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.
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