June 29, 2023

Elder Law Benefits

I. Impact of Medicaid Requirements in Drafting Trusts

Medicaid rules differ from the various types of trusts. Below are the three (3) different types of trusts and the impact of Medicaid requirements for each:

1. Revocable Trusts

According to 18 NYCRR §360-4.5(b)(2), the trust principal and income of a revocable trust must be considered an available resource. Payments made from a revocable trust to or for the benefit of the applicant/recipient must be considered to be available income in the month paid.

2. Irrevocable Trusts

Irrevocable Trusts created by an applicant/recipient are governed under 18 NYCRR §360-4.5(b)(1). Availability of assets held in an irrevocable trust to an applicant/recipient depends on the trustee’s authority, under the specific terms of the trust agreement, to make payments to or for the benefit of the applicant/recipient.

Any portion of the trust principal, and of the income generated by the trust principal, from which no payments may be made to the applicant/recipient under any circumstances, must be considered to be assets transferred by the applicant/recipient for purposes of the transfer of assets rules (transfer subject to 60 month look back period and will create a penalty period for applicant/recipient).[1]

Any portion of the trust principal, and of the income generated from the trust, which can be paid to or for the benefit of the applicant/recipient, under any circumstances, must be considered to be an available resource. [2]

Payments made from the trust to or for the benefit of the applicant/recipient must be considered to be available income in the month paid.[3]

3. Testamentary Trusts 

Testamentary Trusts are trusts that are created under a Will and deemed a third party trust. Social Services districts are authorized, but not required, to commence court proceedings on behalf of applicant/recipients who are beneficiaries of third party trusts, seeking to compel the trustee to use trust assets to pay for necessary medical care.[4]

Based on 18 NYCRR §360-4.5(c), payments made from a testamentary trust to the applicant or recipient are available income in the month received. Neither the principal of such a trust nor any in-kind benefits received by the applicant or recipient as a result of disbursements from the trust will be counted as or deemed to be an available resource for purposes of determining eligibility for Medicaid purposes.

Careful consideration of Medicaid rules is important in drafting testamentary trusts such as Credit Shelter Trusts and Marital QTIP trusts since distributions may be considered available income to the surviving spouse.

4. Drafting Recommendations for Irrevocable Trusts

When drafting irrevocable trusts for Medicaid purposes, the following trust terms should be considered:

 – Net income from the trust to or for the benefit of the Grantor.

 – Absolutely no principal distributions from the trust to Grantor.

 – Ability for the Grantor to remove and replace Trustees

 – EPTL §7-1.6(b) allows principal to be distributed to any income beneficiary whose support or education is not sufficiently provided for, whether or not such person is entitled to the principal of the trust, unless otherwise provided in the disposing instrument. The trust instrument should specifically state EPTL §7-1.6(b) shall not apply.

 – Include ability for Grantor to reside in house to maintain New York STAR and Veteran’s benefits.[5]

 -Add Power of Substitution for Grantor Trust status of corpus (IRC §675-4).

 – Include inter vivos Limited Power of Appointment during the Grantor’s lifetime and/or Testamentary Power of Appointment.

The courts in Spetz v. New York State Dep’t of Health, 737 N.Y.S.2d 524 (Sup. Ct., Chautauqua Co., Jan. 15, 2002), and Verdow v. New York State Dep’t of Health, 209 F.R.D. 309 (N.D.N.Y. 2002) ruled that assets held in an irrevocable trust created by a Medicaid applicant or his/her spouse can not be considered an available resource based on the grantor’s retention of a Limited Power of Appointment. [6]

Both courts rejected the argument that since EPTL §7-1.9 allows any trust to be revoked with the consent of all beneficiaries, the retention of a power to remove beneficiaries would allow the applicant to exercise control over the beneficiaries and therefore over the trust itself. [7]

In addition, the courts held that absence evidence of bad faith or fraud, assets in an irrevocable trust cannot be considered available to the applicant based on the remote possibility of collusion among the grantor, the trustee and the beneficiaries. [8]

II. Trust Taxation 

1.        Simple Trust

A simple trust requires all income to be distributed annually to named beneficiaries. Income of the trust is taxable to recipient (IRC §641, §651 and §652).

A Taxpayer Identification Number (TIN) and Form 1041 are always required to be filed.

2. Complex Trust

A complex trust does not require all income to be distributed annually. The trust provides that income may be distributed to beneficiaries or accumulated.   Income of the trust is taxable to recipient to the extent distributions are received (IRC §641, §661 and §662).

           Typical Complex Trusts:

 – Generation Skipping Transfer Trust:  A trust created for the benefit of a skip person. The trust is usually a Complex Trust; IRC §2642(a) for Crummey notice. A TIN and Form 1041 are always required under general method.

 – Education/2503(c) Minor Trust: A trust that receives gifts equal to the annual exclusion amount by the Grantor for the benefit of a beneficiary under age of 21. Trust property may be expended for the benefit of the minor; any remaining balance must be distributed to minor at age 21. Grantor utilizes annual exclusion under IRC §2503(b) for gifts to trust. No Crummey  notice is needed to satisfy present interest requirement. Trust is not treated as a Grantor Trust. A TIN and Form 1041 are always required under general method.

 – Testamentary Trust (Non-QTIP):  A trust that is created under a will. A TIN is always required under general method.

3. Grantor Trust

A grantor trust is a trust in which all items of income, gain, loss or deduction will be reported on the grantor’s personal income tax return.[9]

• 671: Where the grantor is treated as the owner of any portion of a trust, items of income, deductions and credits of the trust which are attributable to that portion of the trust are taken into account in computing taxable income of the grantor.

• 672: Definitions and Reporting

a. Adverse Party: Substantial beneficial interest

b. Nonadverse Party: Anyone not an adverse party

c. Related or Subordinate Party: any nonadverse party who is the Grantor’s spouse (if living with the grantor), Grantor’s father, mother, issue, brother or sister; an employee, a corporation or any employee of a corporation in which the stock holdings of the grantor and the trust are significant from the viewpoint of voting control, or a subordinate employee of a corporation in which the grantor is an executive.

• 673: Reversionary Interests: The grantor shall be treated as the owner of any portion of a trust in which he has a reversionary interest in either the corpus or the income, if, as of the inception of that portion of the trust, the value of such interest exceeds 5% of the value of such portion.

• 674: Power to control beneficial enjoyment: Grantor is treated as the owner of any portion of a trust if the beneficial enjoyment of the corpus or income is subject to a power of disposition excercisable by the grantor, a nonadverse party, or both, without the approval of consent of any adverse party.

•  675: Administrative Powers: Grantor is treated as the owner of any portion of a trust in respect of which:

 1. Power to deal for less than adequate and full consideration

2. Power to borrow without adequate interest or security

3. Borrowing of the trust funds

4. General Powers of administration: Power to vote; power to control investment of trust funds; power to reacquire trust corpus by substituting other property of equivalent value

•  676: Power to Revoke:  Grantor shall be treated as the owner of any portion of a trust where at any time the power to reinvest in the grantor title to such portion is exercisable by the grantor or a nonadverse party or both.

• 677: Income for Benefit of Grantor:  Grantor shall be treated as the owner of any portion of a trust whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be

 1. Distributed to the grantor or grantor’s spouse

2. Held or accumulated for future distribution to the grantor or the grantor’s spouse

3. Applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse

• 678: Person other than Grantor treated as Substantial Owner:  a person other than the grantor shall be treated as the owner of any portion of a trust with respect to which:

 1. Such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself; or

2. Such person has previously partially released or otherwise modified such a power and after the release or modification retains such control as would, within the principles of sections 671-677 subject to grantor of a trust to treatment as the owner thereof

According to Treas. Reg. §1.671-4(a) General Reporting Requirements, the Trustee of a Grantor Trust must file Form 1041 and provide grantor with statement. However, Treas. Reg. §1.671-4(b) Reporting Requirements provides Alternate Method (on wholly owned):

 1. If grantor is also Trustee:  Grantor must complete W-9 and information to banks for issuing 1099 (using grantor’s Social Security Number)

2. If grantor is not a Trustee: Must comply with #1 PLUS the Trustee must give grantor statement each year with income, deductions and credits; or the Trustee gives 1099 to grantor and file with IRS

Types of Grantor Trusts:

 – Revocable Trust:  Grantor Trust under IRC §676 per se. As such, ignored for federal income tax purposes during Grantor’s lifetime. No EIN for trust is necessary if Grantor is the sole Trustee or a Co-Trustee. If the Grantor is a sole Trustee or Co-Trustee, it is permissible to use the Grantor’s Social Security Number. No 1041 is required to be filed unless the trust is a joint revocable trust and married filing separately. If the Grantor is not a Trustee of the trust, then an election can be made to use the Grantor’s Social Security Number (such election is not automatic) or if election is not made, then an EIN is required. Upon the death of the Grantor, the trust becomes a complex trust. An EIN will be required upon death of the Grantor or if Grantor has multiple revocable trusts.

– Irrevocable Life Insurance Trust:  The irrevocable life insurance trust is the owner and beneficiary of one or more life insurance policies in order to remove the insurance proceeds from the taxable estate of the Grantor upon his death. Grantor gifts to trust each year for premium costs. Grantor utilizes annual exclusion amount under IRC §2503(b) for gifts to trust (as long as trust provides for Crummey powers for the present interest requirement). Grantor Trust under IRC §677 as to income. Grantor Trust to principal if IRC §675-4 power included. A TIN and Form 1041 are always required under general method.

– Intentionally Defective Grantor Trust: A trust purposely created as a Grantor Trust for income tax purposes. Grantor Trust under IRC §675 (also see Rev. Rul 2004-64, 2004-2; and Rev. Rul 2008-16). A TIN and Form 1041 are always required under general method.

– Beneficiary Defective Grantor Trust: A beneficiary of the trust is treated as the Grantor for income tax purposes. Grantor Trust to beneficiary under IRC §678(a). A TIN and Form 1041 are always required under general method.

 – Asset Protection Trust:  A self-settled trust which provides for funds to be held on a discretionary basis for the benefit of the beneficiary to prevent attack of trust property from future creditors and predators. Not applicable in New York. Grantor Trust under IRC §677(a)(2) as to income and IRC §675-4 as to principle and possibly IRC §674 due to Special Power of Appointment. No gift by Grantor because of Special Power of Appointment under Treas. Regs. §25.2511(2)(b). A TIN and Form 1041 are always required under general method.

– Qualified Personal Residence Trust:  Grantor gifts title to real property into a Qualified Personal Residence Trust (QPRT) and retains right to live in property for a fixed term. Upon expiration of fixed term, the property is removed from the estate of Grantor. Gift made to QPRT requires gift tax return to be filed. During fixed term, Grantor Trust under IRC §677 as to income and IRC §673(a) as to principal. Upon expiration of fixed term, possibly a Grantor Trust depending on the terms of the QPRT. A TIN and Form 1041 are always required under general method.

– Grantor Retained Annuity Trust:  Grantor gifts assets into Grantor Retained Annuity Trust (GRAT). Grantor receives annual payment from the trust for a fixed term. Upon expiration of term, remaining trust property distributed to beneficiary of trust. Gift made to GRAT requires gift tax return to be filed. During fixed term, Grantor Trust under IRC §677 as to income and IRC §673(a) as to principal. Upon expiration of fixed term, possibly a Grantor Trust depending on the terms of the GRAT. A TIN and Form 1041 are always required under general method

– Self-Settled Supplemental Needs Trust:  A trust which is designed to preserve government benefits a beneficiary may be receiving as a result of a disability. Tax Treatment:  If self-settled trust, then Grantor Trust. A TIN and Form 1041 are always required under general method. If third party trust, the trust will be treated as a non-Grantor Trust.

– Medicaid Trust:  A self-settled trust created to shield assets from Medicaid (pursuant to Federal law). Grantor Trust under IRC §677 and possibly IRC §675. No gift by Grantor because of Special Power of Appointment under Treas. Regs. §25.2511(2)(b). A TIN and Form 1041 are always required under general method.

 III. Income Tax Traps with Gifts and Too Much Qualified Retirement Money

 1. Gift Tax

Gift Tax is a tax on the transfer of property by one individual to another for less than full value. According to Treas. Regs. §25.2511-2(b), the gift is complete when the donor has parted with dominion and control as to leave him no power to change its disposition, whether for his own benefit or for the benefit of another. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be incomplete. Therefore, if the Grantor retains a testamentary or special power of appointment, the gift is incomplete.

Currently the Federal lifetime gift tax exemption for 2012 is $5,120,000[10] and the gift tax rate is 35%. In 2013, lifetime gift tax exemption and gift tax rate will default to $1 million exemption and 55% gift tax rate. New York State gift tax was repealed as of January 1, 2000.

Recently In re John Does, 2011 WL 6302284 (E.D. Cal. Dec. 15, 2011), a California Federal Judge granted the Department of Justice a summons requiring California Board of Equalization to provide information on property transfers from parents to children and grandparents to grandchildren, for little or no consideration between 2005 and 2010 in which the parties may not have filed Form 709 and paid Federal gift tax.

2. Treatment of Retirement Accounts

 IRAs and any qualified retirements accounts will not be counted as resources (Matter of Arnold S., Case #MA0582399, April 9, 2002). Before Arnold S., IRAs and qualified retirement plans were available for Medicaid purposes, therefore applicant had to liquidate retirement account, pay income tax and “rule of halves” with net remaining. If Medicaid applicant is privately paying, may be beneficial to liquidate IRA and pay income tax.

IV. Tax Planning to Avoid Risking Medicaid Eligibility

 1. Planning to avoid risking Medicaid eligibility is analogous to oil and water. Since the New York State estate tax exemption is currently $1 million, clients with an estate valued between $1 and $3 million must consider both.

Medicaid Trusts are generally includible in the Grantor’s estate under IRC §2036 due to the Grantor’s right to income from the trust property. Specifically, IRC §2036 states the value of the gross estate shall include the value of all property to which the decedent has retained the possession or enjoyment of, or the right of the income from the property. In order to avoid inclusion in the Grantor’s estate, consider the following drafting recommendations:

 – No Limited Power of Appointment

– No income to Grantor

– Grantor can retain ability to change trustees, however, limit to IRC §672(c). In Estate of Wall, 101 T.C. 300 (1993), the grantor’s ability to remove the corporate trustee and appoint a successor corporate trustee did not cause the trust property to be includible in the grantor’s estate.

– Avoid legal and funeral expenses from trust assets

– Include Power to Substitute in trust to retain Grantor Trust status (Revenue Ruling 2008-22; and Revenue Ruling 2011-28).

– Transfer residence to Qualified Personal Residence Trust (QPRT) with a term of five (5) years or more

– Create testamentary trust without standard spousal access (i.e. HEMS and 5&5 Power).

2. Common mistakes made by clients which affect Medicaid eligibility are as follows:

– Charitable Planning. There is no exception for charitable gifts. A gift to a charitable organization would affect Medicaid eligibility.

– College/Education Tax Deferred 529s:  No exception for gifts to 529s plan. A gift to a 529 plan would disqualify applicant for Medicaid benefits.

– Beneficiary Defective Trusts: Any gifts made by parents to initially fund a Beneficiary Defective Trusts for their children would affect Medicaid eligibility for the parent.

[1] 18 NYCRR §360-4.5(b)(1)(i)

[2] 18 NYCRR §360-4.5(b)(1)(ii)

[3] 18 NYCRR §360-4.5(b)(1)(iii)

[4] 96 ADM-8

[5] Office of Real Property Services, Counsel Opinion SBRPS No. 44

[6] GIS 04 MA/001

[7] GIS 04 MA/001

[8] GIS 04 MA/001

[9] IRC §671-677

[10] 26 U.S.C. §2505(a)

Circular 230 Disclosure: 

*** The Treasury Department has newly promulgated Regulations effective June 20, 2005, that applies to those attorneys and accountants (and others) practicing before the IRS that require such individuals to provide extensive disclosure in certain written communications to clients.  In order to comply with our obligations under these Regulations, we want to inform you that since this communication is not intended to and does not contain such disclosure, you may not rely on any tax advice contained in this document to avoid tax penalties.