Tax Planning vs. Medicaid Planning: Know The Rules to Avoid Costly Mistakes - Cona Elder Law

Tax Planning vs. Medicaid Planning: Know The Rules to Avoid Costly Mistakes

April 2011

A couple in their 80’s made annual exclusion gifts of $13,000 per year to their 12 family members, including their children and their children’s spouses as well as grandchildren.  Not long thereafter, the elderly woman suffered a stroke and required long term care in a nursing home.  She found out the hard way that the tax exempt gifts resulted in a penalty period for Medicaid purposes, making her ineligible to receive Medicaid benefits for 14 months.  Now the couple has to get the gifted money back or pay privately for the wife’s care during the 14 months, which will cost upwards of $180,000.

Although the IRS rules permit the annual $13,000 exclusion gift per person per year with no tax consequences, there are penalties for Medicaid purposes, which can amount to months or years of penalty period.  This unintended consequence can be financially devastating for a single person or a married couple.

“Many of our clients fall into this paradox,” says Jennifer B. Cona, managing partner of the Melville, LI based Cona Elder Law, a leading elder law and estate planning firm.  “It is very unsettling to learn that your proper estate and financial planning can lead to problems for Medicaid purposes.  And getting the gifted money back is not always possible.” 

While accountants and financial planners may know all of the tax rules, they typically are not familiar with the Medicaid rules regarding gifting, transfers to trusts, treatment of IRAs and more. 

Other issues that affect taxes and Medicaid planning include: 

Outright Gifts vs. Gifts to a Trust:

Trusts can have certain tax benefits and may be more advantageous than transferring assets directly to a child.  

Transferring assets to a Grantor Trust allows the assets to continue to be taxed at the senior’s tax bracket, which typically is lower than the child’s tax rate.  If the trust is not a Grantor Trust, the trust income will be taxed at the highest income tax level.

Gift Taxes - For gift tax purposes, a trust can be drafted so that gifts made to the trust are not “completed gifts” and therefore the grantor would not need to file a gift tax return or pay any gift taxes upon the creation of the trust.

Income Taxes - There can also be income tax advantages to establishing a trust.  If your children are in a higher tax bracket than you are, it’s preferable for you to continue paying taxes on the income from the gifted assets.  This can be accomplished with a trust.   

Capital Gains Taxes on real property or stock can be reduced or eliminated altogether by transferring such assets to a trust.  The children would thereby receive the appreciated value of those assets as their cost basis.

Real Estate Tax Exemptions, such as STAR or Veteran’s exemptions can be maintained despite the transfer of title to a trust if the trust is drafted with a form of 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 can be protected for Medicaid purposes provided the asset is in “pay status”.  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”.  Further, the IRS and Medicaid use different life expectancy tables to calculate such distributions thereby dramatically affecting the amount of the pay-out.

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.

Caregiver Contract:

Family members can be paid for taking care of a loved one through a Caregiver Contract.  This amount can be deducted from your assets for Medicaid planning purposes.  However, that family caregiver will have to pay taxes on that money as earned income.  “If possible, it may be best to divide the payments over two tax years but you have to be careful not to interfere with the Medicaid rules,” explains Ms. Cona.


About the Author Cona Elder Law

Cona Elder Law is a full service law firm based in Melville, LI. Our firm concentrates in the areas of elder law, estate planning, estate administration and litigation, special needs planning and health care facility representation. We are proud to have been recognized for our innovative strategies, creative techniques and unparalleled negotiating skills unendingly driven toward our paramount objective - satisfying the needs of our clients.

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