Creating a plan to protect assets from Medicaid spend-down will often involve gifting assets. Although outright gifts have the advantage of simplicity and minimal costs, using an irrevocable trust to hold the gifted assets can provide more control, protection and tax benefits. In addition because the Deficit Reduction Act of 2005 (DRA) made the look-back period for transfers to trusts and out right transfers five years, direct gifts no longer have the advantage of a three year look-back period.
Benefits of Gifting Assets to an Irrevocable Trust:
Preservation of the Capital Gain Exclusion for a Personal Residence
If the Settlor’s family home is transferred to a trust, the IRC Section 121 exclusion of capital gains upon sale of the Settlor’s principal residence is preserved. Section 121 provides an exclusion from capital gains of up to $250,000 of capital gains upon the sale of the taxpayer’s principal residence if the taxpayer owned and lived in the residence at least two out of the last five years prior to the sale. If there are two qualifying co-owners, each may exclude up to $250,000 of capital gains. If the home is gifted outright, rather than to a trust, the exclusion is lost unless the donee can qualify for the Section 121 exclusion.
The Settlor’s Step-up in Basis is Preserved Upon the Death of the Settlor
When an appreciated asset is included in a decedent’s taxable estate for federal estate tax purposes, it receives a step-up in basis to the date of death value. Gifted assets do not receive a step-up in basis. Rather, the donee takes the donor’s basis in the asset. A basis step-up to the date of death value can reduce or eliminate taxes upon the sale of appreciated assets. Although assets gifted to an irrevocable trust are removed from the Settlor’s estate, special provisions can be drafted into the trust document to “pull the assets back” into the decedent’s estate for tax purposes. When an asset is included in the decedent’s estate for estate tax purposes, it receives a step up in basis to the date of death value. The basis step-up can be a huge benefit for highly appreciated assets that would be lost for assets donated outright.
A Trust Can Preserve a Beneficiary’s Eligibility for Governmental Assistance Programs
The trust can be drafted to make the assets noncountable with regard to a beneficiarys’ eligibility for SSI and Medicaid. If a child or grandchild needs or may have a future need for Medicaid and/or SSI, direct transfers to that child or grandchild my cause them to be ineligible. An irrevocable trust can be drafted with supplemental needs provisions to preserve eligibility for governmental assistance programs.
A Trust Can Protect Assets from the Beneficiary’s Creditors
A trust can be drafted to provide protection from lawsuits and creditors of the beneficiaries. Louisiana Spendthrift provisions provide protection from liens and seizure by creditors of the beneficiaries as well as protection from voluntary alienation by a beneficiary. The trust can also provide protection from scams and financial predators.
The Ability to Determine Who is Taxed on Trust Income
The Trust can be drafted to provide the ability to choose whether the settlors (the person creating and funding the trust) or the beneficiaries will be taxed on trust income. Trusts can be drafted to be grantor trusts which are treated by the tax code as owned by the settlor (also called the grantor) for income tax purposes. As a result trust income will be taxed to the settlor, rather than to the trust or the beneficiaries. If assets are gifted directly, the income generated by the assets will be taxed to the recipient of the assets.
Ability to Specify Terms and Incentives for Beneficiaries’ Use of Trust Assets
Many parents and grandparents, as trust settlors, wish to incorporate incentives into their planning to encourage or discourage certain behaviors and outcomes. For example, the trust may provide that the assets be used only for educational or career training, for medical needs, or for a first time home purchase. The trust may also be drafted to encourage a beneficiary to avoid or give up undesirable behavior (e.g. drug addiction) or to reinforce positive behavior (e.g. remaining employed).
Assets in Trust Avoid Probate
Keep in mind that assets transferred to an irrevocable trust will avoid probate and provide for asset management in the event of incapacity just as assets transferred to a revocable living trust. Of course, assets transferred outright will also avoid probate.
These are some of the advantages the use of irrevocable trusts can provide in Medicaid planning. If the trust is drafted to include the desired provisions, an irrevocable trust can enhance the value of Medicaid planning beyond what can be accomplished through outright gifting.
If you have questions about Medicaid planning in Louisiana or how a trust can be used in Medicaid planning, contact John Sirois at 985-580-2520 or email him at jsirois@retirementandestateplanning.com.
