By Thomas D. Begley, Jr., CELA

One of the trusts used in Medicaid Planning is a Disability Annuity Special Needs Trust (“DASNT”). A previous Straight Word article discussed a Disability Annuity Trust (“DAT”). These trusts are designed so that an individual can establish a trust and transfer assets to the trust for the benefit of a disabled child of any age or a disabled individual under age 65 without incurring a Medicaid transfer of asset penalty. The problem with that trust is that the assets in the trust are considered available for public benefit purposes. Therefore, if  a DAT were established for the benefit of an individual receiving Supplemental Security Income (“SSI”) and/or Medicaid, they would become ineligible for those public benefits because the assets in the trust would be countable. The solution would be to wrap a DAT inside a Special Needs Trust (“SNT”). In a Medicaid Planning context, the monies to be used to fund the trust would belong to the third party, usually a parent or a grandparent, so the SNT would be a Third-Party Special Needs Trust (“TPSNT”). In a typical situation, the parent would require long-term care and be applying for Medicaid.   In order to become immediately eligible, from an asset standpoint, the parent would transfer the assets to a DASNT. The trust is exempt from the SSI and Medicaid transfer of asset penalties, and the assets in the trust would not be considered available because of the special needs provisions.

Generally, a family member, other than the trust beneficiary, would be the trustee of the DASNT, although a professional trustee could be utilized.

There are seven main issues to be considered in drafting any trust involving a potential Medicaid recipient.

These include:

• Availability;
• Transfer of asset penalty;
• Payback provision;
• Funding;
• Tax considerations, including income, gift and estate taxes;
• Estate recovery; and
• Elective share.

Let’s examine each of these issues in the context of a DASNT.

Availability

The assets in the DASNT would not be available, because the trust would be designed to give the trustee complete discretion with respect to distributions. Standard Third­ Party Special Needs Trust language would be used in designing the trust. The standard DAT language would also be included. Because of the special needs provisions, the assets in the trust are not counted as assets of the beneficiary.

Transfer of Asset Penalty

There would be no transfer of asset penalty imposed upon the grantor, usually a parent or grandparent, by SSI and Medicaid, because there is a statutory exemption(1) from the penalties for transfers of assets to or for the sole benefit of individuals with disabilities. For a child with a disability, there is no age limit. If the beneficiary of the DASNT is an individual other than a child, there is an age limit of 65.

Payback

Whether a “sole benefit of” trust is subject to a Medicaid payback is open to question. New Jersey takes the position that such a trust must include a Medicaid payback and this issue has not been litigated. Under the provisions of HCFA Transmittal 64, a payback does not appear to be required so long as distributions are made to the beneficiary on an actuarially sound basis. This means that the distributions must be made over the actuarial life expectancy of the beneficiary as determined by the tables contained in HCFA Transmittal 64. Many states follow this interpretation with respect to “sole benefit of” trusts including DATs and DASTs.

Funding

Because a DASNT is a crisis Medicaid planning strategy, generally all assets are placed in the trust.   A careful analysis must be made as to whether to include retirement accounts. If the life expectancy of the grantor is short, a better strategy may be to take the risk and use the retirement accounts to pay for care. If the life expectancy is longer, the best strategy may be to simply pay the tax and transfer the after-tax assets to the DASNT.

Tax Considerations

• Income. The income generated by a DASNT is taxed to the beneficiary.

• Gift.  There would be a gift from the grantor to the trust for gift tax purposes.
• Estate tax. The assets in the trust would be excluded from the estate of the grantor, but included in the estate of the beneficiary.

Estate Recovery

There would be no Medicaid estate recovery from the estate of the grantor, but there would be estate recovery from the estate of the beneficiary. Since the state requires a payback, then the payback would replace the estate recovery provisions. The payback would include all medical assistance paid to the beneficiary since birth.

Elective Share

Transfers of assets to a DASNT would be subject to elective share considerations. It is good practice for both spouses to contribute the assets to the DASNT.

Comparison Between DAT and DASNT

CONSIDERATION             DAT                                                       DASNT

Typical Grantor                Parent/Grandparent                             Parent/Grandparent

Typical Trustee                 Family Member (Non-Beneficiary)         Family Member (Non-Beneficiary)

Assets Available                Yes                                                              No

SSDI/Medicare                 Yes                                                              Yes

SSI/Medicaid                    No                                                               Yes

Transfer Penalty               No                                                               No

HEMS Standard               Yes                                                              No

SNT Standard                   No                                                               Yes

(1) 42 U.S.C. §1396p(c )(2)( B).

by Thomas D. Begley, Jr., CELA

The following chart compares the advantages and disadvantages of an outright transfer of assets and putting assets in a Children’s Trust.

by Thomas D. Begley, Jr., CELA

The following chart compares the advantages and disadvantages of an outright transfer of assets and putting assets in an Income Only Trust.

by Thomas D. Begley, Jr., CELA

An Income Only Trust can be designed as a grantor trust. The trust assets are unavailable for Medicaid, but there are some potentially significant tax benefits to the grantor. The Internal Revenue Code contains certain requirements for a grantor trust.[1] 

Income Tax. Income is taxed at the grantor’s individual tax rate, which is usually less than the trust’s compressed tax rate.

Capital Gains Tax. Capital gains tax treatment is maintained. This is particularly important if the trust is funded with a primary residence. The §121 exclusion from capital gains tax can be maintained. The trust must contain a provision that the trustee must allocate the gain on the sale of the home to principal and not to income.

The benefit of the capital gains tax can be achieved for non-home appreciated assets as well.

Gift Tax. An Income Only Trust can be designed in such a way that a transfer into a trust can be either a gift or not a gift. If the grantor desires that the transfer be considered a gift for tax purposes, a gift tax return would be filed based on the present value of the gift. This would be the value of the assets transferred, less the value of the grantor’s retained interest in the income stream.

Estate Tax. Since the trust is a grantor trust, the entire value of the estate would be included in the grantor’s estate for federal estate tax purposes.[2]

Because the assets are included in the estate of the grantor, the estate should receive a step up in tax basis as to trust assets to the fair market value of the assets as of the grantor’s death. To achieve the step up in basis, the trust should contain a limited power of appointment on death. In many cases, this is a significant advantage over outright transfers to children.

Estate Recovery. The assets in the Income Only Trust would not be subject to estate recovery in states having a probate definition of estate, but would be included in states having a broad definition of estate for estate recovery purposes.

[1] I.R.C. §§ 673–677.

[2] I.R.C. §§ 1014, 2036, 2038; Treas. Reg. §§ 1.1014-2(a)(3), (b).

by Thomas D. Begley, Jr., CELA

Purpose

Income Only Trusts are a means by which seniors transfer assets to a trust rather than to their children. Seniors tend to view transfers to trusts as protection, while they tend to view transfers to children as gifts. Trusts provide them with a sense of dignity and security.

Requirements

Income only trusts are permitted by OBRA-93.[1] They must be irrevocable. The trust instrument provides that the grantor or the grantor’s spouse receive all of the income from the trust, but has no access to principal.

Design of the Trust

In order to structure the trust as a Grantor Trust and to receive a step up in basis on death, practitioners often give the grantor a right to substitute and reacquire property and/or a limited power of appointment. The grantor can reserve the right to income, but the trust must absolutely prohibit any access to principal by the grantor or grantor’s spouse. The trust can permit the trustee to make distributions to third parties, such as children.

When Income Only Trusts are Useful

There are a number of reasons why transfers to an Income Only Trust should be considered in lieu of transfers to children. When transferring assets to the Income Only Trust, the grantor can retain the right to receive income. The principal will not be counted as an asset, but there will be a transfer of asset penalty if the transfer occurs during the five-year lookback period.

If the elderly parent transfers assets to children, rather than put them in a trust, certain risks must be anticipated. These risks can be avoided if the assets are put in a trust. The risks of an outright transfer include:

• Claims of creditors. The claims of the creditors of the adult children could be satisfied through the assets of the parent, if the parent makes outright transfers to the children.

• Matrimonial action. If a child to whom assets are transferred is subsequently divorced, the transferred assets may become subject to a claim of equitable distribution. While the law dictates that assets transferred from a parent to a child are not subject to equitable distribution, practitioners in the field of family law indicate that judges often find ways to give additional assets, other than the transferred assets, to the other spouse. In addition, the assets transferred could affect alimony or support rights or obligations.

• Bad habits. If a parent transfers assets to a child who is a gambler, a drug addict, an alcoholic, or a spendthrift, the assets may be squandered and no longer available to the parent.

• Death of Child. If the child dies holding the parent’s assets in the child’s name, the assets will likely pass by Will or Intestacy to the spouse or children of the deceased child.

• Capital Gains Tax. If a parent has highly appreciated assets and transfers them to children, the transfer is subject to carryover basis and will result in the children paying significant capital gains tax in the future. If the highly appreciated assets are transferred to an Income Only Trust, since the trust is a grantor trust and the assets will be included in the estate of the parent on death, the children will receive a “step up” in basis and will be able to avoid paying significant capital gains taxes.

Planning Considerations

Availability

The principal in the Income Only Trust would not be considered an available resource, but the income would be available to the recipient of the income.

Transfer of Asset Penalty

The problem with Income Only Trusts is that if money remains in the trust at the death of the grantor, it is subject to Medicaid estate recovery. If assets are distributed out of the trust during the lifetime of the grantor, there is a transfer of asset penalty. The transfer to the Income Only Trust would be subject to the Medicaid and Supplemental Security Income (“SSI”) transfer of asset penalties. There is an issue as to whether a transfer from an Income Only Trust is subject to transfer of asset penalties. New Jersey takes the position that a distribution of principal from an Income Only Trust to a third party constitutes a transfer of an income interest. The penalty is calculated by multiplying the annual income by the actuarial life expectancy of the income beneficiary and dividing by the divisor. In states with a broad definition of estate recovery that would include assets in a Living Trust, it is necessary to distribute assets from the Income Only Trust at the time of the Medicaid application.

No payback provision is required for an Income Only Trust.

Ideal assets to fund an Income Only Trust are appreciated assets. Retirement accounts are not suitable, because the income tax would have to be paid on the withdrawal of the assets prior to funding the trust.

Tax Consequences

An Income Only Trust can be designed as a grantor trust. The trust assets are unavailable for Medicaid, but there are some potentially significant tax benefits to the grantor. The Internal Revenue Code contains certain requirements for a grantor trust.[2]

• Income tax. Income is taxed at the grantor’s individual tax rate, which is usually less than the trust’s compressed tax rate.

• Capital gains exclusion for sale of principal residence. Capital gains tax treatment is maintained. This is particularly important if the trust is funded with a primary residence. The §121 exclusion from capital gains tax can be maintained and the beneficiary can receive a step-up in basis on the death of the grantor, if the property has not been sold during the lifetime of the grantor. The trust must contain a provision that the trustee must allocate the gain on the sale of the home to principal and not to income. The benefit of the capital gains tax can be achieved for non-home appreciated assets as well.

• Estate Since the trust is a grantor trust, the entire value of the estate would be included in the grantor’s estate for federal estate tax purposes.[3]

Estate Recovery

The assets in the Income Only Trust would not be subject to estate recovery in states having a probate definition of estate, but would be included in states having a broad definition of estate for estate recovery purposes, such as New Jersey.

Elective Share

State Medicaid agencies require that a Medicaid recipient who is predeceased by a spouse assert the Medicaid recipient’s right to an elective share against the estate of the predeceased spouse.[4] Failure to do so is considered a transfer of assets subject to the Medicaid transfer penalty rules. If an Income Only Trust for the benefit of the community spouse provides for distribution to the children on the death of the community spouse, then these assets, in most states, would be subject to the elective share provisions. The surviving Medicaid recipient would, therefore, have an obligation to assert his or her right to the elective share against the trust assets. Failure to do so would constitute a transfer for Medicaid eligibility purposes.

Funding the Income Only Trust

Ideally, the trust will be funded with the least amount of assets possible. In calculating how much to put in the trust, the client can carve out assets that can be used in the future for the following:

• Community Spouse Resource Allowance (CSRA)
• Spend down
• Key money to gain admission to a facility
• Any amount of money the client is willing to lose 

Good/Bad Assets for Funding Trust

• Ideal assets. Ideal assets to fund an Income Only Trust would include appreciated real estate, such as a primary residence or a vacation home, or appreciated securities. There are significant tax advantages in utilizing trusts for these assets as opposed to transferring outright to children.

• Bad assets. Bad assets to use in funding trusts include retirement accounts, deferred annuities, and government bonds with significant accumulated interest. The problem is the transfer of those assets would result in immediate income tax. To the extent possible, these assets should be left outside the trust.

[1] 42 U.S.C. § 1396p(d)(3)(B).

[2] I.R.C. §§ 673–677.

[3] I.R.C. §§ 1014, 2036, 2038; Treas.Reg. §§ 1.1014-2(a)(3), (b).

by Thomas D. Begley, Jr., CELA

Purpose

Income Only Trusts are a means by which seniors transfer assets to a trust rather than to their children. Seniors tend to view transfers to trusts as protection, while they tend to view transfers to children as gifts. Trusts provide them with a sense of dignity and security.

Requirements

Income only trusts are permitted by OBRA-93.[1] They must be irrevocable. The trust instrument provides that the grantor or the grantor’s spouse receive all of the income from the trust, but has no access to principal.

Design of the Trust

In order to structure the trust as a Grantor Trust and to receive a step up in basis on death, practitioners often give the grantor a right to substitute and reacquire property and/or a limited power of appointment. The grantor can reserve the right to income, but the trust must absolutely prohibit any access to principal by the grantor or grantor’s spouse. The trust can permit the trustee to make distributions to third parties, such as children.

When Income Only Trusts are Useful

There are a number of reasons why transfers to an Income Only Trust should be considered in lieu of transfers to children. When transferring assets to the Income Only Trust, the grantor can retain the right to receive income. The principal will not be counted as an asset, but there will be a transfer of asset penalty if the transfer occurs during the five-year lookback period.

If the elderly parent transfers assets to children, rather than put them in a trust, certain risks must be anticipated. These risks can be avoided if the assets are put in a trust. The risks of an outright transfer include:

• Claims of creditors. The claims of the creditors of the adult children could be satisfied through the assets of the parent, if the parent makes outright transfers to the children.

• Matrimonial action. If a child to whom assets are transferred is subsequently divorced, the transferred assets may become subject to a claim of equitable distribution. While the law dictates that assets transferred from a parent to a child are not subject to equitable distribution, practitioners in the field of family law indicate that judges often find ways to give additional assets, other than the transferred assets, to the other spouse. In addition, the assets transferred could affect alimony or support rights or obligations.

• Bad habits. If a parent transfers assets to a child who is a gambler, a drug addict, an alcoholic, or a spendthrift, the assets may be squandered and no longer available to the parent.

• Death of Child. If the child dies holding the parent’s assets in the child’s name, the assets will likely pass by Will or Intestacy to the spouse or children of the deceased child.

• Capital Gains Tax. If a parent has highly appreciated assets and transfers them to children, the transfer is subject to carryover basis and will result in the children paying significant capital gains tax in the future. If the highly appreciated assets are transferred to an Income Only Trust, since the trust is a grantor trust and the assets will be included in the estate of the parent on death, the children will receive a “step up” in basis and will be able to avoid paying significant capital gains taxes.

Planning Considerations

Availability

The principal in the Income Only Trust would not be considered an available resource, but the income would be available to the recipient of the income.

Transfer of Asset Penalty

The problem with Income Only Trusts is that if money remains in the trust at the death of the grantor, it is subject to Medicaid estate recovery. If assets are distributed out of the trust during the lifetime of the grantor, there is a transfer of asset penalty. The transfer to the Income Only Trust would be subject to the Medicaid and Supplemental Security Income (“SSI”) transfer of asset penalties. There is an issue as to whether a transfer from an Income Only Trust is subject to transfer of asset penalties. New Jersey takes the position that a distribution of principal from an Income Only Trust to a third party constitutes a transfer of an income interest. The penalty is calculated by multiplying the annual income by the actuarial life expectancy of the income beneficiary and dividing by the divisor. In states with a broad definition of estate recovery that would include assets in a Living Trust, it is necessary to distribute assets from the Income Only Trust at the time of the Medicaid application.

No payback provision is required for an Income Only Trust.

Ideal assets to fund an Income Only Trust are appreciated assets. Retirement accounts are not suitable, because the income tax would have to be paid on the withdrawal of the assets prior to funding the trust.

Tax Consequences

An Income Only Trust can be designed as a grantor trust. The trust assets are unavailable for Medicaid, but there are some potentially significant tax benefits to the grantor. The Internal Revenue Code contains certain requirements for a grantor trust.[2]

• Income tax. Income is taxed at the grantor’s individual tax rate, which is usually less than the trust’s compressed tax rate.

• Capital gains exclusion for sale of principal residence. Capital gains tax treatment is maintained. This is particularly important if the trust is funded with a primary residence. The §121 exclusion from capital gains tax can be maintained and the beneficiary can receive a step-up in basis on the death of the grantor, if the property has not been sold during the lifetime of the grantor. The trust must contain a provision that the trustee must allocate the gain on the sale of the home to principal and not to income. The benefit of the capital gains tax can be achieved for non-home appreciated assets as well.

• Estate Since the trust is a grantor trust, the entire value of the estate would be included in the grantor’s estate for federal estate tax purposes.[3]

Estate Recovery

The assets in the Income Only Trust would not be subject to estate recovery in states having a probate definition of estate, but would be included in states having a broad definition of estate for estate recovery purposes, such as New Jersey.

Elective Share

State Medicaid agencies require that a Medicaid recipient who is predeceased by a spouse assert the Medicaid recipient’s right to an elective share against the estate of the predeceased spouse.[4] Failure to do so is considered a transfer of assets subject to the Medicaid transfer penalty rules. If an Income Only Trust for the benefit of the community spouse provides for distribution to the children on the death of the community spouse, then these assets, in most states, would be subject to the elective share provisions. The surviving Medicaid recipient would, therefore, have an obligation to assert his or her right to the elective share against the trust assets. Failure to do so would constitute a transfer for Medicaid eligibility purposes.

Funding the Income Only Trust

Ideally, the trust will be funded with the least amount of assets possible. In calculating how much to put in the trust, the client can carve out assets that can be used in the future for the following:

• Community Spouse Resource Allowance (CSRA)
• Spend down
• Key money to gain admission to a facility
• Any amount of money the client is willing to lose

Good/Bad Assets for Funding Trust

• Ideal assets. Ideal assets to fund an Income Only Trust would include appreciated real estate, such as a primary residence or a vacation home, or appreciated securities. There are significant tax advantages in utilizing trusts for these assets as opposed to transferring outright to children.

• Bad assets. Bad assets to use in funding trusts include retirement accounts, deferred annuities, and government bonds with significant accumulated interest. The problem is the transfer of those assets would result in immediate income tax. To the extent possible, these assets should be left outside the trust.

[1] 42 U.S.C. § 1396p(d)(3)(B).

[2] I.R.C. §§ 673–677.

[3] I.R.C. §§ 1014, 2036, 2038; Treas.Reg. §§ 1.1014-2(a)(3), (b).