Tax Planning vs. Medicaid Planning: Avoid Costly Mistakes

Tax season is an important time to re-visit the difference between the IRS rules and the Medicaid eligibility rules – in order to avoid potential costly mistakes.

For example, you may want to give a gift of $14,000 to your children and benefit from the IRS annual gift tax exemption.  However, if you need Medicaid coverage within five years, this gift would trigger a waiting period before you can be eligible for Medicaid benefits.   While the gift is permissible for IRS purposes, it most definitely is not for Medicaid purposes.  This mistake and its consequences can be quite costly.

Accountants and financial planners may know all of the tax rules, but they are not usually well-versed with the Medicaid laws.  It’s important for seniors over 65 to consult with both their accountant and an experienced elder law attorney before making gifts and asset transfers.

Outright Gifts vs. Gifts to a Trust
When planning ahead to protect assets, it may be wise to transfer assets to a trust rather than to a child directly.  Transferring assets to a Grantor Trust may be advantageous as it allows the assets to continue to be taxed at the senior’s tax bracket, which is typically lower than the child’s tax rate.

A Grantor Trust allows any income earned by the trust to be reported under the senior’s/Grantor’s Social Security Number.  The Trust does not need its own Tax ID number and a separate tax return is not required.

Real Estate Tax Exemptions
STAR and Veteran’s exemptions can be maintained despite the transfer of real property to a trust provided the trust document states that you have the right to live in the house for your lifetime (a life estate).  Those exemptions would be lost with an outright transfer of the house.

Retirement Savings and Distributions
Currently, the principal of an IRA or 401K is exempt for Medicaid purposes provided the asset is in “pay status”, meaning you are taking monthly distributions.  However, while the IRS requires a minimum distribution when the beneficiary reaches age 70 ½ (the so-called “RMD” or Required Minimum Distribution), Medicaid requires that the distribution be “maximized”.  

Roth IRAs are also treated differently by the IRS and Medicaid.  Even though you are not required to take a distribution from a Roth IRA, it must be put it in “pay status” for Medicaid purposes or the principal will not be protected.

Long Term Care Insurance Tax Credits
A portion of your Long-Term Care insurance premium is deductible on your federal income tax return, provided you itemize your deductions.  The deduction amount is age based, increasing with every ten years starting at age 41 up to the maximum deduction amount at age 71 and older.  New York State allows a tax credit of 20% of annual premiums paid (regardless of age).

Be Aware
Following the IRS rules for gifting, transfers to trusts, and the treatment of IRAs may have serious unintended consequences should you need long term care and Medicaid benefits.  

As always, our Elder Law attorneys are available to answer any questions you may have. Contact us here or call 631.390.5000.