Problems with Outright Gifts in the Medicaid Planning Context
An Irrevocable Trust Is Sometimes a Better Planning Maneuver Than an Outright Gift.
There are several problems with outright gifts in the Medicaid planning context that can lead to the recommendation of the use of an irrevocable trust. Below are a few of these problems.
(1) Appreciated Assets
Clients are often concerned about leaving behind the greatest possible inheritance, yet they are unaware of the consequences of making gifts of appreciated assets. Upon a gift, the transferees receive a carryover basis (i.e., will be treated for capital gains tax purposes upon a subsequent sale as if the transferees had purchased the asset for the same price at which the client had purchased it, plus capital improvements, if applicable). Thus, any gift of appreciated assets is also a gift of a possible capital gains tax. If a trust (or other legal device, such as a gift of real estate with a reserved life estate) is structured so that the assets of the client are subject to estate taxation, the transferees would then receive a step-up in basis (i.e., the transferees would be treated for capital gains tax purposes, upon any sale occurring after the death of the client, as if the transferees had purchased the asset from the estate at its fair market value as finally determined for estate tax purposes). Thus, by use of an irrevocable trust which causes assets to be subject to estate taxation, the transferees would in all likelihood not be liable for any capital gains taxes upon a sale immediately after the death of the client. This result will occur even if the client’s gross estate is less than $1,000,000.00 and no federal or Massachusetts estate taxes would thereby be due. Further, this result is often of greater benefit to the transferees than the avoidance of a minimal level of estate taxation.
(2) Fear of Complete Loss of Control
The most obvious situation where an outright gift would not be feasible is where the client does not wish to lose control over the assets, due to the desire to maintain control over his or her own destiny. If the lawyer begins with the premise that estate taxation is not undesirable, an irrevocable trust can be drafted to give the Donor a degree of reserved control.
(3) Transferees of Unequal Financial Abilities or Situations
The client may wish to treat all of his or her children (or other transferees) equally, and may not wish to make any gifts unless treatment is exactly equal. The problem the client may have is that either the investment prowess of the transferees or their ability to segregate and maintain the transferred assets may be questionable. The issue of a transferee’s spouse meddling into these affairs can also be a concern in this regard. With such client concerns, a trust would be appropriate in that one or more of the transferees who will handle investment and managerial responsibilities better than the others can become the trustee(s). By use of an irrevocable trust, then, the client can feel secure that the assets will be managed properly and for such person’s benefit during such person’s lifetime, and after such person’s death whatever assets remain will be distributed equally to all of such person’s children.
A child who has children going to college may find that an outright gift interferes with possible financial aid.
Upon a conveyance of real estate subject to the Donor’s reserved life estate, any attempted sale, mortgage or other conveyance of the real estate would require the signature of the life tenant, or someone acting in a fiduciary capacity or under a durable power of attorney on behalf of the life tenant. Further, a particular person would not be empowered to make any decisions or expend any funds with regard to upkeep of and improvements to the property. By way of contrast, placing the home into an irrevocable trust could allow the trustee to take any action with respect to the property without any action required by the Donor or someone acting on behalf of the Donor and without obtaining the agreement of all of the remainderpersons.
(4) Possible Bankruptcy of or Other Lawsuit Against Transferee
The client may be concerned that if the transferees are sued for any reason, the assets could be lost. Such a concern can be especially valid where one or more of the transferees own their own businesses or otherwise engage in risky endeavors. Whereas an outright gift could thereby cause the assets to be lost, a properly drafted irrevocable trust would shield the assets from the bankruptcy, or any lawsuit against, any transferee, even if the transferee is a trustee of the trust.
A transferee may have marital problems, and the client may be concerned that a divorce is imminent. In such a case the client is often concerned that the assets will become part of the marital estate for purposes of equitable division. The use of a trust will obviate the possibility of the assets being treated as part of the marital estate of a transferee, even if the transferee is a trustee.
(5) Possible Death of Transferee
The client may be concerned that if one of the transferees dies before the client, the assets will end up being inherited by others who would not feel morally compelled to use these assets for the benefit of the client. Due to this concern, gifts can create a need for the transferees to have their wills redrafted. The intention of such redrafted wills may not be fulfilled if the will is successfully contested or a disgruntled spouse files a waiver of it. The client could therefore be left with little or nothing back from a predeceased transferee. The use of an irrevocable trust obviates this problem, and may be more economical where several transferees exist.
A further problem which could be caused by a transferee predeceasing the client is that gifted assets would be taxable in the estate of the transferee, and estate taxes may be payable out of these transferred assets. A properly drafted irrevocable trust obviates this problem also.
(6) Income Taxation
Because a client who is concerned about nursing home costs is usually retired, he or she is often in a lower income tax bracket than his or her children. A gift, then, could cause the income from the transferred assets to be subject to a higher level of income taxation, as well as lose capital gains tax benefits which the client might have had upon a later sale of the home.
(7) Capital Gains Taxation on Sale of Home
Under Internal Revenue Code section 121, a homeowner can sell his or her home and pay no capital gains tax on the first $250,000.00 of appreciation. A gift to the children results in their having ownership interests that do not qualify for this capital gains exclusion, whereas a transfer of the home to a properly drafted irrevocable trust can result in the retention of the ability to use this exclusion.
For more information about this topic, see MassHealth.info, which has blog posts in the following categories that are relevant to this article: Gifts and Disqualifying Transfers, Irrevocable Trusts, Protecting the Home and Tax Issues.