Investment Article
An Operational Guide to the Use of Irrevocable Med
An Operational Guide to the Use of Irrevocable Medicaid Income Only Trusts
Cushing & Dolan, P.C.
Attorneys at Law
375 Totten Pond Road, Suite 200
Waltham, MA 02451
Tel: 617-523-1555
Fax: 617-523-5653
By
Todd E. Lutsky, Esq., LL.M
Hypothetical Fact Pattern for Mrs. Public
Surviving spouse, Mrs. Public, established an income only irrevocable Medicaid trust in 2002, naming herself and her oldest child as trustees. The trust provides as follows:
1. For so long as Mrs. Public is alive, income from the trust is payable to Mrs. Public.
2. Under no circumstances is the Trustee permitted to use principal for Mrs. Public’s benefit.
3. The Trustee, in its discretion, may pay principal to or for the benefit of the class consisting of Mrs. Public’s issue.
4. Mrs. Public reserved, in the trust instrument, the right to tell the Trustee to make a distribution of principal to or for the benefit of one or more of her issue.
5. Upon Mrs. Public’s death, the property in the trust will be paid over to those persons selected from the class consisting of her issue, as designated in a Last Will and Testament referring to this power executed after the execution of the trust.
6. In the event the power is not exercised, the property shall be sold and the proceeds divided equally among the issue by right of representation.
The property in question was worth $400,000 at the time of the transfer to the trust and the tax assessed value of the property was $300,000. Mrs. Public had acquired the property from her husband six months earlier as the result of his death and the property had been owned jointly. The fair market value of the property at the time of Mr. Public’s death was $400,000. Mrs. Public was 75 years old at the time of the transfer into the trust. Simultaneous with the execution of the trust, Mrs. Public conveyed her home to the trust reserving a life estate as well as 1 million dollars in cash and securities. Let’s look at how the trust works including the income, gift, estate and MassHealth consequences.
Question:
Who would consider using these Medicaid irrevocable trusts?
Answer:
While there is no hard and fast rule as to who can use these trusts, it is generally recommended to folks who have attained 60 years of age or older. In addition, you should consider using these irrevocable trusts if in fact one of your objectives in the estate and elder law planning world is to protect assets from the cost of long term care. In the event this type of asset protection planning is not important to you, then a revocable trust would be the recommended vehicle for your estate planning needs. Finally, if you happen to be under age 60 but have a diagnosed mobility related illness, then of course you could consider the use of these irrevocable trusts as well.
Question: Who can be the Donor of these irrevocable trusts and what does that mean?
Answer:
The Donor is referred to as the individual who creates the trust. The Donor may also retain certain powers over the trust, most importantly, the power to remove and replace a trustee at any time for any reason, provided, however, that the replacement trustee can never be the Donor of the trust. This retained power by the Donor allows the Donor to retain a significant degree of control over the operation of the trust, even though the Donor does not serve as trustee. In addition, the donor will also be an income beneficiary of the trust.
Question: Who can be the trustee of these irrevocable trusts?
Answer:
Often times, the Donor would like to serve as trustee of the trust thereby significantly increasing the Donor’s control over the operation of the trust assets during the Donor’s life. There is support for this position in Massachusetts where there is a case entitled Ledger vs. Department of Medical Assistance in which the Court indicated that, while this may appear to be an unappetizing maneuver, it nonetheless fails to contravene any rule or regulation. However, there has since been another case known as the Muriel Doherty case in which the Appellate Court in Massachusetts indicated that the irrevocable trust was not drafted properly and provided too much control to the Donor, whereby causing the assets of the trust to be at risk. Therefore, it is the recommendation of this author that, if the Donor of the trust has children or trustworthy family members, that they serve as trustee and that the Donor relies on his or her power to remove and replace the trustee, as mentioned above, in order to provide a comfort level when implementing these irrevocable Medicaid trusts.
Question:
Do these trusts avoid the costs associated with the probate process?
Answer: An individual who passes away and owned assets in their own name, without a designated beneficiary, will subject all of those assets to the costs associated with the probate process. By establishing this irrevocable trust and, most importantly funding the trust with assets, will enable the assets that have been retitled to the name of the irrevocable trust to avoid the costs associated with the probate process.
Question:
Do these irrevocable trusts protect assets from the costs of long term care and how long does it take?
Answer:
Once assets have been transferred to these properly drafted Medicaid irrevocable trusts, the assets will be protected from the costs of long term care after the expiration of five years from the date of transfer. This is known as a five year lookback period for Medicaid eligibility purposes. This means that, from the date in which you would apply for Medicaid benefits, the state is entitled to look back at all of your prior transactions, bank accounts, investment accounts, etc., for the previous five years in order to see if there were any disqualifying transfers made during that period which would in fact prevent you from being eligible for Medicaid benefits. A disqualifying transfer is when a formerly available asset is transferred for less than fair market value to a place where it is no longer available for the nursing home, such as into this irrevocable trust. Once you have successfully made it beyond five years from the date of transfer to the trust, the state would then no longer be able to see such a transfer and therefore it would be protected from the costs of long term care.
Question:
Which type of assets should a person retitle or transfer into one of these irrevocable Medicaid trusts?
Answer:
First and foremost, IRA asses or any other qualified plan asset or retirement type asset, such as a 401(k) plan or a 403(b), should not and, in fact, cannot be transferred into these irrevocable trusts during life. In order to transfer one of these qualified plan assets into the trust, you would first need to withdraw the money from the qualified plan, thereby subjecting it to ordinary income tax liability and transferring only the amount net of taxes to the trust. Generally, this makes funding an irrevocable trust with such assets cost prohibitive.
The qualified plan type assets should now be used to live on during your life before looking to the trust assets for that purpose since the retirement plan assets would be outside the trust and therefore at risk for the costs associated with long term care. A common asset that folks like to transfer to the trust would be their primary residence. It is also possible to transfer rental property or vacation property to these irrevocable trusts in order to protect them from the costs of long term care. Finally, people also wish to transfer their investment portfolios or a portion of their investment portfolios to these irrevocable trusts in order to protect them from the costs of long term care much life Mrs. Public did in our example.
Question:
Is the transfer of the property to the trust a completed gift?
Answer:
The answer is no. Treasury Regulation 25.2511-2(c) provides that a transfer is an incomplete gift for gift tax purposes if the Donor retains the right to designate the final beneficiaries. See number 5 in the example listed in the beginning of the article. Specifically, a gift will be incomplete (but only for gift tax purposes) under Regs. 25.2511-2(c) “if and to the extent that a reserved power giving the donor the power to name new beneficiaries or to change the interest of the beneficiaries as between themselves [make the gift incomplete] unless the power is a fiduciary power limited by a fixed or ascertainable standard.”
Planning Note
If the Deed transferred the real estate to a child and the Donor, Mrs. Public, reserved a life estate, there would have been a completed gift, which would need to be reported since the grantor did not reserve the right to designate the final beneficiaries. In addition, if the 1 million in cash and marketable securities had been transferred to a child, a gift tax would have been due since the total gifts would have exceeded the 1 million dollar gift tax exemption.
Question:
Does a gift tax return need to be filed?
Answer:
The answer probably should be yes, but only to provide disclosure. If the donor retained a provision in the trust rendering the gift incomplete, the Regulations provide that a gift tax return should be disclosed on a return but a failure to file would not render the taxpayer subject to any penalties or gift tax. In most cases, no gift tax return would have been filed. The risk is that the transfer was not incomplete and a gift tax would have been due giving rise to penalties and interest. Specifically, Regulation 25.6019-3(a) provides: “If a Donor contends that his retained power over property renders the gift incomplete and hence not subject to tax as of the calendar quarter or calendar year of the initial transfer, the transaction should be disclosed in the return for the calendar quarter or calendar year of the initial transfer and evidence showing all relevant facts, including the copy of the instrument of transfer, shall be submitted with the return.”
Question:
How do you compute the amount of the gift for gift tax purposes if the transfer of the real estate had been to a child rather than to a trust?
Answer:
Assume the 7520 rate applicable for the date of the transfer was 2.4%. Using Table S, single life factors based on Life Table 90CM with interest at 2.4%, the life estate portion is worth .22012 and the remainder interest is worth .77988. Therefore, to compute the value of the gift, you would multiply the fair market value of the property of $400,000 by .77988 ($311,952).
Question:
What is the value of the transfer of the real estate for MassHealth purposes?
Answer:
Pursuant to MassHealth Eligibility Operations Memo 07-18, the same rate would be applicable by referring you to Table S. The difference, however, would be to use the assessed value rather than fair market value pursuant to MassHealth Regulation 103 CMR 520.007(G)(3)(a). The value of the transfer for MassHealth purposes will be $300,000 multiplied by .77988 ($233,964).
Question:
Who is responsible for paying expenses attributable to the property after the property is transferred to the trust subject to a life estate?
Answer:
The life tenant is responsible for paying all expenses associated with ownership, with the exception of capital improvements. This means that the life tenant would be paying property taxes and will be entitled to an income tax deduction with respect to such payments. If the property was rental income, then the rental income would simply be reported by the life tenant on Mrs. Public’s Form 1040. A remainderman owes no duty of care to the life tenants, absent a duty voluntarily assumed by the remainderman. Delprete v. Ferrante, et al, L.W. No. 16-106, Judge King, Suffolk County No. 90-2152B. There will be a discussion below on how rental income will be treated if the entire property had been transferred to the trust without a retained life estate.
Planning Note
It is important to remember that any net rental income generated from the property will be available to the donor of the trust under the terms of the trust, and as such will also be available to the nursing home for MassHealth purposes.
Question:
Can I sell my home after it has been transferred to one of these Medicaid irrevocable trusts and, if so, how does it work?
Answer:
Yes, you can sell the home after it has been transferred to the irrevocable trust. Generally, the Donor simply tells the trustee that the house is to be placed on the market and sold. The trustee of the irrevocable trust would sign the purchase and sale agreement in order to complete the transaction. Selling the property from the irrevocable trust in no way complicates the transaction nor adversely impacts the buyer. Upon completion of the transaction, the buyer would cut a check made payable to the trustee of the irrevocable trust who then would in turn deposit the check into a bank account that is established in the name of the irrevocable trust. It is important to insure that the Donor does not receive the money personally, but instead the money is transferred directly into the irrevocable trust bank account. Finally, the house can be sold any time after it is transferred to the trust, even if it is during the initial five year period from the date of transfer.
Question:
Does the sale of a home from the irrevocable trust re-set the Medicaid five year lookback period?
Answer:
The five year lookback period is unaffected, and, in fact, not reset by the selling of a home from the irrevocable trust, since nothing new was placed into the trust. The five year lookback period starts to run on the day an asset was transferred from an individual’s own name into the irrevocable trust and not the day the trust sells the property.
For example, if the Donor establishes an irrevocable trust and transfers the property into the trust on January 1, 2011, and then, on January 1, 2013, the trustee of the trust sells the property and in exchange the trust receives the proceeds, which are promptly deposited into the irrevocable trust bank account, that transaction will have no impact on the initial five year waiting period that began on January 1, 2011, when the home was transferred to the irrevocable trust.
In other words, the proceeds from the sale of the home, which are now deposited in the trust, will be protected from the cost of long term care in three more years, which represents the balance of the number of years remaining from the initial transfer of the home to the trust on January 1, 2011. Again, since nothing new was placed into the trust, there is no new five year waiting period created. In this case, the trustee simply reinvested the assets that were already inside the trust from real estate to cash or any other investment.
Question:
Can the trustee of the trust use the proceeds from the sale of a previous home to purchase a new home inside the trust?
Answer:
Yes. Once the irrevocable trust receives the proceeds from the sale of the home and are deposited into the trust bank account, the trustee may invest those assets in any manner the trustee deems fit. In other words, the trustee may simply write a check to the seller of a home that you are interested in purchasing and the seller will prepare a deed transferring the property to the trustee of the irrevocable trust. Once again, this transaction of purchasing the home inside the irrevocable trust does not reset the five year waiting period.
As a practical matter, when one spouse passes away, it is not uncommon for a surviving spouse to downsize and sell the old primary residence and convert it to a condominium or some other downsized home. This transaction is completely permissible within the terms of the trust and again would not reset the five year waiting period for Medicaid eligibility purposes.
Question:
Do I need the children’s permission in order to buy or sell real estate after it has been transferred to the Medicaid irrevocable trust?
Answer:
No, you, as Donor of the trust, will simply instruct the trustee to place the home on the market for sale or to purchase a new home following the sale of the previous home. In the event the trustee does not comply, you, as Donor of the trust, retained the ability to remove and replace the trustee at any time and would thereby simply remove the trustee and put in a trustee who is willing to complete your requested transaction. Therefore, you do not technically need the children’s permission to complete the purchase or sale of a new home after it has been transferred to the irrevocable trust. Finally, in some instances, you, as the Donor, may also be serving as trustee, thereby eliminating this issue altogether.
Question:
Will I still receive my capital gains tax exclusion upon the sale of my primary residence after it has been placed into an irrevocable Medicaid trust?
Answer:
Yes. This capital gains tax exclusion amounts to the ability of married people to shelter the first $500,000 of capital gains on the sale of their primary residence while allowing single people to shelter the first $250,000 of capital gains on the sale of their primary residence. The rule simply states that you must have owned and used the property as your primary residence for two of the last five years in order to take advantage of this capital gains tax exclusion upon the sale of the property. Since the trust is designed as a grantor trust for income tax purposes, the individuals transferring the property to the trust will not lose their ability to take advantage of this capital gains exclusion once the property is sold from the trust.
The term “grantor trust” means that the Donors, or creators of the trust, will be considered the owner of the trust for all income tax purposes and, therefore, will be eligible to maintain their capital gains tax exclusion on the sale of the property from the trust. The trust is a grantor trust because the Donor has retained the ability to direct where the principal and/or income of the trust can go during the Donor’s lifetime and in accordance with Internal Revenue Code Section 674(a), this retained power is what makes the trust a grantor trust for income tax purposes, thereby preserving the capital gains tax exclusion.
Planning Pointer:
Some Attorneys have used IRC section 675(4)(c) which give the grantor the right to remove the assets from the trust as long as they are replaced with an amount assets of equal value, in order to make the trust a grantor trust. While this grantor retained power does make the trust a grantor trust for income tax purposes, it can also make the principal of the trust a countable asset for Medicaid eligibility purposes and thus should not be used.
Question:
Assuming Mrs. Public sold the home in our example for $600,000 with that retained life estate how would the sale process and the income tax and MassHealth consequences be different than the sale described above when there was no life estate retained? The answer will also consider the effects of granting the remainder interest to the kids instead of the irrevocable trust.
Answer:
- Income Tax Consequences:
In order to sell the property, Mrs. Public, as well as the trustees of the trust, would need to sign the deed. Since the life estate is a property interest, a portion of the proceeds would need to be paid directly to Mrs. Public and a portion would need to be paid directly to the irrevocable trust. The amount to be paid to each party is determined based upon the Table S using the 7520 rate. Basis in the property is similarly allocated.
Cash and the gain are allocated based upon these percentages. That portion of the sale proceeds allocated to the life tenant will be eligible for the capital gain tax exclusion under IRC § 121. As a single person who owned and occupied the residence as her home for two out of the last five years, she would be able to exclude up to $250,000 in capital gain. The balance will be taxable at 15% and 5.3% (Massachusetts). Revenue Ruling 71-122. The portion of the proceeds allocated to the trust may or may not be taxable depending upon whether the trust is a grantor trust. If the property had been deeded to the child instead of the trust, the portion of the proceeds allocated to the child would be taxable as capital gain with no exclusion since the child did not live in and own the home for two of the last five years.
If the trust is a grantor trust, the trust must file Form 1041, identify itself as a grantor trust, and send a tax letter to the grantor informing the grantor that the grantor is responsible for reporting the trust’s portion of the gain. In this case, the total gain is $200,000 ($600,000 - $400,000). This assumes that Mrs. Public was able to get a full step up in basis to $400,000 upon the death of her husband. Assuming the same 7520 rate of 2.4% used above in the gift tax calculations, the life estate portion is 14.8%, which means $29,600 would be included, but the remaining $170,400 would be reported by the remaindermen. If the remaindermen are the children, it would be fully taxable at capital gain rates. If the remainder portion was owned by a grantor trust, then that gain would be reallocated to the grantor and eligible for the capital gain tax exclusion making the full $200,000 income tax free. Rev. Rul. 66-159 and Rev. Rul. 85-45.
As a result of the sale, a 1099-S will be issued to either Mrs. Public or her irrevocable trust, or both depending upon whether or not Mrs. Public directs the closing agent to issue separate 1099s (one to Mrs. Public and one to Mrs. Public’s Irrevocable Trust) in order to reflect the appropriate percentage of the gross proceeds allocated to her (as the holder of the life estate) and to her trust (as the remainderman).
- MassHealth Consequences:
Sale of a life interest is governed by 130 CMR 520-019(I)(2). “If the nursing facility resident’s . . . life estate interest or property including the life estate interest is sold or transferred, the value of the life estate interest at the time of the sale (emphasis added) or transfer is calculated in accordance with the Life Estate Tables as determined by the MassHealth agency. The MassHealth agency will attribute the value of the life estate interest at the time of the sale or transfer to the person selling or transferring the life estate.” This would result in a disqualification period for Medicaid Eligibility.
The portion of the sale proceeds allocated to the life tenant becomes a countable asset, which is once again determined by looking to the applicable 7520 rate and Table S. If the grantor is in a nursing home, to the extent the life tenants share of the proceeds together with other assets exceed $2,000, the applicant would be disqualified from MassHealth benefits unless further action is taken, such as an annuity or an additional gift.
Planning Note
This is probably the biggest disadvantage to retaining a life estate. In this case, assuming a life interest of 14.8%, $88,800 would be allocated to the grantor disqualifying the grantor from receiving benefits. If instead of reserving a life estate the property had been transferred by fee simple interest into the trust, no portion of the sale proceeds would need to be reallocated to the grantor and the entire sale proceeds would be protected from MassHealth and the taxpayer would not have to pay any capital gain because the gain, even though realized by the trust, would be reallocated to the grantor for income tax purposes and it would be eligible for the capital gain tax exclusion under IRC § 121.
Question:
Does it make sense to have these clients release/give away their life estate?
Answer:
Probably not since the transfer/release of a life estate would create a new penalty period subject to a new look back period. Remembering that the penalty does not begin to run until Mrs. Public is otherwise eligible with assets under $2,000.
Question:
Assume instead of selling the property that Mrs. Public dies owning the life estate. What are the estate and income tax ramifications?
Answer:
The fair market value of the property is includible in the grantor’s estate under IRC § 2036 and, as a result, the property would receive a full step-up in basis. IRC 1014. In other words, there is a full step-up in basis to the fair market value as of the date of death of the Donor. This means that the trust would acquire a basis in the property equal to $600,000, and a subsequent sale by the trust or the beneficiaries of the trust would be income tax free to the extent the sale proceeds do not exceed $600,000.
Question:
Can I transfer rental property into one of these Medicaid irrevocable trusts and, if so, what are the implications?
Answer:
Rental property can be transferred to these irrevocable trusts and there would be no adverse tax implications of doing so. Remember, like the primary residence, this rental property can be sold and the proceeds can in fact be used to purchase another piece of property at any time during or after the five year lookback period. There would also be no adverse income tax consequences associated with any such sale. In other words, you would continue to pay all of the same capital gains taxes associated with the sale of rental property out of the trust as you would if you had sold the property from your own name.
In addition, you would retain the ability to pay the bills associated with the rental property, make decisions regarding rental increases, make decisions regarding removal of existing tenants and continue to collect and use the rent as usual. Remember, these were all decisions that were made by you prior to transferring the property to the trust.
Question:
After rental property has been transferred to a Medicaid irrevocable trust, how is the rental income generated handled and who receives it?
Answer:
These Medicaid irrevocable trusts are designed as income only trusts, which means that the trustee is obligated to pay out the income earned by the trust to the Donor. In this regard, the tenant would write a check for the rent and make it payable to the trustee of the irrevocable trust. The trustee of the irrevocable trust must have established a checking account in the name of the irrevocable trust under its own tax identification number in order to deposit this rent check into the trust checking account. The rent check represents trust rental income in which the trustee is then obligated to write a check out of the trust checking account payable to the Donor of the trust, who in turn will deposit that check into his or her own personal checking account, or the account can be set up for automatic transfer to the donor’s account.
In other words, the rental income will end up in the Donor’s personal checking account through this two-step approach instead of directly, which is where the rental income use to go prior to the rental property being transferred to the irrevocable trust. The Donor is then free to spend that rental income on anything he or she desires, just like before the establishment of the trust.
Planning Pointer:
In our case Mrs. Public retained a life estate in the property so she would be entitled to the rental income directly and nothing would need to flow through the trust as is the case when the entire property is transferred to the trust as shown above.
Question:
Do these Medicaid irrevocable trusts have to file separate income tax returns and, if so, does that result in an increased income tax liability?
Answer:
If the trust has income then these trusts are in fact required to file a separate income tax return known as a Form 1041 as well as possibly a corresponding state trust income tax return. It is also important that the trust obtain a separate tax identification number for this purpose. In addition, having this separate tax identification number also helps maintain the integrity of the trust for Medicaid eligibility purposes. However, since the trust is a wholly owned grantor trust for income tax purposes, as described above, the trust will effectively not pay any separate federal income taxes. Instead, this grantor trust status causes the Donor to be treated as the owner for income tax purposes and essentially flows the income through the trust and causes it to be reported on the individual Donor’s income tax return, Form 1040, just like it use to be done prior to the establishment of this irrevocable trust. Therefore, these Medicaid irrevocable trusts are known to be income tax neutral, resulting in no increase or decrease in income tax liability to the Donor. The Donor will continue to pay the same tax as he or she did prior to the establishment of the irrevocable trust.
Question:
Are the trust assets subject to estate recovery?
Answer:
No, although the legislation has had a tortured history. 130 CMR 515.001(c) followed legislation which subjected non probate assets to estate recovery for deaths occurring on or after July 1, 2003, but fortunately this legislation has been repealed retroactively to July 1, 2003. The law as it reads today only allows the state to recover against assets that an individual had in his own name on the date of death as these are probate assets. The assets inside these trusts are not probate assets and thus are not subject to estate recovery provisions. In other words, after the donor passes away the state cannot attach the assets in the trust in an attempt to get paid back for the benefits provided to the donor now deceased.
Question:
Do I have to sell my assets inside my investment portfolio prior to transferring them into the trust?
Answer:
No. In general, the funding of an irrevocable trust does not result in any income tax related issues whatsoever. In other words, when a trust is funded, it generally means nothing more than retitling the existing assets to the name of the trust. If you have an investment account at Fidelity, you are likely to receive a statement from Fidelity and it generally comes in your name, which is indicated in the upper left hand corner of the statement.
Once this Fidelity account has been successfully retitled to the name of the irrevocable trust, you, as Donor of the trust, will continue to receive these same statements from Fidelity, except in the upper left hand corner of the statement will appear the name of the irrevocable trust along with the trustee’s name and all of the investments that were listed on that statement prior to transferring it to the trust will, in fact, be there after they are transferred to the trust. Therefore, there is no adverse income tax consequences associated with retitling assets to the trust as nothing was sold prior to the transfer.
Question:
How do I transfer real estate to the irrevocable Medicaid trusts and are there any adverse income tax consequences?
Answer:
The funding of a trust with real estate is generally done through the preparation of a new Quitclaim Deed. The deed simply transfers the property from the individual name of the Donor to the name of the trustee of the irrevocable trust. Alternatively, the deed can be transferred to the trustee of a nominee realty trust in which the schedule of beneficiaries would state the irrevocable Medicaid trust as beneficiary. Either way, there is no adverse income tax consequences associated with this transfer nor is there a gift tax liability due.
Question:
Are there any investment limitations on the trustee of a trust?
Answer:
No. The trustee of a trust can invest in all of the same investment options that would be available to an individual and therefore are not limited by having the assets invested inside a trust. However, the trustee should follow the prudent investment rule as a guide towards making investment decisions. The only caveat, of course, is that there are no individual retirement accounts owned inside of an irrevocable trust as mentioned above.
Question:
Can these irrevocable trusts be changed in any way after they are created and, if so, how?
Answer:
While the trust is irrevocable, it nevertheless can be changed through the use of a limited power of appointment. This is a power in the trust in which the Donor is granted the ability to change the beneficiaries of the trust but generally are limited to a class consisting of the Donor’s children of all generations and charities. This power enables the Donor to retain a significant degree of flexibility to adjust their wishes as life events unfold after the creation of the trust.
For example, a Donor may wish to leave a little more assets to grandchildren or perhaps may find that one child is doing extremely well financially while another child is struggling and may desire to reallocate the percentages in which the children are to receive assets, all of which can be done through the use of exercising this limited power of appointment.
Finally, this limited power of appointment may also entitle the Donor to completely eliminate any child or grandchild from receiving any benefits and thereby offers a significant degree of control in the event a child during life does not cooperate.
Question:
Can I add assets to the irrevocable trust many years later?
Answer:
Yes, assets can be added to the irrevocable trust at any time after the trust has been created. However, the addition of assets to the trust will result in the creation of a new five year lookback period, but the lookback period will be associated only with those assets that were transferred. The creation of this new lookback period for those newly created assets will in no way affect the lookback period for previously contributed assets. In other words, if you had contributed assets to the trust five years earlier and only now wish to put additional assets into the trust, the assets that were put into the trust five years earlier will remain protected from the cost of long term care and this new lookback period will only apply to these newly added assets.
Question:
Is it important to use one or two irrevocable trusts when doing this type of asset protection planning?
Answer:
If you are single, then only one irrevocable trust would be needed. However, if you are married and the value of your assets exceed $1,000,000, or may exceed $1,000,000 over the balance of your lifetime, then you should consider two irrevocable trusts. The reasoning behind two irrevocable trusts is to help you more fully utilize both of your federal and state estate tax exemption equivalent amounts, thereby serving to reduce your estate tax liability. In other words, these Medicaid irrevocable trusts can also help you reduce your estate tax liability while serving to protect your assets from the cost of long term care at the same time. A discussion on the reduction of your estate tax liability and how the trusts are designed to accomplish that is beyond the scope of this letter. If you have questions on this aspect of the article please do not hesitate to contact Todd E. Lutsky at 617-523-1555 for more information.
Question:
Can the Donors borrow against any real estate that has been transferred to the irrevocable trust?
Answer:
Once real estate has been transferred to these irrevocable trusts, generally you cannot borrow against the property any more. This is generally not a concern for many of the elderly folks who do this type of planning as they have paid off their mortgages and are not interested in going into debt any more. In the event you happen to have an existing mortgage on the property but wish to transfer it into one of these irrevocable trusts, the transfer of an existing debt to the trust will not trigger the due on sale clause but you will be prohibited from refinancing such debt. Therefore, it is important that any such encumbered property being transferred to the trust have a fixed rate mortgage for the life of the loan.
If borrowing against the property in the future is of importance to you, then it is recommended that you establish a home equity line of credit prior to transferring such property to the irrevocable trust. This will enable you to borrow against that equity line after the property has been transferred to the trust. Once the equity line expires, however, you would not be able to renew it.
Question:
What are the ramifications of the Doherty Case?
Answer:
As a result of Doherty, practitioners are reluctant to give or to allow the grantor to retain the right to make discretionary distributions of principal to or for the benefit of their issue, but yet need to be sure the trust remains a grantor trust as to both income and principal. For this reason, the reservation of rights may be limited to appointing principal during life to one or more charitable organizations.
Question:
If the entire property is transferred to the irrevocable trust without the retention of a life estate, should the trust provide language in it granting the right to live in or use and occupy the property to the grantor of the trust?
Answer:
No. MassHealth regulation 130 CMR 520.023(C)(1)(d) indicates that if the home is transferred to an irrevocable trust and is AVAILABLE to the donor according to the terms of the trust then it is a countable assets. The court in the Doherty case also indicated that the donor retaining the right to control whether the house could be sold or not was too much control and led to the conclusion that the assets in that trust were countable for Medicaid eligibility purposes.
Question:
Can the Donor receive principal from the trust?
Answer:
The trustee must be prohibited from distributing principal directly to the Donor as this is the paragraph that provides the protection from the costs associated with long term care. Generally, this is also not a problem for most of the people who use these irrevocable trusts as they are usually living off of their income. Remember, the income, such as social security, pensions, any interest and dividends generated from assets inside the trust, rent generated from inside the trust, or, of course, any IRA type assets which are outside the trust, are all available to the Donor after the trust is established. This flow in income generally is enough to allow the individual to continue to maintain the lifestyle they were used to prior to establishing the trust.
In the event extraordinary events arise and principal is needed in the future, the Donors of the trust generally look to assets that were left outside of the trust to spend first, more specifically the individual retirement account assets. Remember, these assets will remain at risk and therefore should be spent down first prior to any assets that are in the trust which would be protected from the cost of long term care and preserved for and used by the surviving spouse.
If an individual were to completely run out of assets outside of the trust and needed assets that were inside of the trust, however, there is a provision in the trust that enables the trustee to make distributions of principal generally to a class consisting of the Donor’s children of all generations, nieces, nephews, or siblings. Once such a gift has been made, the beneficiary of that gift can endorse the back of the check and give it back to the Donor/parent who, in turn, can deposit it into their checking account which is outside of the irrevocable trust and can be spent as desired. This transaction in no way impacts the balance of the assets inside the irrevocable trust. The asset that is now in the hands of the donor, however, would of course be at risk again for the costs associated with long term care.
Finally, in the event a child is not cooperative, remember the Donor reserves the right to change the beneficiaries of the trust during his or her lifetime thereby effectively eliminating or threatening to eliminate the non-cooperative child as a beneficiary upon your death. This power generally provides significant control to the donor over the assets in the trust.
In the event you wish to learn more about how these irrevocable trusts operate or have questions on how the estate tax component can factor into the use of these trusts, please do not hesitate to contact Todd E. Lutsky at (617) 523-1555.
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