Two common methods of Medicaid planning are irrevocable trusts and gifting. Outright gifts have the advantage of being simple to do with minimal costs involved. So, why complicate things with a trust? Why not just keep the planning as simple and inexpensive as possible? The short answer is that gift transaction costs are only part of what needs to be considered. Many important benefits that can result from gifting in trust are forfeited by outright gifting. These benefits are what give value to using irrevocable trusts in Medicaid planning.
Asset Protection from Future Creditors of Beneficiaries
A central benefit of gifting in trust is to protect the gifted assets from the creditors and predators of the beneficiaries. This is accomplished by means of a spendthrift provision –special provisions in the trust that make trust assets not subject to attachment, foreclosure, garnishment, or a laundry list of undesirable actions by the creditors of the beneficiaries.
Preservation of Step-Up of Basis
When an appreciated asset is included in a decedent’s taxable estate for federal estate tax purposes, it receives step-up (or down) of basis to the date of death value under Section 1014 of the Tax Code.Normally gifted assets pass to gift donees with “pass through basis”; that is, the donees receive the assets with the donor’s adjusted cost basis, rather than the date of gift value of the assets.If, however, something pulls the assets back into the taxable estate of the donor upon the donor’s death, the donee will own the asset at that point with the donor’s date of death value as his or her basis, rather than the donor’s original adjusted cost basis.For highly appreciated assets, such as the donor’s home or stocks that he or she owned for a long time, obtaining step-up of basis can be a huge benefit for minimizing or eliminating capital gains tax when the donee later sells the assets.This benefit of step-up in basis can easily be forfeited by outright gifting.However, a provision in an irrevocable trust that pulls the property back into the taxable estate of the settlor upon the death of the settlor can preserve step-up of basis for benefit of the donee.With the amount of assets that can pass free of federal estate tax being well beyond the value of most Medicaid planning clients’ estates, estate inclusion and step-up of basis is generally a great benefit to design into the trust, without any actual tax liability.A Limited Power of Appointment retained by the settlor can accomplish this.Other provisions can also cause taxable estate inclusion.
Ability to Make Trust Assets Noncountable for Beneficiaries’ Medicaid or SSI
It is a sad fact that an outright gift or bequest from a donor, such as a parent, to a disabled donee can result in the donee becoming ineligible for means-based governmental benefits that he or she was eligible for before the gift or bequest, or soon would have become eligible for. In such situations, unless irrevocable trust planning is then done to establish a “self-settled special needs trust,” the gifted or bequeathed assets typically get consumed for the donee’s care and once they are gone, the donee goes onto the governmental benefits from which the gift or bequest disqualified him or her until consumed. One way of looking at this outcome is that the indirect recipient of the gift or bequest was the governmental benefit program from which the gift disqualified the disabled person for a period of time. This is generally considered poor planning. Better planning is for the gift or bequest to be made in an irrevocable special needs trust for benefit of the disabled beneficiary, so the gift or bequest will be managed to enhance the living conditions of the disabled beneficiary by paying for things that the governmental benefits do not pay for. If a disabled person becomes entitled to an outright gift or bequest, or an outright gift or bequest recipient later becomes disabled, depending on the age of the disabled person, it may be possible to establish a “self-settled special needs trust” for the disabled beneficiary. Such trusts (funded with assets of the disabled person) must contain a provision stating that upon the death of the disabled beneficiary any remaining trust assets must pay back the state up to the full amount of Medicaid benefits received by the beneficiary, and only after the state is reimbursed may any excess pass to other beneficiaries such as other relatives. The payback provision requirement is Congress’s “quid pro quo” –the balancing deal that makes it fair for the disabled person’s otherwise disqualifying assets to be set aside in a Medicaid-and Supplemental Security Income-noncountable trust that is nonetheless able to be consumed by the trustee for benefit of the disabled person to supplement but not replace the governmental benefits.
Other benefits of gifting in trust are:
- Preservation of the Section 121 exclusion of capital gain upon sale of the settlors’ principal residence (the settlor is the trustmaker)
- Ability to select whether the settlors or the beneficiaries of the trust will be taxable as to trust income
- Ability to design who will receive the net distributable income generated in the trust
- Ability to specify certain terms and incentives for beneficiaries’ use of trust assets
- Ability to decide (through the settlors’ other estate planning documents) which beneficiaries will receive what share, if any, of remaining trust assets after the settlors die
- Ability to determine who will receive any trust assets after the deaths of the initial beneficiaries
The above discussions demonstrate that use of irrevocable trusts in Medicaid planning, as in other fields of estate planning, provides many opportunities to create great benefits beyond simply transferring assets.Some or most of these benefits may be achieved through the use of an irrevocable trust.If care is taken to include the desired provisions, an irrevocable trust can greatly enhance the value of the clients’ Medicaid planning beyond what can be accomplished through outright gifting.We are happy to assist seniors and their loved ones with considering whether an irrevocable trust may be appropriate for them.Please contact our office to schedule a time to discuss these issues further.