust

income or principal not be utilized for such purposes to the extent such needs

are otherwise provided for from such public assistance or other resources. In

addition, if, notwithstanding the foregoing provisions, (a) the income or principal

of a trust would either be deemed to be a resource to a trust beneficiary who

would otherwise be qualified to receive any of the foregoing governmental

resource benefits, or (b) the trust estate at any time would otherwise be subject

to any legal claim by any governmental agency for any benefits paid to such

beneficiary for which the beneficiary would be eligible, irrespective of whether

the beneficiary actually applies for such benefits or is actually being paid such

benefits, and provided such beneficiary is not serving as a Trustee of such trust,

any discretionary trust distributions of income or principal during the term of

such trust in which either such circumstance is applicable shall be in the sole

discretion of the Trustee and such beneficiary shall have no legal right to compel

any such distribution, irrespective of the distribution standard which would

otherwise be applicable to such trust.

Note that the above provision only makes the trust totally discretionary if it needs to be

under the circumstances in order for the trust estate not to be considered a resource for public

assistance purposes. This has two benefits. First, it would permit the beneficiary to be able to

compel a distribution and have enforceable rights in all circumstances in which the beneficiary

was not on governmental assistance, and probably in Kansas even if the beneficiary was on

governmental assistance. Second, arguably, it should ensure that the beneficiary will be eligible

for governmental assistance should either the beneficiary reside in another jurisdiction that

requires the trust to be a pure discretionary trust for the trust not to be considered an available

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resource to the beneficiary or Kansas change its laws in the future to reinstate the common law

position.

In addition, it should be noted that specific supplemental needs provisions (i.e.,

distributions are to be made for needs not provided for by governmental resources) found in a

large number of “supplemental needs” trusts, although perhaps desirable if the beneficiary is

already on governmental assistance when the trust is drafted for guideline purposes, are not

necessary in Kansas for the trust to not be an available resource to the beneficiary. Thus, the

above provision should suffice to make the trust estate of any discretionary trust of any type

not a resource in Kansas for governmental resource purposes, and in most other jurisdictions as

well, should any trust beneficiary at any subsequent time following the creation of the trust

otherwise qualify for public assistance.

Finally, it is almost obligatory in today’s rapidly changing environment to include a well

drafted sophisticated Special Trustee/Trust Protector provision in the trust instrument to

provide the flexibility necessary to address changed circumstances with regard to the

beneficiaries or the law applicable to the trust and such beneficiaries, most especially in this

context with regard to avoiding trust assets from being a resource for Medicaid and any other

type of governmental assistance.

II. Avoiding Estate Recovery

Even if a trust is properly drafted so as to avoid the trust estate being considered a

resource to the beneficiary for Medicaid purposes, care must be exercised so as to avoid an

estate recovery claim following the beneficiary’s death for Medicaid benefits paid to such

beneficiary. In order to understand such exposure, a review of Kansas estate recovery laws

would be helpful.

K.S.A. 39‐709(g)(2) provides that the amount of medical assistance paid to a recipient is

a claim against the property or any interest therein belonging to and a part of the estate of any

deceased recipient, or if there is no estate, the estate of the surviving spouse. Such statute

goes on to provide that if there is a surviving spouse, there shall be no recovery until the death

of the surviving spouse.

K.S.A. 39‐709(g)(2)(B) provides that such claim shall apply to the “medical assistance

estate” of the recipient or the recipient’s surviving spouse. It defines the medical assistance

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estate as including an interest in all real and personal property and other assets in which the

deceased individual had any legal title or interest immediately before or at the time of death to

the extent of that interest or title. Further, the medical assistance includes, without limitation,

assets conveyed to a survivor, heir or assign of the deceased recipient through joint tenancy,

tenancy in common, survivorship, transfer‐on‐death deed, payable‐on‐death contract, life

estate, trust, annuities or similar arrangement. In addition to the exception for a claim against

the estate of a Medicaid recipient who has a surviving spouse, there are also exceptions for

estates where the decedent has a surviving child who is under 21 years of age, blind, or

permanently and totally disabled. Both the KS Economic and Employment Support Manual at

Section 1725.1(2) and K.A.R. 30‐6‐85(c) provide that a disability determination of the Social

Security Administration is conclusive and recognizable in meeting such statutory criterion of

disability. Every judicial decision that was found by the author addressing this issue has found

that there need be only one beneficiary of the estate who is disabled for such exception to

apply, thereby barring any estate recovery claim in that circumstance. See, e.g., Dazlin v.

Belshe, 993 F. Supp. 732 (N.D. Cal. 1997); In re Estate of Peck, 416 N.W. 2d 158 (Minn. Ct. App.

1987); Matter of Burstein, 160 Misc.2d 900 (N.Y. Sur. 1994).

The amount of the estate recovery is limited to such “interest” constituting the medical

assistance estate.

a. Interest Terminating at Death of Medicaid Recipient

The main potential problem with “supplemental needs” trusts is whether there is any

portion of the trust estate which is deemed to pass to the remainder beneficiaries on the death

of a current beneficiary that would constitute a portion of the “medical assistance estate” so as

to be subject to estate recovery. Although there have been no appellate cases to date on this

issue, the analogous circumstance of a retained life estate which terminates upon the death of

the life estate holder has been the subject of many asserted estate recovery claims by the KERU

for benefits paid to the life estate holder against the property then held outright in sole

ownership by the remainder beneficiaries. Consequently, such position is worthy of further

analysis.

With regard to life estates in a Medicaid recipient, the term “interest” could not mean

an actual life estate interest, for such interest would have previously terminated at the death of

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the life tenant. This is why the foregoing statutes create a fiction, valuing the life estate

immediately prior to death. Case law, SRS’ own publications and Black’s law dictionary all stand

for the axiomatic proposition that the term “interest” means the value of such interest, in this

case the value of the life estate immediately prior to death. Unless the context clearly indicates

otherwise, the term value is almost universally interpreted to mean “fair market value,” i.e.,

what a willing seller is willing to sell the interest or property for on the open market, and what a

willing buyer is willing to pay for same, both being fully aware of all salient aspects of the

interest or property, and neither being under any compulsion to buy or sell.

In determining the value of such interests immediately prior to death, the KERU in the

past has arbitrarily applied pre‐1989 tables utilized by the Internal Revenue Service in valuing

life estates, remainders, term of years interests and annuities for federal gift, estate and

generation‐skipping tax purposes (hereinafter “transfer taxes”). See Treas. Reg. Section

20.2031‐7A(d)(6), specifically Table A. Such tables utilize high interest (10%) economic

conditions, appropriate for the time they were issued, as well as then applicable life expectancy

tables, in valuing not only life estates, but also the other aforementioned interests for which

the tables were designed. In today’s low interest environment, such tabled obviously grossly

overstate the actual fair market value of life estates.

The problems with Kansas Estate Recovery Unit’s (KERU’s) usage of this table are

several. First of all, such tables are calculated by using the age in years of the taxpayer which is

nearest to the actual age of the measuring life. Treas. Reg. Section 20.2031‐7A(d)(3). KERU has

been utilizing the decedent’s actual age, which 50% of the time is one year too low.

A much more fundamental and greater problem for the KERU is that there is absolutely

no statutory or regulatory authority for it to utilize any life estate tables, let alone life estate

tables promulgated by the IRS, in valuing life estates. This is important because life estate,

remainder, term of years and annuity tables are not designed to achieve actual fair market

value with respect to a particular interest in a given property. To the contrary, such tables are

intended to avoid the stygian factual morass of the IRS and taxpayers having to arduously

determine (i.e., approximate or estimate) the life expectancy of every subject life estate holder

and the income potential of every subject property, then subsequently having to utilize such

specific data to determine the present value of such “income stream” over the duration of the

taxpayer’s life expectancy. The tables are thus, by their very nature, “rules of convenience.”

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They are designed to sacrifice any semblance of trying to determine the actual fair market value

of a given life estate interest in every circumstance for the much simpler, less costly and

expedient logistics of achieving an average fair market value of a “life estate pool,” utilizing

current market factors (i.e., selected current interest rates) and average current life

expectancies. The interest rate and life expectancy components are utilized by the Service in

the tables to “split” the fair market value of the entire property into its separate life estate and

remainder interest components. The sum of the life estate and remainder factors generated is

the integer one (1). Consequently, they will result in separate life estate and remainder values

which total the fair market value of any given subject property.

As values of life estates, remainder interests, annuities and interests for terms of years

for transfer tax purposes would otherwise have to be based on their actual fair market values,

Section 7520 of the Internal Revenue Code had to specifically except life estate, remainder,

annuity and term of year interests from this requirement in order to achieve the foregoing

pragmatic goal. It did so by statutorily authorizing the Internal Revenue Service to publish

tables and factors employing the foregoing principles. Taxpayers and the government alike

were thereby legally authorized to use such tables as conclusive “value determinants” for

federal gift, estate and generation‐skipping tax (i.e., “transfer tax”) purposes, subject to the

singular “terminal condition” exception discussed below. Such tables are updated monthly to

reflect current economic conditions.

Even if the KERU, like the Internal Revenue Service, was given regulatory authority it

does not currently possess by statute to similarly publish tables so as to sanction departing

from a fair market value determination in valuing life estate interests, the issuance of tables

would have to be based on current economic factors in valuing such interests to not only be fair

and equitable, but to avoid a constitutional challenge. As noted above, using rates which are

unreasonably high in the current low interest environment would grossly overstate life estate

values. For example, the current Section 7520 rate under the Service’s tables is only 1%, which

is only one/tenth of the income the property is assumed to generate under the 10% tables

utilized by KERU.

Another problem in KERU’s use of IRS tables is that such tables are inapplicable and

can’t be used by the IRS when the taxpayer is “terminally ill,” i.e., the taxpayer has at least a

50% probability of passing within one year. Treas. Reg. Section 1.7520‐3(b)(3). In that

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situation, the life expectancy of the general population used to determine the duration of the

interest under the tables becomes inapplicable and a mortality factor specific for that individual

must be procured from the Service. Treas. Reg. Section 25.7520‐1(c). It is hard to conceive of

many situations in which a decedent/life estate holder would not have been terminally ill

immediately prior to death. As such, the mortality factor would normally result in an

exceedingly short term interest, from a minute to perhaps a few days or weeks.

That leads to the most problematic aspect of the KERU’s use of tables in valuing such life

estate interest as part of the medical assistance estate. Devoid of statutory or regulatory

authority or support to depart from fair market value, it follows that the valuation of the a

decedent’s life estate interest must be its fair market value statutorily dictated to be at the time

immediately prior to the her death (assuming the KERU does not desire to choose a zero value

applicable to a date of death value). There is no ambiguity in the statute in that regard.

Consequently, it is not surprising that there was no authority found for any state agency,

lacking any statutory or regulatory authority to do so, to utilize any tables, whether devised by

the state agency or not, to value a life estate interest for estate recovery purposes as opposed

to determining the interest’s actual fair market value.

When valued immediately prior to death, a decedent’s life estate interest has no more

value than an income interest limited to a term certain which was to expire at the decedent’s

death. It does not involve the passing of any additional interest to the remainder beneficiaries

upon the present interest holder’s death. It would be pure legal fiction and sophistic, as well as

a potential violation of constitutionally guaranteed equal protection, to hold that any such

passing occurred. In short, in most cases such value would only be nominal.

There also is a clearly justiciable issue with respect to KERU’s claim being an unlawful

taking of the remainder interest in the subject property. In that regard, the subject estate

recovery statute makes no distinction as to whether a given life estate was retained by the

grantor or created by a third party. Without question, there is no conveyance of any property

interest upon the death of a life tenant. The life tenant’s interest merely is extinguished by the

death of the life tenant, for the remainder interest owner(s) owned the entire interest in the

property subject to the interest of the life tenant. To say that any property interest passed by

virtue of the death of the life tenant that was truly the subject of the claim would be nothing

more than a legal fiction.

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Let’s assume a grantor had conveyed property to a party subject to a life estate in

another person. Assume further that the life tenant was a Medicaid recipient. To burden the

remainder beneficiary with a Medicaid recovery claim of the life tenant would be the same as

burdening the remainder beneficiary with a tax or judgment claim against the life tenant. It

would not be expected that any law would be found imposing the liability for any tax liability or

judgment claim against the remainder beneficiary, for no property interest passed at the time

of the life tenant’s death.

For a state agency to do so should constitute an unlawful taking of the remainder

beneficiary’s property interest without due process and just compensation. The same would be

true with respect to a party who purchased a property interest subject to a life estate retained

by the seller. However, the fact that there was no consideration paid by the remainder interest

beneficiaries in this situation does not change the nature of the taking. Nor does the statute

even make any concession to the amount of the recovery in a situation where the remainder

beneficiary actually may have purchased the property subject to the retained life estate.

Let’s assume a situation where a church purchased a fee simple interest in property

subject to the retained life estate of the seller. This was an actual situation in Hutchinson a few

decades past. The church purchased the property for a site to build a new church once the life

tenant had passed away. Had the life tenant subsequently been the recipient of Medicaid

benefits, and further, if upon her death the foregoing statutory provision was interpreted to

accord any substantial value to her life estate immediately prior to her death, under the

rationale of the KERU, the church would have had to pay the amount of such “remaining life

estate value” at the time of the seller’s death up to the amount of Medicaid assistance paid. As

the church had already paid the full value of the property, less the retained income value of the

property which the life tenant actually received through her anticipated life expectancy, and no

additional property interest passed to the remainder beneficiary by virtue of the death of the

life tenant, it is hard to conceive this would not be an unlawful taking of property from the

remainder beneficiary. Indeed, had the life tenant lived beyond her anticipated life expectancy,

she would have received more value than that attributed to her life estate in the purchase price

and the church would have overpaid for the property. Yet, under the KERU’s interpretation of

the statute, the state would have been able to exact yet additional money from the church

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attributable to a hypothetical value of her life estate just prior to her death. Again, the

unlawful taking of property under this scenario is patently obvious.

Although one could argue there should be a different result in the situation where the

life tenant created the interest by retaining a life estate in the conveyance, the taking of

property attributable to the remainder interest is nonetheless the same. Admittedly, one state

decision has held to the contrary. In In the Matter of the Estate of Ruby Laughead, 696 N.W.2d

312 (2005), the Iowa appellate court erroneously held that there was no such unlawful taking

by virtue of the fact that the remainder interest beneficiaries did not receive less upon the

death of the life tenant due to an unlawful taking, but due to the value of the decedent’s life

estate being charged with the burden of such payment. In Laughead, the value of the

decedent’s life estate was not at issue because the parties had stipulated to the value of the life

estate and the governing statute did not address the time at which such life estate was to be

valued.

The argument of the appellate court in this regard appears to have been cut from whole

cloth and dissembling. The interest of the remainder interest holders in the subject property

was clearly lessened both in value and in quantity due to the claim of the estate from what it

would have been had the decedent died in the absence of such claim. The claim did not arise

out of any additional property interest given to the remainder interest holders as a result of the

death of the decedent. It came from a property interest they had possessed prior to the

Medicaid claim even arising, indeed before the decedent even became a Medicaid recipient.

Moreover, the interest of the decedent’s life estate was extinguished by her death and had no

more value at the time of its expiration than a term interest which extinguished upon the

expiration of a specified term. Clearly, the latter situation would not permit the state to

constitutionally recover a claim against the remainder beneficiaries for Medicaid paid to the

term interest holder. Neither should it in the former situation simply merely due to an

ephemeral distinction that the life estate holder had a term interest tied to an independent

event, i.e., the term interest holder’s death.

No doubt due to the foregoing formidable legal hurdles in KERU making an estate

recovery claim against a life estate holder, HB 2742 was introduced in the 2012 legislative

session. Inter alia, if passed its provisions would have essentially given the Secretary of Health

and Environment virtual “carte blanche” statutory authority to determine the value of life

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estates for estate recovery purposes by rules and regulations, irrespective of any semblance to

their fair market value. Further, it provided that such life estates would be valued at time of

death, irrespective of the actual life expectancy of the holder of the life estate.

Fortunately, such legislation did not pass. A hearing was held in the Kansas House and it

was assigned to a subcommittee which recommended that further study be done and that it be

referred to an interim committee or to the Kansas Judicial Council. No formal referral was

made. Even had it passed, although valuations of life estates for estate recovery purposes

would have been authorized to be made by the KERC, the clear constitutional issues it would

have presented would not only have remained, they would have been exacerbated by the

failure to require that any life estate valuation under its provisions have any semblance to a

realistic market rate or that the actual life expectancy of the life estate holder be utilized in

circumstances where the life estate holder was terminally ill just prior to death.

b. Potential for Estate Recovery Expansion to Interests Created by Third Persons

The problems of estate recovery involving life estates principally have involved transfers

with a reserved life estate. However, it is important to note that the aforesaid Kansas estate

recovery statute makes no distinction between a “self‐settled,” i.e. retained, life estate and a

“third party” created life estate. Irrespective of the party creating the life estate, there is no

more a transfer of property upon the death of a life estate tenant who reserved such interest

than upon the death of a life estate tenant who received such interest from a third party.

What should be particularly troubling to elder law attorneys is the prospect of such

overreaching principles finding a transfer where none has actually occurred at the death of a

life tenant being also applied to interests in “third party trusts” at the time of the beneficiary’s

death and the simultaneous passing of the trust estate to remainder beneficiaries. In another

state, Iowa, which has estate recovery statutes substantively the same as Kansas, such

overreaching principles have been applied to just that situation.

In the case of In Re Barkema Trust, 690 N.W.2d 50 (Iowa S.Ct. 2004), the Iowa Supreme

Court held that a hybrid testamentary trust which provided for a beneficiary receiving Medicaid

benefits was subject to estate recovery by the State of Iowa upon the beneficiary’s death. The

theory of recovery was that had the State of Iowa not provided Medicaid benefits to the

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beneficiary, the trust would have been required to do so. Thus, the Court found that the

amount of the transfer at the time of the Medicaid recipient/beneficiary’s death to the

remainder beneficiaries was an amount of the trust estate equal to the amount that Medicaid

had paid for the beneficiary’s care during the beneficiary’s lifetime. The rationale was that had

the State of Iowa not provided such care, the trustee could have been compelled to do so.

The reason that the foregoing discussion involving Kansas appellate courts is particularly

important is that the State of Iowa in the Barkema decision followed the Third Restatement of

Trusts position on hybrid trusts, which, as noted above, the Kansas appellate courts have not to

date in any decision involving a hybrid trust. Because the Iowa Supreme Court found that

hybrid trusts do not create a discretionary trust in which distributions are limited to a support

standard, but a continuum, the Court was able to conclude that under the circumstances the

beneficiary could have compelled a distribution for support in the event that Medicaid had not

otherwise provided such support. Such decision has been consistently followed in subsequent

cases in Iowa. See, e.g., In the Matter of the Estate of Elenore Gist Iowa Department of Human

Services v. Susan Eral and Colleen Conrad, 763 N.W.2d 561 (Iowa S.Ct. 2009).

Given the disfavor, if not outright distaste, as clearly expressed in its decisions, of Kansas

appellate courts regarding estate planning strategies which limit assets in trust from being

considered a resource for Medicaid purposes, an estate recovery claim by the Kansas

Department of Health and Environment against a trust in a similar circumstance to that in the

Barkema decision may be just the vehicle that will result in Kansas appellate courts deciding to

adopt the Third Restatement of Trusts’ position on hybrid trusts in the same manner as has

Iowa. Indeed, it is highly likely that Kansas DCF will pursue just such an approach, as the Kansas

estate recovery statute is actually modeled after the Iowa statute.

Such fear is underscored by other provisions of the above discussed HB 2742,

introduced in the 2012 Kansas legislative session. A provision therein would require a trustee

to give notice to the State within 90 days of the death of a settlor or beneficiary if either

received Medicaid assistance, going on to provide that the State “shall recover upon any claim

to the trustee against such property.” It is hard to conceive of any other purpose for including

the underscored language other than to seek a claim against the trust estate passing to

remainder beneficiaries under the “Barkema” rationale.

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That is why it is very important to include the foregoing sample language in trusts not

only to make distributions discretionary in circumstances where it is necessary to do so to avoid

the trust estate being deemed an available resource for governmental resource benefits, but

also to ensure that the distribution provisions automatically convert to a purely discretionary

standard in the event that the trust estate would otherwise be subject to estate recovery.

Arguably, due to such provisions converting to a purely discretionary standard in a

circumstance that it would need to do so to preclude estate recovery, the beneficiary could not

have compelled a distribution in the very circumstances the beneficiary would otherwise qualify

for governmental resource benefits would preclude such theory resulting in estate recovery.

Also, as noted above with respect to including Special Trustee/Trust Protector provisions to

ensure governmental resource availability, such provisions also would be desirable to authorize

an amendment to the trust in the event such provisions were not efficacious in avoiding estate

recovery against the trust estate upon the death of a beneficiary receiving Medicaid or any

other governmental resource benefits.

These are not only important provisions to include in trusts specifically drafted for

beneficiaries who are already receiving Medicaid benefits, but also as a general provision for all

long‐term trusts, particularly lifetime generation‐skipping trusts created for asset protection.

Beneficiaries who may not be currently suffering from a disability could obviously incur a

disability for which they might otherwise qualify for governmental resource benefits at any

time in the future.

III. Spousal Revocable Trust Planning

Estate planning through revocable trusts is preferred from a number of perspectives,

including avoiding probate, preserving privacy regarding assets in the estate and its disposition

with respect to the general public and other family members, simplifying post‐death

procedures and minimizing exposure to creditor claims against the estate. The problem is that

it is not favored with regard to Medicaid eligibility planning for a surviving spouse. The vast

majority of estates of predeceased spouses will not have an immediate issue regarding a

surviving spouse being on Medicaid, and there would be only a minority of such situations in

which the surviving spouse would later become disabled and otherwise qualified for Medicaid

benefits. The problem is thus one of properly drafting revocable trusts so as to preserve their

benefits in the vast majority of circumstances in which the issue of the predeceased spouse’s

assets does not impact the Medicaid eligibility of the surviving spouse, but also to not adversely

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impact such eligibility when it does. Once that problem has been properly addressed, other

provisions of the revocable trust can ensure that the maximum amount of assets is held in the

predeceased spouse’s revocable trust so as to minimize the amount of required “spend down”

by the surviving spouse.

a. Impact of the “Miller decision”

In a Kansas Supreme Court decision in which the KBA Real Property, Probate and Trust

Section Executive Committee strongly disagreed with respect to its legal analysis and statutory

construction, Miller v. SRS, 275 Kan. 349 (2003), the Court held that with respect to assets left

in a testamentary trust for the benefit of the surviving spouse, the amount of the trust with

respect to which the surviving spouse would be entitled under Kansas law, including the

spousal elective share under K.S.A. 59‐6a201, et seq., and statutory allowances, will be deemed

to be a resource of the surviving spouse and subject to “spend down” prior to the surviving

spouse qualifying for Medicaid. This result ensues irrespective of whether the surviving spouse

actually made such election or even was precluded from making such election by a spousal

consent to the predeceased spouse’s will (and also presumably under the provisions of a

premarital agreement) that was not even motivated by any intent to qualify the surviving

spouse for Medicaid benefits.

The legal conclusion of the Court in Miller was that the surviving spouse should be

deemed to have made such election unfettered by any legal restrictions and then have

contributed such amount to the predeceased spouse’s testamentary trust. That would in turn

result in such deemed contributed amount to be “self‐settled,” thereby requiring such amount

to be spent down prior to the surviving spouse qualifying for Medicaid. Had the predeceased

spouse left the estate assets entirely to the predeceased spouse’s children, e.g., children of a

prior marriage pursuant to a premarital agreement, presumably to be consistent, the Court

would have similarly deemed such transfer to be a disqualifying transfer by the surviving spouse

with respect to such same amount. The surviving spouse in that situation would then have had

to rely on the discretion of the Division of Children and Families to not consider such transfer

due to it not having any relation to qualifying for Medicaid eligibility. If the DCF gave deference

to such argument, which would be expected to be highly unlikely, it would then be treating

such “transfer” differently depending upon to whom it was deemed made, thereby encouraging

predeceased spouses to disinherit their spouses in many circumstances when they would not

have done so in the absence of Medicaid considerations.

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Without question, the “Miller rationale” is now governing law and thus must be

factored in with respect to any estate planning impacting the qualification of a surviving spouse

for Medicaid.

b. Federal Statutory Authority Favoring Wills Over Revocable Trusts

In defining what constitutes a “self‐settled trust” such that the trust estate would be

deemed to be a resource to the beneficiary to the extent that the trustee has any discretion to

distribute the assets of the trust estate to such beneficiary, 42 U.S.C. Section 1396p(d)(2)(A)

provides that an individual shall be considered to have established a trust if assets of the

individual were used to form all or part of the corpus of a trust and if the individual or the

individual’s spouse established such trust other than by will. It was argued by the trust

beneficiary in Miler, understandably to no avail, that such provision precluded the trust estate

of the testamentary trust from being considered a resource to the surviving spouse for

Medicaid purposes.

Thus, in using a revocable trust as the primary estate planning instrument, there is the

clear risk that a trust created for the surviving spouse upon the death of the grantor spouse will

be considered to be a self‐settled trust, thereby exposing the entire trust estate to being

considered a resource to the surviving spouse. Although one could argue that a revocable trust

following death performs essentially the same function as does a will with respect to

disposition of the estate, such argument very well may not prevail, particularly in Kansas’

judicial climate disfavoring such Medicaid planning strategies. In the Connecticut cases of

Bezzini v. Department of Social Services, 715 A.2d 791 (1998) and Skindzier v. Department of

Social Services, 2001 Conn. Super. LEXIS 12 (2001),which was within the context of determining

whether disqualifying transfers had occurred with respect to transfers involving an inter vivos

trust or a will under the same statutory distinction, the court was quick to find the exception for

trusts created by a predeceased spouse for the surviving spouse by will to not be equally

applicable to revocable trusts, citing the different procedures involved in their administration.

Consequently, careful drafting is required to preclude such adverse result in

circumstances where the DCF should assert a post‐death trust created for a surviving spouse

under the provisions of the deceased spouse’s revocable trust runs afoul of such foregoing

federal statutory provisions. Thus, a provision should be included in the revocable trust giving

the trustee the discretion upon the grantor’s death to distribute the trust estate to the personal

representative of the decedent’s estate (who or which should be the same) in the event there is

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a “pour over” will with respect to which the revocable trust is the sole beneficiary and the

assets of the revocable trust otherwise would be deemed to be a resource to the surviving

spouse for Medicaid purposes. In addition, a coordinating provision would be included in the

grantor’s/decedent’s “pour over” will which authorizes the personal representative to not

distribute the estate to the trustee of the decedent’s revocable trust in that same event , but

alternatively to the trustee of a testamentary trust incorporating by reference the provisions of

the decedent’s revocable trust. Provisions such as the following should suffice to effectuate

that result:

Discretionary Distribution of Trust Assets to My Estate. The Trustee, in the

Trustee’s sole and absolute discretion, may distribute all or a portion of the trust

estate to the Personal Representative of my probate estate following my death,

provided the Trustee determines it is to the advantage of the trust beneficiaries

to do so and such assets so and such assets so distributed to my probate estate

are either distributable to the trust estate under the provisions of my Will or

distributable to the trustee of a testamentary trust incorporating by reference all

provisions of this Trust Agreement as they exist at the time of my death, in which

latter event the Trustee is additionally authorized to distribute the trust estate

directly to the Trustee of such testamentary trust.

Residuary Estate. After satisfaction of the foregoing provisions, my entire

residuary estate I give to the Trustee of my Revocable Trust, as it may be

amended from time to time prior to my death, to hold, administer and distribute

as a part of the trust estate. Alternatively, in the event the Trust Agreement is

not then in existence, the Trust is not legally valid, or my Personal

Representative, in the Personal Representative’s discretion, determines that

such distribution to the Trustee of my Revocable Trust would subject the assets

so distributed to be considered an available resource to a Trust beneficiary for

governmental resource purposes (e.g., Medicaid or SSI), whereas such would not

be the case if such distribution was made to a testamentary trust created under

the provisions of my Will having provisions identical to that of my Trust with

regard to such beneficiary, my Personal Representative is authorized to

distribute my residuary estate to the Trustee of my Revocable Trust, as a

testamentary Trustee and not as Trustee of my Revocable Trust, to be held and

disposed of for the same uses and purposes, and subject to the same powers

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and duties as are set forth in the Trust Agreement as it exists as of the date of

execution of this Will; and for this purpose, the provisions of the Trust

Agreement are hereby incorporated by reference in this Will as if fully set forth.

Note that the foregoing provision for inclusion in the trust agreement does not mention

a Medicaid qualification purpose. Such reference is omitted so as to not be a “red flag” to DCF

and also permit a distribution for any other beneficial purpose, e.g., an income tax benefit

available to the estate which was not available to the trust.

Such provisions would also permit the testamentary trust to be created without actually

distributing the trust estate to the estate, but directly to the trustee of the testamentary trust.

In circumstances where there would as otherwise no probate estate and it was not desired to

admit the will to probate for the purpose of creating a testamentary trust upon the grantor’s

death due to there being no immediate or reasonably foreseeable need to do so, the decedent

spouse’s will simply could be filed by K.S.A. 59‐618a affidavit and admitted to probate for such

purpose at any subsequent time the surviving spouse should incur a disability and otherwise

meet Medicaid qualification requirements.

c. Ensuring Most Marital Assets Held In Predeceased Spouse’s RT

To minimize the amount of “spend down” required for a surviving spouse to qualify for

Medicaid, it is best that the vast majority of marital assets be held in the RT of the predeceased

spouse. This not only avoids the surviving spouse having assets in excess of the elective share

and statutory allowances, but also the wrong kind of assets, i.e., non‐exempt assets versus

exempt assets. It also would permit the trustee of the predeceased spouse’s trust, when

authorized to do so, to either distribute exempt assets to the surviving spouse in order to

qualify the surviving spouse for Medicaid or no assets at all, in which event distributions to the

surviving spouse would remain subject to the distribution standard of the trust. The latter

course of inaction may be desirable if the surviving spouse had been on Medicaid for an

extended period of time prior to the predeceased spouse’s death and it would better to private

pay long‐term care up to the amount of the elective share and spousal allowances than expose

exempt assets to full estate recovery upon the death of the surviving spouse by distributing

them outright to the surviving spouse to satisfy the surviving spouse’s elective share and

spousal allowances in order to accelerate the surviving spouse’s continued eligibility for

Medicaid benefits. Under Kansas provisions of the Uniform Trust Code, if not expressly

provided in the trust instrument, the trust, if necessary, could be divided into “elective share”

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and a “non‐elective share” for the purpose of keeping such shares separate and accounting for

such “spend down.” See K.S.A. 58a‐417.

Not knowing with any degree of certainty which spouse will predecease the other, the

only way to ensure that result and the aforesaid flexibility is for the RTs to include reciprocal

powers of appointment in both RT’s pursuant to which assets held in the surviving spouse’s

revocable trust, or held in the predeceased spouse’s name, excluding assets held in joint

tenancy or which have a beneficiary designation (such as IRAs), are “pulled into” the

predeceased spouse’s RT. This is accomplished by reposing general powers of appointment in

the other spouse in both RTs in the event the grantor is the surviving spouse and then including

an additional provision in both RTs which results in the exercise of such power of appointment

by the spouse who predeceases the surviving spouse in favor of the trustee of the predeceased

spouse’s RT.

If desired, the provisions reposing such general power of appointment in favor of the

predeceased spouse’s RT could include a self‐revocation provision in the event the predeceased

spouse has subsequently amended the dispositive provisions of his or her RT without securing a

spousal consent. However, for the power to still be a general power of appointment and not a

limited power of appointment (to secure potential income tax and asset protection benefits

and avoid the adverse aspects of the “relation back doctrine” discussed below), the assets

would have to be exposed to the creditors of the predeceased spouse’s estate, which they

would be under provisions of the Kansas Uniform Trust Code, for assets in a revocable trust are

subject to claims of the grantor upon the grantor’s death. K.S.A. 58a‐505(a)(3).

In addition to Medicaid planning advantages, such reciprocal powers of appointment

have asset protection advantages in precluding the assets held in trust for the surviving spouse

from passing to a new spouse should the surviving spouse remarry and providing some

protection to the trust estate being exposed to claims of the surviving spouse’s creditors. With

respect to any appreciated capital gain assets “pulled into” the predeceased spouse’s RT, such

assets should receive a “step up” in income tax basis under Section 1014 of the Internal

Revenue Code due to being includible in the estate of the predeceased spouse for estate tax

purposes (irrespective of whether an estate tax is actually owing). Although the Service has

taken the position in private letter rulings that such “step up” would not occur due to the

application of Section 1014(e) of the Internal Revenue Code, the literal language of such Code

provision does not apply to such circumstance. However, in such same private letter rulings the

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Service concluded that the marital gift tax deduction will apply upon the exercise of such

general power of appointment by the predeceased spouse and the predeceased spouse will be

deemed to be the transferor for estate tax purposes, thereby sanctioning the use of such

reciprocal powers of appointment for estate and gift tax planning purposes.

However, using such strategy raises the specter of DCF asserting that the assets of the

surviving spouse which are “pulled into” the predeceased spouse’s RT by virtue of the exercise

of such general power of appointment by the predeceased spouse results in such assets being

deemed to be in a “self‐settled trust” for the benefit of the surviving spouse. However, DCF’s

successful assertion of such position would be far from certain. DCF would have to have

inquired as to the source of such assets for the issue to even have arisen. Secondly, unlike

limited powers of appointment, in which the exercise of the power “relates back” to the donor,

i.e., the donor of the power is deemed to have exercised it (e.g., for rule against perpetuities

purposes), increasingly the exercise of a general power of appointment is being deemed by the

courts not to relate back, but be considered a transfer by the donee exercising the power. This

makes sense, for a holder of a general power of appointment is deemed to be the owner of

property for both estate tax purposes and exposure of assets to creditors. If so, the only issue

would appear to be whether the surviving spouse would nonetheless be deemed to have made

a disqualifying transfer for Medicaid purposes, for the transfer would be to a revocable trust of

a spouse who died at the time of the exercise of such power, rather than directly to the spouse.

The argument against such result is that the Service, in a gift and estate tax context, has ruled

that such transfer is equivalent to a transfer to a spouse for purposes of the analogous

circumstance of achieving a marital gift tax deduction.

Such strategy could also be beneficial should a spouse on Medicaid predecease the

community spouse. By “pulling in” the assets of the surviving spouse into the predeceased

spouse’s RT and then leaving the trust estate in a “special needs” trust for the surviving spouse,

arguably not only should it achieve the same benefit should the surviving spouse later become

disabled, it should also reduce the exposure to estate recovery of the trust estate upon the

surviving spouse’s death, for the assets that would have otherwise been held by the surviving

spouse are in a “supplemental needs” trust created by the predeceased spouse.

IV. Transfer of Assets in Trust for Purposes of the Five Year “Look Back” Rule

The “five year look‐back period” under the Deficit Reduction Act of 2005 applies to both

outright transfers and transfer of assets into an irrevocable trust. For most individuals, it is

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desirable to make such transfers into an irrevocable trust, rather than outright to children. Not

only will such transfers in trust keep the assets intact during the grantor’s lifetime free of claims

of spouses of children and their creditors, and make provisions for any distributions to children

in the manner the grantor intends, it can continue such asset protection following the grantor’s

death by creating separate trusts for children for their lifetime. Moreover, gifting assets to an

irrevocable trust can achieve substantial income tax benefits not achievable with outright

distributions.

a. Principal a Resource to Grantor if Grantor a Principal Beneficiary

Principal will be deemed to be a resource to the grantor to the extent the trustee has

the discretion to distribute principal to the grantor. However, the income of the trust can be

distributed to the grantor for the remainder of the grantor’s life without resulting in the

principal being deemed a resource to the grantor.

Query: At the grantor’s death, will KERU seek estate recovery against remainder

beneficiaries using the same theory it has employed in a retained life estate context? If so,

perhaps this problem could be avoided by making the distribution of such income completely

discretionary with the trustee. However, the income in that event still would be deemed to be

available to the grantor for Medicaid eligibility purposes, irrespective of whether it was actually

distributed to the grantor.

b. Provisions Providing Flexibility and Indirect Grantor Control

It is not desirable for the grantor to serve as trustee. However, there should be no

adverse Medicaid eligibility issue after the expiration of the five year look‐back period if the

grantor retains the ability to discharge the trustee and name successor trustees. If descendants

are discretionary beneficiaries of the trust during the grantor’s lifetime, there also should be no

problem in the grantor retaining, or perhaps giving a third party Special Trustee/Trust

Protector, veto authority as to such distributions. Moreover, the grantor can retain a limited

power of appointment pursuant to which the grantor may appoint the trust estate during

lifetime (exercised through a written instrument) or at death (under the provisions of the

grantor’s will or revocable trust) typically among the grantor’s descendants, surviving spouses

of descendants and charities. None of such provisions should pose any Medicaid eligibility

issues after the five year look‐back period, for they don’t reserve any economic benefit in the

grantor. However, if the grantor has retained an income interest in the trust for lifetime,

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exercising any such lifetime limited power of appointment could be deemed to result in a

subsequent transfer of the income interest attributable to the principal being appointed.

c. Benefits of “Grantor Trust Status”

For reasons discussed below, it is also usually desirable to achieve “grantor trust” status

for the trust, such that all income of the trust is taxed back to the grantor in the grantor’s

individual capacity under the so‐called “grantor trust rules” found in Sections 671 through 679

of the Internal Revenue Code. If the grantor has reserved a lifetime power of appointment

discussed above during lifetime, such power of appointment alone would cause the trust to be

a “grantor trust” under Section 674 of the Code, for the grantor has reserved the right to

control the beneficial enjoyment of the trust estate. If the grantor does not retain a lifetime

limited power of appointment, but retains only a limited power of a power of appointment at

death, there would be no right to control such beneficial appointment during lifetime and thus

“grantor trust status” should not be activated by virtue of such retention. If the grantor has

retained the right to the income of the trust, it would be a “grantor trust” under Section 677 of

the Code.

There is one provision under the “grantor trust rules,” Section 675(4)(C) of the Code,

which alone would invoke “grantor trust” status. That provision would be a reservation by the

grantor, in a non‐fiduciary capacity, of the right to substitute assets in the trust in return for an

equivalent value of assets in the trust estate. This should not make the grantor a beneficiary of

the principal for Medicaid purposes, for the grantor has to transfer to the trustee assets having

the same value as assets the grantor receives from the trust estate, thereby not providing any

economic value to the grantor “in the trade” so as to consider the grantor a beneficiary. Should

such status not be desirable later and this was the only provision in the trust which created

such status, the trust could be subsequently transformed into a non‐grantor trust by reposing

authority in a Special Trustee/Trust Protector to amend the trust by deleting such provision.

Once “grantor trust status” is achieved, the following income tax benefits can be

achieved: (a) the income of the trust can be taxable at the grantor’s normally low income tax

rates compared to those of the trust or its beneficiaries; (b) the sale of the grantor’s personal

residence can qualify for the income tax exclusion upon its sale under Section 121 of the

Internal Revenue Code to the full extent it would have so qualified had the grantor not

transferred it to the trust; (c) medical expenses due to grantor’s long term care can be

deducted against the trust income and any other income of the grantor; and (d) no separate

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income tax return need be filed for the trust, as all income of the trust is reportable under the

grantor’s social security number.

d. Benefits of Inclusion in Grantor’s Taxable Estate

If appreciated capital gain property is transferred outright to children, the income tax

basis of the gifted assets in the children’s hands is the same as that it was in the grantor. On

the other hand, if assets transferred to the trust remain includible in the taxable estate of the

grantor, the assets of the trust are normally eligible to receive a “step up” in basis to their fair

market value on the grantor’s date of death under Section 1014 of the Code. The grantor’s

estate does not have to actually pay any estate tax to receive such income tax benefit. With a

current $5.12 million federal estate tax exemption and the probability it will remain quite high

in future years (for it is likely that Congress will prevent the reversion of such exemption back to

$1.0 million in 2013), such inclusion is not likely in the vast majority of estates to occasion any

actual estate tax liability. Moreover, Kansas repealed its estate tax effective for decedents

dying after December 31, 2009.

If the grantor retains the foregoing limited power of appointment, whether during

lifetime or only at death, such retention avoids both a completed gift for gift tax purposes upon

the transfer to the trust and causes the trust estate to be includible in the grantor’s taxable

estate under Section 2036(a)(2) of the Code. If the grantor reserves an income interest for life,

such retained income interest in the trust estate would likewise cause the trust estate to be

includible in the grantor’s taxable estate under Section 2036(a)(1) of the Code. In short, either

approach will effectuate the desired qualification for a “step up” in the income tax basis of

appreciated assets in the trust estate at the time of the grantor’s death.

e. Use of Strategy by Surviving Spouse When Predeceased Spouse Received

Medicaid Benefits

The identical strategy should also able to be utilized by the surviving spouse of a

predeceased spouse who received Medicaid benefits in order to avoid or limit estate recovery.

Although transfers to avoid estate recovery for Medicaid benefits against the estate of a person

can be set aside, such statutory authority is limited to transfers by a “Medicaid recipient.”

K.S.A. 39‐709(g)(2). Such statutory provision literally would not apply to a surviving spouse of a

Medicaid recipient.

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The foregoing strategy could have a dual benefit should the surviving spouse survive the

five year look‐back period from the date of the transfer and thereafter also qualify for Medicaid

benefits in their own individual right by virtue of the transfer. However, if the grantor/surviving

spouse reserves an income interest for life, the same foregoing life estate strategy KERU has

argued in the past upon the death of a life tenant could be invoked as well in this situation. If

so, it would have the potential to recover the amount of Medicaid benefits paid to both the

predeceased spouse and the surviving spouse up to the value of the retained life interest

deemed to have been transferred to the remainder beneficiaries at the time of the surviving

spouse’s death.

f. Include Savings Clause in Trust Instrument

To ensure that the transfer to the trust commences the five year look‐back period and

no provision of the trust instrument could be construed to adversely affect or negate that

intended consequence, a “savings clause” should be included in the instrument. Such provision

would delineate that it is the grantor’s intent that notwithstanding any provision in the

instrument to the contrary, no provision of the trust instrument may be construed, or given

effect, to the extent that it would negate such consequence, and any such provision which

could be so construed to negate such intent shall be null and void, ab initio. As state law

governs the construction of trust provisions, and the grantor’s intent is the polestar in such

construction, such savings clause should be given effect by the courts to the extent any

provision that would adversely affect such desired result was inadvertently included in the trust

instrument.

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