ART OF SETTLEMENT

In The Art of Settlement, Jason Lazarus helps you navigate the complexities at settlement for catastrophic claims and provides you with the best practices for each potential issue. As a nationally recognized settlement compliance expert, Jason shows you how to address important ethical issues, navigate settlement planning concerns, preserve government benefits, and employ lien reduction strategies. You’ll gain insightful, essential perspectives on how to deal with Medicare compliance, fight ERISA liens, and leverage qualified settlement funds.

Protecting the Recovery – Preservation of Needs-Based Benefits & Other Considerations

August 10, 2023

By Jason D. Lazarus, J.D., LL.M., MSCC

Section 1: Introduction to Special Needs Trusts

Medicaid and SSI are income and asset sensitive public benefits, which require planning to preserve. In many states, one dollar of SSI benefits automatically provides Medicaid coverage. A special needs trust is a trust that can be created pursuant to federal law whose corpus, or any assets held in the trust do not count as resources for purposes of qualifying for Medicaid or SSI. Thus, a personal injury recovery can be placed into an SNT so that the victim can continue to qualify for SSI and Medicaid. Federal law authorizes and regulates the creation of an SNT. The 1396p^[1] provisions in the United States Code govern the creation and requirements for such trusts. First and foremost, a client must be disabled to create an SNT.^[2] There are three primary types of trusts that may be created to hold a personal injury recovery and one type used when it isn’t the injury victim’s own assets, each with its own unique requirements and restrictions. First is the (d)(4)(A)^[3] special needs trust which can be established only for those who are disabled and are under age sixty-five. This trust is established with the personal injury victim’s recovery and is established for the victim’s own benefit. Second is a (d)(4)(C)^[4] trust, typically called a pooled trust, that may be established with the disabled victim’s funds without regard to age. The third is a trust that can be utilized if an elderly client has too much income from Social Security or a pension to qualify for some Medicaid based nursing home assistance programs. This trust is authorized by the federal law under (d)(4)(B)^[5] and is commonly referred to as a Miller Trust. Lastly, there is a third-party^[6] SNT which is funded and established by someone other than the personal injury victim (i.e., parent, grandparent, donations, etc.) for the benefit of the personal injury victim. The victim still must meet the definition of disability but there is no required payback of Medicaid at death as there is with a (d)(4)(A) or (d)(4)(C).

Section 2: Stand-Alone (d)(4)(A) versus Pooled (d)(4)(C) Special Needs Trusts

Since the pooled (d)(4)(C) trust and the (d)(4)(A) SNT are most commonly used with personal injury recoveries, it is useful to compare these two types of trusts. There are several significant differences between a (d)(4)(C) pooled trust and a (d)(4)(A) special needs trust. I will discuss these differences first starting with the (d)(4)(C) pooled trust. As a starting point, a disabled injury victim joins an already established pooled trust as there is no individually crafted trust document. There are four major requirements under federal law necessary to establish a pooled trust. First, the trust must be established and managed by a non-profit.^[7] Second, the trust must maintain separate accounts for each Beneficiary, but the funds are pooled for purposes of investment and management.^[8] Third, each trust account must be established solely for the benefit of an individual who is disabled as defined by law, and it may only be established by that individual, the individual’s parent, grandparent, legal guardian, or a Court.^[9] Fourth, any funds that remain in a Beneficiary’s account at that Beneficiary’s death must be retained by the Trust or used to reimburse the State Medicaid agency.^[10]

In directly comparing a (d)(4)(C) to a (d)(4)(A) special needs trust, there are four primary differences. First, a (d)(4)(A) special needs trust can only be created for those under age sixty-five; however, a (d)(4)(C) pooled special needs trust has no such age restriction and can be created for someone of any age. The only caveat to the lack of an age restriction is that certain states may impose a transfer penalty for people who are over the age of sixty-five and fund a pooled trust causing a period of ineligibility. Second, a pooled special needs trust is not an individually crafted trust like a (d)(4)(A) special needs trust. Instead, a disabled individual joins a pooled trust and a professional non-profit trustee pools the assets together for purposes of investment, but each beneficiary of the trust has his or her own sub-account. Third, a pooled trust is managed by a not-for-profit entity who acts as trustee overseeing distributions of the money. The non-profit trustee may manage the money themselves or hire a separate money manager to oversee investment of the trust assets. Fourth, at death the non-profit trustee may retain whatever assets are left in the trust instead of repaying Medicaid for services they have provided, which is a requirement with a (d)(4)(A) special needs trust.^[11] By joining a pooled trust, a disabled aged injury victim can make a charitable donation to the non-profit who manages the pooled trust and avoid the repayment requirement found within the federal law for (d)(4)(A) special needs trusts. Other than the aforementioned differences, it operates as any other special needs trust does with the same restrictions on the use of the trust assets.

With a (d)(4)(A) special needs trust, a trustee needs to be selected, unlike the pooled trust where it is automatically a non-profit entity. This provides some flexibility to the family or loved ones to have a hand in the selection of the trust company or bank acting as trustee; however, it is important to have a trustee experienced in dealing with needs-based government benefit eligibility requirements so that only proper distributions are made. Many banks and trust companies don’t want to administer special needs trusts with a corpus under $1,000,000.00, which can make it difficult to find the right trustee. Most pooled special needs trusts will accept any sized trust and the non-profit is experienced in dealing with people receiving disability-based public benefits. With the (d)(4)(A), there are no startup costs except the legal fee to draft the trust which can vary greatly. The (d)(4)(C) pooled trusts typically have a one-time fee at inception which can range from $500 to $2,000, which is typically much cheaper than the cost of establishing a (d)(4)(A) special needs trust. Most trustees (pooled or (d)(4)(A)) will charge an ongoing annual fee which is typically a percentage of the trust assets. These fees vary between 1-3% depending on how much money is in the trust. A (d)(4)(A) will offer unlimited investment choices for the funds held in the trust while a (d)(4)(C) will have fewer investment choices.

The following chart illustrates the five primary differences between these two trusts:

Stand-Alone Special Needs Trust	Pooled Special Needs Trust
Can only be created for those under the age of 65.	Can be created for someone of any age. Caveat though for a possible transfer penalty in some states.
Individually drafted for someone who is disabled. Provisions are unique and tailored to the trust beneficiary. A qualified elder law attorney who understands the unique needs of a personal injury victim should be consulted to assist with drafting the stand-alone special needs trust.	Not individually drafted. A disabled individual joins an established master trust, and his or her funds are pooled for investment purposes with those of other beneficiaries. Beneficiaries have their own sub-accounts where an accounting of their funds is maintained. A qualified elder law attorney who understands the unique needs of a personal injury victim should be consulted to assist with joining a pooled trust.
Trustee may be an individual but is typically a bank or trust company who may or may not handle investment of the trust assets. Investments may be personalized for the trust beneficiary’s circumstances.	Trustee is a non-profit entity who oversees distributions but often delegates investment functions to a third-party money manager using model portfolios.
All funds left in trust at death must be used to repay Medicaid for services provided to the trust beneficiary.	All funds left in trust at death may be retained by the non-profit instead of repaying Medicaid for services provided, allowing an injury victim to make a charitable donation to the non-profit and avoid repayment to Medicaid.
No startup costs except the legal fee to draft the trust, which can vary greatly. Most trustees charge an ongoing annual fee, typically a percentage of the trust assets. These fees vary from 1% to 3%, depending on how much money is in the trust. A stand-alone special needs trust will offer unlimited investment choices for the funds held in the trust. Typically, there are additional costs tied to investment management.	Typically have a one-time fee at inception, ranging from $500 to $2,000 (often much cheaper than the cost of establishing a stand-alone special needs trust). Most non-profit trustees charge an ongoing annual fee, typically a percentage of the trust assets. These fees vary from 1% to 3%. A pooled special needs trust will offer fewer investment choices—oftentimes, only one choice.

Key Takeaway: Different methods for protecting needs-based benefit preservation must be explored for any disabled injury victim who is currently eligible. Special needs trusts allow injury victims to continue to access critical needs-based government benefits after settling their cases. Federal law authorizes and regulates the creation of special needs trusts. Two primary types of trusts may be created to hold a personal injury recovery, each with its own requirements and restrictions. First, is the (d)(4)(A) stand-alone special needs trust. A stand-alone special needs trusts can be established only for those who are disabled and under age sixty-five. This trust is established with the personal injury victim’s recovery, for the victim’s own benefit. It can be established by the victim, a parent, a grandparent, or a guardian, or by court order. Second, is the (d)(4)(C) pooled special need trust. A pooled trust can be established with a disabled injury victim’s funds, regardless of age. Like a stand-alone trust, this trust is established with the personal injury victim’s recovery, for the victim’s own benefit, and can be established by the victim, a parent, a grandparent, a guardian, or by court order.

Section 3: Limitations on Spending & Advantages/Disadvantages of Establishing an SNT

The major limitation of all types of special needs trusts is that the assets held in trust can only be used for the “sole benefit” of the trust beneficiary. The disabled injury victim could not withdraw money and gift it to a charity or family. The purpose of the special needs trust is to retain Medicaid eligibility, and use trust funds to meet the supplemental, or “special” needs of the beneficiary. These can be quite broad, however, and include things that improve health or comfort such as non-Medicaid covered medical and dental expenses, trained medical assistance staff (24 hours or as needed), independent medical check-ups, medical equipment, supplies, programs of cognitive and visual training, respiratory care and rehabilitation (physical, occupational, speech, visual and cognitive), eye glasses, transportation (including vehicle purchase), vehicle maintenance, insurance, essential dietary needs, and private nurses or other qualified caretakers. Also included are non-medical items, such as electronic equipment, vacations, movies, trips, travel to visit relatives or friends and other monetary requirements to enhance the client’s self-esteem, comfort or situation. The trust may generally pay for expenses that are not “food and shelter” which are part of the SSI disability benefit payment; however, even these items could be paid for with trust assets, but SSI payments could be reduced or eliminated. This may not be problematic if the disabled injury victim qualifies for Medicaid without SSI eligibility; however, many states grant automatic Medicaid eligibility with SSI so one has to be careful about eliminating the SSI benefit.

Each type of trust discussed above has advantages and disadvantages. Some think of pooled trusts as only being appropriate for a smaller settlement, which is not the case. Some think of pooled trusts just for the elderly, which is not the case either. In the right case, the pooled trust is an excellent alternative to a (d)(4)(A). Just the same, in some cases a (d)(4)(A) may be the best option because of the flexibility in selecting a trustee and the customizable money management options. In the end though, a special needs trust, be it pooled or a (d)(4)(A), must be considered because it will safeguard a disabled client’s recovery from dissipation and protect future eligibility for needs-based public benefits. Just as importantly, the different types of trusts and their advantages as well as disadvantages should be closely considered before making a decision since special needs trusts are irrevocable along with bringing substantial restrictions on how the money may be used. Creating a special needs trust for a disabled injury victim gives them the ability to enjoy the settlement proceeds while preserving critical healthcare coverage along with government cash assistance programs.

Key Takeaway: There are important advantages and disadvantages to establishing a special needs trust for an injury victim. The advantages are that the injury victim can retain SSI/Medicaid eligibility; get professional trustee services; can avoid guardianship and annual reports; and the trust can pay for everything except “food & shelter”. The disadvantages are that there is no unrestricted use of funds by the injury victim; “Sole Benefit” rule applies; at death Medicaid must be paid back (except 3rd party); adds an extra layer of complexity; and the trust is irrevocable.

Section 4: Spousal & Parental Deeming in Cases with a Consortium Claim

Deeming is an important concept to understand for trial lawyers when working with their client to construct a plan post settlement to preserve needs-based government benefits. The following example will illustrate the point. Assume you have just resolved a catastrophic birth injury matter for a minor client and his parents. The minor receives SSI as a result of severe injuries from hypoxia at birth due to negligence. Upon resolving the case, the parents agree, and the court approves that all settlement proceeds for the minor child will go into a special needs trust. Mom and dad are given $200,000.00 for their consortium claim. The minor child is now ineligible for Medicaid and SSI as a result of “parental deeming” until he reaches age 18.

What is deeming? Deeming is when either a parent’s or spouse’s income and/or assets are counted towards the SSI/Medicaid recipient’s resources when applying for or receiving SSI. In my example, “parental deeming” is triggered as the child is under the age of 18 and is living in the same household as his parents. The theory behind deeming between a parent and minor child living at home is that it is the responsibility of the parent to care for a minor child. As part of deeming, a parent’s earned and unearned income as well as assets deem to a child. For a married couple, resources over $3,000 deem to the child. In my example of a $200,000 recovery for a consortium claim allocated to the parents, that well exceeds the asset cap of $3,000. Deeming of that recovery would cease once the minor reaches age 18 even if he is still residing at home; however, if the settlement occurred when the child was relatively young, say at 5 years of age, there would be 13 years of ineligibility due to the deeming from the consortium recovery (assuming it wasn’t spent down before the 13 years had passed).

Similarly, there is spousal deeming. If you represent a married couple where one is on SSI and there is a consortium claim, a similar issue could be created as with the example of a minor child parental deeming. This is so since if the combined assets of a couple exceed the $3,000.00 asset cap, then the SSI benefit will be lost by the injury victim that is disabled. In the event there is a consortium claim on behalf of the non-injured spouse and money is allocated to them, then the injury victim with SSI will lose their eligibility even if their settlement money goes into an SNT.

Given the complexities of deeming and some exceptions, it is important to consult an elder law attorney at settlement. If it is possible to avoid allocating monies to a parent or spouse in a deeming situation, that is advisable; however, often that simply doesn’t work given the dynamics of settlement. That is where an elder law attorney’s experience and expertise can help trial lawyers navigate these issues.

Key Takeaway: Deeming is a critical concept for trial lawyers to understand when planning to preserve their clients’ needs-based government benefits post-settlement. Deeming occurs when a parent’s or spouse’s income and assets are considered as part of the SSI/Medicaid recipient’s resources. Parental deeming can make a minor child ineligible for Medicaid and SSI until age 18 if the parents receive a settlement exceeding the $3,000 asset cap. Similarly, spousal deeming can affect a disabled spouse’s SSI eligibility if the non-injured spouse’s consortium claim results in combined assets exceeding the cap. The intricacies of deeming necessitate consultation with an elder law attorney to ensure proper allocation of funds and benefits preservation.

Section 5: Spend Down

In the right settlement situation, an alternative to establishing an SNT that is often overlooked is a spend-down plan on exempt assets. A “spend-down” plan involves promptly spending settlement money in excess of the applicable asset limit within the same calendar month of receipt to maintain eligibility for public benefits. The Social Security Administration (SSA) considers a lump sum of money as income only in the month received, so long as it is spent within that same calendar month (SI 01110.600); therefore, by the month-end of receipt, the injury victim must retain no more than the resource limit, usually $2,000 for an unmarried individual and $3,000 for a married couple.

A well-planned spend-down leverages SSA statutes and regulations that exempt certain assets from the “countable resources” category. The personal injury settlement proceeds can thus be used to acquire or pay off certain exempt assets permitted by statute, 42 U.S.C. § 1382b(a), potentially eliminating the need for an SNT. These exempt resources are detailed in the Program Operations Manual System (POMS) at SI 01110.210 and typically include:

A primary residence of any value, 20 C.F.R. §§ 416.1210(a), 416.1212.

One vehicle of any value for transportation of the SSI recipient or a household member, 20 C.F.R. §§ 416.1210(c), 416.1218.
Household goods and personal effects, irrespective of value, 20 C.F.R. §§ 416.1210(b), 416.1216.
Any-valued burial plots, 20 C.F.R. §§ 416.1210(l), 416.1231(a).
A dedicated account for burial expenses up to $1,500, 20 C.F.R. §§ 416.1210(l), 416.1231(b), though an unlimited amount is allowed in an irrevocable funeral service contract, POMS SI 01120.201.H.1.a.
Life insurance policies with a cash surrender value under $1,500 and unlimited term insurance, 20 C.F.R. §§ 416.1210(h), 416.1230.

For example, as part of a comprehensive spend down plan, a recipient could use the settlement to pay off a mortgage, purchase a new home, repair an existing one, or buy long-needed household goods or appliances. They could also use the funds to clear credit card debts. The following is a non-exclusive list of potential ways to spend down:

• Paying off existing debts (note: loans from family members or friends need to be bona fide with an expectation of repayment).

• Purchasing or paying off a home or part of a mortgage.

• Paying only that calendar month’s rent.

• Making home repairs and modifications for disabilities.

• Purchasing home furnishings, electronics or appliances.

• Paying an attorney for estate or Medicaid planning.

• Paying off non-Medicaid/Medicare medical bills, educational expenses, entertainment/recreation expenses, and vacation travel.

• Pre-paying burial arrangements.

• Purchasing a vehicle.

• Buying personal products or services like clothing or hygiene products.

However, making purchases for someone else or giving away money should be avoided, as these are considered transfers for less than market value and could result in loss of public benefits (SI 01150.001, SI 01150.007).

Lastly, it is important to report spend-down to the local Social Security Administration (SSA) office and/or the state Medicaid office. As a trial lawyer, you can either directly advise your client on these issues or engage an elder law attorney to guide the client in tracking and reporting their spend-down, including dates, amounts, and items purchased. It’s crucial to remember that if the client is on SSI, the money they get and spend down is income in the calendar month they get the money, so it does interfere in that one month’s SSI payment. If spend-down exceeds one month, the interference with SSI (and Medicaid) will continue beyond that one month. If there is no SSI and only Medicaid, then as long as spend down occurs in the same calendar month there should be no interference with medical coverage.

Key Takeaway: A “spend-down” plan is a viable alternative to a Special Needs Trust (SNT), in the right settlement scenario. It involves the prompt expenditure of settlement funds that exceed the asset limit within the same month of receipt to retain public benefits eligibility. The plan leverages statutes and regulations that exempt certain assets from being countable resources, thus permitting the use of settlement proceeds to acquire, pay down, or improve exempt assets, potentially bypassing the need for an SNT; however, the spend-down must be strategically planned and promptly executed, taking into account eligible exemptions and avoiding non-permissible transactions. All transactions should be timely reported to the Social Security Administration and/or the state Medicaid office. While a spend-down may cause interference with benefits for the month in which the lump sum is received, especially for SSI recipients, if effectively managed, it provides a pathway to preserve government benefits while monetarily benefiting from the settlement.

Conclusion

In conclusion, the evaluation of different methods for protecting needs-based benefit preservation must be explored for any disabled client who is currently eligible. Special needs trusts allow injury victims to continue to access critical needs-based government benefits after settling their case. When creating a plan that includes an SNT for a minor child or a spouse, understanding the impact of deeming and consortium claims is important. Spend-down is a viable alternative to establishing an SNT in some situations. Every case and client is different though and careful consideration of the advantages and disadvantages should be done with an elder law attorney.

[1] 42 U.S.C. § 1396p.

[2] To be considered disabled for purposes of creating an SNT, the SNT beneficiary must meet the definition of disability for SSDI found at 42 U.S.C. § 1382c. 42 U.S.C. § 1382c(a)(3) states that “[A]n individual shall be considered to be disabled for purposes of this title … if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or … last for a continuous period of not less than twelve months (or in the case of a child under the age of 18, if that individual has a medically determinable physical or mental impairment, which results in marked and severe functional limitations, and which can be expected to result in death or … last for a continuous period of not less than 12 months).”

[3] 42 U.S.C. § 1396p(d)(4)(A) provides that a trust’s assets are not countable if it is “[a] trust containing the assets of an individual under age 65 who is disabled (as defined in section 1382c(a)(3) of this title) and which is established for the benefit of such individual by a parent, grandparent, legal guardian of the individual, or a court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual under a State plan under this subchapter.”

[4]42 U.S.C. § 1396p(d)(4)(C) provides that a trust’s assets are not countable if it is “[a] trust containing the assets of an individual who is disabled (as defined in section 1382c (a)(3) of this title) that meets the following conditions: (i) The trust is established and managed by a non-profit association. (ii) A separate account is maintained for each beneficiary of the trust, but, for purposes of investment and management of funds, the trust pools these accounts. (iii) Accounts in the trust are established solely for the benefit of individuals who are disabled (as defined in section 1382c(a)(3) of this title) by the parent, grandparent, or legal guardian of such individuals, by such individuals, or by a court. (iv) To the extent that amounts remaining in the beneficiary’s account upon the death of the beneficiary are not retained by the trust, the trust pays to the State from such remaining amounts in the account an amount equal to the total amount of medical assistance paid on behalf of the beneficiary under the State plan under this subchapter.”

[5] 42 U.S.C. § 1396p(d)(4)(B).

[6] Third-party special needs trusts are creatures of the common law. Federal law does not provide requirements or regulations for these trusts.

[7] 42 U.S.C. § 1396p(d)(4)(C).

[8] Id.

[9] Id.

[10] Id.

[11] If the funds remaining in the trust at death are sufficient to repay Medicaid’s payback right in full, many pooled trusts will distribute some portion of the remaining monies to the trust beneficiary’s heirs; however, each pooled trust will have a different policy and the amount retained at death can vary greatly. It is very important to investigate how much is retained in this type of situation. Some trusts will only retain $5,000 while others may retain $50,000.

Different methods for protecting needs-based benefit preservation must be explored for any disabled injury victim who is currently eligible.

Attorney Fee Deferral – A Unique Opportunity for Contingent Fee Lawyers to Tax Plan for Tomorrow

November 10, 2022

By Jason D. Lazarus, J.D., LL.M., CSSC, MSCC

An often-overlooked issue for plaintiff attorneys is the management of taxation of their own contingent legal fees. As part of the normal rhythm of their practices, many attorneys experience peaks, and valleys with their own personal income. This leads to concerns for trial attorneys about the unpredictability of their own income. However, attorneys have a unique opportunity, not available to others who earn professional fees, to take their contingent legal fees and invest them on a pre-tax and tax-deferred basis to smooth out income. Attorney fee structures and deferred compensation arrangements allow lawyers to avoid taking income all in one taxable year when they earn a large fee. However, these solutions must be explored and decided upon prior to signing a release. While these financial products may seem complex, they are quite simple. Having an expert advisor who can provide you with different options is critical. The remainder of this chapter answers some frequently asked questions about deferral of contingent legal fees.

The legal foundation for this comes from a 1994 tax court decision Childs v. Commissioner.^[1] This decision was the last time the Internal Revenue Service challenged an attorney’s ability to enter into an agreement to defer their contingent legal fees. In Childs, U.S. Court of Appeals for the 11^th Circuit affirmed the tax court’s ruling that attorneys may structure their fees, holding that taxes are payable on structured attorney fees at the time the amounts are received.^[2] The IRS has now cited the Childs decision favorably and recognized it as binding precedent in a Private Letter Ruling.^[3] In that PLR, the IRS described that the “Tax Court held that the fair market value of taxpayer’s right to receive payments under the settlement agreement was not includable income in the year in which the settlement agreement was effected because the promise to pay was neither fixed nor secured.” It went on to state that the “court further held that the doctrine of constructive receipt was not applicable because the taxpayer did not have a right to receive payment before the time fixed in the settlement agreement.”

Since these are “tax-advantaged” plans there are rules and formalities which can be a bit inflexible. It is a well-accepted tax construction that works. A lawyer, who earns a contingent fee, must decide before settlement to have his/her fee paid over time instead of taking it in a lump sum. The fee that is being deferred is paid to a life insurance company which will agree to make future periodic payments. The decision to defer can be made at any point before the settlement agreement is signed, even right up to the moment before the agreement is signed. Even though a fee has been technically earned over the course of representation of the client, the lawyer (according to tax authorities) hasn’t earned the fee for tax purposes until the settlement documents are executed. An attorney has the autonomy to decide whether to defer all or part of their fee in this way.

Attorney Fee Structures

Attorney fee “structures” are annuities and work very much like a non-qualified deferred compensation plan. The taxes that would be otherwise paid on the fee earned at the time the case is settled are deferred, and that money grows without tax on the growth. When distributions are made, the entire amount distributed during a year is taxable for that year. Based upon a taxpayer’s tax bracket, there may be some distinct tax advantages to entering into this type of arrangement as opposed to being taxed on the entire fee in the year it was earned and investing it after tax. Depending on how much the fees are, current tax bracket rates and any other sources of income, stretching out payment of fees can result in potentially a smaller tax burden. This is a challenge in most professions; timing of income but controlling the realization of income is possible for attorneys. Using attorney fee structures, plaintiff attorneys can defer their fees and income taxes on those fees for personal injury cases as well as many other types of cases. An attorney fee structure allows an attorney to set up a personally tailored retirement plan without the monetary and age restrictions or other drawbacks of a qualified plan. The attorney can defer taxes on his or her fees as well as the interest that those fees earn until the year in which a distribution is received from the fee structure.

The fee structure can help a lawyer avoid the highest tax brackets by leveling off income spikes due to large fees and spreading the income out over several years. An attorney who otherwise would have an unusually high income in one taxable year, but elects to spread the income over several years, avoids paying taxes in the highest bracket. Couple the tax savings with guaranteed earnings on the deferred funds, and the benefits of an attorney fee structure become obvious. Fee structures can be done by one attorney in a firm, without the requirement that other attorneys and employees participate, as would be the case in a qualified retirement plan. Also, there is no limit as to the amount of income deferred. By comparison, there are statutory limits to the amount one can defer in a qualified retirement plan. Even if the attorney participates in a qualified retirement plan or individual retirement account (IRA), he or she may still defer additional income through an attorney fee structure. Unlike traditional retirement plans, there is no requirement of annual deferments. A bonus is that the attorney fee structure is exempt from creditor’s claims in most jurisdictions.

When an attorney fee is earned in a personal physical injury case, including mass torts, with all payments to the claimant being eligible for exclusion from taxable income under I.R.C. § 104(a)(2), or workers’ compensation case under section 104(a)(1), the same structured settlement annuities that the personal injury victim obtains can be used and the payment options are greatly expanded. A qualified assignment is done just as in the case of the personal injury victim. Attorney fee structures can also be done on fees from cases that are not personal physical injuries under section 104 (a)(2). These include fees from cases based on claims of discrimination, sexual harassment, employment litigation, defamation, wrongful imprisonment, wrongful termination, other non-physical personal injuries including emotional distress, punitive damages, bad faith, breach of contract and construction defects, to name several.

Since fee structures are pre-tax and tax-deferred investment vehicles, a major benefit is the compounding effect of deferring payments out over longer periods of time. The longer an attorney waits for payments or the longer the duration of the distribution term, the better the financial result and possibly the tax result as well. Payments can start right away, but don’t have to. They can be deferred for any length of time and then can be paid out over a duration of years or for life. There are almost infinite possibilities in terms of the different types of arrangements that can be set up.

While structuring one hundred percent of every contingent fee earned probably doesn’t make sense or even a percentage of every fee, there are some unique benefits to doing so that shouldn’t be ignored. A systematic approach to structuring a portion of every fee can lead to a very attractive end result when an attorney wishes to retire. For example, if an attorney took fifteen to twenty five percent of every contingent fee earned and deferred it out to retirement, then they would have taken advantage of the benefits of a stable retirement income, estate planning advantages and tax benefits that most people in the workforce can’t achieve. With the unpredictability of the contingent fee law practice and life in general, you don’t want to rely on any one solution for retirement and so exploring fee structures is one way to hedge against the uncertainties.

There are some key reasons to do an attorney fee structure:

It is a pretax investment in a guaranteed high yielding tax deferred annuity.
Deferring compensation over time results in less being lost to taxes.
Application of AMT can potentially be avoided.
Gives you custom cash flow management and allows you to tailor your own income stream.
Structured fees have enhanced protection from creditors, judgments, and divorce decrees.

There are some frequently asked questions related to structured attorney fees.

Does the personal injury victim have to structure a portion of their settlement before the attorney fee can be structured? No. The claimant can take one hundred percent cash and the attorney fee can still be structured.
How does fee structuring work? Structuring an attorney fee works very similarly to structuring the victim’s settlement. The most important thing to remember is you can’t take receipt of the fees.
Why structure an attorney fee in a fixed interest rate annuity? Every portfolio should have some portion of the investments in fixed income. An attorney fee structure is a fixed income investment but unlike all others an attorney can make, the fee structure is a pre-tax investment. Whether a fee structure is appropriate for you will depend on a variety of factors, including your age, health, risk tolerance, retirement goals, tax bracket as well as your current and long-term needs. However, structuring your attorney fees could provide beneficial tax relief as well as secure and stable tax deferred income up to, and including, your lifetime.
Can I receive the same types of income streams the victim can with their settlement proceeds? Yes, you can have lifetime benefits. You can have a “period certain” for a defined amount of time or a future lump sum payment as well as a series of lump sum payments. You can select immediate or deferred payments. You can have multiple income streams such as lifetime payments coupled with lump sum payments.
Can I only structure contingent fees from a personal physical injury or wrongful death settlement? No. You can structure contingent fees from nearly any type of settlement. Companies have developed innovative products to expand the availability of attorney fee structures.
What do I need to do to prepare for structuring my attorney fees? You should negotiate the inclusion of the fee structure when settling the case since the creation of a tax-deferred fee structure does require the cooperation of the defendant like when the victim’s settlement is structured.

While the foregoing discussion focused on “fixed” attorney fee structure annuities, there are two other potential options that are available. First, there is an equity indexed attorney fee structure product. The equity indexed attorney fee structure ties return to the S&P 500 index. If the index is up, your payments increase. If the index is flat or negative, there is no decrease. So, no downside risk, only upside. The upside though is limited to a maximum ceiling of 5%. As the payments increase, they lock and you can only go up, never down. This type of product provides more upside potential than the traditional “fixed” fee structure while remaining conservative. Second, there is a “non-qualified” attorney fee structure. These products in this type of structure involve an “off-shore” assignment to achieve tax-deferral based on international tax treaties. Instead of using an annuity as the funding vehicle, these are open architecture allowing the attorney to use his own financial advisor to select appropriate investments which typically include stocks, mutual funds, ETFs, bonds and other investments. These types of products are like the deferred compensation plans described immediately below since there are more available investment options but inherently have some additional risk due to the “off-shore” assignment. As with all the decisions associated with fee deferral, you should consult with your own tax advisors to determine what is most suitable.

Deferred Compensation Plans for Attorneys

A non-annuity deferred compensation arrangement is another mechanism that trial lawyers can use to invest the contingent legal fees they earn on a pre-tax and tax-deferred basis. Like Fortune 500 executives who defer their compensation, you can defer all or a portion of your fees until you are ready to start receiving them. Using this kind of solution, you have flexibility with investments as well as more control over timing of income. For example, if you wanted to defer a five hundred-thousand-dollar fee in the current taxable year by splitting the fee plus the investment gains into twenty quarterly payment buckets you could do so. Thirteen months prior to any scheduled quarterly payment, you can elect to withdraw it. However, if you don’t need the payment, the payment bucket will automatically roll forward to the end of the line. By laddering payments in this way, you can effectively manage your cash flow and better control the timing of taxation.

From a legal-tax perspective, fee deferrals are subject to the same body of tax rules that govern Nonqualified Tax-Deferred Compensation (NQDC). So, this means that the deferrals must avoid the application of the constructive receipt and economic benefit doctrines. NQDC has been used for decades by Fortune 500 companies to attract, retain, and further compensate their top-level executives. These deferred compensation plans rely upon the same decision as attorney fee structures, Childs. Since the legal underpinnings are the same and are well established, the risk is relatively like attorney fee structure annuities.

Conclusion

In summary, attorney fee deferral solutions allow a plaintiff lawyer to not only defer receipt of (and tax on) fees until received, he or she can have the deferred fees invested, and have the income produced from it also taxable over time rather than immediately. A lawyer may want to consider deferring fees as part of his or her own income tax planning, financial planning, and estate planning. Tax deferral mechanisms for lawyers are a great way to smooth out those income spikes caused by larger fees or just take better control over timing of income. Due to the variety of options, there is likely something that will best suit an attorney’s needs and investment preferences. Attorneys should explore these options to take back control of timing of income.

[1] Childs v. Commissioner, 103 T.C. 634 (1994) affirmed without opinion 89 F. 3d 56 (11^th Cir. 1996).

[2] Id.

[3] PLR-150850-07

An often-overlooked issue for plaintiff attorneys is the management of taxation of their own contingent legal fees.

Settlement Compliance Strategies for Closing Cases

October 13, 2022

By Jason D. Lazarus, J.D., LL.M., CSSC, MSCC

Ethical Issues at Settlement

Suffering even a moderate personal physical injury can create difficult challenges both financially and emotionally for even the strongest among us. However, what happens when someone suffers a serious or catastrophic personal physical injury? Do they get the proper counsel regarding the form of the settlement to protect their current assets, preserve public benefits and safeguard the physical injury recovery? Will the recovery be enough to pay for all the victim’s future medical needs without public assistance? Can they recover physically? Can they recover emotionally? All these issues can be very difficult to face for someone who is seriously injured. Personal injury practitioners who represent disabled clients should be aware of their obligations to advise these clients properly and understand the hurdles faced by the injury population in terms of recovery both financially and physically. This white paper addresses issues of major importance when dealing with the form of settlement for a personal injury matter involving a disabled client.

Ethical Concerns & Malpractice Liability

The ABA Model Rules and Ethical Obligations to Advise the Personal Injury Client

Personal injury lawyers are excellent at consulting with clients on the value of their case and obtaining significant monetary results in the litigation, however the practitioner sometimes fails to properly advise/protect their client financially post-settlement.^[1] For personal injury victims there is usually a focus on the dollar amount of the recovery rather than how the recovery can be structured to provide protection to the disabled injury victim.^[2] The concentration of substance over form by the lawyer handling the physical injury suit can have devastating consequences for an injury victim. A disabled injury victim can mismanage their personal injury recovery and lose the public benefit eligibility they desperately need.^[3] Therefore questions arise: Does a lawyer have an ethical obligation to advise a disabled client regarding the form of their recovery? Does the lawyer have an ethical duty to explain the impact of a personal injury recovery on public benefits and techniques to protect eligibility? Below I examine the ethical rules, statutes and case law to shed some light on potential answers to these questions.

There are four provisions within the ABA Model Rules of Professional Conduct that are particularly relevant to the personal injury lawyer’s advisement obligations when it comes to consulting on the form or structure of disabled injury victim’s recovery. Rule 1.4 (b) provides: “A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions . . . .”^[4] Rule 1.3 states: “A lawyer shall act with reasonable diligence and promptness in representing a client.”^[5] The commentary warns: “A client’s interests can be adversely affected by the passage of time.”^[6] 1.2 (a) admonishes that: “A lawyer shall abide by the client’s decisions concerning the objectives of representation . . . and shall consult with the client as to the means by which they are to be pursued.”^[7] Rule 1.2 also says “a lawyer shall abide by the client’s decision whether to settle a matter.”^[8] Finally, Rule 2.1 indicates: “In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social and political factors, that may be relevant to the client’s situation.”^[9]

Many personal injury practitioners seem to believe that advice regarding financial matters and techniques to preserve public benefit eligibility crosses the line between legal and “financial” advice. However, as I will discuss more thoroughly below, these issues touch on the law and do create an obligation on the part of the personal injury practitioner to properly advise the client regarding their implication as to the form or structure of the recovery. If you take the Model Rules together with the legal malpractice case law discussed below, it is this author’s opinion that the personal injury lawyer must address the financial implications of the settlement and impact on public benefit eligibility with the injured client to enable the client to make an informed decision about the form of the settlement. Allowing a disabled client to take the personal injury recovery in a single lump sum without any advice on the impact of that decision would set up a situation where the client could be adversely impacted by the passage of time.

Malpractice Liability for Failing to Advise Injury Victim Clients

The Grillo^[10] case from Texas is the most widely publicized legal malpractice settlement involving liability for failing to counsel a minor client on the form of a personal injury settlement. Christina Grillo was born with Cerebral Palsy, cortical blindness and quite a few other medical problems.^[11] Her parents instituted a medical malpractice action alleging her medical problems were due to negligent medical care during delivery in a Texas Hospital. The medical malpractice case was settled for $2.5 million.^[12] The settlement was placed into the court registry.^[13] The interest earned from the investments in the trust was taxable and the child lost her Medicaid eligibility since no special needs trust was established.^[14]

The personal injury lawyers who handled the case were later sued for legal malpractice for their handling of the settlement. In the legal malpractice action, Grillo’s legal counsel, Kevin Isern, alleged that her personal injury lawyer “didn’t offer a structured settlement to the child and “[t]hey had the money deposited into the registry of the court . . . and she lost Medicaid.”^[15] Having the money placed in the court registry meant Christina Grillo could not have a tax-free structured settlement and all of the accrued interest was taxable. Isern pointed out that “[i]n a structured settlement, that does not occur.”^[16] He also pointed to the fact that the lawyers also failed to set up a special needs trust which would have preserved her Medicaid eligibility.^[17] Finally, Isern pointed out that in the Grillo case “[y]ou have a child who has all these needs, requires 24-hour care and has no government assistance to help pay for it. She got taxed on all the money she gained.”^[18]

The Grillo legal malpractice case was settled by the personal injury firm that handled the medical malpractice action on behalf of the minor and by the guardian ad litem (“GAL”) who had represented the minor’s interests when the settlement was approved. ^[19] The personal injury firm settled the legal malpractice action for its handling of the medical malpractice settlement for $1,600,000. Interestingly, the suit against the GAL was settled for $2,500,000. For attorneys that serve as guardian ad litems with any frequency, it is attention grabbing that the GAL wound up with the largest share of the liability in terms of the gross settlement amount. However, it sends a clear warning message to personal injury lawyers as well as guardian ad litems about their obligations to properly advise a client about the financial options they have and preservation of public benefits.

The only other reported decision regarding suit over failing to give advice about the form of settlement is the French v. Glorioso decision.^[20] In French, the injury victim, Karen French, was shot during a robbery attempt at a parking garage in New Orleans and was rendered a quadriplegic.^[21] She brought suit against the owners of the parking garage for providing insufficient security.^[22] At the time of the shooting, she was covered by a group health care plan but subsequently lost the coverage and was dependent on Medicaid. The case was settled in November of 1998.^[23] In July of 1999, French consulted an attorney about setting up an SNT. The attorney advised her that she would lose her Medicaid eligibility since the settlement was deposited into the plaintiff attorney’s trust account.^[24] Following this discovery, French sued the personal injury lawyer for legal malpractice, negligent misrepresentation, breach of contract and breach of fiduciary duty.^[25]

Ultimately, the French case was not decided upon the merits of her claim against her personal injury attorney but instead on a personal jurisdiction issue.^[26] Ms. French hired a Texas lawyer to handle the claim, who in turn associated with local Louisiana counsel since the suit needed to be filed in Louisiana.^[27] The legal malpractice action was brought in Texas against the Louisiana attorney, which raised personal jurisdiction issues.^[28] There appeared to be some factual dispute between French and her personal injury attorney over what had been recommended in terms of setting up an SNT, but this case again demonstrates the potential malpractice liability for failing to properly and fully advise clients about the impact of the settlement on their financial situation and public benefit eligibility.^[29]

Finally, the American Bar Association released its report on the Profile of Legal Malpractice Claims in 2003 and personal injury lawyers made up the largest percentage of malpractice claims, twenty percent.^[30] Advice and settlement/negotiation made up over twenty three percent of the claims overall.^[31] When those two categories are combined they are tied for first in terms of the highest claims by type of activity in the study.^[32] While the report does not specify, it is logical to conclude that claims of failing to give advice about financial options, taxation of damages and preservation of public benefits would squarely fall within the purview of advice as well as settlement/negotiation malpractice claims.

Ethical and Legal Duties to the Plaintiff at Settlement

The fact that all the issues relating to the form of the recovery touches the law drives home the fact that it is the personal injury lawyer’s obligation to at least raise these issues as part of their discussions with the disabled client. As discussed above, there are provisions in the United States Code along with the Internal Revenue Code that impact the form of the recovery. These provisions, if not explained to the injury victim client, can result in the client’s inability to avail themselves of options available under the law. If the injury victim’s lawyer does not explain these issues to them, who will?

If the disabled client is not given advice about how to structure their recovery, they could suffer quantifiable damages that can be proven in a legal malpractice case. There are many experts that can be hired to make sure clients are properly advised of all their options for their recovery. To avoid future liability, the personal injury lawyer should hire such experts to protect their clients and themselves. If clients refuse counseling or refuse methods to protect their recovery, a good course of action is to have them sign a waiver or acknowledgement that they have been advised of their options and understand what they are giving up. If the personal injury practitioner gives clients all their options regarding how to structure their recovery, and has them sign a waiver/acknowledgement if they decline the options presented to them, the lawyer has at least documented the file so if there is a subsequent legal malpractice claim they can offer evidence of the advice they gave.

Pursuant to the Grillo decision and the Model Rules, a lawyer must counsel clients regarding their financial options and techniques to preserve public benefits to avoid causing a potential loss to the client. Grillo’s message to plaintiff lawyers is to employ or consult competent experts in taxation, trusts and structured settlements prior to distributing any funds to the injury victim. If a lawyer fails to discuss the financial options a client has and then the client sues for legal malpractice, there are demonstrable damages as Grillo so aptly demonstrated. Without knowledge of the tax law, the client can lose the power of a significant tax exemption offered for structured settlement recipients. He or she can lose out on the opportunity for a safe investment with competitive rates of return. Finally, and potentially the most damaging, the client can lose public assistance eligibility.

The problem is that plaintiff counsel typically has a very short time period within which to counsel the client in between settlement/verdict and disbursement of the funds. The biggest mistake a personal injury lawyer can make is triggering constructive receipt^[33] by placing the settlement proceeds in his or her trust account. One solution to the settlement time crunch is to use a qualified settlement fund (QSF). A QSF is a temporary settlement related trust that can be created pursuant to Treasury Regulations to receive personal injury settlement proceeds.^[34] A court with jurisdiction over the matter must issue an order creating the trust and the trust must meet the definition of a trust under state law.^[35] Once created, it allows for an immediate cash settlement with the defendant and removes the defendant from the process. The QSF acts as a holding tank for the settlement proceeds and gives plaintiff counsel time to employ experts while preserving the ability to structure the settlement as well as create public benefit preservation trusts without violating the tax doctrine of constructive receipt. A financial plan can be developed, and the client’s needs addressed.

A personal injury practitioner must discuss with disabled clients the form of their personal injury recovery or hire an expert to do so. There are many different options when it comes to the form of the financial recovery. While there certainly is no clear-cut answer as to the amount of the recovery that would trigger the counseling obligation, if a physical injury recovery could result in loss of public benefits it is prudent for the lawyer give advice to that client about the options or have an expert do so. Every client, no matter age, sex or level of sophistication, should be given their options regarding the form of the recovery which are available under the law. Disabled clients especially need counseling given the likelihood they will be receiving some type of public benefits. To prevent being exposed to a malpractice cause of action, the personal injury practitioner should understand the types of public benefits that a disabled client may be eligible for and techniques that are available to preserve those benefits. Having this knowledge will help the lawyer identify disabled clients they may want to refer for further consultation with other experts.

Overview of Public Assistance Programs & Laws That Impact Settlement

Because most of a lawyer’s malpractice exposure at settlement is related to public benefit preservation, it is important to understand the basics of these benefits. Ethically, a lawyer must be able to explain these matters to the extent that the client is informed sufficiently to make educated decisions. There are two primary public benefit programs available to those who are injured and disabled. The first is the Medicaid program and the intertwined Supplemental Security Income benefit (“SSI”). The second is the Medicare program and the related Social Security Disability Income/Retirement benefit (“SSDI”). Both programs can be adversely impacted by an injury victim’s receipt of a personal injury recovery. Understanding the basics of these programs and their differences is imperative to protecting the client’s eligibility for these benefits.

Medicaid and Supplemental Security Income (hereinafter SSI) are income and asset sensitive public benefits which require special planning to preserve. In many states, one dollar of SSI benefits automatically provides Medicaid coverage. This is very important, as it is imperative in most situations to preserve some level of SSI benefits if Medicaid coverage is needed in the future. SSI is a cash assistance program administered by the Social Security Administration. It provides financial assistance to needy, aged, blind, or disabled individuals. To receive SSI, the individual must be aged (sixty-five or older), blind or disabled^[36] and be a U.S. citizen. The recipient must also meet the financial eligibility requirements.^[37] Medicaid provides basic health care coverage for those who cannot afford it. It is a state and federally funded program run differently in each state. Eligibility requirements and services available vary by state. Medicaid can be used to supplement Medicare coverage if the client is eligible for both programs^[38]. For example, Medicaid can pay for prescription drugs as well as Medicare co-payments or deductibles. Medicaid and SSI are income and asset sensitive, therefore, creation of a special needs trust may be necessary which is described in greater detail below.

Medicare and Social Security Disability Income (hereinafter SSDI) benefits are an entitlement and are not income or asset sensitive. Clients who meet Social Security’s definition of disability and have paid enough quarters into the system can receive disability benefits regardless of their financial situation.^[39] The SSDI benefit program is funded by the workforce’s contribution into FICA (social security) or self-employment taxes. Workers earn credits based on their work history and a worker must have enough credits to get SSDI benefits should they become disabled. Medicare is a federal health insurance program. Medicare entitlement commences at age sixty-five or two years after becoming disabled under Social Security’s definition of disability.^[40] Medicare coverage is available again without regard to the injury victim’s financial situation. A special needs trust is not necessary to protect eligibility for these benefits. However, the Medicare Secondary Payer Act (MSP) may necessitate the use of a Medicare Set Aside discussed in greater detail below.

Laws that Impact Settlement

In order to properly advise personal injury victims about their legal options at settlement, an attorney first must know and understand the laws that impact settlement. There are important federal laws that can impact a client’s eligibility for public benefits post settlement that must be explained. There are also financial options provided for under the Internal Revenue Code that should be explored. These issues are laid out in more detail with a focus on the ethical and malpractice issues raised in discussing the form of a personal injury settlement.

Public Assistance

The Medicare Secondary Payer Act: §1862(b) of the Social Security Act

A client who is a current Medicare beneficiary or reasonably expected to become one within 30 months should concern every trial lawyer because of the implications of the MSP. The Medicare Secondary Payer Act (“MSP”) is a series of statutory provisions^[41] enacted in 1980 as part of the Omnibus Reconciliation Act^[42] with the goal of reducing federal health care costs. The MSP provides that if a primary payer exists, Medicare only pays for medical treatment relating to an injury to the extent that the primary payer does not pay.^[43] The regulations that implement the MSP provide “[s]ection 1862(b)(2)(A)(ii) of the Act precludes Medicare payments for services to the extent that payment has been made or can reasonably be expected to be made promptly under any of the following” (i) Workers’ compensation; (ii) Liability insurance; (iii) No-fault insurance.”^[44]

There are two issues that arise when dealing with the application of the MSP: (1) Medicare payments made prior to the date of settlement (conditional payments) and (2) future Medicare payments for covered services (Medicare set asides). Since Medicare isn’t supposed to pay for future medical expenses covered by a liability or Workers’ Compensation settlement, or a judgment or award, Centers for Medicare & Medicaid Services (CMS) recommends that injury victims set aside a sufficient amount to cover future medical expenses that are Medicare covered. CMS’ recommended way to protect an injury victim’s future Medicare benefit eligibility is establishment of a Medicare Set Aside (“MSA”) to pay for injury related care until exhaustion.

In certain cases, a Medicare Set Aside may be advisable in order to preserve future eligibility for Medicare coverage. A Medicare set aside allows an injury victim to preserve Medicare benefits by setting aside a portion of the settlement money in a segregated account to pay for future Medicare covered healthcare. The funds in the set aside can only be used for Medicare covered expenses for the client’s injury related care. Once the set aside account is exhausted, the client gets full Medicare coverage without Medicare looking to their remaining settlement dollars to provide for any Medicare covered health care. In certain circumstances, Medicare approves the amount to be set aside in writing and agrees to be responsible for all future expenses once the set aside funds are depleted.

The problem is that MSAs are not required by a federal statute even in Workers’ Compensation cases where they are commonplace. There are no regulations, at this time, related to MSAs either. Instead, CMS has intricate “guidelines” and “FAQs” on their website for nearly every aspect of set asides from submission to administration. There are only limited guidelines for liability settlements involving Medicare beneficiaries. Without codification of set asides, there are no clear-cut appellate procedures from arbitrary CMS decisions and no definitive rules one can count on as it relates to Medicare set asides. While there is no legal requirement that an MSA be created, the failure to do so may result in Medicare refusing to pay for future medical expenses related to the injury until the entire settlement is exhausted. There has been a slow progression towards a CMS policy of creating set asides in liability settlements over the last seven years as a result of the Medicare Medicaid SCHIP Extension Act’s passage^[45]. This creates a difficult situation for Medicare beneficiary-injury victims and contingent liability for legal practitioners as well as other parties involved in litigation involving physical injuries to Medicare beneficiaries given the uncertainty surrounding the need to create a set aside. There appear to be regulations on the horizon for set asides based upon a Notice of Proposed Rulemaking from CMS entitled “Medicare Secondary Payer and Future Medicals”.^[46]

Special Needs Trusts: 42 U.S.C. §1396p(d)(4)

The receipt of personal injury proceeds by someone seriously injured can cause ineligibility for means based tested government benefit programs. Medicaid^[47] and SSI^[48] are two such programs. However, there are planning devices that can be utilized to preserve eligibility for disabled injury victims. A special needs trust (SNT) can be created to hold the recovery and preserve public benefit eligibility since assets held within a special needs trust are not countable resources for purposes of Medicaid or SSI eligibility. The creation of special needs trusts is authorized by the federal law.^[49] Trusts commonly referred to as (d)(4)(a) special needs trusts, named after the federal code section that authorizes their creation, are for those under the age of sixty five.^[50] However, another type of trust is authorized under the federal law with no age restriction and it is called a pooled trust, commonly referred to as a (d)(4)(c) trust.^[51] These trusts are described fully below.

A personal injury recovery can be placed into a SNT so that the victim can continue to qualify for SSI and Medicaid. Federal law authorizes and regulates the creation of a SNT. The 1396p^[52] provisions in the United States code govern the creation and requirements for such trusts. First and foremost, a client must be disabled in order to create a SNT.^[53] There are three primary types of trusts that may be created to hold a personal injury recovery each with its own requirements and restrictions. First is the (d)(4)(A)^[54] special needs trust which can be established only for those who are disabled and are under age sixty-five. This trust is established with the personal injury victim’s recovery and is established for the victim’s own benefit. It can only be established by a parent, grandparent, guardian or court order. The injury victim can’t create it on his or her own. Second is a (d)(4)(C)^[55] trust, typically called a pooled trust that may be established with the disabled victim’s funds regardless of age. A pooled trust can be established by the injury victim unlike a (d)(4)(A). Third and last is a third party^[56] SNT which is funded and established by someone other than the personal injury victim (i.e., parent, grandparent, charity, etc. . .) for the benefit of the personal injury victim. The victim still must meet the definition of disability.

Dual Eligibility: The Intersection of Medicare and Medicaid – SNT/MSA

If you have a client who is a Medicaid and Medicare recipient, extra planning may be in order. If it is determined that a Medicare Set Aside is appropriate, it raises some issues with continued Medicaid eligibility. A Medicare Set Aside account is considered an available resource for purposes of needs-based benefits such as SSI/Medicaid. If the Medicare Set Aside account is not set up inside a SNT, the client will lose Medicaid/SSI eligibility. Therefore, in order for someone with dual eligibility to maintain their Medicaid/SSI benefits the MSA must be put inside a special needs trust. In this instance you would have a hybrid trust which addresses both Medicaid and Medicare. It is a complicated planning tool but one that is essential when you have a client with dual eligibility.

Financial Considerations

Periodic Payments: §104(a)(2) of the Internal Revenue Code

When any physical injury victim recovers money either by settlement or by verdict, the question of the tax treatment of said recovery arises. As long as it is compensation for personal physical injuries it is tax-free under Section 104(a)(2) of the Internal Revenue Code.^[57] Section 104(a)(2) of the Internal Revenue Code states that “gross income does not include . . . the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness.”^[58] Section 104(a)(2) gives the personal injury victim two different financial options for their recovery, lump sum or periodic payments.^[59]

The first option is to take all of the personal injury recovery in a single lump sum. If this option is selected, the lump sum is not taxable, but once invested, the gains become taxable and the receipt of the money will impact his or her ability to receive public assistance.^[60] A lump sum recovery does not provide any spendthrift protection and leaves the recovery at risk for creditor claims, judgments and potential rapid dissipation.^[61] The personal injury victim has the burden of managing the money to provide for their future needs be it wage loss or future medical. The second option is receiving “periodic payments” known as a structured settlement^[62] instead of a single lump sum payment. A structured settlement’s investment gains are never taxed^[63], it offers spendthrift protection^[64] and the money has enhanced protection against creditor claims as well as judgments.^[65] A structured settlement recipient can avoid disqualification from public assistance when a structured settlement is used in conjunction with the appropriate public benefit preservation trust.

If a structured settlement is to be used for someone eligible for needs based public benefits such as Medicaid and/or SSI, it is vitally important that a plan be properly constructed to avoid disqualification. A structured settlement alone will never preserve public benefit eligibility and may in fact cause permanent disqualification when lifetime benefits are involved. For example, in Sams v. DPW ^[66], a Pennsylvania court found that the purchase of a structured settlement as part of a personal injury settlement was a transfer of assets for less than fair market value, causing disqualification from needs-based benefits for the recipient. To avoid this sort of outcome, it is necessary that a structured settlement’s payments be irrevocably assigned to a properly created special needs trust. According to a 2006 Social Security Administration letter, “if the beneficiary of a trust which is not a resource for SSI has no right to anticipate, sell or transfer the annuity payments, the payments from a structured settlement annuity that are irrevocably assigned to an SNT, are not income to the trust beneficiary when paid into the trust.”^[67] In addition, under the Sams decision, payments should begin immediately into the trust. They cannot be deferred, and the death beneficiary of future payments should be the special needs trust so as not to frustrate federal payback requirements.

[1] This statement is based on the author’s personal experience and observations in countless cases. However, the author acknowledges that practices do vary considerably in this area. Some trial lawyers may simply refer a client to a financial advisor or a local bank. Others may employ a settlement planner with expertise in structured settlements and public benefit preservation techniques. See also Ellen S. Pryor, Liability for Inchoate and Future Loss After Judgment, Va. L. Rev., 1758, 1813 – 1827 (2002) (concluding that practices vary considerably in terms of advisement by the trial lawyer regarding financial obligations at settlement).

[2] Id.

[3] See Generally Marcus L. Plant, Periodic Payment of Damages for Personal Injury, La. L. Rev., 1327, 1331 – 1332 (discussing numerous studies on dissipation of settlements and the resulting dependence on public assistance programs).

[4] Model Rules of Professional Conduct Rule 1.4(b) (2007).

[5] Model Rules of Professional Conduct Rule 1.3 (2007).

[6] Model Rules of Professional Conduct Rule 1.3 (2007).

[7] Model Rules of Professional Conduct Rule 1.2(a) (2007).

[8] Model Rules of Professional Conduct Rule 1.2 (2007).

[9] Model Rules of Professional Conduct Rule 2.1 (2007).

[10] Grillo was a confidential legal malpractice settlement that became public due to a filing error on the part of the court approving the malpractice action. See Amy Johnson Conner, Is Plaintiffs’ Lawyer Liable for Not Offering Structured Settlement?, Lawyers Weekly USA (August 6 2001).

[11] Id.

[12] Id.

[13] Id.

[14] Id.

[15] Id.

[16] Id.

[17] Id.

[18] Id.

[19] Amy Johnson Conner, Is Plaintiffs’ Lawyer Liable for Not Offering Structured Settlement?, Lawyers Weekly USA (August, 6 2001).

[20] French v. Glorioso, 94 S.W.3d 739 (Tex. Ct. App. 2002).

[21] Id. at 743.

[22] Id.

[23] Id.

[24] Id.

[25] Id.

[26] Id. at747.

[27] Id. at 743.

[28] Id.

[29] Id. at 747.

[30] American Bar Association Standing Committee on Lawyers’ Professional Liability, Profile of Legal Malpractice Claims (2003).

[31] Id.

[32] Preparation, filing, and transmittal of documents made up 23.08% of claims. The next highest claim by type of activity, after the combination of advice and settlement/negotiation, was pre-trial and pre-hearing at 19.47%. American Bar Association Standing Committee on Lawyers’ Professional Liability, Profile of Legal Malpractice Claims (2003).

[33] Constructive receipt is a tax doctrine that says even though a taxpayer might not have actual possession of money, they have constructively received the money if it has been set aside, credited to an account or otherwise is available without limitation to the taxpayer. Money held in a plaintiff attorney’s trust account that belongs to the personal injury victim is constructively received for tax purposes. This concept is important because once triggered; the plaintiff forever loses the ability to structure his or her settlement and could lose public benefits.

[34] Treas. Reg. § 1.468B-1 (2007). There are three requirements for creation of a QSF: (1) It is established pursuant to an order of . . . a court of law . . .; (2) It is established to resolve or satisfy one or more contested or uncontested claims . . . and that has given rise to at least one claim asserting liability (i) Under CERCLA (ii) Arising out of a tort, breach of contract, or violation of law; or (iii) Designated by the Commissioner in a revenue ruling or revenue procedure; and (3) The fund, account, or trust is a trust under applicable state law . . .

[35] Treas. Reg. § 1.468B-1 (2007). The mechanical steps involved in utilizing a QSF are as follows: 1. Settle with Defendant for cash and execute a cash release which includes the agreement that Defendant will pay the settlement proceeds into the QSF. 2. Petition a court with jurisdiction for creation of Qualified Settlement Fund and obtain order creating QSF. 3. Defendant writes a check for the net proceeds to the Plaintiff to the Qualified Settlement Fund. 4. Funds remain in Qualified Settlement Fund, without violating constructive receipt doctrine, until: a. Allocation decisions are made; b. Liens are satisfied; c. Special needs trust is created or deemed not necessary. Amount to be structured and the plan are decided upon. 5. QSF automatically terminates when all funds have been dispersed.

[36] Disability is defined the same way as for Social Security Disability benefits which is that the disability must prevent any gainful activity (e.g. employment), last longer than 12 months, or be expected to result in death. If someone receives disability benefits from Social Security, they automatically qualify as being disabled for purposes of SSI eligibility.

[37] An individual can only receive up to $552.00 per month ($829.00 for couples) and no more than $2,000 in countable resources.

[38] This is commonly referred to as “dual eligibility”. For those who are dual eligible, Medicaid will pay Medicare premiums, co-payments and deductibles within prescribed limits. There are two different programs. First, is Qualified Medicare Beneficiaries (“QMB”). The QMB program pays for the recipients Medicare premiums (Parts A and B), Medicare deductibles and Medicare coinsurance within the prescribed limits. QMB recipients also automatically qualify for extra help with the Medicare Part D prescription drug plan costs. The income and asset caps are higher than the normal SSI/Medicaid qualification limits. Second is Special Low-Income Medicare Beneficiary (“SLMB”). The SLMB program pays for Medicare premiums for Part B Medicare benefits. SLMB recipients automatically qualify for extra help with Medicare Part D prescription drug plan costs. Again, the income and asset caps are higher than the normal SSI/Medicaid qualification limits.

[39] While most often we deal with someone who has a disability, Social Security Disability also provides death benefits. Additionally, a child who became disabled before age 22 and has remained continuously disabled since age 18 may receive disability benefits based on the work history of a disabled, deceased or retired parent as long as the child is disabled and unmarried.

[40] SSDI beneficiaries receive Part A Medicare benefits which covers inpatient hospital services, home health and hospice benefits. Part B benefits cover physician’s charges and SSDI beneficiaries may obtain coverage by paying a monthly premium. Part D provides coverage for most prescription drugs, but it is a complicated system with a large co-pay called the donut hole.

[41] The provisions of the MSP can be found at Section 1862(b) of the Social Security Act. 42 U.S.C. § 1395y(b)(6) (2007).

[42] Omnibus Reconciliation Act of 1980, Pub. L. No. 96-499 (Dec. 5, 1980).

[43] 42 CFR § 411.20(2) Part 411, Subpart B, (2007).

[44] Id.

[45] The MMSEA created a mandatory insurer reporting requirement which tasks defendants/insurers with reporting settlements involving Medicare beneficiaries to Medicare. The reporting requirement requires settlements of $2,000 or greater to be reported as of 10/1/13. Medicare, Medicaid, and SCHIP Extension Act of 2007 (P.L. 110-173). This Act was passed by the House on December 19, 2007, and by a voice vote in the Senate on December 18, 2007.

[46] See OMB Website at http://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201304&RIN=0938-AR43&utm_source=hs_email&utm_medium=email&utm_content=9802088&_hsenc=p2ANqtz-_euylttJVQH6n2LezrHHgA7PMzVcdcZQAsDlnCG1ebSm8BHxtM5Ar222rNomoh-yQIo5y49aJC-7LqU-KfmwSRwyL2xmKNhbg9vTUcuUjT1mNfif4&_hsmi=9802088

[47] Medicaid is a needs based public benefit that provides basic health care coverage for those who are financially eligible. The Medicaid program is federally, and state funded but administered on the state level. Services and eligibility requirements vary from state to state. The asset limit is $2,000 for most Medicaid programs but the income limits vary by state.

[48] SSI or Supplemental Security Income, administered by the Social Security Administration, provides financial assistance to U.S. citizens who are sixty-five or older, blind or disabled. The recipient must also meet the financial eligibility requirements. 42 U.S.C. § 1382 (2007).

[49] 42 U.S.C. § 1396p (d)(4) (2007).

[50] 42 U.S.C. § 1396p (d)(4)(A) (2007).

[51] 42 U.S.C. § 1396p (d)(4)(C) (2007).

[52] 42 U.S.C. § 1396p (2007)

[53] To be considered disabled for purposes of creating an SNT, the SNT beneficiary must meet the definition of disability for SSDI found at 42 U.S.C. § 1382c. 42 U.S.C. § 1382(c)(a)(3) states that “[A]n individual shall be considered to be disabled for purposes of this title … if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or … last for a continuous period of not less than twelve months (or in the case of a child under the age of 18, if that individual has a medically determinable physical or mental impairment, which results in marked and severe functional limitations, and which can be expected to result in death or … last for a continuous period of not less than 12 months).”

[54] 42 U.S.C. § 1396p (d)(4)(A) provides that a trust’s assets are not countable if it is “[a] trust containing the assets of an individual under age 65 who is disabled (as defined in section 1382c(a)(3) of this title) and which is established for the benefit of such individual by a parent, grandparent, legal guardian of the individual, or a court if the State will receive all amounts remaining in the trust upon the death of such individual up to an amount equal to the total medical assistance paid on behalf of the individual under a State plan under this subchapter.”

[55]42 U.S.C. § 1396p (d)(4)(C) provides that a trust’s assets are not countable if it is “[a] trust containing the assets of an individual who is disabled (as defined in Section 1382(a)(3) of this title) that meets the following conditions: (i) The trust is established and managed by a non-profit association. (ii) A separate account is maintained for each beneficiary of the trust, but, for purposes of investment and management of funds, the trust pools these accounts. (iii) Accounts in the trust are established solely for the benefit of individuals who are disabled (by the parent, grandparent, or legal guardian of such individuals, by such individuals, or by a court. (iv) To the extent that amounts remaining in the beneficiary’s account upon the death of the beneficiary are not retained by the trust, the trust pays to the State from such remaining amounts in the account an amount equal to the total amount of medical assistance paid on behalf of the beneficiary under the State plan under this subchapter.”

[56] Third party special needs trusts are creatures of the common law. Federal law does not provide requirements or regulations for these trusts.

[57] I.R.C. § 104(a)(2) (2007).

[58] Id.

[59] Id.

[60] Id.

[61] Unlike a structured settlement, simply receiving a lump sum does not provide any spendthrift protection as the money can be dissipated rapidly. Similarly, there is no protection from creditor claims like a structured settlement enjoys.

[62] A structured settlement is a single premium fixed annuity used to provide future periodic payments to personal physical injury victims. The interest earned is not taxable under Section 104(a)(2) and a series of revenue rulings that provide the basis for structured settlements.

[63] See I.R.C. § 104(a)(2) (2007). See also Rev. Rul. 79-220 (1979) (holding recipient may exclude the full amount of the single premium annuity payments received as part of a personal injury settlement from gross income under section 104(a)(2) of the code).

[64] Structured settlements can’t be accelerated, deferred, anticipated or encumbered. The payments are made pursuant to the terms of the contract with the life insurance company. Thus, a personal injury victim is protected from spending the money too quickly. However, there are “factoring” companies that will purchase structured settlement annuities and provide a lump sum payment. These transactions are now regulated by IRC 5891 and many states have enacted provisions to protect structured settlement recipients from unfair transactions. IRC 5891 requires a finding that the sale is in the best interest of the annuitant and requires judicial approval. IRC 5891

[65] Many states offer protection by statute for annuities. For example, in Florida, the Florida Statutes provide annuities immunity from legal process as long as they are not set up to defraud creditors. See generally § 222.14 Fla. Stat. (2007).

[66] Sams v. Department of Public Welfare, 2013 Pa. Commw. LEXIS 337 (August 21, 2013).

[67] Letter from Nancy Veillon, Associate Commissioner for Income Security Programs to Roger M. Bernstein dated January 1, 2006.

This blog addresses issues of major importance when dealing with the form of settlement for a personal injury matter involving a disabled client.

Free Download: Resolution of Part C Medicare Advantage (MAO) Liens White Paper

April 7, 2022

Jason D. Lazarus, J.D., LL.M., CSSC, MSCC

Some clients, post-accident, may have switched from Medicare Parts A/B over to a Part
C Medicare Advantage Plan. Therefore, even if you have gone through the resolution process
for your client and gotten the Medicare conditional payment related issues dealt with, you might
not be finished. What lurks out there is that a Part C Advantage Plan (hereinafter MAO) may
have paid for some or all of your client’s care. You may wonder how that is possible when you
were told that the client was a Medicare beneficiary and Part A/B was paid back for conditional
payments.

For more information, read this excerpt from my book ‘The Art of Settlement‘.

Free Download: Medicare Advantage Liens Whitepaper

Free Download: Structured Settlement Whitepaper

January 10, 2022

When any physical injury victim recovers money either by settlement or by verdict, the question of the tax treatment of said recovery arises. As long as it is compensation for personal physical injuries it is tax-free under Section 104(a)(2) of the Internal Revenue Code.¹ Section 104(a)(2) of the Internal Revenue Code states that “gross income does not include . . . the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness.”² Section 104(a)(2) gives the personal injury victim two different financial options for their recovery, lump sum or periodic payments.³ For more information, read this excerpt from my book ‘The Art of Settlement‘.

Advanced Strategies for Closing Cases Compliantly: A Case Study

November 11, 2021

In the confusing landscape of public benefits and planning issues that arise today for trial lawyers when settling catastrophic injury cases, finding your way can be a daunting task. Many
questions come up such as should the client seek Social Security Disability (SSDI) benefits and become Medicare eligible? Doesn’t that trigger the need for a Medicare Set-Aside? What if the
client is receiving needs-based benefits such as Medicaid and/or Supplemental Security Income (SSI)? Is coverage under the Affordable Care Act (ACA) a better or even an available option?
How should the recovery be managed from a financial perspective? Is a trust appropriate? Should a structured settlement be considered?

Learn the answers to all of these complex questions by downloading this case study written by Synergy’s CEO, Jason D. Lazarus, J.D., LL.M., MSCC, CSSC:

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ART OF SETTLEMENT

Protecting the Recovery – Preservation of Needs-Based Benefits & Other Considerations

Attorney Fee Deferral – A Unique Opportunity for Contingent Fee Lawyers to Tax Plan for Tomorrow

Settlement Compliance Strategies for Closing Cases

Free Download: Resolution of Part C Medicare Advantage (MAO) Liens White Paper

Free Download: Structured Settlement Whitepaper

Advanced Strategies for Closing Cases Compliantly: A Case Study

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