A Primer for Estate Tax Planners
Many estate planners tend to become disengaged when the topic of Medicaid and Medicaid planning arises and even more so when tax issues are added to the discussion. However, this has become an increasing issue with a number of clients whose needs have been met by a growing number of attorneys who deal with both areas of the law.
This article provides an overview of Medicaid planning for estate planners. The first part carves out exceptions to the federal Medicaid system and then reviews the Medicaid eligibility and transfer rules, particularly the rules governing asset and income limitations and the ways in which those limitations can be satisfied through certain permitted transfers. The second part deals with various Medicaid planning considerations, particularly focusing on asset transfers, methods of converting assets to income, insuring assets or spending them. Numerous examples are used throughout the article to clarify this area and help those unfamiliar with the concepts to better understand them. Indeed, the overall purpose of the article is to provide in a single source the information that all planners should know if the issue arises, although each state's specific requirements may necessitate either involving an Elder Law specialist, Estate Tax Planner or specific research by the estate planner into the nuances of the specific state's requirements.
STATES MAY OPT OUT OF FEDERAL MEDICAID REGULATIONS
On April 20, 2002, nearly 40 national organizations sent a letter to Tommy Thompson, Secretary of the Department of Health & Human Services in Washington, DC, requesting a rejection of the State of Connecticut's request for a waiver from the Medicaid Transfer of Asset rules under 42 U.S.C.A. § 1396p.1 This letter marked a line drawn in the sand between organizations representing the elderly and disabled and many state governors (48 participating) who in February of 2001 reached a consensus on implementing Medicaid reform at a National Governors Association meeting.2 It also marked the solidification of a trend among state governments and state courts to hold back the tide of Medicaid planning, which has been growing since 1987 with the founding of the National Academy of Elder Law Attorneys.
Initially introduced as part of President Johnson's "War on Poverty," Medicaid was designed to be a federal safety net for low income individuals, so that they would have their basic medical needs furnished, notwithstanding their inability to pay. The legislation permitted states to apply for exceptions to the federal rules, initially with the intention that such states would be providing more extensive coverage than the minimum set forth in the Federal Medicaid Regulations. As state treasuries have become more bare, these requests for waivers have actually sought ways by which the state could provide less than the federal minimum. The resulting controversy between elder advocacy groups and the states has been exacerbated by some sensationalist reporting regarding the activities of some attorneys to qualify their clients for these programs.
These battle lines were further sharpened as a result of a Newsweek article on January 27, 2003, titled "Cheating Uncle Sam for Mom & Dad." Bernard A. Krooks, Esq., an estate planner and then President of the National Academy of Elder Law Attorneys (NAELA), sent a terse letter to the editor of Newsweek defending the work done by NAELA's over 3,000 member attorneys. Krooks said "Medicaid is the product of our nation's unwillingness to treat health care -- including long-term care -- as a basic human right. If we did, we would embrace some system of universal access to care, whether it be a social insurance model or a private model with guaranteed access. In a universal model, everyone pays a fair share, and everyone receives coverage."344 Krooks further outlined the public policy issues related to the Medicaid program when he explained, "Paradoxically, we do give seniors virtual universal coverage for meeting their acute care needs. Heart bypass surgery, costing tens of thousands of dollars, will not impoverish any senior, because Medicare will cover it. And we all pay our fair share for that coverage. But if we are inflicted with a chronic illness such as Alzheimer's disease, then we are left to fend for our care on our own, until we are officially impoverished under Medicaid criteria. Is this an ethical social policy that puts mom and dad into a lose-lose corner? First they lose their health; then they lose their financial solvency? Is it a surprise to anyone that mom and dad will look for legal ways to preserve what they can of the fruits of their lifetime in order to protect each other's solvency and leave some legacy to family? That's not cheating. That's preservation of one's dignity and self-worth. The ethical scandal here is our public policy, not mom or dad's avoidance of poverty. Moms and dads everywhere are willing to pay their fair share. We just don't give them a system to do it in."4
Unfortunately for the elderly and disabled, that system may soon be in place and it may well be a private pay system that is a backlash to the nearly two decades of aggressive Medicaid planning around the country. An article in the Wall Street Journal pointed out that many of the practices labeled Medicaid planning are getting greater scrutiny as states face their worst fiscal crisis in decades, especially since they pick up roughly half of the costs of the federal Medicaid program. It cited the Connecticut waiver request as the beginning of a new trend for a program that pays nearly $50 billion each year for nursing home costs alone.5
Several years ago Connecticut had proposed a transfer of assets Medicaid waiver. It did not propose to increase access to the federal program or expand the number of persons on the program that has been the basis for most state waivers. Instead, it was designed to encourage the purchase of long-term care insurance and move long-term care costs to a private pay system. The proposal was designed to discourage people from giving away their assets in order to qualify for Medicaid nursing home benefits. Connecticut wanted to impose a prospective penalty period beginning on the date when the applicant would otherwise be eligible for Medicaid coverage or was in the nursing home instead of a retroactive penalty period which began on the date a transfer or gift was made. Connecticut also wanted to impose a five-year penalty for the transfer of a principal residence. Years later, much of the Connecticut proposal has become federal law with the enactment of the Deficit Reduction Act of 2005 on February 8, 2006.
Under prior federal rules, a gift of $7,000 in State A resulted in a disqualification for Medicaid benefits for one month beginning at the time of transfer. Under the waiver provision and now new federal and state law, the $7,000 gift would result in a disqualification for Medicaid benefits for one month, beginning at the time a person medically and financially qualifies for benefits. Because the elder or disabled person would have no assets, they would either need long-term care insurance to cover the cost or that prospective month of ineligibility or family members would have to pay for the care.
The concept of increased state control of Medicaid is not something new. For instance, 36 states have implemented 46 Medicaid waivers dealing with behavioral and mental health issues alone; and the Balanced Budget Act of 1997 dramatically expanded the authority of the states to provide covered health services through managed care organizations without seeking a waiver.6 Rhode Island continues to struggle with its new waiver program designed to expand community services because of budget shortfalls. Many states are actively seeking to limit the benefits of their Medicaid programs.7 The question half a decade ago was, "Will Connecticut Kill Medicaid Planning?" as posed by John W. Callinan, Esq., who pointed out that the largest class of Medicaid planning clients comes from the lower-middle class and working class.8 Today, the question is whether DRA '05 "is killing" it. During the Clinton Administration, many waivers were denied. Under the Bush Administration, they were being encouraged. The Connecticut proposal, however, was not consistent with the original intent of Congress regarding waivers. Timothy L. Takacs, Esq., a practitioner in Tennessee had explained that when Medicaid became part of the War on Poverty in the 1960s, the concept of waivers was to encourage states to experiment for the purpose of increasing access or covering more persons under the program. For instance, Tennessee has had a Medicaid waiver program since 1994 called TennCare, which was designed to meet the means tests imposed by the federal Medicaid program and to provide benefits to state residents who were not insurable under the private pay system.9
While the debate about Medicaid reform continues, particularly after DRA '05, practitioners are still able to recommend a vast array of planning strategies that allow a person to qualify for the federal Medicaid program. These techniques include gifting outright or into trust, protecting the principal residence, and shifting assets and/or income to a spouse who is living in the community from the spouse who is institutionalized and needs care. Many of the rules that allow such transfers have been designed to protect the community spouse from catastrophic financial loss as a result of the other spouse needing long-term care; they are not always intended to benefit heirs, although that can be the ultimate consequence of such planning.
MEDICAID ELIGIBILITY AND TRANSFER RULES
For many elders, the prospect of long-term care in a nursing home is unpleasant, especially because elders are also often concerned that the cost of long-term care will deplete their estate. The cost of nursing home care in many states is estimated at between $100,000 and $120,000 per year, which only serves to compound these fears.
Many elders receive assistance from the federal Medicare program to help pay some medical expenses and some short-term nursing home care. Medicare, however, does not pay for extended nursing home care. Medicaid, on the other hand, is a joint federal-state program that pays for nursing home care for elders (age 65 or over) who meet the financial eligibility rules. (Medicaid is also available to blind and disabled individuals who meet the eligibility guidelines.)
In determining the financial eligibility of an applicant (an individual applying for Medicaid), Medicaid looks at the applicant's assets and income. The assets considered include cash, mutual funds, cars, real estate; the income considered includes Social Security, dividends, pensions, and annuity payments.10
Medicaid places a limit on the amount of assets an applicant can own and still be eligible for Medicaid. Currently, the asset limitation is usually $2,000, although it can vary from state to state. Rhode Island has set its limit at $4,000.11 Medicaid divides an applicant's assets into three categories: (1) non-countable assets; (2) inaccessible assets; and (3) countable assets. Non-countable assets, as the name implies, are not included in the calculation of an individual's assets in determining Medicaid qualification. These excluded assets include: (a) personal belongings such as clothing and jewelry; (b) burial plots for the applicant and members of his or her family; (c) pre-paid burial contracts; (d) a $1,500 burial account for miscellaneous funeral and burial expenses; (e) life insurance with a face value up to $1,500; and (f) one automobile for use by the applicant or his or her family.12
Richard owns a house worth $150,000, a car worth $4,000, and mutual funds worth $50,000. Medicaid does not consider the value of Richard's house (if he intends to return home) or car when calculating Richard's countable assets. Medicaid does consider the $50,000 Richard owns in mutual funds as countable assets.
Special Rules For The Principal Residence
Medicaid will only categorize an applicant's home as a noncountable asset if any one of the following conditions is met: (1) an applicant living in a nursing home intends to return to the home; (2) the applicant owns a long-term care insurance policy meeting certain requirements at the time he or she entered the nursing home (a limited number of states, including Massachusetts); or (3) any one of the following live in the home: the applicant; the applicant's spouse; a child under age 21; a disabled child of any age; a blind child of any age; a relative who is dependent on the applicant; a child who lived in the home for at least two years before the applicant moved into a nursing home and provided care which permitted the applicant to remain at home; and a sibling who has an equity interest in the home and has lived there for at least one year before the applicant moved into a nursing home.13
Also note that under DRA ‘05 certain equity limitations were enacted with respect to the exemption of the principal residence. As a result, in Massachusetts the home will be noncountable as long as the equity value of the home does not exceed $750,000 ($500,000 in Rhode Island). Any value in excess of this figure will be deemed an available resource. An applicant can reduce the equity value by means of a mortgage if it is determined to exceed the threshold.
Like noncountable assets, inaccessible assets also are not included in the calculation of an applicant's assets. Inaccessible assets are assets to which the applicant has no legal access, such as expected inheritances before probate is completed or marital assets prior to a final decree of divorce.14
Karen's sister Betty died six months before Karen applied for Medicaid. Under Betty's Will, Karen is entitled to one-half of Betty's estate which is worth $200,000. Karen has not yet received any money from Betty's estate. The $100,000 Karen expects to receive from Betty's estate is an inaccessible asset. Once Karen receives the $100,000, it is no longer inaccessible.
All assets not considered noncountable or inaccessible are counted towards the $2,000 asset limitation. In some cases, both jointly held assets and assets in a trust will be viewed as countable assets.
Jointly Held Assets
Medicaid presumes that all funds held in joint bank accounts are the applicant's assets. This presumption can be overcome if the joint owner can demonstrate that he or she contributed part or all of the funds to the account. Proof is needed to overcome the presumption.
Andy owns a joint bank account with his daughter, which totals $10,000. When Andy applies for Medicaid, it is presumed that Andy owns all of the $10,000 in the joint account. If, however, Andy can prove that $8,000 of this account is attributable to his daughter, only $2,000 will be counted as Andy's assets. Other assets held jointly, such as real estate, stocks, and bonds, are presumed to be owned equally. This presumption can also be overcome.
Edna and Charley are joint owners of a sailboat with a value of $20,000. The certificate of title to the boat does not specify the percentage of each person's ownership. If Edna applies for Medicaid it will be presumed that she owns 50% of the sailboat, or $10,000.
If a Medicaid applicant is both the beneficiary and grantor of a trust, and the applicant may receive payments of interest or principal from the trust, the income or principal that the applicant can receive is considered a countable asset. These assets are considered countable even if distributions from the trust to the applicant are never made.15
Jim sets up a revocable trust with $50,000 he received as an inheritance from his father's estate. Jim's children are the beneficiaries of the trust. Medicaid would consider the entire $50,000 as Jim's countable assets, because the Trust is revocable by Jim.
Even if the applicant is not the grantor of a trust, so long as his or her beneficial interest is one subject to a broad standard of invasion (i.e., the familiar HEMS (Health, Education, Maintenance and Support) provisions for an ascertainable standard under the Internal Revenue Code), then the assets would be included. If, however, there is no invasion standard, or it is very narrowly drafted, the assets of the trust created by someone other than the applicant will not be included, although the income may be taken into account with respect to determining qualification under the income limitations discussed below.
In addition to the asset limitation, Medicaid places a limit on the monthly income an applicant can receive. Medicaid considers both earned income (wages) and unearned income (interest on investments, pensions, gifts) when it calculates an applicant's total income.16
For applicants living in nursing homes, the income limit is usually $72.80 per month. Nursing home residents, however, can deduct the cost of the nursing home care from their total income to remain under the $72.80 limit. All income remaining after the resident keeps a $72.80 "personal needs allowance" and deducts money spent on health care must be paid to the nursing home. Medicaid covers the difference between what the resident can pay and the cost of the nursing home care.
Owen lives in a nursing home that costs $10,000 per month. Owen has $1,200 in monthly income comprised of Social Security benefits and a pension. Suppose Owen spends $140 per month on his Medicare premiums (a Medicare supplemental insurance). From his $1,200 monthly income Owen can deduct and keep $72.80 for his personal needs allowance and can also deduct the $140 he spends on health care. The $987.20 in income that remains must be spent on the cost of Owen's nursing home care. Medicaid will pay the balance needed to cover Owen's bill to the nursing home at state rates.
Community Spouse Resource Allowance
Under the Medicaid rules, a couple's assets are pooled (added together) for the purpose of determining eligibility. At the time an applicant is institutionalized (the first day of a stay in a long-term care facility or hospital which lasts 30 days or more), Medicaid calculates the couple's total "countable assets." The couple's assets are pooled without regard to which spouse actually owns the assets. The spouse still living in the community (the "community spouse") is allowed to keep a portion of the couple's countable assets, the minimum community spouse resource allowance.17
This portion of the countable assets is called the "community spouse resource allowance." The community spouse resource allowance is around $113,640. Thus, the most that the community spouse can keep is $113,640. In some jurisdictions, a community spouse can only keep half of the assets up to $113,640. However, in 2012, a community spouse may keep the first $22,278 of the allowance, even if that is more than half of the couple's assets (the "minimum community spouse resource allowance").
In situations where one member of a couple refuses to cooperate with Medicaid, such as a refusal to supply the necessary documents, Medicaid will disregard the uncooperative spouse's assets. In this situation, however, the uncooperative spouse will not be able to take advantage of the community spouse resource allowance or the community spouse maintenance needs allowance; this is called a spousal refusal.
On the date Mr. Jones enters a nursing home he has $150,000 in countable assets and Mrs. Jones has $54,000 in countable assets. The Jones' pooled assets are $204,000. Of this total, Mrs. Jones, as the community spouse, is allowed to keep $113,640 as the community spouse resource allowance. The assets attributed to Mr. Jones, therefore, total $90,360 (pooled assets minus community spouse resource allowance). Of this $90,360, Mr. Jones is allowed to keep $2,000 and still be eligible for Medicaid. Thus, the Jones' must spend down $88,360 before Mr. Jones is eligible for Medicaid.
In order to transfer assets between a couple to ensure that an institutionalized spouse has only $2,000 in his or her name, Medicaid allows a 90-day period after an eligibility determination within which transfers between spouse can be made or 120 days if a court order is required for applicants under guardianship.
In the previous example, assume that the Jones' have spent down $88,360 to make Mr. Jones eligible for Medicaid. There remains, however, $20,000 in assets in Mr. Jones' name. The Jones' are allowed 90 days within which to transfer the $20,000 into Mrs. Jones' account.
Community Spouse Maintenance Needs Allowance
Under the Medicaid rules, the spouse of an individual in a nursing home is entitled to a portion of the institutionalized spouse's income under certain circumstances.19 This sharing of income is allowed when the community spouse has monthly income below the level of the "community spouse maintenance needs allowance." This minimum level is $1,839, which may be increased by an excess shelter allowance if the spouse qualifies; in that event, the actual expenses that exceed that state's guidelines will qualify for the excess shelter allowance although there is a cap on this allowance of around $2,841, unless the spouse can successfully appeal that limitation. The excess shelter allowance is the community spouse's actual monthly housing costs, including mortgage payments, rent, property taxes, and utilities.
The community spouse is entitled to as much of his her spouse's income as is needed to bring the community spouse's income up to the minimum level. If the couple's combined income does not reach the minimum level, the community spouse is entitled to the couple's total income (less around $72.80) for the institutionalized spouse's personal needs allowance.
Mr. and Mrs. Haywood have a total monthly income of $2,500, $2,000 of which comes in Mr. Haywood's name and $500 in Mrs. Haywood's name. Mr. Haywood lives in a nursing home and Mrs. Haywood lives in the community. Mrs. Haywood's excess shelter allowance is $200, giving her a community spouse maintenance needs allowance of $2,039 (minimum level of about $1,839 plus excess shelter allowance of $200). Mrs. Haywood is entitled to a share of her husband's income that will bring her from her current income level of $500 up to her $2,039 allowance. Mrs. Haywood's is therefore entitled to $1,539 of Mr. Haywood's monthly income.
Medicaid was designed to benefit those individuals with little or no assets. Through a number of rules, Medicaid discourages individuals from intentionally impoverishing themselves to qualify for Medicaid. The most important of these rules involves transfer made within the 60-month period prior to applying for Medicaid.
The purpose of the 60-month "look-back period" is to determine if any transfers (gifts or sales) the applicant made in the 60 months prior to applying for Medicaid will act to disqualify him or her from Medicaid. The look-back period for transfers prior to February 8, 2006, and not to trust is 36 months, if a disqualifying transfer existed in this period, the penalty that results from an asset transfer began in the month of transfer, i.e. immediately. Under the new law, the penalty will not begin to run until (a) the patient is in the nursing home bed, (b) he or she is otherwise eligible for Medicaid (i.e. has spent down his other assets to $2,000) and (c) he or she applies for benefits. In other words, a person could easily end up with a 10 year disqualification period for what would be only a five year period today in cases where a person applied at the four year and eleventh month mark.
Unless the person can make it through the entire five years post-transfer without needing care, all or some of the gift will likely have to be returned in order to pay for care. In order to protect assets, clients are going to have to transfer more assets, clients are going to have to transfer more assets earlier and wait longer to obtain eligibility. The use of irrevocable trusts with powers of appointment will also increase. Return of assets with conversation to annuities will offer some protection but will require a pay-back at death to the state for a sum up to the state rate paid for care.
Florence owns a house with a fair market value of $278,000. On January 1, 2003, Florence transfers the house to her daughter as a gift. On June 1, 2003, Florence applies for Medicaid. The gift of the house is considered a disqualifying transfer, because it was made within the 60-month period prior to Florence's application for Medicaid and before February 8, 2006.
The period of ineligibility for Medicaid for a disqualifying transfer is obtained by dividing the fair market value of what was transferred by the average daily (sometimes calculated as monthly) cost of a nursing home in the state of the applicant's residence.20 The average monthly nursing home cost ranges from $7,777 in Rhode Island to $8,333 in Massachusetts.21
The ineligibility period equals the fair market value of the transferred asset divided by the average daily cost of the nursing home.
In the previous example, Medicaid would take the fair market value of Florence's house, and divide it by the daily cost of a nursing home in her home state of Massachusetts. $278,000.00 divided by $278.00 per day = 1000 days of ineligibility in Massachusetts, more or less.
This transfer rule does not apply to applicants living in the community but will apply if the applicant living in the community is subsequently institutionalized. Also, transfers made to an applicant's blind or disabled child are not disqualifying transfers.22
For transfers made on or before August 10, 1993, the ineligibility period for a disqualifying transfer was limited to 30 months.23
Mike owned a house with a fair market value of $334,000. On January 1, 1993, Mike transferred the house to his son as a gift. On May 1, 1995, Mike applied for Medicaid. Because the transfer was made prior to August 10, 1993, Medicaid looked back 30 months from the date of Mike's application and recognized the disqualifying transfer. Medicaid will calculate the ineligibility period ($300,000/$185 per day or the state daily disqualification rate) to get a 2000 day ineligibility period today. The maximum ineligibility period for transfers made prior to August 10, 1993, however, was 30 months. Therefore, Mike's ineligibility period was 30 months from the date of the transfer or July 1, 1995.
Ineligibility periods for transfers made after August 10, 1993, are not capped. Thus, the ineligibility period for large transfers is considerable. If an applicant, however, delays his or her application for Medicaid for 60 months after making a disqualifying transfer, the transfer is not reported to Medicaid. In this manner, applicants can essentially cap their ineligibility at 60 months or five years (and one day).
When an applicant has countable assets that exceed the amount allowed by Medicaid, he or she will want to reduce these assets below the $2,000 limit. The process by which an applicant reduces his or her assets to $2,000 is called a "spend-down." During the spend-down, the applicant will usually want to avoid making disqualifying transfers in order to qualify for Medicaid as quickly as possible.
Jack has countable assets that total $90,000. In order to become eligible for Medicaid, Jack will need to spend-down $88,000 (Jack is allowed to keep $2,000). Jack chooses to spend-down his assets in the following way:
Purchase of a pre-paid burial contract - $ 8,000
Purchase of burial plot - $ 1,000
Pay off credit card debt24 - $ 5,000
Purchase of an annuity - $35,000
Total $ spend-down = $49,000
Once Jack spends-down the remaining $39,000 he will be eligible for Medicaid. Previously, he could gift $20,000 for a four-month disqualification (where the disqualification rate is $5,000 per month) and spend the remaining funds for nursing home care (this is called a half-a-loaf transfer). In some states, notably Rhode Island, a strategy creating promissory notes for about half a person's assets and gifting the other half and erecting a hybrid half-a-loaf transfer is meeting some success. In other states, such as Massachusetts, it is not.
Medicaid has the right to recover money it paid on a recipient's behalf after age 55 (although this is disputed in some states).25 Recovery, however, is limited to a recipient's probate estate and self settled special needs trusts no matter a person's age. Medicaid is supposed to only pursue claims against the recipient's probate estate if there is no surviving spouse, child under age 18, or disabled child of any age.
If the recipient owns a house, Medicaid may place a lien on the house for the amount of funds expended on the recipient's behalf after the recipient reached age 55, Rhode Island does not. This lien may be placed on the house even before the recipient's death provided that the following conditions are met: (1) the recipient permanently resides in a nursing home and is not expected to return home; (2) the recipient receives notice of the lien; (3) there is no surviving spouse, child under age 18, or disabled child of any age residing in the house. These pre-death liens are used in a limited number of jurisdictions and are simply "notice" liens; Medicaid has no claim against the real estate until the recipient dies. In Massachusetts, if the house is sold during the recipient's life, Medicaid will seek recovery from the proceeds of the sale. In Massachusetts and Rhode Island the net proceeds will be deemed excess assets.
The Medicaid Application is often difficult and extremely time consuming to complete. The supporting documents needed for a successful application are substantial and include a birth certificate, Medicaid card and premium information, 60 months of bank statements, 5 years of tax returns, investment information and insurance policies, all income checks, expense information, and trust documents. Any substantial withdrawals of assets occurring in the 60 month period preceding the application must be explained or disqualification period may result.
Applications are submitted to a local office of the Department of Medicaid's Long Term Care Units.
As a general rule, a response can be expected within 30 to 90 days. If the response is unfavorable, the applicant has a right of appeal within the state agency, generally governed by the appropriate state's Administrative Procedures Act. If the determination is still unfavorable, the applicant needs to resort to judicial intervention in the Superior Court for the jurisdiction in question.
Medicaid planning can be classified into four general techniques:
1. Transferring assets;
2. Converting assets to income;
3. Insuring assets; and
4. Spending assets (for instance, home repairs and renovations are allowable).
As previously explained, transferring assets by gift or to a trust - the two most popular estate planning methods - requires a waiting period before the transferor is eligible for Medicaid. The waiting period is based on the value of the asset transferred - typically one day of disqualification for each amount transferred that is equal to the average daily cost of a nursing home in the state as determined by that state's agency.
Transferred assets are not reportable by a Medicaid applicant once the reporting or look-back period has passed. As stated earlier, the look-back period is 60 months for all transfers after February 8, 2006.
Many planners mistake the look-back periods as disqualification periods. In fact, the look-back periods are simply regulatory reporting periods under 42 U.S.C.A. § 1396. A transfer or gift that is reported during the look-back period results in a separate disqualification period that is based on the value of the asset transferred according to each state's average cost of nursing home care. The look-back period that applies to disbursements that could be made to or for the applicant, but are made to another person or persons, is 60 months; an example would be distributions from a revocable grantor trust to someone other than the grantor. Previously, the penalty date was the beginning date of each penalty period imposed, and was generally the first day of the month in which the transfer was made, or (at the state's option) the first day of the month following the transfer. Now, it is more or less upon entry to a nursing home when made within five years previous.
If a client provides $13,000 as an outright gift, those monies would be reported as a transfer at any time the client applies for Medicaid during the 60- month period following the date of the gift. If that same client provides $13,000 as an outright gift to a 2503(c) minor's trust, those monies would be reported as a transfer at any time the client applies for Medicaid during the 60-month period. If the client establishes a revocable trust for his benefit and allows distributions to family members, a distribution of $13,000 will be reported during the 60- month period. With all three gifts, the disqualification period is based on the value of the amount transferred and starts at nursing home admission and no longer when the date the gift was made.
Assume that in State B, the average cost of a nursing home is $300/day or about $9,000 per month. A $9,000 transfer to anyone other than the grantor on June 30 will result in a one-month disqualification beginning on June 1, if the patient is in the nursing home and otherwise qualifies. Alternatively, a $90,000 gift will result in a disqualification of ten months. Similarly, an outright gift or transfer of $324,000 will result in a three-year disqualification. Prior to February 8, 2006, an outright gift of more than $324,000 could be capped at the three year mark if an application for Medicaid is made after the 36 month look-back period. A large transfer (defined as anything more than the state average disqualification rate resulting in a three year disqualification which more or less matched the 36 month look-back period i.e. $400,000) reported during the 36 month look-back resulted in a disqualification based on the amount transferred because it will be captured during the reporting period. As a result, it was important to wait three years and one day to apply for Medicaid when large transfers are made which in the case of State B would be anything over $324,000. Now, it's the full five years and a day for any amount.
Prior to February 8, 2006, if mom lives in State B, where the nursing home costs are the same as in the previous example. If Mom transferred $240,000 outright and waits three years and one day to apply for Medicaid, the 36-month look-back period would not catch the transfer to create a disqualification. Similarly, if Mom gifted one million dollars and waited three years and one day to apply for Medicaid, the 36-month look-back period will not catch the transfer to create a disqualification. The same example applies with the new five year wait.
Prior to February 8, 2006 if in State B, Mom gifts $432,000 outright and applies the next day for Medicaid. In this case, she will be disqualified for four years ($432,000/ $9,000 per month), and during that time will require private payment or long-term care insurance. Mom is disqualified for more than 36 months because she did not wait three years and one day to apply for Medicaid. The same example applies with the five year or 60-month wait.
Mom in State B gifts $648,000 to an irrevocable trust for the benefit of her children. In this situation, there will be a six-year disqualification period ($648,000/$9,000 per month) and a five-year look back period. Prior to February 8, 2006, and if a trust had not been used, Mom would have avoided the 60-month look-back period for trusts at that time.
It is important to note that transfers under the Medicaid regulations are not always treated as gifts under the tax code and that gifts under the tax code are not always treated as transfers under the Medicaid regulations.26
Certain assets and certain transfers of the principal residence are exempt in calculating available resources for purposes of determining Medicaid eligibility. Exempt trusts include: (1) discretionary or spendthrift trusts established for the applicant by another person with assets not belonging to the applicant; (2) supplemental or special needs trusts; and (3) trust established by the will (or funded by a will) of a spouse for a spouse/applicant if the trust is discretionary.27
The Medicaid rules categorize a principal residence as a non-countable asset if (1) the applicant intends to return home (an increasingly difficult element to prove because states are beginning to require medical evidence on the ability to return home), (2) the applicant has long-term care insurance meeting specific minimum requirements (in Connecticut, Illinois, Indiana, Maryland, Massachusetts (under M.G.L. c. 118E § 33), and New York), or (3) any one of the following live in the home: the applicant (for community Medicaid or if returning home); the applicant's spouse; a child under the age of 21; a totally and permanently disabled child of any age; a blind child of any age; a relative who is dependent on the applicant; a caregiver child who has resided there for at least two years; or a sibling who has had an equity interest for at least on year.28 The most common form of exempt transfer of the principal residence is to the community spouse.
If a Medicaid applicant is the beneficiary and grantor of a trust, the principal and income that the applicant can receive are considered countable assets to the extent that principal and income are available. This is true for both revocable and irrevocable trusts. Full discretion of a trustee to distribute to the grantor equates to total access to the trust assets by the grantor, even if there is an independent trustee (for instance, offshore and domestic asset protection trusts are not effective for Medicaid planning). If the applicant or the applicant's spouse is the grantor of a revocable trust, all assets in the trust are countable, except in Rhode Island, for principal residence transfers to revocable trusts prior to December 1, 2000. For instance, let's say an elderly couple decides to combine probate avoidance and Medicaid trust planning with a special needs trust for a disabled adult child; the result is simple: protection of assets while maintaining the child's eligibility for assistance programs, because neither the child or the child's spouse is a grantor of the trust. The special needs trust provides that the principal and income will be used for any needs of the beneficiary that are not otherwise provided by a public benefit program (such as Medicaid or Social Security Disability (SSI)). The trust thus supplements, rather than supplants or replaces, public benefits to which a beneficiary was entitled.
Mom and Dad have a $250,000 house and $209,560 in cash. Mom and Dad have done no planning, and Dad requires long-term care. Mom and Dad will have to spend around $100,000 before Dad will qualify for Medicaid because Mom is allowed $109,560 (in most states) in assets. Assume that Dad subsequently dies and now Mom needs care. Mom must spend $107,560 of the remaining $109,560 (she is permitted to have only $2,000) and the house will probably have to be sold to pay for her care.
Suppose that Mom later dies with $40,000, which is left outright to her disabled adult son. The son will lose his public benefits until he spends the $40,000. This could have been avoided with a special needs trust created by Mom for her disabled adult son. In contrast, assume that Mom and Dad do plan and establish a defective irrevocable trust (a trust which is considered a grantor trust under IRC 671-679) with a reserved life estate in their principal residence, which is transferred to the trust, with the remainder to their son's special needs trust. They fund a special needs trust for their disabled son with $200,000.
Five years and one day later, Dad needs care. Mom has $100,000 of which $18,000 could be used to pay for funerals, resulting in qualification for Medicaid for Dad. Mom later takes $82,000 (after Dad has qualified for benefits, because this transfer will only impact Mom's future eligibility) and transfers it to the special needs trust. Five years and one day later, Mom needs care. She immediately qualifies for Medicaid, and the total savings to the family amount to up to $400,000 to $500,000. When Mom dies, the home receives a step-up in tax basis by virtue of the grantor trust rules. The home is sold at its stepped-up basis, and no capital gains tax is due; the sale proceeds are poured over into the special needs trust. The disabled adult child continues to receive public benefits and has his parents' estates available for supplemental needs for the rest of his life. If the son needs to protect his own assets, a so-called d4A trust must be created.
Disabled adult son is in a car accident and receives net settlement proceeds of $250,000. By court order, a trust funded with the settlement proceeds is established under 42 U.S.C.A. § 1396p(d)(4)(A). The trust must allow reimbursement to the state of any assets remaining at the son's death, but the trust will be exempt during son's life because it was created and funded with his assets.
Asset and Income Levels
Each state determines the allowable asset and income levels for the non- institutionalized spouse. In most states, the community spouse (i.e., the non- institutionalized spouse) keeps all of his or her own income and assets up to some threshold, plus the principal residence. The most effective way to increase resources or income retention of the institutionalized spouse is by showing a need at an administrative appeal, referred to as a "fair hearing."
Calculating a Gift of the Right to Income
Medicaid regulations treat the transfer of income as an asset transfer. Therefore, a release of annuity or pension payments, or income from a trust, will be considered a transfer of an asset. If a stream of income or the right to stream of income is transferred, a calculation is made as if it were a lump sum.
The value of a transfer of a stream of income is based on the payments expected. The transfer of a right to income is valued based on the total amount of income expected during the person's life, according to an actuarial projection pursuant to federal HCFA tables (HCFA stands for Health Care Financing Administration, the name has been changed under the current administration but the agency is often described under its former designation).
Calculating Partial Transfers
The value of a partial transfer, such as a deed with a retained life estate, is determined by calculating the value of the life estate versus the remaining interest, based on HCFA tables, which are found in HCFA Transmittal No. 64.
Mom is age 65 and owns a house with a small farm worth a total of $300,000. Mom deeds the house and farm to her son but retains a life estate in the property. Mom also retains the right to receive an income generated by the farm. The value of Mom's life estate equals the current value of the property ($300,000) multiplied by the life estate factor corresponding to Mom's age in the table (.67970). The result is a life estate worth $203,910 (.67970 x $300,000). In determining the disqualification period for purposes of Medicaid eligibility, the penalty is based on the difference between the value of the asset transferred $300,000) and the value of the life estate ($203,910), or alternatively, the penalty is based on a factor of .32030 or (.32030 x $300,000), which equals $96,090. This amount ($96,090) results in a disqualification period that is less than the five-year look-back. The disqualification period would be less than two years in most jurisdictions. Now, it is always going to be five years (or more).
Calculating transfers of life estates
In calculating transfers of life estates, an interesting dilemma results.
The facts are the same as in the previous example, except that ten years have passed and Mom is now age 75. Her life estate factor is .60522. Is the value of her life estate $181,566 or $203,910? The passage of time resulted in a further (indirect) gift that is not counted, and the answer is $181,566, although the disqualifying transfer calculation is based on the original life estate factor.
Calculating Annuity and Income Streams
One of the most effective means to shelter assets is not by making gifts, but making transfers for consideration and thereby eliminating any disqualification period. This can be done for an institutionalized spouse or for the spouse remaining in the community.
In the two previous examples, suppose that Mom did not transfer the house and farm and that she is now 85 years old. She could now sell the house and farm to son using a private annuity, mortgage, and promissory note. Only her monthly payment from her son would be counted toward her required patient pay amount to the nursing home. These strategies are coming under increased scrutiny.
The tax benefit for an installment sale is that the post-sale increase in the value of the asset sold is excluded from the seller's gross estate, and is not subject to income, gift, estate, or generation skipping transfer (GST) taxes.29 The reason is that the value of the asset is fixed at the time of the sale; the value of the note remains unchanged, while the asset itself (which has now been sold) may appreciate as part of the buyer's estate. The major advantage for Medicaid planning is that a countable asset is now an income stream, and no disqualification period exists. The seller in an installment sale receives an installment note, which generates income. The installment method permits the seller to report the gain from the sale in income over a period of years. Moreover, a sale of property to a family member enables the family to retain the property, which is often desirable.
The drawbacks of an installment sale include: (1) gain that is taxable to the seller; (2) surrender of control; (3) retention of value in the seller's estate; (4) inapplicability of the gift tax annual exclusion, as well as the marital and charitable deductions; (5) inflexibility, because the note is a fixed asset; (6) possible acceleration of installment gain if the buyer sells the asset within two years; and (7) acceleration of gain if the seller transfers the note for consideration. An installment note could be transferred to a revocable trust for probate avoidance. If a self-canceling note is used, a premium might have to be calculated or a balloon payment included in order for the transaction to be actuarially sound.30 After February 8, 2006 self-canceling notes are not permitted.
Mom and Dad have a multi-family unit worth $185,000. Dad needs long term-care. Mom has been hospitalized and may need care. Under the Medicaid rules, the $185,000 property will be accessible to pay for their care. Mom and Dad sell the property to sons G and D. G and D sign a note for $185,000 that provides for a 15-year amortization schedule at 7% interest and a monthly payment of $1,662.83. Because the note is due in 15 years, the longest of both Mom's and dad's life expectancy, it is actuarially sound according to Medicaid actuarial tables. Dad applies for Medicaid. His Social Security is $497.00 per month, and his share of the note is $831.41, for a total monthly income of $1,328.41. His allowances, which are subtracted from his countable income, include the following in State A: $72.80 for personal needs, $166.35 for health insurance, and $272.59 for the community spouse (his wife, Mom), because Mom's Social Security and pension income is below State A's monthly allowance. Dad pays $816.67 per month for nursing home care, Medicaid picks up the balance at state nursing home reimbursement rates, which are often at 50 to 60% of the private pay rate.
Mom and Dad report the sale on the installment method. They have a gain, because of depreciation previously claimed and because of appreciation value, but they pay little or no income tax on the gain because they have medical expense deductions for the payments to the nursing home. When Mom and Dad die, sons G and D have income in respect of a decedent (IRD) for any remaining gain in the parents' estate when the sons inherit the note. Yet, while owning the property, the sons may claim a deduction for interest payments, because this is property held for productive use and is not personal use property. The sons also acquire a new full cost basis for purposes of depreciating the property, which over time offsets the tax owed on the IRD.
A private annuity is similar to an installment sale, for it permits gains to be reported over a period of years and provides a good strategy for Medicaid planning. The buyer (i.e., the transferee) has a basis in the property received in exchange for the buyer's agreement to make the annuity payments.31 In general, the IRS views a private annuity as a retained life estate with a gift of the remainder interest if: (1) the payments are determined by the actual income of the transferred property; (2) the buyer is not personally liable; (3) the buyer or obligator has no resources -- other than the transferred property -- to make the payments; or (4) the annuitant retains control over the property.32
For income tax purposes, an annuity payment received by the seller consists of three parts: a tax-free recovery of basis; the gain portion; and ordinary income. The gain realized is capital gain if the property transferred was a capital asset. The amount of each annuity payment that is excludable from the recipient's income is based on the "exclusion ratio." The exclusion ration is the seller's investment in the contract (i.e., the seller's basis in the property transferred) divided by the expected return from the annuity. The expected return equals the annual annuity payments multiplied by the annuitant's life expectancy. The capital gain is the excess of the present value of the annuity received over the adjusted basis, divided by the life expectancy.33 The balance of the annuity payment is ordinary income.
In the Medicaid context, take this example. Mom's only asset is $50,000 of low basis stock. At age 81, she needs long-term care, but will not qualify for Medicaid because she has excess assets and no spouse. Mom enters into an annuity contract with Daughter, exchanging the $50,000 of stock for an annuity payment by Daughter of $600 per month for life. Provided that the transaction is properly structured and calculated, Mom will now qualify for Medicaid if she contributes toward her care the $600 annuity payment along with Social Security or other pension monies, after deducting the personal needs allowance. Private annuities are being challenged in many states including Massachusetts and Rhode Island. Mom could also purchase an annuity through an insurance company which continues to be an effective planning strategy.34
Assume that Mom now has a spouse. Assets are transferred to the spouse; the spouse establishes an annuity and keeps the income as a spousal annuity, even if Mom needs Medicaid. Massachusetts requires a lien on community spouse annuities. However, Rhode Island does not have such a requirement.
Mom is to be placed on Medicaid, and must sell her home or face a lien on the property (the federal rules require the states to implement estate recovery on probate assets, some states have liens on assets beyond the probate estate). She sells her home for $118,000. After the payment of commissions, expenses, legal fees, and various bills, a net of $96,000 is left. Mom signs a private annuity contract with her son under which she transfers the $96,000 to her son in exchange for a monthly payment by her son of $810.81 for Mom's life expectancy (a term of 11 years), like a standard commercial contract. The annuity payment includes a 2% interest figure and is slightly above commercial quotes with an interest rate below the applied federal rate. Mom applies for Medicaid. Her monthly income is $1,583.81, which includes the annuity payment and Social Security of $773.00 per month. She is allowed $60.00 in State A for personal needs and $65.00 for health insurance; she is required to pay the remaining $1,458.81 to the nursing home. Her son is the remaining beneficiary on the annuity, subject to a state lien under DRA ‘05. Interest payments by him are not deductible, but he may invest the funds at his own discretion and can manage the investment as he pleases. He could also covert the obligation to a commercial annuity which may be more advisable given the current disdain for private transactions.
Traps for the Unwary
There are many traps for the unwary estate planner who views the world strictly from a tax avoidance perspective. The traps result because, in many cases, Medicaid planning is counter intuitive to trusts and estates lawyers who focus on tax planning. Here are some examples:
IRAs and Other Qualified Retirement Plans
The retirement accounts of a Medicaid applicant are countable in Massachusetts (not Rhode Island). The only way to protect them is by liquidation and a combination of gifting and spending as described earlier in this article. In instances where there is a community spouse, the liquidated retirement funds (after taxes are calculated) can be transferred to that spouse, who can convert them to a personal annuity (however note that any nursing home payments made will be a medical expense deduction, with offsets against any income taxes).
Assume husband and wife live in Massachusetts. Husband (age 70) and wife (age 60) are clients. Wife has a limited income and retirement benefit. Husband has a small Social Security check and a substantial IRA. He has not started taking his minimum distributions. Husband has Alzheimer's disease. Wife is fit, walks daily, gardens, and takes no medication. Her father died at age 85. Her mother is 90 and in a nursing home. What do you advise these clients to do with Husband's IRA? The answer is not to spend hours deciding about minimum distribution formulas. Why? Wife appears to have the expectancy of longevity. Husband may be in a nursing home for some time as Alzheimer's patients are often physically fit. The answer is to liquidate Husband's IRA. If it is near the end of the year, split the liquidation into two tax years. Transfer the funds to Wife and have her purchase a fixed annuity for herself that falls within the state guidelines. Husband will qualify for Medicaid and the IRA proceeds will be protected (after adjustments for tax and medical expense deductions).
Exempt transfers allow assets to go to other family members based on the public policy of not displacing persons from their homes. Transfers of cash and other investment assets may be transferred to the community spouse by an institutionalized spouse for support reasons.
Brother Sam and Sister Sue live together. Sue's husband is deceased, and they had no children. Brother Sam's Daughter Diedre takes care of Sam and Sue. Diedre receives SSI. Sue owns the home and wants Sam and Diedre to receive the property. Both Sam and Sue may need long-term care within one year. How should the property be transferred? Sue sells a small fractional share of a tenancy in common interest. Later, she applies for Medicaid and the transfers the balance of the property to her brother who has lived with her for one year and owns an equity interest in the home, so that this is now an exempt transfer under the federal rules. One month later, Sam enters a nursing home. Sam conveys the real estate to daughter as an exempt transfer to a disabled adult child. If Diedre was not disabled and Sam did not receive nursing home care for two years after owning the property, an exempt transfer could be made to Diedre as a caregiver child who prevented her father from going into a nursing home for two years.
Defective irrevocable trusts can be an effective means by which to make Medicaid transfers when there is not a desire to do estate tax planning. They also have the advantage of allowing a step-up in basis under current limitations.
Client wants to give his principal residence in trust even though the estate is under $1,000,000. Do you use a Crummey trust and part of the unified credit? No. Use a defective irrevocable trust with no Crummey powers, no partition rights, and a special power of appointment with the right to occupy. For purposes of Medicaid, it is a completed transfer and the client will qualify for benefits once he is beyond the disqualification period. For estate tax purposes, the house is includable in the estate under the grantor trust rules. The result is a Medicaid transfer and a stepped-up basis for the real estate at the client's death.
Transferring the Principal Residence
Typically, many lawyers advise clients to transfer their principal residence to their children with an occupancy agreement for the parent-clients, or life estate deeds may be used. Some more creative attorneys use irrevocable grantor trusts for the benefit of children; these trust include special powers of appointment in order to change beneficiaries, and incorporate reserved life estates. Practitioners also recommend a transfer of the clients residence to an individual that would not result in a disqualification for purposes of Medicaid eligibility (i.e., a transfer of the client's house to a spouse; a caregiver child; a sibling co- owner; or a minor, blind, or disabled child). Aggressive planners have been known to transfer a small percentage interest in highly valued real estate to a sibling who "moves in"; after a short period of time, the disqualification period has run, and an allowable transfer of the full remaining value to a sibling co-owner takes place. For cases where there is a husband and wife it's possible to transfer the principal residence to the community spouse as the institutionalized spouse or will leave assets in a purely discretionary testamentary trust created by will. The latter is exempt as to any assets left for the benefit of the institutionalized spouse. Neither Massachusetts nor Rhode Island require a forced elective share to be made an institutionalized spouse against the will of a decedent spouse.
Sue owns a home valued at $500,000. She sells $50,000 in value to her sister, Nancy. Nancy moves in to take care of Sue. In two years, Sue needs long-term care. Sue transfers the remaining interest in the home to Nancy, and no disqualification results.35
One problem created under the Balanced Budget Act of 1977 (BBA '97) was a concern about the criminalization of Medicaid planning. Then U.S. Attorney General Janet Reno found the act to be unenforceable. The current administration under U. S. Attorney General John Ashcroft has not changed that view.36
A transfer by clients of their home to an irrevocable grantor trust protects for the clients exclusion of gain upon sale of the residence.37 This is useful if the clients wish to buy a smaller home or condo, move into a senior citizens apartment building, or move in with one of the children, or if the clients require long-term care.
If there is no spouse at home, a sale in exchange for an annuity (i.e., conversion of an asset into an annuity) would possibly protect some of the asset. Why? If an unmarried client has $100,000, that amount would have to be spent down to a typical resource allowance of $2,000; some states have higher figures. Yet if that same client transferred the $100,000 asset in exchange for a present life annuity paying $1,000 per month for a ten-year certain period or life, only the $1,000 per month would be paid for nursing home care (subject to new lien restrictions).
If a client with $100,000 made a typical "half-a-loaf" transfer, $50,000 would be spent for care and $50,000 would be given away. If that person survived for the two- to three-year average stay in a nursing home, $50,000 of private funds would be used for his care. On the other hand, if that person converted assets to a monthly annuity paying $1,000 per month, in three years the nursing home would receive $36,000 from private funds or $14,000 less than in the typical half-a-loaf transfer (the preceding set of facts). Therefore, the new law may encourage the conversion of assets into annuities, resulting in less -- not more -- being spent on a client's care with his own funds (subject to new lien restrictions).
Furthermore, while annuities and other transfer methods are coming under attack by the government, it seems certain that valuable consideration is received in the form of an obligation to pay an annuity, and it would be difficult to prevent such transfers on the grounds of basic property rights and constitutional rights. Because some of the techniques described above would be used in estates of $850,000 in Rhode Island or $1,000,000 in Massachusetts, primarily for tax planning purposes, the incidental Medicaid planning advantages of these strategies can be beneficial.
No matter what the outcome, it appears that, for both tax and Medicaid planning, more creative planners should turn to estate freeze techniques that traditionally have been used more often for large taxable estates, and to a lesser degree, for smaller taxable estates.
Suppose that client in the example above owns stock. If client creates an income only trust (not a Grantor Retained Annuity Trust), the same result as above is achieved.
A different problem is created by second homes. In many instances, the best course of action is to transfer the property outright to children with no retention of interest, or to an irrevocable trust.
Mom has Parkinson's disease; she owns a vacation property valued at $750,000 and a primary home worth $400,000. Her counsel is asked what to do with both properties. The immediate response by someone who focuses on tax planning is a Qualified Personal Residence Trust (QPRT) for the vacation property and a will for the balance. Is this the correct option? No! Mom should transfer the vacation property outright to her children and use some of her unified credit, especially if the property is expected to be kept in the family and is not expected to be sold, so that a possible capital gains tax is avoided. After three years, the transfer will not be reported for purposes of Medicaid eligibility. Next, talk to the clients about the possible sale of Mom's primary home in order to use the proceeds to pay for assisted living; the rest of Mom's assets could be converted to a fixed annuity for her, allowing her to qualify for Medicaid immediately. At Mom's death, the beneficiaries of the annuity will receive the balance under the annuity contract subject to any Medicaid liens.
Credit Shelter Trusts
For married couples with taxable estates, it often makes sense to abandon marital deduction planning and trusts.
Husband and Wife have $1.2 million in assets. Mom is going into a nursing home. Dad will be going into assisted living but may need nursing home care later. Mom and Dad have appropriate marital and credit shelter trusts. Is their planning all set? No! They should gift up to $850,000 of Mom's assets to the children (up to $1 million in states where the estate tax has not been decoupled), and up to $150,000 of Dad's assets. Use the remaining $200,000, plus Mom and Dad's income, to private pay for the nursing home for three years and to pay for assisted living. In five years and one day, they will both qualify for Medicaid. If the assets given away are cash or low-basis assets that are not expected to be sold, this example poses a few tax problems. If there is an asset the children would want to sell, be less aggressive and defer gift giving as long as possible.
In the example above, assume that Dad is terminal. In this situation, keep all low-basis assets up to $850,000 in Dad's name (if the state is decoupled). Dad executes a will with a discretionary trust for Mom and the remainder to the children. Mom gives away up to $150,000 and personally pays her nursing home care for five years with high-basis assets or cash or the proceeds from the sale of the principal residence. Her $850,000 testamentary trust created by her husband will be exempt.
Because homes (or interests in a principal residence) are exempt assets, one way to protect newly found monies would be to convert them to a principal residence. Under the new DRA rules, the purchase of a life estate must be held for at least one year before entering a nursing home; otherwise it will be considered a transfer of assets. Some courts have distinguished between life estates and other interests such as joint tenancy.
Daughter lives with Mom and Dad, and is receiving SSI and Medicaid. She inherits $100,000, which will disqualify her from receiving benefits. How can daughter avoid losing her benefits? She purchases a joint interest in Mom and Dad's home. SSI and community Medicaid recipients are allowed to own a home or an equity interest in a home. Mom and Dad can use the cash to create a special needs trust for daughter.
There is no doubt that estate planners who deal primarily with tax matters will increasingly be asked questions about elderly parents or disabled relatives. Conversely, elder law attorneys need to understand basic tax planning. The answers are never as simple as the questions, and the strategies suggested should be creative. As states look to regulatory waivers because of increasing budget constraints and the high cost of caring for the elderly and disabled, many of the techniques described in this article will disappear. Concern about that response, however, should not preclude planning at this time. Every practitioner should consult his or her state's code of regulations adopting the federal law and be attentive to any proposed or pending public policy changes at the federal and state level, or consult a planner knowledgeable in these areas, in order to maximize the family estate.
This article was originally published in Estate & Personal Financial Planners Series, Summer, 2003, West Law Publishing
(1) The Leadership Council of Aging Organizations, Letter to Tommy Thompson, Secretary of the Department of Health & Human Services, Washington, D.C., available online at http://www.lcao.org/legagenda/ ss/reject_conn.htm (August 20, 2002).
(2) Guiden, Governors Give Thumbs Up to Medicaid Reform, Stateline.org, http://www.stateline.org/story.do?storyId=116905 (February 28, 2001).
(3) Bernard A. Krooks, Esq., Letter to the Editor of Newsweek (January 23, 2003).
(4) Bernard A. Krooks, Esq., Letter to the Editor of Newsweek (January 23, 2003).
(5) Higgins, "States Crack Down on Families That Shed Assets to Get Benefits, Personal Lifestyle Section," page 1, Wall Street Journal (February 2, 2003).
(6) Pub. L. No. 105-33 (Aug. 5, 1997).
(7) See The Nation's Voice on Mental Illness, State Trends, www.nami.org (February 4, 2002); See also Medicaid-State by State Descriptions & Plans, http://188.8.131.52/medicaid/states.html (revised March 16, 2003).
(8) Callinan, "Will Connecticut Kill Medicaid Planning?," http:// www.njseniorlaw.com/connwaiver.html.
(9) See Takacs, State Proposes Controversial Medicaid Waiver, Elder Law FAX, http://www.tn-elderlaw.com/prior/021118.html (November 18, 2002); See also Niesz et al., Connecticut Medicaid Overview and Recent Changes, OLR Research Report, Document 2002-R-0560, available online at http:// www.cga.state.ct.us/2002/olrdata/hs/rpt/2002-R-0560.htm (June 7, 2002); Medicaid and SCHIP, Recent HHS Approvals of Demonstration Waiver Projects Raise Concerns, Report to the Committee on Finance, U.S. Senate, by the United States General Accounting Office, GAO-02-817, available online at http://www.gao.gov/ new.items/d02817.pdf (July 2002).
(10) The federal government has tried to control and curb Medicaid planning for almost two decades, dating from TEFRA in 1982. TEFRA authorized restrictions on transfers of assets, liens, and recoveries from estates to discourage Medicaid planning. OBRA '85 attempted to curb the misuse of trusts to hide assets. MCCA '88 made restrictions on transfers of assets longer and stronger while implementing protection against spousal impoverishment in an attempt to eliminate the need for Medicaid planning. OBRA '93 further discouraged Medicaid planning. This legislation closed some key eligibility provisions and made recovery from estates mandatory by requiring states to impose liens on probate property. These rules challenged estate planners to use in the Medicaid context more creative techniques that had been traditionally used for estate tax planning. The Health Insurance Portability and Accountability Act of 1996 (HIA) contained language intended to limit Medicaid planning, and purported to make such planning a crime in some cases. The law applied to whoever "knowingly and willfully disposes of assets (including by any transfer in trust) in order for an individual to become eligible for medical assistance under a state plan under title XIX (i.e. Medicaid), if disposing of the assets results in the imposition of a period of ineligibility for such assistance." There were many uncertainties regarding the measure, known as the "Granny Goes to Jail" law. It was clear, however, that the legislation attempted to some degree to create criminal liability for Medicaid planning that used the routine legal technique called the "half-a-loaf" strategy. Under this strategy, an individual gives away half of his estate in order to become eligible for Medicaid benefits in half the time with half the penalty intended by Congress. This technique always seemed to be applicable to anyone who applied for Medicaid during a "disqualification period," which may or may not run the full length of the look-back period, particularly if one applies during that particular period. Many seniors' groups lobbied for the repeal of the "Granny Goes to Jail" law, as did the National Academy of Elder Law Attorneys. As a result, the Balanced Budget Act of 1997 (BBA '97), signed by the President on 8/5/97, limited the penalties to anyone (including attorneys) who, for a fee, "counsel or assist an individual to dispose of assets" in order to become eligible for Medicaid. BBA '97 thus eliminated the "Granny Goes to Jail" provisions and replaced it with a "Granny's Advisor Goes to Jail" law. This latest revision was challenged by the New York State Bar Association on constitutional grounds. Two attorneys in Rhode Island filed a similar suit. With respect to the suit by the New York State Bar Association, the U.S. District Court for the Northern District of New York approved, on 4/9/98, the Bar Association's request for a preliminary injunction. This relief barred U.S. Attorney General Reno from enforcing the "Granny's Advisor Goes to Jail" law. Furthermore, papers submitted by the government indicate that on 3/11/98, Reno wrote to the Speaker of the House Gingrich and to Vice President Gore, stating that the Justice Department will neither defend the constitutionality of this current version of the Act nor prosecute anyone for violation of it.
(11) HFCA Transmittal Letter 64.
(12) HFCA Transmittal Letter 64.
(13) HFCA Transmittal Letter 64.
(14) HFCA Transmittal Letter 64.
(15) Specific rules pertaining to trusts vary according to the date the trust was established and the specific terms of the trusts.
(16) 42 U.S.C.A. § 1396r-5.
(17) HFCA Transmittal Letter 64; 42 U.S.C.A. § 1396r-5.
(18) HFCA Transmittal Letter 64; 42 U.S.C.A. § 1396r-5.
(19) 42 U.S.C.A. § 1396r-5.
(20) HFCA Transmittal Letter 64; 42 U.S.C.A. § 1396p.
(21) The average daily or monthly nursing home costs that translate as the asset transfer penalty rate will vary from state to state. Here are a few examples of the monthly rates: California, $4,300; Connecticut, $7,062; Hawaii, $7,314; Louisiana, $3,000; Maryland, $4,300; Massachusetts, $6,200; Michigan, $5,043; New Hampshire, $5,348; Oklahoma, $2,000; Rhode Island, $5,512 (Note: these figures change on a regular basis). List Serv Survey, National Academy of Elder Law Attorneys (Winter 2003).
(22) HFCA Transmittal Letter 64; 42 U.S.C.A. § 1396p.
(23) HFCA Transmittal Letter 64; 42 U.S.C.A. § 1396p (prior to 1993 amendment by Pub. L. No. 103-66).
(24) Note that the mere existence of debt does not reduce the asset for purposes of the limitations test unless the indebtedness is actually paid off by the applicant before making the application for Medicaid.
(25) HFCA Transmittal Letter 64; 42 U.S.C.A. § 1396p.
(26) Under 42 U.S.C.A. § 1396, a disqualifying transfer is that sum value that is conveyed for lack of consideration. For instance, if a client deeds his or her property to children subject to a life estate, the client will have made a disqualifying transfer of the remainder interest. However, because the client has kept a life estate, a completed gift will not have been made under the tax code. Also, if a client converts assets to a private annuity agreement and calculates an interest rate below the adjusted federal rate, a partial gift will be calculated for gift tax purposes, but there will be no disqualifying transfer in states that allow private annuities because the promise to repay the monies in the form of an annuity would be adequate consideration under the Medicaid regulations.
(27) For a discussion of the tax and regulatory issues involving Medicaid planning and trusts in particular, See Correira, "Disability Trusts that Allow a Client to Qualify for Medicaid," 30 Estate Planning 233 (May 2003).
(28) Report of Emily Starr, Esq., Elder Law & Disability Conference, Massachusetts Continuing Legal Education (MCLE) Inc. (November 3, 2000). See also 42 U.S.C.A. § 1396 and HCFA Transmittal Letter 64 (October 1993).
(29) See Zaritsky, Tax Planning for Family Wealth Transfers, § 3.08 (3d ed. 1997). For further background on the use of installment sales in estate planning, See Zaritsky, "The Role of Infrafamily Sales in Estate Planning," 1980-2 TM Est., Gifts & Tr. J. 4 (1980); and Croft & Hipple, "Private Lifetime Property Transfers: Private Annuities, Installment Sales, and Gift Leasebacks," 11 Real Prop., Prob. & Tr. J. 253 (1976).
(30) See note 1. See also Reg. 20.2031-4; I.R.C. § § 453B, 453B(f).
(31) Bird, "Private Annuity Offers Widespread Tax Benefits Despite Risk and Uncertainty," 16 Tax'n for Accountants 248 (1976).
(32) See Lazarus v. C. I. R., 58 T.C. 854, 75-1 U.S. Tax Cas. (CCH) ¶ 13065, 1972 WL 2477 (1972), recommendation regarding acquiescence, 1973 WL 34985 (I.R.S. AOD 1973) and acq., 1973-2 C.B. 1 and aff'd, 513 F.2d 824, 75-1 U.S. Tax Cas. (CCH) ¶ 9387, 35 A.F.T.R.2d 75-1191 (9th Cir. 1975); Rev. Rul. 79-94, 1979-1 C.B. 296. See also Rev. Rul. 68-183, 1968-1 C.B. 308 (relating to the grantor trust rules of Section 677, but equally applicable to section 2036). Estate of Holland v. C.I.R., 47 B.T.A. 807, 1942 WL 155 (B.T.A. 1942), adhered to, 1 T.C. 564, 1943 WL 128 (T.C. 1943).
(33) Rev. Rul. 69-74, 1969-1 C.B. 43; I.R.C. § 72(b); and Reg. § 1.72- 4(a)(4).
(34) See Zaritsky, Tax Planning for Family Wealth Transfers, § 12.05 (3d ed. 1997). See also Bove, Jr., "Making Resources Disappear-The Magic of Private Annuities and Self-Canceling Installment Notes," Elder Law Institute, Suffolk University Law School, Boston, MA (3/21/97); Begley, Jr., "The Use of Annuities and Spousal Annuity Trusts in Medicaid Planning," 10 NAELA Quarterly 6 (Winter 1997).
(35) Bove, Jr., "A Creative Strategy for Protecting the Home for Medicaid Purposes," 24 ETPL 22 (Jan. 1997); 42 U.S.C.A. § 1396p(c)(2)(a).
(36) See note 1. Several years ago, the United States District Court of Oregon dismissed Peebler v. Reno, 965 F. Supp. 28, 53 Soc. Sec. Rep. Serv. 601 (D. Or. 1997); the first and only significant case in which "The Granny Goes to Jail" law was applied to persons who transferred assets to do Medicaid planning. The most important result was the federal government's response explaining its interpretation of HR 3103 (Pub.L. No. 104-191, codified at 48 U.S.C.A. § 1320a-7b(a)(6)), warning of application during any disqualification periods. It interpreted the new act as being applicable to anyone who applies for Medicaid during the disqualification period only. Finally, a federal judge in New York ruled the law unconstitutional. In New York State Bar Ass'n v. Reno, 999 F. Supp. 710 (N.D. N.Y. 1998) and Magee v. U.S., 93 F. Supp. 2d 161 (D.R.I. 2000) the Justice Department refused to defend the constitutionality of the "Granny's Lawyer Goes to Jail Law" and indicated that it would not bring criminal prosecutions against attorneys and other professionals for counseling their clients to engage in estate planning. In the New York State Bar case, the state bar association filed for a preliminary injunction preventing the Justice Department from enforcing the statute and won. The chief judge for the Northern District of New York held that the bar association had standing, that the matter was ripe, that the members would likely suffer irreparable harm, and that the bar association would likely succeed on the merits. This stands as the leading ruling on the statute.
(37) See I.R.C. § 121.