Promissory Notes — Know What You Don’t Know

April 2016

Jennifer B. Cona

It is commonly understood that when a person enters a nursing home, she/he can still preserve some assets and engage in last-minute asset protection planning, albeit on a limited basis. What is not commonly understood are the mechanics of such a strategy. Many attorneys and their clients run afoul of the very specific rules governing the use and terms of promissory notes, where costly mistakes are typically only discovered when it is too late to correct.

Promissory notes in the Medicaid planning context are authorized by federal law but implemented at the county level. The Deficit Reduction Act (“DRA”) of 20051 specifically permits planning via a promissory note by dis-regarding the asset as countable if the note: is actuarially sound; provides for equal payments with no deferral or balloon payments; and is not cancelled upon the death of the lender.2 Following these specific requirements as well as the requirements set forth in the state Administrative Directive,3 the use of promissory notes is now commonplace in crisis Medicaid/asset protection planning.

Under the DRA, the penalty period based on a transfer of assets does not begin until the facility resident is “other-wise eligible” for Medicaid benefits but for the asset transfer.4 As such, a Medicaid applicant must be both residing in a long-term care facility and below the resource limit, currently $14,850, before the penalty period clock will begin to run. This means that the resident must spenddown all of his/her remaining assets (to below the applicable resource limit) before the penalty period will begin on any asset transfers made in the past five years, regardless of when such transfers were actually made.

In general, a promissory note is a contract wherein the maker of the note makes an unconditional promise in writing to pay a sum of money to the payee either at a fixed or determinable future time or on demand of the payee. In the Medicaid planning context, it works as follows: the health care facility resident transfers all of his/her funds (less the permissible resource allowance) to an individual (typically a family member). The person receiving the funds signs a note promising to pay back approximately one-half of the monies transferred (the loaned assets), plus interest, to the resident on a monthly basis. The monthly amount to be paid back to the resident is calculated using the long-term care facility daily rate less the resident’s income. Upon payment of the monthly amount to the resident, the resident writes a check for the same amount to the facility. The note repayment amount covers payment to the facility during the penalty period incurred by the transfer of the other one-half of the assets (the gifted assets).

To illustrate: Mrs. Scott transfers a total of $420,407.96 to her daughter on February15, 2016 as a part-gift/part-loan transaction. The health care facility daily rate is $425 (an average rate on Long Island) and Mrs. Scott’s monthly income totals $1,854. To determine the monthly loan repayments, the actual monthly cost at the facility private pay rate is calculated less Mrs. Scott’s monthly income. The average of the monthly payments dur-ing the term of the penalty period (number of months) is calculated and an interest rate (typically 5 percent) is added.

In this example, the average monthly loan repayment amount is$10,908.40 per month. This is the amount which Mrs. Scott’s daughter will pay back to her each month and which she will then turn over to the long-term care facility. The term of the loan will be 20 months beginning in March 2016. As such, $208,907.96 will be the total loan amount and$211,500 will be the total gift made to Mrs. Scott’s daughter, which amount is free and clear to her. After 20 months, the loan will be repaid, the gifted money will be protected and Mrs. Scott will be eligible for Medicaid benefits.

In order for the strategy to work, there must be a monthly shortfall in the amount paid to the long-term care facility each month. The resident must have medical expenses greater than the Medicaid rate in order to be considered “otherwise eligible” for Medicaid benefits while also having medical expenses s/he is unable to meet in full.v Attorneys must be overly instructive in detailing for clients the exact monthly re-payment amount that must be paid to the health care facility each month regardless of the actual monthly invoice from the facility.

As Medicaid applications with promissory notes are submitted to the local Departments of Social Services, the caseworkers have aggressively sought to throw out promissory notes for failure to comply with the exact letter of the DRA. As a result, a penalty period would be assessed on the entire asset transfer, not just the gifted one-half. The local Departments of Social Services have challenged promissory notes where: the interest rates were not amortized while maintaining equal monthly repayment amounts; the note did not explicitly state that payments would continue to be made to the estate of the lender even though the note clearly stated that pay-ments would not be cancelled in the event of the death of the lender; the note stated that the terms could be modified, waived, changed or discharged only by written document signed by all parties, which the Department of Social Services interpreted to mean the terms would be modified. 

Not only do the terms of the promissory note need to be carefully construed to be compliant with federal law and subject to re-interpretation at the county level, but clients must be well-informed of the mechanics of the note, such as the manner in which re-payments are to be made to the resident/lender, the requisite under-payment to the health care facility, etc.  In addition, clients must be advised of the circumstances, which may give rise to a re-calculation, such as a hospitalization with resulting additional Medicare covered days, a change in the facility’s daily rate, such as by annual increase or by relocating to a different facility. The vigorous requirements of the DRA combined with aggressive policies at the local Departments of Social Services leaves much room for error. Practitioners are cautioned to “know what you don’t know” in order protect your clients and yourself.

Note: Jennifer B. Cona, Esq. is the managing partner of the Elder Law firm Cona Elder Law, LLP, located in Melville.  Ms. Cona practices exclusively in the field of Elder Law, including asset protection planning, Medicaid planning, representation in Fair Hearings and Article 78 proceedings, estate planning, trust and estate administration, guardianships and estate litigation.  For further information, call (631) 390-5000 or visit www.conaelderlaw.com.