How to draft and use DRA compliant promissory notes

How to draft and use DRA
compliant promissory notes

by Howard S. Krooks and Michael J. Amoruso1

As we all know, of the rules, drafting suggestions and Partial Return of Funds States in the
tax considerations involving the DRA situation where the client is in need
on Feb. 8, 2006, compliant promissory note in “Non- of long-term care services (defined in
Partial Return of Funds States” and some states to mean nursing home
President George in “Partial Return of Funds States” level of care, whereas other states fol-
(Florida being a Partial Return Funds low the federal definition of long-term
W. Bush signed the State). care as being the type of care provided
in a nursing home setting, but which
Deficit Reduction The promissory note can also be provided in any other
strategy in ‘Non-Partial type of setting or through a home and
Act of 20052 (the Return of Funds States’ community based waiver program).
versus ‘Partial Return of And as we know, the DRA mandates
DRA) into law. Por- Funds States’ that the Medicaid penalty period on
the transfer of the gifted share does
tions of the DRA In some states (Florida is not one of not start until the applicant files an
them), the post-DRA world resulted in application for Medicaid and would be
constitute the first a situation where asset preservation eligible for such coverage except for
in the crisis planning scenario hinged the resulting penalty period. This is
H. KROOKS monumental chang- upon dividing the client’s estate into the point in time that the individual
es to the Medicaid two shares; namely, the “gifted share” is receiving long-term care services,4
and the “DRA compliant share,” and and penalty period aside, the appli-
eligibility rules since OBRA 1993. then transferring both of these shares cant is otherwise financially eligible
out of the client’s estate. The need to for institutional Medicaid (i.e., non-
By now, most states have adopted en- create these two shares emanated exempt assets are less than the state’s
from the state’s position that if any resource allowance and available
abling legislation and/or rulemaking assets were returned to the applicant monthly income is less than monthly
subsequent to the initial transfer of medical expenses).5 If the client meets
implementing the DRA, with only a funds (bringing the applicant below the level of care requirement and has
the applicable resource allowance), monthly income that is less than the
handful of states yet to do so. To assist this return of funds rendered the in- monthly cost of care, the transfer of
dividual otherwise ineligible for Med- the gifted share and the DRA compli-
the states with interpreting the DRA, icaid and precluded the triggering of ant share out of the client’s estate will
a penalty period under the new DRA render the client “otherwise eligible”
the Center for Medicare & Medicaid transfer of asset rules (let’s call these for Medicaid, thereby triggering the
states “Non-Partial Return of Funds penalty period for the gifted share.
Services issued a transmittal on July States”). Thus, promissory note plan-
ning in Non-Partial Return of Funds The computation of the gifted
27, 2006 (Transmittal SMDL # 06- States had as its primary objective share and the DRA compliant share
the preservation of the gifted share requires a careful balancing of the
018), arguably to clarify the federal while utilizing the DRA compliant desire to preserve the client’s assets,
share (or the share transferred pur- the need to obtain “otherwise eligible”
government’s position on the DRA suant to the terms of the promissory Medicaid status and the ability to
note) as an income stream to contrib- ensure payment for the client’s care
transfer of assets provisions.3 ute toward the cost of care during during the resulting penalty period.
the Medicaid penalty period caused The key is that the DRA compliant
We in Florida approached the new by transferring the gifted share. All share will return an income stream
other factors of eligibility must be coupled with the client’s income (i.e.,
DRA provisions with trepidation, satisfied to use the DRA compliant Social Security, pension and other
note in crisis planning. Thus, this income) that is slightly less than the
not knowing how or when the DRA strategy is only appropriate in Non- private pay rate for the cost of care

would be implemented. Yet, one area continued, next page

where the elder law bar considered

there to be an expanded planning

opportunity was in promissory note

planning. Since December 2004 (later

extended to March 2005), the Florida

Department of Children and Families

effectively eliminated the use of all

promissory notes as a planning tool

via the issuance of the now infamous

promissory note transmittal. Then

along came the DRA, with provisions

that seemed to revive the use of notes

in the planning process by setting

clear guidelines, which, if followed,

deemed the use of a note not to be a

transfer of assets subject to a penalty

period. Given these changes, an op-

portunity existed for Florida elder

law attorneys well versed in these

sophisticated Medicaid eligibility

rules to provide clients with an ad-

ditional asset preservation solution.

This article will provide an overview

The Elder Law Advocate • Vol. XVIII, No. 2 • Summer 2010 • Page 15

DRA compliant icaid agency refused to allow the use able alternative. The promissory note
from preceding page of such notes, declaring informally is such an alternative. By making a
in discussions with the Joint Public loan to a family member in exchange
and will continue paying until the Policy Task Force that notes would for a promissory note, the community
penalty period expires. At that point, nevertheless be treated as an avail- spouse’s resources are brought below
the gifted share is preserved and the able resource (note the distinction the CSRA at the point of applica-
client is eligible to receive Medicaid between imposing a penalty period tion for Medicaid benefits for the ill
benefits. and treating the note as an available spouse. This unmarketable income
resource). The story of how Florida stream would constitute income to
It should be noted that the strategy Medicaid came to reverse its position the community spouse, but not a
may also be used to correct a post- on the so-called secondary market resource, thereby avoiding the need
DRA gift by the client made prior to issue, thereby allowing Medicaid to to file a spousal refusal. Further,
meeting with the elder law attorney. take the position that a DRA compli- once the note is paid in full, because
In such a case, where a return of the ant promissory note could be treated a spousal refusal was not filed, the
previously gifted funds is not avail- as an available resource, is detailed community spouse could then request
able, the elder law attorney’s focus in a prior article on the subject which diversion of the ill spouse’s income if
will shift from determining the gift appeared in the Spring 2010 issue of necessary to bring the CS up to the
share (since the client already made The Advocate. Once Florida began to maximum MMMNA level.
the gift) to calculating the appropri- allow the use of promissory notes (as
ate payback timeframe of the DRA per the January 2010 change in the Another use of the promissory note
compliant promissory note to obtain ESS Manual), meaning that a DRA in a Partial Return of Funds State is
“otherwise eligible” status, trigger the compliant note was neither a transfer where the elder law attorney has con-
penalty on the previously made gift of assets for penalty period purposes cerns about the person designated by
and ensure a payment stream during nor an available resource due to the the client to receive the “loaned” funds
the penalty period. secondary market issue, the use of that are intended to be returned. In a
notes could be pursued. Partial Return State, such as Florida,
Since Florida is a Partial Return of a typical planning example would
Funds State, meaning that a simple So where would we use a promis- require that all but just under $2,000
return of funds will not affect the sory note in the planning process? of an individual’s funds be transferred
“otherwise eligible” status of the in- One circumstance that comes to mind to a son or daughter, with the intent
dividual, the need to use promissory is that of a community spouse who that approximately one-half of the
note planning in a crisis situation could use a promissory note to reduce funds constitute a gift and the other
did not (and still does not) exist. countable assets to below the CSRA one-half constitute a pool of funds
Nevertheless, it seemed rather odd, of $109,560, thereby eliminating the that are intended to be returned to
and a bit incongruous, that the DRA need to execute a spousal refusal. For assist the individual with the pay-
should specify parameters for the use many elderly spouses, the execution ment of long-term care costs while
of promissory notes, outlining the cir- of a spousal refusal weighs heavily on the penalty period is running. What
cumstances where such notes would their minds, and they would prefer would happen if the son or daughter
not result in a transfer of assets/pen- not to proceed in this fashion if we, was involved in a lawsuit and a judg-
alty period, and yet the Florida Med- the elder law bar, could present a vi- ment was entered against him or her?
Suppose the applicant’s son or daugh-
THE FLORIDA BAR MEMBER BENEFITS ter needed the funds to cover college
expenses for a grandchild. Any one of
www.floridabar.org/memberbenefits a number of life events could cause
the unavailability of funds that were
• BANK PROGRAMS • INSURANCE & designated to be returned, and this
RETIREMENT would cause problems for the elder
• LEGAL RESEARCH PROGRAMS law plan after the train has already
left the station. One way to protect
• LEGAL • EXPRESS SHIPPING against this result is by entering
PUBLICATIONS into a promissory note with the son
• GIFTS & APPAREL or daughter, thereby creating a legal
• CAR RENTALS obligation to pay back the “loaned”
funds, and if no payment is forthcom-
ing, it puts the applicant in a better
position vis-à-vis Medicaid because
a legal note was entered into and an
action to seek the return of the funds

Page 16 • The Elder Law Advocate • Vol. XVIII, No. 2 • Summer 2010

can be brought. It justifies the loan as available resource for determining expiration of the penalty period. In
a legitimate legal transaction that, if Medicaid eligibility. Partial Return of Funds States, this
it falls apart, gives rise to a possible could be any amount of time desired
undue hardship claim should the To avoid treatment as an avail- as long as it was actuarially sound.)
funds not be paid back as required able resource, the elder law attorney It is important to remember, howev-
under the note. should ensure that the promissory er, that the final payment of the note
note is not categorized as a negotiable must be scheduled to occur within
The DRA compliant instrument. Proper drafting would the life expectancy tables required by
promissory note suggest that the elder law attorney the DRA. Further, the state need not
should draft the note by explicitly be named as a remainder beneficiary
A promissory note is a transaction stating on the face of the note that with the use of notes as is the case
where one party purchases (the pay- it is non-negotiable, non-assignable with annuity transactions.
ee) from another party (the maker) and otherwise not transferable by
the promise to receive a specified sum the payee. These precautions should There are, however, tax consider-
with interest over a period of time. remove the availability of the note ations that must be discussed with
The DRA explicitly excludes funds from treatment as an available re- the client and his or her income tax
used to purchase a promissory note source by Florida’s Medicaid agency, advisor. First, the interest received by
if the note particularly after the January 2010 the payee (our client) will be consid-
alteration to the language in the ESS ered taxable income. In Non-Partial
1. has a repayment term that is Manual at Section 1640.0561.03. Return of Funds States, during the
actuarially sound as determined time the note is repaid, the client
in accordance with actuarial pub- Drafting tip - For an added level will be entitled to take the medical
lications of the Office of the Chief of comfort, make the note even less expense deduction, assuming that
Actuary of the Social Security attractive to a potential third party the long-term care costs exceed 7.5
Administration; buyer. For example: 1) do not pro- percent of the client’s adjusted gross
vide for acceleration in the event income. On the other side of the trans-
2. provides for payments to be made of default; 2) do not provide for an action, assuming that the maker de-
in equal amounts during the term incremental increase in interest rate posited the lump sum of principal into
of the loan; due to a missed payment or default; an investment account to generate
3) do not add a provision authorizing the required interest payment, the
3. does not permit deferral or balloon the collection of attorney’s fees in the interest generated would be subject
payments; and event of default; and 4) do not waive to income tax for the maker. However,
the requirements for presentment, it would be important for the maker
4. prohibits the cancellation of the notice of dishonor and protest— make to consult his or her accountant to
balance upon the death of the it difficult for a potential third party ascertain whether the investment
lender.6 to enforce the note. Obviously, the income expenses deduction is avail-
import of these suggestions must be able to the maker.8
Any note that does not comply thoroughly discussed with the client
with all of these requirements shall prior to including them in any docu- Putting the promissory
be deemed an “asset” for purposes of ment. note into practice
the transfer of asset provisions of the
DRA, and the value of the transferred Practically, the promissory note is Non-Partial Return of Funds
asset will be the outstanding balance a document that may be easier for State
of the note on the date of applica- the client, the Medicaid caseworker
tion.7 and the elder law attorney to com- First, let’s see how a promissory
prehend and use. Unlike a private note would operate in a state such
Drafting tip - Be certain that the annuity transaction, the promissory as New York, which is a Non-Partial
face of the note addresses each of the note is not subject to the Internal Return of Funds State. Assume the
foregoing DRA requirements. The Revenue Code’s annuity factors, following facts: Client is an 83-year-old
DRA graciously informs us how a linear interpolations, interest rate woman in a Westchester, New York,
note can avoid transfer of asset treat- and calculation of the return of or- nursing home and has $215,000 in
ment, and these guidelines should be dinary income and capital gain with cash. The private pay rate is $400 per
strictly adhered to by the elder law each monthly payment. Instead, the day. The client’s income is limited to
attorney. promissory note merely requires Social Security and a VA benefit total-
the calculation of a monthly loan ing $1,473 per month. The Westchester
It is important, however, that the amortization schedule based upon a regional rate is $10,163 (the applicable
elder law attorney does not get lost in reasonable rate of interest until the divisor, as we call it in Florida), and
the trees when drafting a promissory desired time to zero out the note is the Medicaid individual resource
note that complies with the DRA. Ar- reached. (In Non-Partial Return of amount is $13,800 (the applicable
guably, even a note that complies with Funds States, this would be at the
the DRA transfer of asset provisions continued, next page
(meaning that no transfer penalty
will apply) still may be deemed an

The Elder Law Advocate • Vol. XVIII, No. 2 • Summer 2010 • Page 17

DRA compliant suggested above, the strategy could be resource allowance. The calculation

from preceding page used in a spousal planning scenario, would look like Table 1, below.

whereby assets of the community In this case, if the Medicaid eligi-

spouse are made the subject of a note bility date is May 2010, then the note

resource allowance in New York). to the extent such assets exceed the would be entered into as of that date

How will a post DRA promissory CSRA. This allows the CS to avoid so as to remove the funds from the

note strategy assist this client? How executing a spousal refusal and the name of the CS. Thus, as of the snap-

does the attorney implement this concomitant emotional distress that shot date, the CS has an amount equal

strategy? goes along with that planning strat- to or less than $109,560 and need not

After crunching the numbers to egy, while achieving the same if not execute a spousal refusal. Then, as

determine the DRA compliant share, better results from an income diver- long as the repayment terms are such

the gifted share and the amount to re- sion standpoint. that level payments are required to

tain in the client’s name, the following Let’s assume the same facts as be made and the note is actuarially

asset preservation can be achieved: set forth above in our crisis planning sound based on the life expectancy of

the CS, the note will be a DRA com-

„Gift $103,251.76 in April 2010 pliaint promissory note and will not

ƒCauses a 10.16 month penalty period (May 2010 – June 2011) result in a penalty period for purposes
of establishing the institutionalized

„Transfer $101,748 in exchange for a DRA compliant spouse’s Medicaid eligibility. In fact,

promissory note the note could be structured to pay

ƒTerm – 10 Months back using a shorter term than might
ƒInterest Rate: 3.25% (April 2010, IRC Section 7520 Rate) be advisable in a Non-Partial Return
of Funds State because we don’t need

„Keep $10,000 in client’s name since she can have up to the to concern ourselves with scheduling

Medicaid resource amount ($13,800 for New York in 2010) the note payments for any specific

„The Promissory Note will “zero-out” in 10 months by length of time (in a Non-Partial Re-
paying $10,327 month (principal and interest) turn of Funds State for the length of
the resulting penalty period). Thus,

ƒ2010 Private Pay Rate = $12,000 (30-day month) a repayment term of two months is

ƒTotal income = $11,800 ($1,473 + $10,327 Promissory Note conceivable, thereby giving the CS
Payment) her excess funds back in a relatively
short period of time while still avoid-
ƒMedical expenses exceed income by $200 = OTHERWISE ing the filing of a spousal refusal.

ELIGIBLE In addition, the CS could then

„What is preserved? seek diversion of the institutionalized
spouse’s income since a spousal refusal
ƒ$103,251.76 = 51% – of net assets was not filed (in Florida, a spousal
ƒMedical expenses exceed income by $200 = OTHERWISE refusal eliminates the possibility
of seeking an increased MMMNA).
ELIGIBLE

The diversion could not be sought at

As the numbers reveal, with the scenario in a Non-Partial Return of the time of the filing of the Medicaid

proper guidance from an experienced Funds State such as New York. How- application because while the note

elder law attorney schooled in the ever, instead of the A/R making the payments are being made, the note

DRA compliant promissory note loan, the community spouse makes payments constitute income to the

strategy, the client can properly pre- a loan equal to available assets, less CS, and this additional income would

serve assets while ensuring that her the institutionalized spouse resource clearly eliminate the ability to seek

long-term care expenses are paid with allowance, less the community spouse diversion.

the returning income stream from the

promissory note during the resulting

period of Medicaid ineligibility caused

by the gift. Table 1

Partial Return of Funds State $215,000 Available Cash
In a state such Florida, which ($2,000) Less Institutionalized Spouse Resource Allowance
($109,560) Less Community Spouse Resource Allowance
permits a partial return of funds, $103,440 Equals Amount of Promissory Note/Loan
the promissory note is not essential
to achieve a so-called reverse rule of
halves planning result. Instead, as I

Page 18 • The Elder Law Advocate • Vol. XVIII, No. 2 • Summer 2010

Howard S. Krooks, JD, CELA, CAP, Congratulations,JUNE 2010
is a partner with Elder Law Associates 2010 board certified
PA, with offices in Boca Raton, Aven- tt elder law attorneys!
tura (N. Miami), Weston (Fort Lau-
derdale) and West Palm Beach, Fla. t Alex Cuello – Miami
Mr. Krooks is of counsel to Amoruso & Margaret Hoyt – Oviedo
Amoruso LLP, located in Westchester, Michael Fowler – Port St. Lucie
N.Y. He serves on the Executive Council Holly O’Neill – Boca Raton
of The Florida Bar Elder Law Sec- Kathleen Flammia – Winter Park
tion and the Joint Public Policy Task Patricia Fuller – Orlando
Force. He is a former chair of the New
York State Bar Association Elder Law # #&ME"FS#-&B5X5"&EWPD"BU$F)
Section, where he continues to serve
on its Executive Committee. He is a AlBWsDoToaCordaWkI’vssne:SDllh:oTaodcyhpeapagilseliasfrut:I&tishddsoeearusssetgi:naalotiroen!s
member of the board of directors and
is an officer of the National Academy of westcoastwoman.com
Elder Law Attorneys, where he serves
as treasurer. Mr. Krooks is a founding Congratulations to our immediate past chair,
principal of ElderCounsel LLP, the
premier document drafting solution for Babette Bach. Babette appeared on the cover
elder law and special needs planning and was featured in the June 2010 issue of
attorneys. West Coast Woman magazine!

Michael J. Amoruso, Esq., is the man- (Cover art provided courtesy of West Coast Woman.)
aging partner of Amoruso & Amoruso
LLP, with offices in Rye Brook, N.Y. Mr.
Amoruso is the immediate past chair
of the New York State Bar Association
Elder Law Section and the immedi-
ate past president of the New York
NAELA Chapter. Mr. Amoruso also
serves as co-chair of the NAELA State
Chapter Presidents Committee, chair
of NAELA’s Telephonic Programming
Committee and is a member of the
NAELA Public Policy Committee. Mr.
Amoruso recently received the 2010 NY
NAELA Chapter Outstanding Member
of the Year Award.

Endnotes:

1 This article is based upon an article written
by Michael J. Amoruso, Esq., which appeared
in the Elder Law Attorney, a publication of the
New York State Bar Association. The article
was rewritten to address the use of promissory
note planning in the state of Florida.

2 Public Law 109-171 (2006).

3 Dennis G. Smith, “New Medicaid Transfer
of Asset Rules Under the Deficit Reduction Act
of 2005,” Center for Medicare & Medicaid Man-
agement, SMDL # 06-018 (July 27, 2006).

4 42 U.S.C.A. § 1396p(c)(1)(C)(i).

5 42 U.S.C.A. § 1396p(c)(1)(C).

6 42 U.S.C. § 1396p(c)(1)(I).

7 Id.

8 Consult IRS Form 4952 to determine
whether or not applicable.

© 2010 Elder Law Associates PA

The Elder Law Advocate • Vol. XVIII, No. 2 • Summer 2010 • Page 19