LEGAL GUIDE
Written by attorney Mark E Wight | Jul 17, 2013

Use of Trusts in Medicaid Planning

Pulling It All Together

With the information from the Trust Primer and the Medicaid Primer we can now address the question of whether or how trusts can be used in Medicaid planning. Individuals (or their attorneys) have long made use of gifting assets to qualify for the Medicaid benefit without spending down to the impoverished levels required by Medicaid. One of the disadvantages of outright gifts, whether to children or friends, is the concern that those assets may not be available later if needed. That is, a true gift means that the client has given up all control. So if the child has a financial struggle, such as bankruptcy or lawsuit, those assets may be gone. If the child has a spending problem, the assets may be gone.

The use of a trust replaces the gift to the children but provides a way to protect those assets if needed in the future. In addition, as noted above, there are a number of tax advantages to using a trust rather than gifting the assets outright, such as the step-up basis at death and the IRC § 125 capital gains exclusion for the sale of the residence that has appreciated in value. There are five different trusts that will be examined here.

Revocable Living Trust

The revocable living trust (“RLT"), (which is a first party, grantor trust) is of little or no help to the grantor (or grantors). Health and Welfare will treat the assets of the RLT as though owned outright by the grantor. So while the grantor may be income eligible, any asset in the RLT will be treated as hers and, if over the applicable limit – $ 2000 for an individual needing care or the adjusted amount for a spouse, she will not qualify for the benefit. Furthermore, H & W will treat any residence in an RLT as a countable asset instead of non-countable, which is what the residence would be outside the trust. This can be cured by transferring the residence back out of the RLT into the name of the applicant.

In sum, the RLT will not help the grantors to qualify any sooner for the Medicaid benefit. [1]

First Party or Self-Settled Irrevocable Trust

Instead of a revocable trust, what if the grantor created an irrevocable trust to preserve assets? This type of planning can be effective. However, there are hurdles to overcome. First, the trust must be drafted correctly. Current budget pressure causes H & W to carefully scrutinize any interest held by an applicant in any trust to see if there is any argument available to bring all or a portion of the trust assets into the applicant’s countable estate.

Generally such a trust could provide the trustee a discretionary distribution standard for income for the benefit of the applicant. This has been accepted in other states. However, the retention of an income interest would cause the close scrutiny mentioned above. A non-grantor irrevocable trust with life-time beneficiaries other than the grantor would avoid this issue altogether. The transfer of assets into this trust is a completed gift requiring a gift tax return and triggers a penalty period if made during the 60 month look back period. Language within the trust that designated that the assets of the trust are not available as an asset is also suggested to be clear on the grantor’s intent.

This non-grantor trust should be effective in Idaho to help preserve assets and allow eligibility for Medicaid benefits. However, there are disadvantages. First, this trust will require the complete surrender of control over the assets. If this is done as a planning strategy before the need for care arises, the grantor has ceded control for at least 60 months before the benefits may be paid. Five years is a long time and it may be that no benefits are actually needed, either due to good health or to a death. In that situation, the un-needed irrevocable trust may not be worth the money and the hassle. [2]

Second, if not done properly, it will be extremely difficult to undo the plan, that is, change the irrevocable trust to do what is needed to qualify for the benefit. For example, what if the grantor needs the care sooner than the 60-month look back period? Is there anything to be done? The Medicaid rules will allow an applicant to cure a gift, as long as it is returned to the applicant’s ownership. Thus, if the residence was transferred to the trust, transferring it back could cure the gift and allow immediate eligibility since the residence is a non-countable asset. However, the “cure" may not be possible from the irrevocable trust. [3]

Third, any appreciated asset gifted to the non-grantor irrevocable trust will retain the original basis of the grantor and will not qualify for a step-up in basis at death. This is so, unless the grantor retains a special power of appointment over the assets of the trust. This will allow the step up. However, it is unclear whether retaining this power will be enough of an interest in the trust to cause H & W to include the trust assets in the applicant’s estate and deny eligibility. For now, this is a risk that the client must take into account in this type of planning.

Third Party SNT

While the self-settled irrevocable trust has a number of hurdles to overcome in order to preserve assets for the grantor, a third party SNT really has none. The self-settled trust requires a transfer out of the grantor’s estate which gives rise to a penalty period if the grantor later applies for Medicaid. If the grantor does not need to apply for Medicaid benefits, the penalty period never becomes an issue.

Let’s take a grantor who wants to provide some assets for her grandchild that has special needs. The grantor creates and funds an irrevocable trust for the benefit of the grandchild and includes the special needs distribution standard discussed above. The grandchild has no assets. The grandchild will not need to make any transfers to qualify. Therefore, no transfer – no look back period and no penalty period. This planning is effective and available to any parent, grandparent or other relative or friend and should be considered in any estate planning discussion. [5]

Testamentary SNT

A grantor can also always create a SNT at his death through a testamentary provision of his will or trust. The testamentary SNT would function the same as the third party SNT discussed in the previous section. In an interesting provision of the Medicaid law that seems to contradict the provisions on gifting from the spouse, a special needs trust created through the estate of the deceased spouse is actually exempt from the look-back period. 42 U.S.C. § 1396p(d)(2)(A). Therefore, it appears that a testamentary SNT for the benefit of a participant spouse, is a non-countable asset.

QIT/Miller Trust

Idaho is an income cap state for the purposes of qualifying for Medicaid benefits. This means that any income over the qualifying level ($2031 for 2013) disqualifies the applicant. This has some harsh results. A tool was developed to allow otherwise qualified applicants to earn more than the strict qualifying amount. An “income qualifying trust," (“QIT") more commonly called a “Miller Trust," can be used to help income qualify the applicant for Medicaid. The Miller Trust is an irrevocable grantor trust that receives the applicant’s entire income each month. From this trust, money is distributed to the care facility to pay the patient’s liability, as determined by Medicaid. For Medicaid purposes, the applicant’s income falls within the acceptable range and H & W reimburses the facility the Medicaid amount.

Any amount remaining in the trust at the participant’s death will be first paid to the state of Idaho the reimburse H & W for the Medicaid benefits paid on the person’s behalf. Any remaining after that is paid to the participant’s estate.

The Miller trust is an irrevocable grantor trust and technically does not need a separate tax identification number and all income is reported on the participant’s Form 1040. However, many banks will not open an account in the name of an irrevocable trust without a separate tax identification number. If the bank is not amenable to some education on this point, obtaining a tax identification number will not create any problems.

Conclusion

Trusts have been an effective planning tool for many years. Trusts are very flexible and can be effective in Medicaid planning. To choose the proper trust tools, the practitioner needs to be aware of how trusts works, how they are created, how they are taxed and how they are viewed by the courts and by state Medicaid agencies. The choice of using a trust or which trust to use and what assets to transfer to the trust, is made on a case by case basis and with each client weighing the pros and cons, including the risks, of using trusts in the planning for paying for long term care costs.

[1] It is possible to draft the RLT to hold a distribution for a contingent beneficiary in a special needs trust. But, this will be after the passing of the grantor and the trust will be a third party irrevocable trust at that point. The third party irrevocable SNT will be discussed later.

[2] Even if the plan is not to try to wait out the 60 month look-back, the transfer of assets to the trust will create a penalty period during which the applicant will not be eligible for benefits. The same discussion applies to the penalty period as to 60 month look-back.

[3] There are other issues with transferring the residence to the trust. The most troublesome is whether the grantor can retain the right to live there rent free or free of other expenses. In Idaho at least, this appears to fall within the state’s definition of expanded estate and would, at a minimum, bring the residence back into the estate for recovery of Medicaid payments.

[5] It is important to note this third party SNT is available for the spouse of the grantor. Because of the Medicaid rules concerning married spouses and the gifting of community assets, a transfer to this trust would be subject to the 60 month look-back provision.

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