Federal Appeals Court Strikes Down State Law Restricting Access to Special Needs Trusts

A federal appeals court has ruled that a Pennsylvania law that penalizes people age 65 and older who set up a special needs trust violates federal law and is therefore unconstitutional.

The lawsuit was filed initially by 12 persons, eleven of whom are residents of Pennsylvania, all of whom are disabled, and all of whom have received benefits under the Pennsylvania Medicaid program.

In addition to these individuals, two trusts are parties to the lawsuit: the ARC-CT and The Family Trust, both which are charitable organizations with over $50 million under management in "pooled trust" accounts.

Together, the ARC Trust and The Family Trust have managed more than 1500 pooled trust accounts for disabled persons, two of whom, in this litigation, are over the age of 65.

The individuals plaintiffs in this case (styled Lewis v. Alexander) have trust balances of from $0 (that's zero dollars) to $1.26 million. But in general, the trust balances are quite low, ranging from a few hundred to a few thousand dollars.

The Federal Law of Special Needs Trusts
In the 1993, Congress established a general rule that trusts would be counted as assets for the purpose of determining Medicaid eligibility. But Congress also excepted from that rule three types of trusts meeting certain specific requirements. Taken together, these are generally called “special needs trusts," which is a discretionary trust established for the benefit of a person with a severe and chronic or persistent disability and is intended to provide for expenses that assistance programs such as Medicaid do not cover.

These expenses – books, television, Internet, travel, and even such necessities as clothing and toiletries – would rarely be considered extravagant.

One type of special needs trust – the one at issue in this case – is the pooled special needs trust. A "pooled trust" is a special arrangement with a non-profit organization that serves as trustee to manage assets belonging to many disabled individuals, with investments being pooled, but with separate trust accounts being maintained for each disabled trust beneficiary.

At the death of the trust beneficiary, instead of reimbursing the state Medicaid program federal law permits the trust to retain the trust funds to advance the trust's charitable purposes.

Transfers of assets to pooled trusts, under federal law, do not result in a Medicaid transfer penalty (that is, a "five-year lookback").

The Pennsylvania Trust Law
In 2005, the Pennsylvania legislature enacted a law that sought to regulate pooled trusts. Among other things, the law limits access to the trust to persons under the age of 65 and limits the amount that can be retained by the charity to no more than half of the deceased trust beneficiary's funds.

The individual and trust plaintiffs argued to the federal court that the Pennsylvania law violated the federal trust law by grafting additional and burdensome requirements onto pooled special needs trusts.

After devoting considerable analysis of the plaintiffs' standing to bring this action against Pennyslvania's Medicaid agency, the federal Third Circuit Court of Appeals held that the state law restrictions on pooled trusts explicitly violated the federal law on Medicaid trusts.

The federal law did and does not write an age limitation in the use of special needs pooled trusts, said the appeals court.
Further, the federal law explicitly says that the charitable trust is required to reimburse the state Medicaid program only to the extent of the trust assets it does not retain. The state cannot compel the charity to reimburse the state for any amounts, other than trust funds not retained.

The state of Pennsylvania defended itself, in part, by pleading for a chance to interpret the statute in such a manner that would not violate the federal law.

In reply, the appeals court quoted a recent U. S. Supreme Court decision: "We would not uphold an unconstitutional statute merely because the Government promised to use it responsibly."

Lewis v. Alexander, June 20, 2012.


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