SSI² and Medicaid³ provide payments and extend services to disabled persons but only those whose assets do not exceed miserly statutory thresholds⁴.

Parents, while living, are able to protect and support their developmentally disabled child, unfortunately unable to secure his own livelihood, much less to accumulate retirement funds to secure him against the progressive ravages of predictable debilities, handmaidens to advancing age. Those parents are properly concerned that, after their own deaths, their disabled child, bereft of parental guidance and deficient in coping skills⁵, will be held hostage to ever changing and likely diminishing government programs. Those parents beseech estate planning lawyers to construct mechanisms designed to provide lifelong protection to their disabled child and continued access to needs-based government benefits.

Unavailing, however, are trusts employing standard "boilerplate" trust language directing trustee application of income and principal for the disabled beneficiary's health and support [a "mandatory support" trust]. Because a mandatory support trust beneficiary through a court of equity can compel the trustee to exercise its fiduciary powers to provide the mandated health and support⁹, such a trust constitutes an "available resource" which disqualifies the beneficiary for needs-based government programs.

Required, instead, are spendthrift¹⁰ trusts available only in the trustee's absolute discretion and then only after all other available resources--including, specifically, government payments and programs--have first been utilized. Such a completely discretionary spendthrift trust does not constitute an "available resource" and the beneficiary remains eligible for needs-based government programs such as SSI and Medicaid; the trust principal cannot be counted in determining the trust beneficiary's "available resources"¹¹.

Such wholly discretionary trusts¹², testamentary or inter vivos, will continue to be utilized by parents and other family members¹³ who seek to provide lifetime protection for their disabled family member funded with the grantors' (as opposed to the disabled beneficiary's) property ["third-party special needs trusts"] and to assure to remainder beneficiaries availability of date of death trust principal free of postmortem Medicaid recapture.¹⁴

Although the grantor of a self-settled trust cannot at common law insulate himself from creditors, tort or contract, by the nimble expedient of inserting spendthrift provisions into the trust document¹⁵, recent federal legislation in effect permits a disabled grantor to spendthrift himself for the limited purpose of needs-based benefits qualification. OBRA `93¹⁶ authorizes three types of self-settled trusts which may be utilized without disqualifying the disabled beneficiary for needs-based benefits.¹⁷ One will be mentioned and two discussed.

(1) Trusts funded exclusively with the disabled beneficiary's pension, social security, or other income stream [the "(d)(4)(B) trust"]¹⁸.

(2) Trusts funded with the disabled beneficiary's own assets if (i) the beneficiary at the trust's inception is under age 65, and (ii) the trust is established by [i.e., the trust's nominal grantor is] the disabled beneficiary's parent, grandparent, legal guardian or a court [the "(d)(4)(A) trust"]¹⁹.

(3) Trusts funded with the disabled beneficiary's own assets if (i) the trust is "established and managed by a nonprofit association", (ii) a separate account is maintained within the trust for each beneficiary, (iii) all separate accounts are pooled for purposes of fund investment and management, and (iv) those separate accounts are established by the disabled beneficiary's parent, grandparent, legal guardian, a court, or the beneficiary, directly²⁰ [the "(d)(4)(C)" or "pooled" trust]²¹.

Advantages of the (d)(4)(A) [under age 65] "payback" trust as opposed to the "pooled" or (d)(4)(C) "payback" trust include the ability to select trustees and determine trust investment policy. Both (d)(4)(A) and (d)(4)(C) trusts permit the trust instrument to designate family members or others as remainder beneficiaries, net of the required recapture amount, on the disabled beneficiary's death²³.

Disabled self-settled "payback" trust beneficiaries age 65 or older, and all self-settled "payback" trust beneficiaries regardless of age who wish to thwart postmortem trust recapture, must utilize the "pooled" trust.

"Pooled" trust²⁴ date of death account balances enjoy a distinct advantage²⁵ unavailable to the other two self-settled "payback" trusts: to the extent "retained by the trust"²⁶, they escape recapture at the beneficiary's death. Presumably, the "retained by the trust" requirement is satisfied by the trustee's postmortem allocation of the deceased beneficiary's date of death account balance pro rata among all other separate accounts then administered by the trustee²⁷. Presumably, too, the "nonprofit association" requirement is satisfied if the trustee is an IRC § 501(c)(3) organization.

Responsive to OBRA '93, several Nebraska located § 501(c)(3) organizations have established "pooled" trusts. Disabled beneficiaries and their families are attracted by the ability by careful drafting to avoid state recapture at the beneficiary's death.

The well-drafted self-settled "payback" trust should be irrevocable³¹ and, lest the trust be deemed an "available resource"³², fully discretionary. Recommended is a severability provision. Identified in an attached trust schedule should be a detailed recital of the property transferred to the "payback" trust. The trust should require annual accountings of trust receipts, expenditures, disbursements, and an inventory of the property comprising trust principal at the end of each accounting period. Conformably with the governing statute, provisions are required directing repayment, at the disabled beneficiary's death, to the Medicaid-providing state(s) in an amount equal to total medical assistance paid to the disabled beneficiary. Competent disabled³³ beneficiaries can be granted testamentary nongeneral powers of appointment respecting trust principal remaining at the beneficiary's death net of the recaptured amount, followed by default provisions absent effective appointment.

Introducing complexity into the self-settled "payback" trust equation for Nebraska residents is Neb. Rev. Stat. § 68-1047³⁷ which, in determining eligibility for needs-based benefits such as Medicaid, deems to be revocable³⁸ any post-June 10, 1993 irrevocable³⁹ trust established "by or on behalf of" a trust beneficiary, the principal of which is comprised of the beneficiary's own assets, litigation proceeds or claims settlement.

The statute declares "void and unenforceable" self-settled trusts if the grantor-beneficiary applies for public assistance (includes Medicaid). The trustee can escape this consequence, however, upon a competent court's order "for good cause shown" approving a self-settled trust whereunder assets or income are available for "specific goods and services not covered by" public assistance. The applicable state agency must receive notice of the court proceeding and is given standing to appear as an interested party. § 68-1047(1).

Unresolved, however, is the extent of the court's discretion under the elastic rubric "for good cause shown". Is "good cause shown", if the grantor-beneficiary merely presents trust language which precludes the trustee from utilizing trust income and principal to pay for "goods and services" statutorily available? Can a court find good cause has not been shown because the state's public assistance rolls have swollen by adding yet another grantor-beneficiary whom the judge believes should utilize his own resources other than those of the state taxpayers?

To the extent the language "for good cause shown" clothes the court with discretion to refuse approval of a self-settled irrevocable trust which clearly qualifies the grantor-beneficiary under OBRA `93 ⁴⁰ to receive government funds and services, the statute is suspect.

Should it be authoritatively held that for "good cause shown" permits the court in its discretion to find the trust "void and unenforceable", § 68-1047 conflicts directly with the Congressional intent expressed in OBRA `93 which on its face pre-empts⁴¹ the area of Medicaid qualification as to self-settled trusts. If, indeed, conflict exists⁴², state statute must yield to federal statute under constitutional principles⁴³ and the conflicting state statute falls.

Required to be irrevocable, self-settled "payback" trusts will create interests in the remainder beneficiaries (net of the "recapture" amount) when funded. Trust drafters will probably wish to reserve to the grantor-beneficiary nongeneral powers of appointment exercisable by will to prevent funding from constituting a taxable transfer⁵⁰.

Self-settled "payback" trusts are includable in the disabled beneficiary's gross estate for federal estate tax purposes⁵¹. Should the trust continue after the disabled beneficiary's lifetime for successive beneficiaries two generations or more below the disabled beneficiary's generation, the trust may attract generation-skipping tax⁵². Although so much of the trust principal as is ultimately recaptured by the state should avoid generation-skipping tax, the overplus should be protected by the trustee's timely electing to apply a portion of the beneficiary's GST exemption⁵³.

This paper provides an overview of trusts designed to qualify disabled beneficiaries for needs-based statutory benefits. Applicable law, however, is expressed in a sprawling maze of intertwining federal and state statutes and regulations, "Byzantine" in complexity [Note 34]. To present core concepts accurately, yet usefully, the text has been purged throughout of qualifications and limitations that may apply to any given factual situation.

¹ Disabled: Persons unable to engage in any substantial gainful activity by reason of medically determinable physical or mental impairment which can be expected to result in death or which has lasted [or can be expected to last] for continuous 12 month period [includes similarly impaired child under age 18]. 42 U.S.C. § 1382c (a)(3)(A); Neb. Rev. Stat. §68-1005. This paper concerns both developmentally [congenitally] mentally disabled and physically disabled persons.
² Supplemental Security Income ["SSI": federally funded program providing cash payments to the aged, blind and disabled]: 42 U.S.C. § 1381 et seq.; 20 CFR § 416.101 et seq. SSI qualification often carries with it qualification for federal and state benefits such as HUD housing supplements, case management services, vocational training and placement, adult education, day programs and social services.
³ Medicaid [federal and state funded, state administered program providing medical assistance to the aged, blind and disabled]: 42 U.S.C. § 1396 et seq. A person who qualifies for SSI qualifies, generally, for Medicaid, also, except that "§ 209(b) states", Nebraska included [Note 18], may impose financial need standards more restrictive than federal standards if those state standards are no more restrictive than those in effect under the state's Medicaid plan as of January 1, 1972. 42 CFR §§ 435.121(a); 435.840(c). See 42 U.S.C. § 1381 et seq.
⁴ Household goods and personal effects up to $2,000; automobile; life insurance (CSV $1,500); cash $2,000; burial space or burial insurance or trust, $1,500; owner-occupied principal residence with surrounding land; trade/business, or nonbusiness, property essential for self-support. 42 U.S.C. § 1382b; 20 CFR § 416.1210.
⁵ Applies to mentally disabled beneficiaries only.
⁶ Kruse, Jr., Third Party and Self-Created Trusts, ABA Publishers (2d ed. 1998); Wernz, Let's Put the Fun Back in Dysfunctional: The Challenges of Drafting and Administering Discretionary Provisions, 23 Notre Dame Tax and Est. Plan. Inst. at 8-28 (1997).
⁷ "Available resources" means "cash or other liquid assets or any real or personal property that an individual owns and could convert to cash to be used for his support and maintenance" [less excepted items, n4]. A "resource" is property the [recipient] has the "right, authority or power to liquidate." 20 CFR § 416.1201(a). Disqualifying "income" means "anything you receive in cash or in-kind that you can use to meet your needs for food, clothing or shelter." 20 CFR § 416.1102. See Mooney, Discretionary Trusts: An Estate Plan to Supplement Public Systems for Disabled Persons, 25 Ariz L. Rev. 939, 959 n.112 (1983). A trust-owned automobile or van [such as a specially fitted handicap-equipped van] is not considered a disqualifying "resource" so long as the trust is wholly discretionary. Program Operations Manual System ["POMS"], Social Security Administration, Department of Health and Human Services, SI §1 00830.640 C3. Discretionary trust-paid personal services such as medical, dental or nursing care, housekeeping, meal preparing, grocery shopping (or like services enabling trust beneficiary to continue to live at home) are not disqualifying. 20 CFR 416.1103(a); POMS SI §1 00810.080 C.
⁸ Note 4. In determining Medicaid eligibility, a recipient's spouse's resources and income are imputed to the recipient. See, e.g., 42 U.S.C. § 1396p(d)(2); (e)(1). See Note 13.
⁹ Illustrative is Sand v. Beach, 270 NY 281,200 NE 821 (1936) (beneficiary can compel trustee to distribute amount trustee in exercise of reasonable discretion determines necessary for support and education); Restatement (2d) Trusts § 157.
¹⁰ Spendthrift trusts are valid under Nebraska law. First National Bank of Omaha v. First Cadco Corp., 189 Neb 734, 205 NW2d 115 (1973); Lancaster County Bank v. Marshel, 130 Neb 141, 264 NW 470 (1936); Beals v. Croughwell, 140 Neb 320, 299 NW 638 (1941); accord: Nichols v. Eaton, 91 U.S. 716 (1875); Restatement (2d) Trusts § 152. Spendthrift provisions affirm the "right of the donor to control his bounty and secure its application according to his pleasure": Matter of Shurley, 115 F3d 333 (5th Cir.1997).
¹¹ Until the trustee elects to exercise its discretion, the beneficiary's interest in the trust is a mere expectancy, Bogert, Trusts and Trustees § 228 (Rev 2d ed 1992). See, e.g., POMS, SI §1 01120.105A2; First Northwestern Trust Co. v. IRS, 622 F.2d 387 (8th Cir), cert. denied 449 U.S. 1065 (1980) (beneficiary of discretionary trust has "no identifiable or ascertainable interest or right" in the trust and, thus, no interest which can be reached by creditors); U.S. v. O'Shaughnessy, 517 NW2d 574 (Minn 1994) (discretionary trust beneficiary has a "more expectancy" in the trust); First National Bank of Omaha v. First Cadco Corp, 189 Neb. 734, 205 NW2d 115 (1973); Godden v. Dept. of Public Welfare, 193 Neb. 269, 226 NW2d 627 (1975); Jansen v. Dept. of Public Welfare, 201 Neb 185, 266 NW2d 742 (1978) ([The interest of a beneficiary in a discretionary trust is not an "available resource"); Smith v. Smith, 246 Neb 193, 517 NW2d 394 (1994) ("[S]upport trusts may be reached by creditors for support-related debts, but . . . discretionary trusts may not be reached by creditors for any reason."); contra; Young v. State Dept. of Human Services, 668 NE2d 908 (Ohio 1996) (dissent-ing opinion).
¹² Third party established and funded discretionary trusts are not deemed Medicaid-disqualifying under Nebraska case law. See Nebraska cases cited in Note 11. Broad discretionary powers over trust income and principal should be confided to the trustee inasmuch as trustee exercise of discretion won't be overridden by the court absent bad faith or fraud. Scully v. Scully, 162 Neb. 368, 76 NW2d 239 (1956); In re Johnson Trust Estates, 211 Neb. 750, 320 NW2d 466 (1982). Principal of a trust is not counted as a "resource" if beneficiary's access to principal is so restricted that only the trustee or a court can invade the principal. POMS SI §1 01120.105A.2. See Frolik, Estate Planning for Parents of Mentally Disabled Children, 40 U.Pitt L.Rev 305, 327-337 (1979).
¹³ Other than the disabled beneficiary's spouse. § 1396p(d)(2)(A) [see Note 4]. A spouse-created inter vivos [but not testamentary] Special Needs (wholly discretionary) Trust is equated with, and must conform to the requirements imposed by, OBRA `93 [Note 15] as to self-settled discretionary trusts, herein discussed. § 1396p(e)(1).
<sup>14</sup> See text incorporating Note 22. Rev. Rul 76-270, 1976-2 CB 194 approved a third-party created charitable remainder trust for the lifetime benefit of a disabled beneficiary although the mandated income [unitrust amounts or annuity amounts] distributions were payable to the trustee of a second trust for the sole benefit of the named income beneficiary of the CRT. In the ruling, the second trust pays a designated portion of the CRT income to the disabled beneficiary plus additional amounts in the trustee's discretion. At the disabled beneficiary's death, the then trust principal of the second trust is distributable to the beneficiary's estate. It should be possible, by extension, to design the second trust as a wholly discretionary trust not constituting an "available resource" and, so, qualify the beneficiary for needs-based benefits. See Kruse, Third Party Trusts Created for Disabled Persons, 22 Notre Dame Tax & Est. Plan. Inst. 9-1(1996).
<sup>15</sup> "[The settlor cannot create a spendthrift trust for his own benefit . . . It is against public policy to permit a man to tie up his own property in such a way that he can still enjoy it but can prevent his creditors from reaching it." IIA Scott, The Law of Trusts § 156 (Fratcher 4th ed. 1987). Creditors of the settlor of a discretionary trust can reach trust property to the maximum extent the trustee can distribute trust property to the settlor. Restatement (2d) Trusts § 156(2)(1957); Matter of Shurley, 115 F3d 333 (5th Circ. 1997); Ware v. Gulda, 117 N.E. 2d 137 (Mass 1954); First National Bank of Omaha v. First Cadco Corp., 189 Neb. 734, 205 NW2d 115 (1973).
<sup>16</sup> Omnibus Budget Reconciliation Act of August 10, 1993, effective October 1, 1993 ("OBRA `93"), amending the trust provisions of the federal Social Security Act, codified as 42 USCA § 1396p(b), permits a trust beneficiary under narrowly circumscribed perimeters to insulate his own assets and remain eligible to receive needs-based statutory benefits.
¹⁷ Qualification for needs-based benefits such as Medicaid requires satisfying a three-prong test: (1) resources [Note 4], (2) income, and (3) status. See generally, 42 U.S.C. § 1396a(a)(10). This paper focuses on the resources aspect of qualification.
¹⁸ OBRA `93 § 1396p(d)(4)(B) trusts [so-called "Miller" trusts]. Applies to "income cap" states only: all states except Connecticut, Hawaii, Illinois, Indiana, Minnesota, Nebraska, New Hampshire, North Carolina, North Dakota, Ohio, Oklahoma, Utah, Virginia [which excepted states are referred to as "§ 209(b) states"]. Because Nebraska is not an "income cap" state, (d)(4)(B) trusts are not relevant to Nebraska residents and will not be further discussed.
<sup>19</sup> OBRA `93 § 1396p(d)(4)(A) trusts. Available in both "income cap" and "§209(b)" states including Nebraska.
²⁰ Logically includes a beneficiary's agent acting pursuant to durable power of attorney.
¹. OBRA `93 § 1396p(d)(4)(C) trusts. Available in both "income cap" and "§209(b)" states including Nebraska. Such a trust appears to be patterned after the pooled income trust, IRC § 642(c)(5).
²¹ 42 U.S.C. § 1396p(d)(4).
²² Only the (d)(4)(C) "pooled" trust, however, permits avoidance of state recapture to the extent the recapture amount is "retained by" the trust at the beneficiary's death.
²³ 42 U.S.C. § 1396p(d)(4)(C).
²⁴ In addition to avoiding postmortem recapture, the (d)(4)(C) or "pooled" trust (1) imposes no age limit on the beneficiary, (2) permits the individual beneficiary, directly, to create the beneficiary's own trust via designation as grantor without interposition of parent, grandparent, guardian or court.
²⁵ Because postmortem state recapture is the default requirement of a (d)(4)(C) "pooled" trust, the drafter must affirmatively provide in the trust instrument that the date of death account balance be "retained by the trust".
²⁶ Arguably, the "retained by the trust" requirement is also satisfied if the date of death account balance is, pursuant to the trust instrument, available for the trustee-"nonprofit association's" own general charitable purposes.
²⁷ Analogous is IRS-provided sample language for charitable remainder trusts authorizing the trustee to amend the trust to comply with IRC § 664(d). Rev. Procs. 90-31 and 90-32.
²⁸ A trust "protector" is a non-grantor, non-beneficiary authorized to revise not only procedural but even dispositive provisions of an irrevocable trust via trust amendment or exercise of a nongeneral inter vivos power of appointment. See, e.g., Early, The Irrevocable Trust That Can Be Amended, 18 U. Miami Inst. on Est. Plan. Ch. 17 (1984); Horn, Whom Do You Trust: Planning, Drafting and Administering Self and Beneficiary-Trusted Trusts, 20 U. Miami Inst. on Est. Plan. Ch. 5 (1986).
²⁹ See text incorporating Note 32, infra.
³⁰ Because the grantor-beneficiary of a self-settled revocable trust can reclaim the trust principal inter vivos, the entire trust principal is a disqualifying "available resource". 42 U.S.C. § 1396p(d)(3)(A)(i) [corpus of revocable trust "shall be considered resources (sic) available to the individual"]. Additionally, the income from a revocable trust distributed to the grantor-beneficiary is counted against income limitations [generally, three times the SSI monthly benefit]. See Note 16, supra.
³¹ See cases cited in endnote 11.
³² Such beneficiaries' disabilities typically result from tortious activity, liability for which on settlement or litigation produces funds comprising the trust principal.
³³ An elaborately detailed statute of "Byzantine construction [which] . . . makes the [Social Security] act almost unintelligible". Schweiker v. Gray Panthers, 453 U.S. 34 (1981), quoting the court below. Its Medicaid provisions constitute "an aggravated assault on the English language". Friedman v. Berger, 409 F.Supp 1225 (S.D.N.Y. 1976).
³⁴ Determined by a three-pronged test. See Note 17.
³⁵ To qualify for federal funding, Medicaid participating states must conform to federal statutory and regulatory requirements: 42 U.S.C. § 1396a(a)(18).
³⁶ NRS § 68-1047 [LB 800] is aimed squarely at self-settled trusts: "[T]rusts are the most common mechanism whereby individuals are placing resources beyond their control, in order to qualify for Medicaid benefits." Michael J. Rumbaugh, Esq., general counsel, State Department of Social Services, legislative journal pages 83, 84, March 4, 1993. During floor debate on LB 800, Senator Curtis Bromm stated in support: "[P]eople . . . [are] creating these irrevocable trusts . . . [to] make those assets unavailable in the event that those persons go into a nursing home or otherwise need the assistance of Medicaid." Legislative journal May 25, 1993, page 6408.
³⁷ Analogous are statutes establishing irrebuttable presumptions, vulnerable, often, to due process challenge. See, e.g., Stanley v. Illinois, 405 U.S. 645 (1972). Courts may sustain such a presumption if the legislature can establish buttressing data and rationale; see, e.g., Usery v. Turner Elkhorn Mining Co., 428 U.S. 1 (1976). See Note, The Irrebuttable Presumption Doctrine in the Supreme Court, 87 Harv. L. Rev. 1534 (1974).
³⁸ Pronouncing irrevocable trusts to be revocable recalls Lewis Carroll's imperishable colloquy in Through the Looking Glass: "When I use a word, "Humpty Dumpty said, in rather a scornful tone, "it means just what I choose it to mean - neither more nor less."

"The question is," said Alice, "whether you can make words mean so many different things."

"The question is", said Humpty Dumpty, "which is to be master - that's all."
³⁹ 42 U.S.C. § 1396p(d)(3)(A).
⁴⁰ To determine whether federal law preempts a state statute, "our sole task is to ascertain the intent of Congress". California Fed. Sav. & Loan Ass'n v. Guerra, 479 U.S. 272, 280 (1987); see Burgio and Campofelice, Inc. v. N. Y. State Dep't of Labor, 107 F3d 1000, 1008 (2d Cir. 1997). If the court determines that Congress has expressly defined a statute's preemptive scope by language providing "a reliable indicium" of what may be ceded to the state, a "reasonable inference" arises that Congress did not intend to preempt beyond that scope. Freightliner Corp. v. Myrick, 514 U.S. 280, 288 (1995) discussing Cipollone v. Liggett Group, Inc., 505 U.S. 504, 517 (1992).
⁴¹ A state statute "directly conflicts" with federal law when (1) compliance with both is a "physical impossibility", Florida Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 142-3 (1963); Environmental Encapsulating Corp. v. City of New York, 855 F2d 48, 53 (2d Cir. 1988) or (2) state law "stands as an obstacle" to "execution of the full purposes and objectives of Congress". Hines v. David Owitz, 312 U.S. 52, 67 (1941); County of Suffolk v. Long Island Lighting Co., 728 F2d 51, 57 (2d Cir. 1984).
⁴² U. S. Constitution Article VI ["This Constitution, and the laws of the United States which shall be made in pursuance thereof, shall be the supreme law of the land; and the judges in every State shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwithstanding"]; Matter of Morette, 606 N.Y.S.2d 543 (Sur. 1993) (New York statute inconsistent with federal Medicaid statute § 1396p(d)(4) violates Constitution's supremacy clause); accord: Matter of Gattison, (NYLJ, May 13, 1994, p. 29, col. 1).
⁴³ IRC § 662 (a)(2).
⁴⁴ IRC § 1(e).
⁴⁵ IRC §§ 671, 1(a)-(d).
⁴⁶ IRC § 1.
⁴⁷ "A person who furnishes the consideration for the creation of a trust is the settlor, even though in form the trust is created by another person." IIA Scott, The Law of Trusts § 156.3 (Fratcher 4th ed. 1987); In Re Jordan, 914 F2d 197 (9th Cir. 1990); McIntosh's Estate v. CIR, 248 F2d 181 (2d Cir. 1957); In re Estate of Hickey, 635 NE 2d 853 (Ill App 1994); POMS SI § 01120.200B2..
⁴⁸ IRC § 671; Rev Rul 83-25, 1983-1CB 116: court-authorized irrevocable discretionary trust for benefit of minor comprised of personal injuries recovery. Because trust beneficiary equitably "owned" the tort-derived funds, court was merely the nominal grantor and the minor trust beneficiary is deemed to be grantor for income tax purposes per IRC § 677(a); PLR 9004007. Although the grantor-beneficiary is liable for the income tax generated by the "payback" trust, IRC § 677(a), it is usually desirable for the trust instrument to direct the trustee to pay the beneficiary's income tax liability.
⁴⁹ Regs § 25.2511-2(b) ["[I]f a donor transfers property to another in trust to pay the income to the donor or accumulate it in the discretion of the trustee, and the donor retains a testamentary power to appoint the remainder among his descendants, no portion of the transfer is a completed gift."]; § 25.2511-2(c). Because the mandated "recapture " amount cannot be determined until the beneficiary's death, the taxable transfer cannot be quantified at the trust's inception, and should be considered "incomplete". Arguably, too, the statutorily mandated "recapture" provision in a "payback" trust constitutes the quid pro quo for Medicaid qualification; thus the entire transfer is for "adequate and full consideration", IRC § 2512(b), and thus free of gift tax liability. See PLR 9639056 (funding of discretionary trust for disabled minor beneficiary does not constitute taxable gift of the remainder because creditors under local law could access the entire remainder interest at the beneficiary's death). In any event, conferring a testamentary nongeneral power of appointment on the beneficiary should be dispositive of gift tax liability; Regs. § 2511-2(b).
⁵⁰ Because the grantor has reserved the right to income and principal, the trust's entire value is includable in the grantor's gross estate. IRC §§ 2036, 2038, 2033; see Rev Rul 76-103, 1976-1 CB 293; Mary M. and Edson S. Outwin, 76 T.C. 153 (1981) (A); Arrington v. U.S., 34 Fed Cl 144 (Ct. Cl), aff'd w/o opinion 108 F3d 1393 (Fed Cir 1995) (principal of trust established for disabled minor funded with personal injury recovery held vested in beneficiary (who died at age 7) and so includible in beneficiary's gross estate); PLR 9437034. Because the "payback" is statutorily mandated, its amount should be deductible in determining the beneficiary's federal estate tax liability as a § 2053(a)(3) claim.
⁵¹ IRC § 2601.
⁵² IRC § 2631(a).
⁵³ § 1396p(d)(4)(C).
⁵⁴ Single transaction protective arrangement. This provision [essentially equivalent to UPC §5-409] was creatively utilized by estate planning lawyers in Matter of Jones, 401 NE2d 351 (Mass. 1980).