Gary A. Loftsgard, CFP®

The subject of this material deals with an area that is of growing concern among many elderly people - qualifying for Medicaid benefits before before incurring a spend-down of assets.  Most clients are not willing to gift their property to another thereby giving up complete ownership so as to qualify for Medicaid benefits because that type of gifting scheme must be put in place 36 months before the giftor can qualify for Medicaid benefits.  A viable alternative to this dilemma exists through trust planning with Medicaid Qualifying Trusts (MQT's).

Medicaid Eligibility Issues
Medicaid is a need-based program that provides medical assistance (including long term care and nursing care) to indigent persons.  Congress created this program in 1965 under Title XIX to the Social Security Act (as an outgrowth to Medicare).  It was codified at Title 42, Section 1396 et. seq. of the United States Code (USC).  It 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, specifically the Health Care Finance Administration (HCFA).

Medicaid requires an individual to be legally indigent (within definition of 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.  The problem is that Medicare provides for "skilled care" not long term nursing care.  The paradox is that someone needs to be "lucky" 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 trust planning can bridge toward a secure financial future for your clients and your clients' families.

Trusts are Legitimate Devices for Qualifying
Congress recognized this gap and addressed the issue of Grantor Trusts, in conjunction with Medicaid eligibility planning, in Title 42 of the USC.  Basic applicable rules and regulations were identified in this Code Section and have proved very useful in designing language to be used in Grantor Trusts where the Grantor/Client is wanting to qualify for Medicaid in the event of a nursing home contingency.

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.  This all changed in 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 have to apply.  These rules were born from Congress' recent estate freezing techniques of IRC 2036 and are relatively complex.  Although tax law changes have plummeted the corpus of such a trust in the Grantor's taxable estate, a properly drafted GRIT is not in the Grantor's estate for creditor purposes, at least not under current law.

Resources Must Become Legally 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 an asset(s) available to the Grantor and therefore available to pay 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 effectively 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, 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, needs to become an unavailable resource.

The methods used to make income as an unavailable resource of a Grantor (of a GRIT) cannot be completely relied on, although they can be used.  An example is where a Grantor retaining income benefits from a GRIT subsequently disclaims his right to income shortly before going in to the nursing home.  The likelihood is that he will not qualify for Medicaid benefits (within the 60 month ineligibility period - EFFECTIVE SINCE COBRA 1993) in proportion to the value that he transferred, i.e.  - the aggregate value of the income benefits that he relinquished within a 60-month period.

Once the determined value (of the disclaimed income) has been brought back as an available resource and used up to pay nursing home expenses, the Grantor would then qualify for Medicaid.  This should hold true even though he had transferred the right to receive income from an existing trust and was the "payor of last resort" (an exception may possibly be of transferring income benefits to a spouse).  Again, keep in mind that even though any Medicaid agencies were to reclaim the disclaimed income as an available resource, it would have been used anyway, no matter, and nothing is for the worse.

No Rights to Withdraw or Distribute Principal
In determining whether or not the principal of a GRIT is an available resource, it is imperative that the Grantor not the right to withdraw funds from principal and that the Trustee not 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, would be considered the same as a power to receive permitted distributions (as discussed above - COBRA) and therefore the Medicaid agency could (and will) require the use of any such available resources to pay for the Grantor's stay at the nursing home because the Grantor will not qualify for Medicaid payments.  So the main concept to remember here is that your client, as a grantor, cannot create an Irrevocable Grantor Trust with powers to withdraw principal funds or to bestow power to the Trustee to make discretionary distributions of principal for the benefit of the Grantor (or the Grantor's spouse, if married).

Tax Issues
The original intent of irrevocable trusts is to remove the corpus of the trust from the taxable estate of the transferor.  Tax & trust law turn on this concept.  A gift (whether a gift to an individual or a gift 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 Unified Credit should be taken against the transfer tax incurred at the time of transfer.

Any such completed gift, as described above, shall "pass through" the original basis of the donor to the donee.  That means that if and when 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 done.

If, however, a transfer can be revoked by the transferor himself or anyone in conjunction with the transferor who is not an adverse party to the revocation, then no completed gift has occurred (IRC #674 / Treasury Reg.  #25.2511- 2).  This would definitely apply in an Irrevocable Living Grantor Trust where the Grantor retains the right to change "natural" beneficiaries.  This lends availability to 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, his creditors, his estate or his creditors estate has retained what is referred to as a general power of appointment over the trust assets (IRC #2041, #671 et.  seq.).  A prime example of this is a Revocable Living Trust (RLT).  At the creator's death, all assets in the RLT are under his control and are stepped-up to the value of the date of death (or alternate valuation date).  This power is to be 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.  What is significant, though, is that a special power of appointment held by a Grantor of an Irrevocable Grantor Trust (irrevocable for transfer purposes) to change beneficiaries, or trustees without just cause, will cause the corpus of the trust to be in his 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.  The gift was not complete because the donor retained the right to change beneficiaries - a special power of appointment.  If the beneficiaries could not be changed, then the transfer would have been a completed gift, at the creation of the trust, and the original basis would been used instead.

If your client has property with a notable percentage of appreciation, he likely would prefer that the basis of that property be stepped-up at the date of his death.  This would definitely be desirable unless your client has an estate tax problem when computed with the value of his stepped-up basis property.  Even though a decedent receives a stepped-up in basis at death, part of it will be confiscated back through estate taxes if the value of the (stepped-up) estate is in excess of the Unified Transfer Credit Equivalents.  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.

Effective construction and identifiable funding
It is apparent that by using carefully drafted trusts, your clients will be able to protect their estates from being spent-down by Medicaid social agencies.  ITS will provide this type of trust primarily through a "Sub-trust" of the Revocable Living Trust Estate Planning Portfolio, or an Amendment to existing RLT's.  This Trust will be referred to as an ASSET PROTECTION TRUST (APT).  Once established, it need not be funded immediately.  In fact, the client may never need to fund it if it appears he will not be using long term care facilities.

If the client creates his RLT with the APT provision, he can transfer all or any portion of his property into the APT.  Although the transfer into the APT will be irrevocable, it can be done at any time.  A prudent method 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 fair market value (a gift).  A transfer into an Irrevocable Grantor Trust is a gift (albeit an uncompleted gift if power to change beneficiaries is retained).  Therefore the Grantor will not qualify for Medicaid for 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.

A Few Final Thoughts
The new Asset Protection Trust provision will have language to address issues in trying to keep it as safe and workable as possible.  It will also be updated, as needed, from time to time.  Therefore, there may a part(s) in the provision, which you may not understand or disagree with.  Contact the Regional Director offices or our office for information if you have any questions of this nature.

In discussing any of the methods defined in this Memorandum with your clients, make sure that they understand there are no ironclad guarantees.  These trusts have worked, in the cases we know about where the clients have entered into a nursing home and applied for Medicaid (after the required term of years for gifting purposes was met).

The only problem we had was that one County (Marshall) in Minnesota ruled that because of the irrevocability of the transfer of a homestead, the clients should not be able to retain their homestead credit.  That problem has since be remedied with the approved language that the State of Minnesota required in such type of Trust.

Although most states have adopted or will be adopting the COBRA provisions as statutory law, not all have done so and some may never do so.  This is a relatively new concept and we are only attempting to use the methods that appear to be available and effective today.