Personal Injury Settlement Proceeds: Special Concerns When Dealing with Special Needs Children
In Estate of Hicks, the Tax Court permitted the estate of a special needs child to deduct a loan made by the child’s parent to a non-special needs trust established for the benefit of the child as part of a transaction intended to preserve the child’s future Medicaid eligibility. Here is how the case unfolded:
The child, Kimberly Hicks, along with her mother and sister, was involved in a horrific car accident when a train collided with the family’s car. Kimberly, who was only three years old at the time of the accident, sustained severe injuries that left her a quadriplegic, dependent on a respirator to breathe. A lawsuit brought by Kimberly’s parents against the train company resulted in a settlement for the family in the amount of $4,650,000. Pursuant to the proposed settlement plan, Kimberly was allocated $1,450,000 for her injuries, while her parents were allocated $1,415,000 for loss of consortium and services. The remainder went to attorneys’ fees and expenses.
Under Ohio law, where the Hicks personal injury case was filed, the probate court’s approval of the settlement plan was required. In addition to approving the proposed allocation of the settlement proceeds, the probate court also approved the following aspects of the plan:
1. The creation of the Kimberly Hicks Special Needs Trust. This trust was to be funded with $1,000,000 of Kimberly's settlement proceeds, and was designed to comply with Medicaid eligibility rules. Because of this, the assets of the trust would not need to be “spent down” to meet Medicaid eligibility requirements, but upon Kimberly’s death, the assets remaining in the trust would be required to be used to pay back the state for any medical expenses paid on Kimberly’s behalf.
2. The creation of the Kimberly Hicks Settlement Fund Management Trust. This trust was to be funded with $450,000 of Kimberly's settlement proceeds. The trust’s assets would be included in determining Kimberly’s eligibility for Medicaid. However, in what I think was a brilliant move, the attorney for the Hicks family proposed that in addition to $450,000 of Kimberly’s proceeds being placed in the trust, that Kimberly’s father loan the trust $1,000,000 of the settlement proceeds which were allocated to him. The loan was to be evidenced by a promissory note that required payment of interest, but not principal, and would be callable by Kimberly’s father on the occurrence of one of two events: Kimberly’s death, or, her inability to obtain medical insurance at a reasonable premium once she reached 18 years of age.
With the approval of the probate court, the two trusts were created and funded, but within four and a half years, Kimberly passed away. The estate tax return filed on behalf of Kimberly's estate included the assets in both trusts, but claimed a deduction under Code Section 2053(a)(3) and (4) for the $1,000,000 owed to Kimberly’s father under the promissory note. The IRS argued the loan was not bona fide, as Kimberly’s father never had control or possession over the $1,000,000. It argued the money was transferred directly from the court's guardianship account to the trust, and thus never really belonged to Kimberly's father. The Tax Court rejected this argument and allowed the deduction. In doing so, it made the following findings:
1. The probate court’s ruling as to the allocation of settlement proceeds, and thus to whom the proceeds belonged, was to be afforded great weight. The probate court had a great interest in seeing to it that Kimberly's interests, as a special needs child, were provided for, and the Tax Court should be very hesitant to interfere with the probate court’s approval of a settlement plan which did just that. Also, even though the probate court allocated $1,415,000 to Kimberly’s father, that large allocation was entirely reasonable in the eyes of the Tax Court, especially given the father’s duty under Ohio law to provide support for his minor child.
2. The loan made by Kimberly’s father was bona fide, and not without value. The interest payments required under the promissory note were concrete and capable of valuation. In short, there was true economic substance to the loan.
The Hicks case provides an example of just how crucial preventative estate planning is when it comes to personal injury or wrongful death cases where large settlements are likely. The importance of such preventative estate planning is heightened when there are children with special needs involved, and there are real concerns about preserving their Medicaid eligibility.
