Tax Issues to Consider in Elder Care Planning

In Brief

When advising individuals about elder care planning, attorneys and CPAs must consider the various tax implications inherent in an elder care or long-term care plan. Starting the process means that more options can be considered and more strategies can be implemented. This article outlines some of the key tax, transfer, and estate issues that advisors should consider, and outlines an alternative technique that can mitigate the negative tax consequences.

Individuals typically begin to consider the costs associated with long-term care as they begin to contemplate the fact that they likely will, at some point in the near future, require additional care and assistance with their activities of daily living. In the authors' experience, many people only begin to think about these issues in their late 80s or early 90s. But because of the various planning limitations, and the all-important five-year look-back period (discussed in greater detail below), the best age for relatively healthy individuals to begin designing and implementing an elder care plan is in the early to mid-60s.

New York Medicaid Rules

In order for an individual to qualify for long-term Medicaid services in New York, in 2015, he or she can own no more than $14,850 in non-exempt assets. [See GIS 14 MA/029. The resource level for a couple (or two-person household) is $21,750. The allowable resources that a community spouse (the "healthy" spouse) is pennitted to retain is a minimum of $74,820 in 2015, or one-half the married couple's resources, up to a maximum of $119,220.] Assets that are considered exempt, and therefore not countable for Medicaid purposes, include qualified retirement accounts (to the extent such accounts are in payout status; see GIS 98 MA/024 and note that income received in the form of required minimum distributions are countable as income to the Medicaid applicant/recipient) and the individual's home, to the extent that the Medicaid applicant, a spouse, a minor, or disabled or blind child is living in the home [see 18 NYCRR section 360-4.7(a)(1)], There are other exempt assets and circumstances in which a home may be exempt that are beyond the scope of this article.

In the case of Medicaid home care services, or "Community Medicaid," there is no look-back period. Thus, an individual can transfer her assets on the last day of the month and be financially eligible for home care on the first day of the following month. This is not the case, however, for nursing home care, often referred to as "Institutional Medicaid." With respect to nursing home care, there is currently a five-year look-back period that must be satisfied in order for an individual to qualify for Medicaid. All assets transferred (gifted) dining the five-year period preceding the Medicaid application may be viewed by the relevant local Medicaid agency as if the applicant owned such assets on the date of the Medicaid application. Therefore, it is crucial for individuals to consider transferring their non-exempt assets as soon as practicable.

The Medicaid rules also include income limitations. In the case of Community Medicaid, the income threshold is $825 per month (plus an additional $20 disregard). To the extent that Medicaid recipients have monthly income m excess of this amount, they will have a "spend down" and be required to contribute that excess income towards the cost of their own care. In the case of institutional Medicaid, Medicaid recipients are only pennitted to retain $50 per month as an incidental allowance. The remainder of their income must be paid to the nursing home for their care. However, to the extent a Medicaid recipient has a spouse living in the community and the community spouse has less than $2,980.50 in monthly income (the minimum monthly maintenance needs allowance), the community spouse is guaranteed to keep up to that amount of monthly income as the community spouse monthly income allowance. The Medicaid spouse can allocate an amount of his own income to the community spouse so that the community spouse has $2,980.50 per month m income. If the community spouse has income in excess of $2,980.50, then all of the institutionalized spouse's income (minus the $50) must be contributed to the cost of his own care. In addition, if the community spouse has income in excess of $2,980.50 per month, she may also be required to contribute towards the cost of the institutionalized spouse's care as a legally responsible relative of sufficient means to contribute.

Issues to Consider

An elder care or asset preservation plan can employ various planning techniques, each with its own inherent tax implications. When advising chents, the elder care attorney and CPA cannot overlook several important considerations. Oftentimes, the cheapest and quickest way to transfer assets is through an outright gift to a child or loved one. While tins may seem like an easy solution, there are many unforeseen consequences, both from a tax and a non-tax perspective.

Nontax implications of an outright gift As mentioned above, many individuals may opt to make an outright gift in order to transfer assets. In this case, the transferor (often the aging parent) would deed over his home and transfer other assets (such as bank accounts, brokerage accounts, real estate holdings) to the transferee (often children or loved ones).

A transfer of an asset via an outright gift is the simplest and least expensive way to remove assets from one's name so that the individual can begin planning to eventually receive Medicaid benefits. Generally, this transfer only entails a new deed (in the case of a home) or a retitling of financial accounts. However, there are important questions that a paient must consider when contemplating an outright asset transfer to children: Does my child have creditor problems, or is my child facing potential bankruptcy? Is there a chance that my child will get divorced? What happens if my child predeceases me? Will my grandchildren be the ultimate recipients of my assets (as generally intended), or could former inlaws be the ultimate beneficiaries of my property?

The aforementioned questions are just a few of the issues that must be considered while contemplating an outright gift. An outright gift to a child will not protect the asset from the child's creditors and could potentially be lost in a creditor action or in bankruptcy. Additionally, if a child were to get divorced while "holding" a parent's asset, then such asset may end up being divided between the child and an ex-spouse pursuant to a divorce settlement. (Though beyond the scope of tins article, typically assets that are gifted to or inherited by a child will avoid equitable distribution in New York; however, it is very easy for an inherited or gifted asset to be "co-mingled" and thus considered the property of both spouses.) Moreover, if the child were to predecease a paient, the asset could very well end up in the hands of the child's former spouse or children, depending on how the child's estate is settled. The donor parent will have no say as to how that asset wall be transferred upon the child's death.

A life estate plan is another technique that many elder care attorneys may utilize in the case of gifting a personal residence. An individual may wash to transfer lus home to a child while reserving a life estate, which would preserve the transferor's light to live in the home for the rest of his life and would bar the transferee (often a child) from selling the house without the parent's consent. A transfer subject to a life estate achieves the desired result from a Medicaid perspective (assuming five years have already elapsed in the case of a nursing home Medicaid application, as described above) but the same non-tax issues described above could potentially spoil the intended result of the transfer. In addition, the family must consider the Medicaid implications that would result if the house were sold while the paient is receiving Medicaid services-in other words, the value of the life estate, based on the individual's life expectancy and IRS tables, wall be attributed to the Medicaid recipient, and could result in a period of Medicaid ineligibility.

Tax Implications

The tax implications of an outright gift often will, and should, dictate how a transfer should be structured. Under IRC Section 1015(a), with respect to gifted property "the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was acquired by gift" [IRC section 1015(a)], Thus, the transferee's basis in the property gifted via an outright transfer will be the same as the transferor's basis, or carryover basis. As such, individuals considering an elder care plan must determine what the basis in the property being transferred is and how to best plan from an income tax perspective, as well as an elder care planning perspective.

When an asset transferred via an outright gift is later sold, the transferee (generally the children) wall be responsible for the resulting income taxes. It is therefore beneficial to mitigate the income taxes that the child will be responsible for, especially since the child will, most likely, be in a higher income tax bracket. This is especially important in tight of recent increases to both ordinary income and capital gains tax rates. As a result, parents should consider the basis in the property and whether the property has appreciated significantly in value. If the property has appreciated significantly, then an outright gift will result in a canyover basis in the property for the children and high income taxes once the asset is sold.

For example, consider a parent who owns an investment property with a fair market value of $500,000. The adjusted basis in the property is $150,000. If the pai ent makes an outright gift of the property to his child, the child's basis in the property will be $150,000. If the child then sells the property for $500,000, he will have a gain of $350,000 and will be taxed on the sale pursuant to his income tax bracket.

While, from a tax perspective, it would be most beneficial for the paient to retain ownership of the asset until death [in which case the heirs enjoy a step-up in basis equal to the fair market value on the date of the parent's death under IRC Section 1014(a)], this will not work for Medicaid purposes. From a Medicaid planning perspective, the parent cannot own nonexempt assets whose total value exceeds the Medicaid asset threshold described above. Other planning techniques must be employed, winch will be described in greater detail below. Note that property subject to a retained hfe estate will qualify for the IRC section 1014 basis step-up.

With regards to a personal residence, an outright gift or a transfer of the home subject to the paient retaining a hfe estate will result in lost tax opportunities, beyond the loss of the step-up in basis. IRC section 121 allows an individual to exclude up to $250,000 ($500,000 in the case of a married couple filing jointly) of gain from the sale of a principal residence if, dining the five-year period ending on the date of the sale the property was owned and used by the individual as a principal residence for periods totaling two or more years (see IRC section 121). In the event a parent makes a gift of the personal residence to one or more children who do not meet the requirements of IRC section 121, then the $250,000/$500,000 exclusion of gam resulting from the sale will be lost if the home is sold. This would lead to a huge missed tax savings opportunity-especially given that many individuals, especially in the downstate New York region, have homes that were purchased years ago for a fraction of current prices.

It is important to note that the IRC section 121 exclusion will be limited, although available, in the case of a home that is transferred to a child subject to a hfe estate but sold during the paient's lifetime. In this case, the IRS has previously ruled that the section 121 exclusion will apply when the property is sold, but only to the extent of the value of the hfe estate. [See IRC section 121(d)(8) and Treasury Regulations section 1.121 -4(e)(1)(i). For a further discussion regarding the applicability of the section 121 exclusion to a life estate, see Morris Sabbagh and Robert Barnett, "Medicaid Planning with Life Estates," The CPA Journal, March 2005.]

There are additional significant tax saving opportunities that will be lost if an individual transfers a personal residence outright to a child or other donee, such as the Enhanced STAR Exemption (see http://www.tax.ny.gov/pit/property/star/eligibility.htm) and the Senior Citizens Exemption (see http://www.tax.ny.gov/pit/ property/exemption/seniorexempt.htm). These real property tax exemptions will not, however, be lost if the home is transferred subject to a retamed hfe estate of the transferor who resides in the house and meets all the relevant requirements.

Irrevocable Medicaid Asset Protection Trust

As mentioned above, transferring assets via outright gift for piuposes of Medicaid planning will result in significant adverse tax and non-tax consequences. Those looking to mitigate these negative implications must consider an alternative method. A transfer of assets to an Irrevocable Medicaid Asset Protection (IMAP) Trust will help mitigate, and in some cases eliminate, many of the aforementioned negative consequences.

Assets transferred to a properly drafted IMAP Trust will be viewed by Medicaid as unavailable to the extent that the trust is irrevocable, and only if the grantor/settlor does not serve as trustee. Any trust income or principal that is payable to or otherwise available to the settlor in any way will also be deemed to be available to the Medicaid applicant/recipient (settlor). Consequently, as the intent of the transfer to the trust is to shield the asset from being considered a countable resource for Medicaid piuposes, the IMAP Trust is drafted so that the principal/trust corpus cannot be touched by the settlor. But because the Medicaid income rules differ from the resource rules, as described above, in most cases the individual planning for Medicaid will determine that he or she needs the income, and therefore the trust will provide for income to the settlor. In that case, all income that is distributable to the settlor will be viewed as available by Medicaid.

To the extent that an individual planning for Medicaid believes that he will have too much income in the future (and if comfortable living without that income), he may decide to execute an additional trust, which would not be a grantor trust, where he will not be receiving the income. This planning technique would take into consideration not only the individual's assets, but also income, which is very important in the Medicaid planning context. However, because only $12,301 of income will put a trust in the highest tax bracket, if an individual decides to reduce the income received by executing this second trust, then the trust should, in most circumstances, permit income distributions to some other beneficiary, such as tlie settlor/grantor's child, so that the trust income is not taxed at tlie trust level, but rather at tlie individual level.

Tlie advantage of a properly drafted and administered IMAP Trust is that the asset transfer to the trust will be viewed as a completed gift from a Medicaid perspective (of course, the five-year look-back rules will apply), yet the assets may remain eligible for the various tax benefits that would have been lost if the assets were gifted outright. For example, to the extent the trust assets would be includable in the settlor's estate under IRC section 2036, tlie assets would enjoy a step-up in basis upon the death of the settlor, thus resulting in significantly lower (or no) income taxes to the beneficiaries once the underlying properties are sold. This is a significant tax advantage which would be lost if the asset were transferred outright. (IRC section 2036 defines the value of a gioss estate as the value of all property to the extent of any interest which the decedent has ever made a transfer-not sale- under winch he has retained for life the right to possess the property or income made from it, as well as designate the people who can possess the property and any income made from it.)

Thus, if the settlor reserves the right to receive income from the IMAP Trust, as many seniors do in order to maintain their lifestyles, the assets in the trust would be includable in the settlor's estate and would benefit from the step-up in basis upon death. Moreover, if the trust is structured as a grantor trust, the relevant senior citizen-related exemptions described above will also be maintained. Furthermore, if the settlor's personal residence is transferred to the trust and the settlor enjoys the right to continue to live in the home for the rest of his life, then if the house is sold dur - ing the life of the settlor it would qualify for the partial IRC section 121 exclusion from capital gains desciibed above.

It is important to note that not all irrevocable trusts are structured as incomplete gifts from a tax perspective. High-basis assets that have not appreciated significantly in value and from which the settlor does not require income may benefit from being transferred to an IMAP trust that does not provide income and which will not be includable in the settlor's taxable estate. the assets held in such a trust will be viewed as having been transferred via a completed gift from both a Medicaid perspective and a tax perspective. Of course, in thus case, the assets will not benefit from a step-up in basis, and the carryover basis rales will apply.

The non-tax benefits of an IMAP Trust are also important to note. Assets transferred to the trust will be protected from the creditors of the child or future beneficiary as long as they are held in trust. In addition, the assets will be protected in the event one or more of the settlor's children goes through a divorce. Furthermore, because the settlor includes direction relating to exactly how the assets are to be distributed, the settlor will be able to address how the assets should be distributed in the event one or more of her children should predecease her.

Of course, when considering the manner in which to draft the trust from a tax perspective, attorneys and CPAs should discuss with clients not only the various income tax issues desciibed above, but also estate tax considerations, which should never be overlooked in an elder care planning context. If a trust is structured as an incomplete gift from a tax perspective so as to maintain income tax benefits, advisors must consider the potential of both federal and New York State estate taxes upon the death of the settlor. Moreover, if a trust is structured as a completed gift for tax purposes, the attorney, together with the CPA, must consider how much of the estate and gift tax unified credit has already used as a result of prior gifting. While estate tax considerations are becoming less of a concern due to the rising estate tax exclusion levels, both on a federal level and in New' York, these are important issues that cannot be overlooked.

Consider All the Implications

As outlined above, there are various tax considerations that must be considered when preparing and executing an effective elder care plan whose primary goal is to protect and preserve an individual's assets. In most cases, the most beneficial and effective planning technique is the Irrevocable Medicaid Asset Protection Trust. Thorough discussion of and careful attention to the various tax implications must take place.

A transfer of an asset via an outright gift is the simplest and least expensive way to remove assets from one's name.

FINANCIAL PLANNING TIPS FOR SENIORS

By Perry A. Shulman

* Analyze whether, and to what extent, retirement assets will last well into retirement, especially in light of longer life expectancies.

* Create a budget that compares income and expenses both before and after retirement.

* Consider an asset preservation plan which includes an irrevocable trust that will protect assets from Medicaid.

* Purchase long term care insurance, if feasible.

* Increase the standard deduction when taxpayer is blind or over age 65.

* Apply for senior citizen real estate tax abatements and other discounts.

* Maintain an accurate and current inventory of all assets owned.

* Update estate planning documents and keep them in a secure location.

* Monitor investment portfolio and other assets with a financial advisor.

* Plan for unexpected contingencies.

* Take into account cost of living increases and healthcare expenses.

* Properly title assets and update beneficiary designations.

* Monitor credit score.

* Retain lines of credit, which may be more difficult to reestablish in the future.

* Consider the financial needs of children, grandchildren, and other loved ones who may not be able to provide for themselves.

Perry A. Shulman, CPA, CFP, has a Long Island, N.Y., practice serving high-networth families and entrepreneurs who seek customized solutions, unique strategies, and personalized care.

Transferring assets via outright gift for purposes of Medicaid planning will result in significant adverse tax and non-tax consequences. Those looking to mitigate these negative implications must consider an alternative method.

If a trust is structured as an incomplete gift from a tax perspective so as to maintain income tax benefits, advisors must consider the potential of both federal and New York State estate taxes upon the death of the settlor.

Ronald Fatoullah, JD, is the founder and principal attorney at Ronald Fatoullah & Associates, a law firm with offices in Long Island and New York City. He is also cochair of the financial planning and investments committee of the elder law and special needs section of the New York State Bar Association (NYSBA) and cochair of the board of directors of the Long Island Alzheimer's Association. Elizabeth Forspan, JD, is the managing attorney at Ronald Fatoullah & Associates, practicing primarily in the areas of elder law, trusts and esta tes, and taxation.

The authors would like to thank Sidney Kess, JD, ILM, CPA, for his contributions to this article and for his continued guidance. The authors would also like to note the valuable contributions of Debby Rosenfeld, JD, and Stacey Meshnick, JD.