MEDICAID REFORM & PLANNING: A PRIMER FOR ESTATE PLANNERS--PART TWO
May 12, 2003
Editor's Note: Increasingly, estate planners are having
to focus more on Medicaid planning, if not for their own clients, then for
relatives of those clients. Certainly, this is an aspect of the practice for
those practicing "Elder Law," but it also arises even for those who only
practice at the high end of estate planning.
This article provides an overview of Medicaid planning
for the estate planner who does not focus on this area of the practice. Last
month, Part One reviewed the issues that have arisen as various states try to
carve out exceptions to the federal Medicaid system, and reviewed 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. A number of examples were used to
illustrate these areas. This month, Part Two completes the primer, by dealing
with various Medicaid planning considerations, particularly focusing on asset
transfers, methods of converting assets to income, insuring assets, or spending
them. The primer has been written in a general context, so someone dealing with
each state's specific requirements will need to look to that state's laws or
associate an Elder Law specialist in that jurisdiction.
MEDICAID PLANNING
CONSIDERATIONS
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 (see
Part One).
Transferred assets are not reportable by a Medicaid
applicant once the reporting or look-back period has passed. The look-back
period is 36 months for outright transfers and 60-months for transfers to
certain trusts in which all or a portion of the trust cannot be disbursed to or
for the benefit of the applicant.
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 (see Part One). 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 36 months; an example would be distributions from a revocable
grantor trust to someone other than the grantor. The penalty date is the
beginning date of each penalty period imposed, and is 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.
EXAMPLE 15 If a client provides $11,000 as an outright
gift, those monies would be reported as a transfer at any time the client
applies for Medicaid during the 366month period following the date of the gift.
If that same client provides $11,000 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 following the date of the gift.
If the client establishes a revocable trust for his benefit and allows
distributions to family members, a distribution of $11,000 will be reported
during the 36- month period. With all three gifts, the disqualification period
is based on the value of the amount transferred. (See next example)
EXAMPLE 16 Assume that in State B, the average cost of a
nursing home is $200/day or about $6,000 per month. A $6,000 transfer to anyone
other than the grantor on June 30 will result in a one-month disqualification
beginning on June 1. Alternatively, a $60,000 gift will result in a
disqualification of ten months. Similarly, an outright gift or transfer of
$216,000 will result in a three-year disqualification. An outright gift of more
than $216,000 will 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 matches the 36-month look-back period)
reported during the 36-month look- back will result in a disqualification based
on the amount transferred because it will be captured during the reporting
period. As a result, it is 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 $216,000.
EXAMPLE 17 Mom lives in State B, where the nursing home
costs are the same as in the previous example. If Mom transfers $240,000
outright and waits three years and one day to apply for Medicaid, the 36-month
look-back period will 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.
EXAMPLE 18 In State B, Mom gifts $288,000 outright and
applies the next day for Medicaid. In this case, she will be disqualified for
four years ($288,000/ $6,000 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.
EXAMPLE 19 Mom in State B gifts $288,000 to an
irrevocable trust for the benefit of her children. In this situation, there will
be a four-year disqualification period ($288,000/$6,000 per month) and a
five-year look back period because a trust was used. If a trust had not been
used, Mom would have avoided the 60-month look-back period for trusts.
The result in both of these examples--giving Mom a
four-year disqualification period--would have been avoided by using outright
transfers and waiting three years and one day to apply for Medicaid. 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.
[FN1]
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 of a spouse for a spouse/applicant if the
trust is discretionary.
[FN2]
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, 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; or a caregiver child who has resided there for at least one
year.
[FN3] 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. 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.
EXAMPLE 20 Mom and Dad have a $250,000 house and $200,000
in cash. Mom and Dad have done no planning, and Dad requires long-term care. Mom
and Dad will have to spend at least $160,000 before Dad will qualify for
Medicaid because Mom is allowed $90,000 (in most states) in assets. Assume that
Dad subsequently dies and now Mom needs care. Mom must spend $88,000 of the
remaining $90,000 (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 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 over one to two
years. Three years later, Mom needs care. She immediately qualifies for
Medicaid, and the total savings to the family amount to up to $400,000. When Mom
dies, the home receives a step-up in tax basis by virtue of her life estate. 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.
EXAMPLE 21 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.
EXAMPLE 22 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 three-year look-back. The
disqualification period would be less than two years in most jurisdictions.
As Example 22 reflects, a deed with a retained life
estate, which allows the full power to mortgage, sell, or convey, is not a
transfer and is treated as if the property were in a revocable trust and is
considered an available asset.
Calculating transfers of life estates. In calculating
transfers of life estates, an interesting dilemma results.
EXAMPLE 23 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.
EXAMPLE 24 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.
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.
[FN4] 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.
[FN5]
EXAMPLE 25 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 30-year amortization schedule at 7% interest
and a monthly payment of $1,230.81. There is also a balloon payment due in 15
years, the longest of both Mom's and dad's life expectancies; this makes the
note actuarially sound according to Medicaid actuarial tables. The note is
assigned to a revocable trust for probate avoidance. Dad applies for Medicaid.
His Social Security is $497.00 per month, and his share of the note is $615.41,
for a total monthly income of $1,112.41. His allowances, which are subtracted
from his countable income, include the following in State A: $60.00 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 $613.47 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 a 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 self-canceling note creates other issues, such as a
possible need for a premium to be paid for the self-canceling feature, or the
fact that a partial gift may result if no premium is included (see Chapter 29
for a discussion of these issues in a general context).
Private Annuities
A private annuity is similar to an installment sale, for
it permits gain 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.
[FN6] 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.
[FN7]
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.
[FN8] The balance of the annuity payment is ordinary income.
EXAMPLE 26 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. Mom could also purchase an annuity through an
insurance company.
[FN9]
EXAMPLE 27 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.
EXAMPLE 28 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 or life), 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. 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.
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. The only way to protect them is
by liquidation and a combination of gifting and spending as described in Part
One. 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).
EXAMPLE 29 Husband (age 70) and Wife (age 60) are your
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. 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.
EXAMPLE 30 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
conveys a small fractional share of a tenancy in common interest, making a
nominal gift to Sam and creating disqualification for one year. After one year,
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.
Irrevocable Trusts. 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.
EXAMPLE 31 Client wants to give his principal residence
in trust even though the estate is under $675,000 ($1 million in states without
decoupling of the federal estate tax). Do you use a Crummy trust and part of the
unified credit? No. Use a defective irrevocable trust with no Crummy 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. 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.
EXAMPLE 32 Sue owns a home valued at $500,000. She gives
$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.
[FN10]
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.
[FN11]
A transfer by clients of their home to an irrevocable
grantor trust protects for the clients the exclusion of gain upon sale of the
residence.
[FN12] 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.
It begs the question as to whether the drafters of the
legislation understood Medicaid planning or were simply persuaded by the
insurance industry, which wanted to sell annuities and long-term care insurance.
EXAMPLE 33 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.
Furthermore, while annuities and other transfer methods
could come 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 $675,000 to $1,250,000 (or in estates of $1 million
to $2 million where decoupling of the estate tax has not taken place) 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 GRAT), the same result as above is
achieved.
Second Homes. 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.
EXAMPLE 34 Mom has Parkinson's disease; she owns a
vacation property valued at $400,000 and a primary home worth $180,000. Her
counsel is asked what to do with both properties. The immediate response by
someone who focuses on tax planning is a 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 free of any Medicaid liens,
unless the state has expanded its lien recovery system to reach beyond probate
assets.
Credit Shelter Trusts. For married couples with taxable
estates, it often makes sense to abandon marital deduction planning and trusts.
EXAMPLE 35 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 $675,000
of Mom's assets to the children (up to $1 million in states where the estate tax
has not been decoupled), and up to $325,000 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 three 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.
EXAMPLE 36 In the example above, assume that Dad is
terminal. In this situation, keep all low-basis assets up to $675,000 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 $325,000 and
personally pays her nursing home care for three years with high-basis assets or
cash or the proceeds from the sale of the principal residence. Her $675,000
testamentary trust created by her husband will be exempt.
Home Purchase. 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.
EXAMPLE 37 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.
FUTURE CONSIDERATIONS
There is no doubt that estate planners who deal primarily
with tax matters will increasingly be asked questions about elderly parents or
disabled relatives. The answers are never as simple as the questions, and the
strategies suggested should be creative. As states look to regulatory waivers
(described in Part One) 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.
[FNa1]. David J. Correira is a partner in the national law firm of Holland &
Knight LLP, resident in the Boston and Providence offices. He concentrates in
the areas of trust & estate litigation, tax & business planning, estate
planning, elder law & Medicaid, and probate. He frequently speaks and writes on
trust and estate topics and has been previously published by the Estate Planning
Journal, the American Bar Association, the National Academy of Elder Law
Attorneys, the Rhode Island Bar Journal, and both Massachusetts and Rhode Island
Lawyers Weekly.
[FN1]. 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.
[FN2]. 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).
[FN3]. 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).
[FN4]. 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).
[FN5]. See note 1. See also Reg. 20.2031-4;
I.R.C. § § 453B,
453B(f).
[FN6]. Bird, "Private Annuity Offers Widespread Tax Benefits Despite Risk
and Uncertainty," 16 Tax'n for Accountants 248 (1976).
[FN7]. 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).
[FN8].
Rev. Rul. 69-74, 1969-1 C.B. 43;
I.R.C. § 72(b); and Reg. § 1.72- 4(a)(4).
[FN9]. 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).
[FN10]. 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).
[FN11]. 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.
[FN12]. See
I.R.C. § 121.
Related Practices