This blog is written by Brian E. Barreira, an estate planning, probate and elder law attorney with offices at 118 Long Pond Road, Suite 206, Plymouth, Massachusetts, and 175 Derby Street, Unit 19, Hingham, Massachusetts. Brian was named a Massachusetts Super Lawyer® in Boston Magazine in 2009, 2010, 2011, 2012 and 2013 and is listed in The Martindale-Hubbell Bar Register of Preeminent Lawyers in the fields of Elder Law and Trusts & Estates, Wills & Probate. Brian's biographical website can be found at SouthShoreElderLaw.com
Nothing on this blog should be considered to be legal advice or tax advice.
The Internal Revenue Service has recently announced that in 2015 the federal estate tax exemption will rise from $5,340,000.00 to $5,430,000.00 per person. (Under current law, this figure is adjusted annually for inflation.) Married couples can get the benefit of two exemptions, so in 2015 the total federal estate tax exemption per couple can be $10,860,000.00. The top estate tax rate on amounts above the exemption is 40%.
Under a new concept known as portability, the surviving spouse in some situations can use the unused exemption of the first spouse to die. Portability requires, in part, the timely filing of a federal estate tax return for the first spouse to die.
Few estates are expected to owe any federal estate tax in 2014, so the federal estate tax is no longer the biggest concern for many wealthy U.S. citizens who want to avoid taxes on wealth they leave behind to their heirs. The focus for many Massachusetts residents has changed to minimizing capital gains taxes and the Massachusetts estate tax, which begins at a taxable estate of $1,000,000.00, with a minimum tax of $33,200.00.
The Internal Revenue Service has also announced that in 2015 the annual gift exclusion will remain $14,000.00 per recipient. The provision sets the highest amount that an individual can give on an unreportable tax-free basis, without affecting the gift-giver’s federal estate tax exemption, to any person who isn’t the gift-giver’s spouse, or to an unlimited number of persons.
Transfers or gifts between spouses are usually tax-free, but not always. Whether the gift is tax-free is based on whether the spouse who is receiving the gift is a U.S. citizen. A spouse who is a U.S. citizen can receive unlimited gifts, but a spouse who is not a U.S. citizen will be limited to receiving $147,000.00 in 2015.
Gifts made in excess of the $14,000.00 or $147,000.00 rules require the filing of a federal gift tax return, and make use of part or all of the gift-giver’s federal estate tax exemption.
Potential Annuity Purchases by the Trustee Do Not Provide the Settlor of an Income-Only Irrevocable Trust with Access to Principal
As noted in prior posts, many irrevocable trusts in Massachusetts are now under wrongful attack during the MassHealth application process by the Office of Medicaid. One of the more specious arguments brought forth by the Office of Medicaid has been that the Trustee could purchase an annuity and thereby provide the Settlor of the trust with access to principal. Unfortunately, the memorandum of the Office of Medicaid that is typically filed at MassHealth fair hearings betrays a fundamental ignorance of basic annuity principles and trust law. When a payment is received from an annuity, the portion of the payment that represents a return of principal is nontaxable, and reasonable accounting principles require the trustee to allocate the return of principal to the corpus or principal of the trust.
Section 103(a)(4) of the Uniform Principal and Income Act, as adopted in Massachusetts as M.G.L. c.203D, s. 3(a)(4), states that, in allocating receipts and disbursements to or between principal and income, a trustee “shall add a receipt or charge a disbursement to principal if the terms of the trust … do not provide a rule for allocating the receipt or disbursement to or between principal and income.” Thus, the legal presumption in Massachusetts is that any amount received by a trustee is not income, but rather principal. In the absence of explicit contrary powers in the trust, the trustee has no power to deviate from generally accepted practices of fiduciary accounting when determining what is income and what is principal. See Restatement (Third) of Trusts §233, comment p.
Under the Massachusetts Principal and Income Act, “[i]f a payment is characterized as interest or a dividend or a payment made in lieu of interest or a dividend, a trustee shall allocate it to income. The trustee shall allocate to principal the balance of the payment and any other payment received in the same accounting period that is not characterized as interest, a dividend, or an equivalent payment.” G.L. c. 203D, § 18(a). The Massachusetts Principal and Income Act also provides that “[a]n amount received as interest, whether determined at a fixed, variable or floating rate on an obligation to pay money to the trustee, including an amount received as consideration for prepayment of principal, shall be allocated to income without any provision for amortization of premium.” G.L. c. 203D, § 15(a). Thus, annuity distributions cannot be treated solely as income under Massachusetts law, where most of such payments are a return of principal.
The memorandum of the Office of Medicaid typically points to Massachusetts law and states that trustees are specifically given the power to invest in annuities, but the Office of Medicaid’s cite to M.G.L. c. 203, § 25A, a section of the Massachusetts Uniform Trust Code (“MUTC”), is pointless. The MUTC simply codifies the rather uncontroversial point that a trustee’s authority includes the power to invest in annuities. The draftspersons of the MUTC recognized that trustees needed to be able to make investments without always going through the expense of asking for court permission, so if a trust is silent with respect to annuities, the MUTC would authorize the trustee to purchase an annuity as an investment. That trustee power, however, is irrelevant to the question of whether the trustee has the discretion to distribute principal to the applicant. The Office of Medicaid cites regulations in support of its position that all payments from annuities are “income,” but if the irrevocable trust does not make reference to those regulations, it is instead governed by its express terms, common law and statutory authority, including the Massachusetts Principal and Income Act.
The Office of Medicaid completely ignores the Massachusetts Principal and Income Act in its memorandum of “law.” The Office of Medicaid may not unilaterally impose its own definition of “income” from another context and create unintended definitions of terms and phrases within an irrevocable trust. Allowing any state agency to do so would wreak havoc on well-established trust doctrine, upset settled legal expectations of settlors, trustees and beneficiaries, and be in violation of the Massachusetts Principal and Income Act.
A Life Estate in an Irrevocable Trust Should Not Cause the Trust to Be a Countable Asset for MassHealth Purposes
In the misleading, unfair and unbalanced memorandum entered into the fair hearing record at MassHealth trust denial cases, the Office of Medicaid usually takes a legally invalid view of life estates that are contained within trusts. The Office of Medicaid makes the specious argument that a life estate in a trust provides access to the principal of the trust, but makes that statement in a conclusory fashion, without explaining how that could possibly be. The position of the Office of Medicaid is directly contrary to what the Supreme Judicial Court wrote in Cohen v. Comm’r of the Div. of Med. Assistance, 423 Mass 399 (1996), that the authority of a trustee to distribute income is not equivalent to the authority of a trustee to distribute principal to the Settlor.
A life estate is established when all of the remainder legal interest in a property is transferred to another, while the legal interest for life rights to use, occupy, or obtain income or profits from the property is retained. See 130 CMR 515.001. The life tenant does not own the principal, so the life tenant is without access to it, and it is not available to the life tenant.
A beneficiary who has the right to live in a house does not have the right to sell or mortgage that house, and the same applies whether the life estate is in the deed or in the trust. “[T]he mere fact that a transferee who is to receive the benefits of the property for life is called a “trustee” is not conclusive and a legal life estate may be found to have been created.” Bogert Hess, The Law of Trusts & Trustees (Third Edition), s. 27 @ 379. See also Schaefer v. Schaefer, 141 Ill. 337, 31 N.E. 136 (1892); Thompson v. Adams, 205 Ill. 552, 69 N.E. 1 (1903). A life estate holder within a trust cannot mortgage the life estate or any other part of the trust because the life tenant cannot give legal title, which is held by the trustee. Further, being trustee and taking principal when entitled to only an income interest is a breach of the trustee’s fiduciary duty.
If the life estate is contained in a deed and the property is sold, the life tenant is entitled to a portion of the net sale price, calculated under Medicaid law based on actuarial tables, but the liquidation value of the life estate is an inaccessible asset unless the remainderpersons choose to participate in the sale. If the life estate is a beneficial interest in a trust, the life tenant does not have any right to any of the sale proceeds, because the proceeds belong to the trust; the life tenant would then be entitled only to the income that could be generated by investing the sale proceeds.
The Massachusetts Legislature Has Prohibited MassHealth Estate Recovery Against Trusts, and Therefore Knows About But Has Not Prohibited Their Use
Under federal Medicaid law, one state option available since 1993 has been to make post-death claims for estate recovery against trusts. In 2004, the Massachusetts legislature voted overwhelmingly not to allow estate recovery against trusts. Thus, the governmental branch in charge of changing laws in Massachusetts has not legislatively expressed its concern about the use of irrevocable trusts to qualify for MassHealth.
Current MassHealth regulations require recovery from the probate estates of MassHealth members who received Medicaid while age 55 or over and those who, regardless of age, received Medicaid while institutionalized. All MassHealth expenses incurred for such members, with certain exception, are counted toward the total recovered amount. An exception from estate recovery is made in cases where recovery would cause hardship, and only partial recovery is required from the estate of members who had long-term care insurance policies that met the Massachusetts Division of Insurance requirements. Estate recovery is deferred while there is a surviving spouse or child who is blind, permanently and totally disabled, or under age 21.
In 2004, the Massachusetts legislature was presented with voting on the option, allowed to the states by federal Medicaid law since 1993, of allowing estate recovery against trusts. The bill it passed limited estate recovery to the probate estate, but was vetoed by Governor Romney. The Massachusetts legislature then voted to override the veto, unanimously in the House and with only one dissenting vote in the Senate. The existing law, M.G.L. c. 118E, s. 31(c), does not allow estate recovery against any trusts and shows that there is no Massachusetts legislative policy against trusts in the MassHealth context.
The Office of Medicaid Ignores that Trustees Have Fiduciary Duties to the Remainderpersons, and Cannot Use Powers to Skew Beneficial Interests
In the misleading, unfair and unbalanced memorandum entered into the fair hearing record at MassHealth trust denial cases, the Office of Medicaid usually takes a legally invalid view of Massachusetts trusts, and ignores the fiduciary duties of the trustee.
As a fiduciary, a trustee has the dual duties of loyalty and impartiality. See Johnson v. Witkowski, 30 Mass. App. Ct. 697, 705 (1997), and more generally, Demoulas v. Demoulas Super Markets, Inc., 424 Mass. 501, at 528-529 (1997) quoting Judge Cardozo in Meinhard v. Salmon, 249 N.Y. 458, 4630464 (1928) “(n)ot honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.” The duty of loyalty to the beneficiaries requires of the trustee that he or she act solely in accordance with the terms of the trust instrument construed so as to carry out the intent of the Settlor. Watson v. Baker, 444 Mass. 487, 491 (2005). Therefore, a trustee may not commit any act that would harm the interest of any beneficiary of the trust, that would waste any trust property, that would give trust property to anyone not entitled thereto, or that would otherwise be contrary to the intent of the Settlor in entrusting the Settlor’s property to the management of a trustee. See King v. Nazzaro, 78 Mass. App. Ct. 1128 (2011); Murphy v. Murphy, Docket No. 2004-3937-BLS2 (2006.) Therefore, if the trust provides that no distribution of principal shall be made to the Settlor, then the trustee is forbidden to do so. To do otherwise would do harm to the beneficial interests of the beneficiaries (or the other beneficiaries, if, for example, the Settlor is an income beneficiary of the trust), and it would be a breach of fiduciary duty. See Anderson v. Bean, 272 Mass. 432, 447-448 (1930).
The Office of Medicaid attempts to argue that the purpose of a trust may not be used as a limitation on trustee discretion to make a distribution of principal to the Settlor, but ignores that it is the responsibility of the trustee to understand all provisions of the trust instrument and construe them so as to give meaning and efficacy to all of them. As the Court stated in Dana v. Gring, 374 Mass. 109, 116 (1977), it is a fundamental principle of Massachusetts law “to ascertain the intention of the testator from the whole instrument, attributing due weight to all its language . . . and to give effect to that intent unless some positive rule of law forbids.”
Another duty of a trustee, the duty of impartiality as between and among the beneficiaries, requires that the trustee not favor one beneficiary over another; instead, the trustee is bound to treat all beneficiaries equitably in accordance with the terms of the trust construed as a whole. King v. Nazzaro, 78 Mass. App. Ct. 1128 (2011). Thus, a power that allows a trustee to make a particular type of investment is not authority to override the intentions of the trust. “Even when there are broad discretionary powers, a trustee may not exercise his or her discretion so as to shift beneficial interests in the trust.” Fine v. Cohen, 35 Mass.App.Ct. 610, 617 (1993). The trustee must balance risk and return in the trustee’s management of the trust estate so as to be fair to both the life income beneficiaries and the remainderpersons.
Trustee duties of loyalty and impartiality are at the very core and essence of what a trust is. A trust is a relationship wherein a trustee manages property for the benefit of others. The trustee is given powers to carry out his assigned duties in the context of the beneficial interests that are bestowed upon the income beneficiary or life tenant and remainderpersons of the trust. For every interest that a beneficiary has under a trust instrument, the trustee has a correlative duty to safeguard and provide that interest to the beneficiary. Thus, trustee powers are made available to the trustee only to the extent necessary to provide the trust beneficiaries with their rightful beneficial interests under the trust. If a beneficial interest is denied to a beneficiary, then the trustee has no authority or discretion to make it available to the beneficiary. The power to purchase annuities, life insurance or any other investment is granted to the trustee only to the extent that the exercise of that power will secure to the beneficiaries their respective beneficial interests. Such a power may not be used to divert one beneficiary’s interest to another beneficiary without breach of fiduciary duty. The conversion of principal to income, or vice versa, to redirect trust resources from one beneficiary to another is not allowed due to the trustee’s duty of impartiality.
MassHealth regulations do not require that the fiduciary duties of a trust be ignored; rather, the fiduciary duties of a trustee are specifically recognized in the definition of “trust” at 130 CMR §515.001: “a legal device satisfying the requirements of state law that places the legal control of property or funds with a trustee. It also includes, but is not limited to, any legal instrument, device, or arrangement that is similar to a trust, including transfers of property by a grantor to an individual or a legal entity with fiduciary obligations so that the property is held, managed, or administered for the benefit of the grantor or others. Such arrangements include, but are not limited to, escrow accounts, pension funds, and similar devices as managed by an individual or entity with fiduciary obligations.” (emphasis added).
History of Federal Medicaid Law Indicates the Term “Available” Is to Be Narrowly Construed When Determining Applicant’s Income
In State of Washington v. Bowen, 815 F. 2d 549 (9th Cir., 1987) the Court delved into the term “available” as utilized in the context of Medicaid law, and determined that the term must be narrowly construed. “As used in public assistance statutes, the term “available” typically functions as a restrictive term defining a subcategory of “income.” See, e.g., Heckler v. Turner, 470 U.S. 184, 200, 105 S.Ct. 1138, 1147, 83 L.Ed.2d 138 (1985); Gray Panthers, 453 U.S. at 48, 101 S.Ct. at 2642; Schrader v. Idaho Dept. of Health and Welfare, 768 F.2d 1107, 1110 (9th Cir.1985); Young v. Schweiker, 680 F.2d 680, 682 (9th Cir.1982). The legislative history of the Medicaid statute also indicates that “available” should be read as a limiting term. The Senate report accompanying the Medicaid legislation provided: States [are required] to take into account only such income and resources as … are actually available to the applicant or recipient…. States [are] not [to] assume the availability of income which may not, in fact, be available or overevaluate income and resources which are available. S.Rep. No. 404, 89th Cong., 1st Sess. 78 (1965), reprinted in 1965 U.S. Code Cong. & Ad. News pp. 1943, 2018.”
Throughout the case of Doherty v. Commissioner, 74 Mass. App. Ct. 439 (2009), it was the official position of the Office of Medicaid that a trust must be read as a whole, but in recent cases, the Office of Medicaid has backed away from that correct legal position, because to do so necessitates an entirely different result from what it is trying to get away with in recent MassHealth trust denial cases. This new position of the Office of Medicaid regarding how a trust should be scrutinized is not entitled to deference. The Supreme Judicial Court, in Cohen v. Commissioner of the Division of Medical Assistance, 423 Mass. 299 (1996), footnote 18, stated why it chose not to give deference to the MassHealth agency’s position in that case, and the same point applies here: “The Commonwealth urges us to give deference to the division’s administrative interpretation of the statute. Although there is some merit to the argument, it is not served up in its most appetizing form in this case. … It is usually the initial not the changed interpretation of a statute that earns the kind of deference the Commonwealth would need here. See Barnett v. Weinberger, 818 F.2d 953, 960-961 n.74 (D.C. Cir. 1987), and cases cited (deference depends on consistency of interpretation).”