The following is for educational use only. This material is not intended to replace any tax or legal advice. The reader should obtain personal counsel before implementing any methods described herein. Masculine can mean feminine, and singular can mean plural.
The subject of this material deals with an area of concern among a growing sector in our society. The question concerns how aging Americans may qualify for benefits under the Medicaid program in the event of a long-term nursing home stay before incurring an entire spend-down of personal assets.
Defining Medicaid Eligibility Issues
Medicaid is a need-based program that provides long term nursing care to indigent persons. A recipient must therefore be legally impoverished before qualifying to receive bundled, federal and state entitlements under the current system. Congress created this program in 1965 under Title XIX to the Social Security Act (as an outgrowth to Medicare) and codified as Title 42, Section 1396 et. seq. / United States Code (USC). Medicaid is a “revenue sharing” program, funded by both federal and state governments. Its federal program operates under the bureau of the United States Department of Health & Human Resources.
As mentioned, Medicaid rules require an individual to be legally indigent (by definition of applicable state law) before becoming eligible to receive its benefits. Medicare, on the other hand, is available to U.S. citizens over the age of 65 and the applicant/recipient of its benefits need not be indigent to qualify. The problem is that Medicare provides for skilled care and not just long-term nursing care.
The paradox is that someone with assets needs to be “fortunate” enough for financial assistance purposes to have a condition that requires skilled, professional care rather than just requiring nursing care. It is this financial assistance gap between Medicare & Medicaid that proper planning can bridge.
Becoming Legally Impoverished
A direct relinquishment or gifting away of all personal and real property interests is one way to become legally indigent. But, for many obvious reasons, most property owners are not going to transfer ownership of their assets to another for the prospect of someday qualifying for Medicaid entitlements. The ownership/qualifying dilemma is the issue at hand.
A parent may try to give property to his children with an unwritten understanding that the parent may still use and enjoy the property or even receive back a portion of the gift simply upon demand. Such arrangements may constitute an “incompleted gift” transaction (for creditor purposes) and thus can be challenged if discovered by a state or federal Medicaid agency. Moreover, the gifting away of essentially all personal assets must have occurred at least 60 months before the transferor/giftor may qualify to receive full Medicaid benefits.
Trusts Can Be Legitimate Devices for Medicaid Qualifying
Windows of opportunity are still available for asset owners wanting to protect their estate yet without giving away all the beneficial enjoyment of their assets. Depending on state law then in force (and cooperative courts), proper trust planning can provide a way around this property ownership/protection dilemma when correctly applied and fully implemented.
Prior to the Tax Reform Act of 1986, the corpus (principal) of irrevocable grantor trusts was generally not considered a part of the grantor’s taxable estate. That has changed since passage of the 86 TRA. In order for the corpus of irrevocable Grantor Retained Income Trusts (GRITs) to be excluded from the taxable estate of the Decedent/Grantor, certain rules generally have to apply. Although tax law can impact the corpus of such a trust in a grantor’s taxable estate, a properly drafted GRIT can usually avoid being in the grantor’s estate for Medicaid creditor purposes and yet be set up to allow the grantor to receive an income stream from the GRIT for his/her lifetime.
So, it is a specially designed income-only, non-reversionary GRIT that can be effective in protecting personal assets from a spend down because of a prolonged nursing home occupancy yet allow the grantor to legally retain certain beneficial rights and lifetime enjoyment of the transferred assets. Such type of “medicaid qualifying” planning can be realized through what is referred to as a Medicaid Qualifying Trust (MQT).
Trust Resources Must Be Classified As “Unavailable”
Lawmakers recognized this conflicting issue of whether or not the corpus of an irrevocable grantor trust was an available resource to the grantor for Medicaid spend-down purposes. Under this definition, an available resource is generally an asset(s) that is available to the grantor and therefore available to pay for the grantor’s long term nursing care costs (instead of Medicaid paying the costs). The availability or non-availability of trust corpus for spend-down purposes had to be defined in more definitive terms.
This issue was addressed in the Consolidated Omnibus Budget Reduction Act (COBRA), June 1, 1986, which created 42 USC 1396a(k). COBRA says that “permitted distributions” are treated as available resources – resources available to the grantor’s creditor. In other words, the grantor could not qualify for Medicaid benefits because he has resources (assets), from “permitted distributions” of his grantor trust, that are available to pay nursing care costs. Obviously, then, the key to qualifying an institutionalized grantor for Medicaid benefits is to make sure that whatever the grantor wants to protect from a spend-down, whether income or principal, it needs to be classified as an unavailable resource.
Exclusionary Rights to Withdraw/Distribute Principal
In determining whether or not the principal of a GRIT is an “available resource”, it is generally not allowable for (a) the grantor to retain the right to withdraw funds from principal and for (b) the trustee to be given a “discretionary” power to use the principal for the support and benefit of the grantor. Withdrawal rights and discretionary power, in such case, may be considered the same as a power to receive permitted distributions (as discussed above).
The Medicaid agency could therefore require the use of any such available resources to pay for the grantor’s stay at the nursing home because of not qualifying for Medicaid payments. So the main concept to keep in mind is that, unless otherwise allowable under state law, a grantor who wishes to qualify for Medicaid should not create a GRIT that explicitly retains (the grantor’s) power to withdraw principal funds or even to authorize the trustee to make discretionary distributions of principal back to and for the benefit of the grantor (e grantor’s spouse, if married).
Tax Considerations
The original intent of irrevocable trusts is to remove the corpus of the trust from the taxable estate of the transferor; transfer tax laws turn on this concept. A gift, whether to an individual or to a qualified irrevocable trust, is valued as to its full market value on the date of the gift. This full market value is used in determining if the gift can be sheltered under the annual exclusion and/or if the federal unified credit should be taken against the transfer tax incurred at the time of transfer. Notwithstanding, any such completed gift, as described above, shall “pass through” the original basis of the donor to the donee. That means that if the donee sells the property, his capital gains tax liability (if any) will be calculated on the gain determined by subtracting the basis of the property of the original donor from the appreciated basis of the property at the time of sale by the donee.
If a transfer can be revoked by the transferor or anyone in conjunction with the transferor who is not an adverse party to the revocation, or if the transferor retains a right to the income of the transferred property, then no completed gift has occurred (IRC #674 / Treasury Reg. #25.2511-2). In such case, the value of the property will be in the transferor’s estate for transfer tax purposes and thus be “stepped-up” at the date of the transferor’s decease. This scenario provides an interesting tax planning tool for the average family estate with appreciated property.
Taxes in More Specific Terms
Any person creating a trust retaining power to control or amend and/or retain the rights to consume or invade the property for the benefit of himself, or his estate, or his creditors, or his creditors’ estates has retained what is referred to as a general power of appointment over the trust assets. A prime example of this is a Revocable Living Trust (RLT). At the creator’s death, all assets in the RLT are under the grantor’s control and are thus stepped-up in basis to the value of the date of death (or alternate valuation date). That power is distinguished from a special power of appointment, which limits the invasion right for the benefit of someone other than the holder of the power, his estate or the creditors of either.
As a rule, a decedent holding a special power of appointment over property (at the time of his death) will not have the value of that property in his estate for estate tax purposes. A special power of appointment held by a grantor of an irrevocable grantor trust (irrevocable for transfer purposes, or to change beneficiaries, or to change trustees without just cause) will cause the corpus of the trust to be in his/her estate for estate tax purposes and thus be stepped-up to the current value at the date of donor’s death. The reason is that there was no completed gift at the time of transfer because the donor retained the right to change beneficiaries, etc. On the other hand, if the beneficiaries could not be changed, then the transfer would have been deemed a completed gift and, as a consequence, the original basis would be retained with no step-up.
If one has property with notable appreciation, he likely would prefer that the basis of that property be stepped-up at the date of his death. Even though a decedent receives a stepped-up-in-basis at death, part of it will be taken back through estate taxes if the value of the stepped-up estate is in excess of the transfer tax exemption amounts. Nevertheless, if a completed gift is made, gift taxes may be due anyway because the value of the gift (and gift tax liabilities) for transfer tax purposes is calculated using the value of the gifted property at the date of the gift. So, generally, it is a good thing for the assets of the decedent being transferred at death to receive a step-up-in-basis – assuming that decedent’s estate does not exceed the exemption equivalent amounts that would cause an estate tax liability at death.
Effective Construction and Identifiable Funding
It is apparent that by using carefully drafted trusts, property owners may be able to protect their estates from being spent-down by governmental agencies to pay for nursing home costs. ITS will provide this type of trust primarily through a “sub-trust” format of the Revocable Living Trust Estate Planning Portfolio. This type of trust is referred to as Medicaid Qualifying Trust (MQT). The MQT format has been designed to conform to rules that would generally allow the asset-protection functionality that we have been discussing, and still provide income to the grantor. It is essentially an “income only”, non-reversionary trust wherein the grantor may not serve as the trustee. A non-reversionary trust does not allow the trustee to disperse (or reverse) any principal back to grantor.
If one creates his RLT with the MQT provision, he can transfer all or any portion of his property/assets into the MQT. Although the transfer irrevocable, it can be done at any time. A prudent method to consider would be to have long-term-care insurance in place to cover the 60-month ineligibility period. This 60-month period is a term of ineligibility from the time that a Medicaid applicant transfers property without being compensated at fair market value rates (i.e., a gift is made). A transfer into an irrevocable grantor trust is a gift and the grantor will not qualify for Medicaid for up to 60 months after the transfer. To cover the ineligibility period, either (i) a part of the transfer to the trust will be recovered as an available resource or (ii) income from another source will need to pay the nursing home costs.
Final Thoughts
The MQT format contains language designed to maximize the most flexibility available under state law that would allow a property owner to enjoy conditional usage of the APT property while still being classified as an unavailable resource for spend-down purposes. Realize there are no “iron clad” guarantees with this type of planning as a court can still rule against what was originally intended by legislators. Nevertheless, good-will attempts to insulate personal property from potential creditors – including governmental agencies – can (should) be made when convenient and lawful to do so.