April 2021 Newsletter

April 2021 Newsletter Image

From The Certified Elder Law Attorney's Desk:

William W. “Bill” Erhart

It Is Too Late Baby

Medicaid Planning Part 2

Previously we looked at the timelines for Medicaid Planning and the Medicaid Asset Protection Trust (MAPT). We will look at how the MAPT works and its advantages in protecting assets and qualifying one for long term care Medicaid.

Asset Protection from Future Creditors

The basic benefit of any asset protection trust of course is protection. Protection from creditors, parties or people outside those intended to benefit from the trust. Those who are intended to benefit from the trust are called beneficiaries. That the assets have been transferred into the MAPT means those assets are protected from creditors, predators and misfortune. The MAPT is specifically designed to provide by its language and intent that the trust assets are not subject to attachment, foreclosure, garnishment or other actions by creditors of the trust beneficiaries. Properly drafted and created, the MAPT can provide protection for the beneficiaries from divorce, child support and if necessary, from themselves. Often potential beneficiaries have substance abuse problems or poor money management skills. Asset protection trusts are commonly used to guard against those problems.

MAPTs are designed so there are none or minimal income tax consequences. For example:

Preservation of Section 121 Exclusion of Capital Gain on Sale of Principal Residence

Section 121 of the Internal Revenue Code (IRC) creates an exclusion from capital gains tax up to $250,000 of capital gain from each taxpayer’s principal residence when it is sold if the taxpayer owned and lived in it for at least two of the past five years before the sale. If the taxpayer has to move into a nursing home, then the taxpayer only needs to live in the home for one of the past five years. If there are two qualifying co-owners, they can each exclude $250,000 of gain. This is because the MAPT is a “grantor trust”, meaning a trust which is treated as the individual trust maker for income tax purposes. This technique has been used for many decades.

Preservation of Step-Up of Basis

When one has an appreciated asset, and sells it, the appreciation is subject to capital gains tax. However, when an appreciated asset is included in a decedent’s taxable estate, the asset receives a step up (or step down) in basis, based upon the date of death value under Section 1014 of the IRC. Usually, assets that are gifted have “pass through basis” or whatever was originally paid for the asset. Which means the gift recipient takes the assets with the giver’s cost basis, rather than the date of death value of the assets when the giver dies. If designed properly, the MAPT can pull the assets back into the taxable estate of the trust maker upon his or her death. The trust assets will be valued as of the date of the trust maker’s death, rather than the trust maker’s original cost basis. For highly appreciated assets, such as a home or stocks owned for a long time, obtaining the step up in basis is a significant benefit in minimizing or eliminating capital gains tax when the assets are finally sold. If someone planning for Medicaid makes an outright gift, the step up in basis is lost. We can draft provisions in irrevocable trusts, such as the MAPT, to pull assets into the taxable estate of the trust maker/decedent upon his or her death which can preserve the step up in basis. Most of our Medicaid planning clients are below the estate tax limits and so the step up in basis is a significant benefit to design into the MAPT, without any actual tax liability. There are several drafting techniques which can be used to accomplish this.

Ability to Select whether Trust Income is Taxable to the Trust maker or to the Beneficiaries

As mentioned above, a MAPT is typically a “grantor trust”. A grantor trust is treated by the IRS as if the assets held by the trust were still owned by the trust maker for income tax purposes. This is important, as mentioned above, for the preservation of the Section 121 exclusion of capital gain and who pays the taxes on income generated by the MAPT. Trusts have compressed tax brackets. Income is taxed much higher if it is taxed to the trust as opposed to an individual. Whether a trust will be a grantor or a nongrantor trust and how that is accomplished is an important decision when drafting any trust. Typically, MAPTs are drafted as grantor trusts, so any income generated within them is taxed to the trust maker. The MAPT can be drafted to reimburse the trust maker for any taxes actually paid. Sometimes, it is important that the income earned by the trust not be taxed to the trust maker. This requires careful drafting regardless of what decision is made. Again, these are estate planning techniques which have been used for many decades.

Ability to Design Who Will Receive Trust Income

When one gives away property to another, one also gives up the right to receive income from that property. The MAPT can be designed so that the income from the property transferred into the trust can still be received by the trust maker. While an option for some clients, any income that is available from an MAPT to a trust maker, will be considered available income for Medicaid eligibility purposes. In some states, if a trust maker can receive income from the MAPT, all of the assets in the MAPT are considered available to the trust maker and thus Medicaid eligibility is impaired. Sometimes trusts are created so that the trustee has the discretion to make distributions of income to the trust maker. In this case the income is also considered available for Medicaid eligibility purposes. We approach income distributions conservatively and prohibit the trustee from distributing any income to the trust maker. There are indirect methods of providing income to the trust maker as well as distributions of principal, but the MAPT in our view should be designed to expressly prohibit these distributions directly to the trust maker.

It is difficult to plan for the unknown. Medicaid is based upon federal law, and federal law is relatively difficult to change. Medicaid is distributed under state rules, which can be changed relatively easily. We base our Medicaid planning on the Federal rules, without relying upon the state rules. Additionally, people travel. Medicaid qualification rules vary from one state to another. The Federal rules are constant across the country. Therefore, our MAPTs have a high degree of predictability.