A 40-year old client of mine, who is disabled and receiving means-tested government benefits, was designated as the direct beneficiary of his deceased mother’s IRA. This arrangement, of course, threatened his ongoing eligibility for those government benefits. The client’s father was still living, and able to serve as the Settlor of a (d)(4)(A) (i.e. first-party) SNT for the sole benefit of the client.
I prepared the SNT so that it qualified as a “grantor trust” with respect to the client for income tax purposes. We used the client’s Social Security Number as the taxpayer identification number for the SNT, in lieu of applying for a separate Employer Identification Number (which is also an option), to emphasize to the IRA custodian that the client and the SNT were deemed to be one and the same taxpayer. I then approached the in-house legal department of the IRA custodian and requested that my client’s inherited IRA be re-titled in the name of his first-party SNT, relying upon the analysis and holdings of Private Letter Ruling 200620025 (which we all know is not binding precedent on the IRS for taxpayers other than the one who requested the Private Letter Ruling).
In that PLR, an adult child with a disability, who was receiving means-tested government benefits, was designated as the direct beneficiary of a share of his deceased father’s IRA. In order to preserve his means-tested government benefits, the son’s legal guardian petitioned a court of competent jurisdiction for authority:
(i) to create a first-party SNT, and
(ii) to fund it with the beneficiary’s share of the inherited IRA.
The IRS held that the first-party SNT was a “grantor trust” for federal income tax purposes under IRC Section 677(a). Thus, since a grantor trust is disregarded for income tax purposes, the IRS held that the funding of the SNT with the beneficiary’s share of the inherited IRA was not a transfer for purposes of IRC Section 691(a)(2). This conclusion remained the same even after the beneficiary’s share of the inherited IRA was transferred, by means of a trustee-to-trustee transfer, to a new IRA account set up and maintained in the name of the deceased IRA owner to benefit the son through his first-party SNT. Finally, the IRS held that the Required Minimum Distributions from the new IRA to the SNT could be calculated using the son’s life expectancy.
In my client’s situation, it was not necessary to secure the appointment of a legal guardian or conservator, because although he was “disabled” within the meaning of the Social Security Act, he was mentally competent and had not been declared to be an incapacitated adult. Our real challenge was the insistence of the IRA custodian that we obtain a court order directing the “reformation” of the decedent’s beneficiary designation from my client individually to his first-party SNT. The custodian of the IRA account stipulated that it did not object to the entry of a court order reforming the beneficiary designation of the IRA from my client individually to his first-party SNT.
Since my client did not have or need a court-appointed guardian or conservator, we could not get the requested court order from the Probate Court. Since all interested parties were in agreement as to the retitling of my client’s inherited IRA, we initially struggled to find a basis upon which to file a civil action in Superior Court that would not be dismissed for lack of a controversy. In the end, we decided to file a Complaint for Declaratory Judgment in the Superior Court, seeking the reformation of the decedent’s beneficiary designation form and an order directing the custodian to retitle the inherited IRA in the name of his SNT.
We were thus able to secure an order and final judgment of the Superior Court holding that the decedent’s IRA beneficiary designation form was “reformed” to substitute the client’s first-party SNT for the client individually, and the IRA custodian was directed to honor the reformation by substituting the SNT for the client individually. When the dust settled, the client’s inherited IRA was retitled as follows: “Jane Doe, Deceased IRA for the Benefit of John Doe through the John Doe Irrevocable Supplemental Care Trust.” (This designation language was taken straight from Private Letter Ruling 200620025.) It is important to note that the success of this approach requires that the first-party SNT be a grantor trust with respect to both income and principal vis à vis the beneficiary in order to avoid a taxable recognition event. The balance in the newly retitled inherited IRA is now being distributed directly to the first-party SNT based on the client’s life expectancy, and the client’s eligibility for means-tested government benefits has been preserved.
Kristen M. Lewis, Esq., Member of the Special Needs Alliance and Fellow of the American Academy of Trust and Estate Counsel.
Technology is absolutely fascinating. As I typed this I was on a Delta flight loaded with WIFI and headed to Atlanta for an action filled transformative week in the Estate Planning and Elder Law World. Tuesday and Wednesday our very own National Experts, Dave Zumpano and Victoria Collier will be leading a Two Day Summit on Asset Protection, Medicaid and VA planning (to a SOLD OUT crowd so if you do not have a reserved seat but would like a recorded copy of the event, email motts@lawyerswithpurpose.com ). We are honored to have the opportunity to provide solutions for Asset Protection, Medicaid, and VA Benefits to some of the nation’s top estate planning & elder law attorneys.
