Medicaid eligibility rules. .

This two-part article provides a road, map to current Medicaid eligibility law. Part II, below, describes a variety of planning strategies and opportunities to help a tax adviser counsel elderly individuals and married couples, as well as concerned members of their families. It also discusses various pitfalls, including state law variations to which advisers must be attuned.

This two-part article provides an analysis of Medicaid eligibility rules and planning techniques. Part I, in the May 2003 issue, examined the critical rules on timing a Medicaid application, transferring assets to trusts to preserve family wealth and understanding the tax consequences of asset transfers and the potential liability of the Medicaid applicant's adviser. Part II, below, considers several other strategies available to protect an individual's assets in the event of Medicaid assistance, and a number of additional techniques particularly suitable for married couples.

Planning Techniques for Singles

Converting to Exempt Assets

By converting nonexempt assets (such as cash) into exempt assets, an individual can protect his or her assets from being deemed "resources" that will restrict Medicaid eligibility. Under 42 USC Sections (Sections) 1396r-5(c)(5) and 1382b(a), an individual's exempt assets include, among other items:

* A residence;

* Household goods;

* Personal effects;

* An automobile;

* A burial space;

* Tools of wade;

* Certain resources of a blind or disabled person; and

* Insurance policies with a cash value of less than $1,500.

Exempt assets are categorized by both Federal and state law, so the specific exemptions and amounts vary from state to state.

An individual can convert liquid assets into an exempt residence asset without having to buy a more expensive new home. For example, he or she can improve a residence by installing a new roof, heating or air conditioning system, kitchen or bathroom. He or she can also make repairs or pay down the mortgage.

In addition, the individual can purchase other exempt property (e.g., an automobile or a burial plot). Some states, however, limit the value of the exempt automobile to a set amount. Also, an individual can prepay bills (e.g., expenses for estimated income taxes, real estate taxes, insurance premiums or utilities). However, the true value of exempt property is reduced by the real possibility of collection by the state from a Medicaid recipient's estate.

Using a Split Transfer

A split transfer (a "50/50" split) offers a way for an individual to shorten his or her ineligibility period without having to gift away all of his or her property before the 36-month lookback period. Because most individuals cannot anticipate that they will need nursing home care 36 months in advance, they do not want to make large gifts based on the mere possibility of a need for future nursing home care. More commonly, individuals discover that they need Medicaid assistance when they have fewer than 36 months in which to accomplish their Medicaid planning.

Under the 50/50 split-transfer strategy, the prospective Medicaid applicant gifts half of his or her property during the 36-month lookback period, and retains the other half. The gift counts toward calculating the ineligibility period. The applicant then "spends down" the retained assets. In most cases, the ineligibility period will be half of what it would have been had the applicant gibed his or her entire property.

Example 1: L lives in a state in which the monthly cost for a nursing home is $4,000. He has $240,000 in assets. He made a gift to his daughter, M, of $120,000 on June 1, 2002. L applied for Medicaid on May 1, 2003. The gift to M is within 36 months, and counts in calculating L's ineligibility period, which is $120,000/$4,000 = 30 months from June 1, 2002. L uses the remaining $120,000 of his assets to pay for his nursing home care during the 30-month ineligibility period.

Example 2: The facts are the same as in Example 1, except, on June 1,2002, L spent the remaining $120,000 to pay off his mortgage. L executed a will leaving his house to M. He applied for Medicaid on May 1, 2003. The gift to M is within 36 months, and counts toward his ineligibility period, which is $120,000/$4,000 = 30 months from June 1, 2002. When L dies, M will inherit the house without any mortgage.

If L had instead gibed $240,000 to M on June 1, 2002, his ineligibility period would have been $240,000/$4,000 = 60 months from June 1, 2002, and M would have inherited a house subject to a $120,000 mortgage. M's net inheritance is the same, because the mortgage liability offsets the extra funds. By using a split transfer, L can cut his ineligibility period in half. From the $120,000 M received, she pays for L's nursing home care only during the period of ineligibility, through Nov. 30, 2004 rather than May 31, 2007.

The split-transfer technique is a conservative approach that offers a substantial savings in assets (net of medical care expenses) available to pass on to heirs. However, the 50/50 formula will often need to be adjusted to account for increases in nursing home costs and other factors, including any income an individual receives.

Compensating Family Members for Caregiving

Many families try to shift assets from the prospective Medicaid applicant to other family members as compensation for prior services (such as providing care). An individual can pay reasonable compensation to family members for providing care, but the debt must be a valid one. A New York court (16) denied the expense when a debt was a sham arrangement to transfer funds away from the Medicaid applicant, and it did not have the indicia of a bona fide loan. However, a Connecticut court permitted an expense when the individual and his relative had a valid written agreement to pay for the care. (17)

Generally, such an arrangement is embodied in a written contract that may provide either for periodic payments or a lump-sum payment to a caregiver. A lump-sum payment under such a contract is not subject to either or estate tax, but the caregiver must pay income tax on the payment.

Protecting the Home

An individual's home often represents the bulk of his or her savings over a lifetime. As was noted above, although a residence is an exempt asset excluded from calculating Medicaid eligibility, a state can impose a lien on an individual's residence for Medicaid expenses paid, but not if the individual reasonably intends to return home. For an individual residing in a nursing home who requires constant care, the state may argue under Section 1396p(a)(1)(B)(ii) that the individual cannot reasonably expect to return home. (18)

Example 3: E owns a home. She broke her hip While descending the basement stairs. As part of her recovery, she resides in a nursing home. E's hip does not fully heal, making it difficult for her to get up and down the stairs in her home. M, E's recently divorced daughter, who is over 21 and not disabled, moves into the home while E is in the nursing home. M has a job that permits flexible hours. E may argue she can reasonably expect to return home, because M is available to help her up and down the stairs.

Example 4: N, a former marathon runner, is troubled by arthritis and knee injuries as she ages. She anticipates she may have to go to a nursing home next year. N persuades her brother, B, to move into her home. B pays N fair market value for a one-fourth equity interest in the home. N spends the cash received from B for a new kitchen, bathroom and roof. N has converted the cash into an exempt asset. One year later, when N enters a nursing home, B will have lived in the home for one year and will have an equity interest. The state cannot impose a lien on the home.

Using a Power of Attorney

One of the simplest devices for Medicaid (or any estate) planning is a financial power of attorney (POA), in which an individual (the principal) designates another person (an attorney-in-fact) to act in his or her place for financial purposes. A POA may be limited to a specified action and/or period or it may last for the rest of the principal's life. In any case, it ceases to operate no later than the principal's death. The POA language should grant specific powers, not just general powers. Often, institutions insist on a specific power before acting as directed by an attorney-in-fact.

For Medicaid planning, a well-drafted financial POA should give the attorney-in-fact the specific power to make gifts and otherwise plan for the estate. For example, the attorney-in-fact should have the power to make maximum use of the $11,000 per-year gift tax exclusion and to transfer assets before the 36-month lookback period. In some circumstances, as discussed earlier, a gift during such period will also be beneficial.

It is very important for the individual to state his or her intention to continue to use the residence and to return to it if ever institutionalized. Under Section 1396p(a)(1)(B), the individual's residence is exempt from Medicaid liens as long as an institutionalized person intends to return home and the state fails to prove otherwise. The POA is one way an individual can state such intention.

In addition to the more general financial POA, another useful estate planning tool is a healthcare POA.

Disclaiming and/or Disinheriting Property

A disclaimer is a written statement by a prospective heir (or devisee) that he or she does not want to inherit property. The decedent's property is then distributed as if the prospective heir had predeceased the decedent. This method is often used to pass property from an individual in a high estate and girl: tax bracket to a lower-bracket individual.

Under Section 1396p(e)(1)(A), an individual's assets include "any income or resources which the individual or such individual's spouse is entitled to but does not receive because of action by the individual or such individual's spouse." As a result, Medicaid counts any disclaimed property as an individual's available assets. Similarly, a will that disinherits an institutionalized spouse will also cause an ineligibility period for Medicaid purposes. Thus, a disclaimer or disinheritance is generally not effective for Medicaid planning. One possible way to mitigate this problem may be for the "community spouse" (19) to leave the "institutionalized spouse" only the statutory minimum share. In any event, the adviser should assess whether the beneficial estate and gift tax effects of a disclaimer or disinheritance outweigh the effect on Medicaid eligibility.

Retaining a Life Estate in Real Property

A life estate in real property is a type of ownership in which a life tenant owns the property during his or her life and a remainder interest holder owns the property free and clear on the life tenant's death. The creation of a life estate is a transfer subject to the 36-month lookback period.

Example 5: P, a 70-year old, owns a house worth $200,000. P transfers a remainder interest in the house to his children, S and D, and retains a life estate. The remainder interest is valued by actuarial tables at $72,000. P has made a transfer of $72,000 subject to the Medicaid 36-month lookback period. On P's death, S and D receive a stepped-up basis in the house for tax purposes.

As the above example shows, an individual may be better off maintaining the home as an exempt asset, rather than carving out a life estate. However, unlike the home itself, the life estate may not be subject to a Medicaid lien or estate recovery on the Medicaid recipient's death.

* Deducting Medical Expenses

Another approach is for a potential Medicaid applicant to transfer all of his or her assets to a family member on the condition that the latter use those assets to pay for the applicant's eventual nursing home costs. The family member can then deduct those costs as a medical expense, assuming he or she pays more than half of the nursing home resident's support and the claimed medical expenses exceed 7.5% of adjusted gross income. The potential benefit of this approach to the donee family member is even greater if the Medicaid applicant can delay becoming institutionalized, resulting in a shorter penalty period.

Using a Life Insurance Trust

A life insurance trust is an irrevocable trust that owns a life insurance policy on an individual's life. The policy benefits are usually payable to the trust; the trust grantor usually designates the beneficiaries. If a Medicaid applicant owns a life insurance policy on his or her life, he or she can transfer the policy to a life insurance trust to insulate the proceeds from Medicaid recoupment.

Example 6: Q owns a life insurance policy on his life with a $200,000 face value and a, $10,000 cash surrender value. He transfers the policy to an irrevocable life insurance trust 60 months before applying for Medicaid. Q receives Medicaid for several years, and the state obtains a $150,000 lien against Q's estate. Q dies, leaving an estate of $4,000. The life insurance proceeds pass outside Q's estate, and are probably not subject to a Medicaid lien.

If an individual creates a life insurance trust at least 60 months before applying for Medicaid, he or she can use a life insurance policy, together with an irrevocable trust, to transfer a significant amount of money to heirs.

Planning Techniques for Married Persons

The planning techniques for married persons include all of the techniques for single persons, plus others described below.

Maximizing the CSRA 

The maximum amount of assets that a community spouse may retain is called the community spouse resource allowance (CSRA).The CSRA varies by state, from a minimum of $18,132 to a maximum of $90,660 in 2003. Under Section 1396r-5(g), this figure is tied to the Consumer Price Index and is adjusted annually.

Under Section 1396r-5(f)(2) and (g), the community spouse may retain up to one half of the couple's assets, but not more than the state's CSRA and not less than the $18,132 Federal minimum. Some states, such as Alaska, California, New York and North Dakota use $90,660 as the minimum, which is the highest minimum permitted (i.e., in these states, the minimum is the same as the maximum). The adviser should determine the CSRA figure for the state in which he or she is located.

Under Section 1396r-5(f)(2) and (g), the CSRA is calculated by taking the greatest of (1) the minimum set by the state; (2) the lesser of $90,660 or one half of the couple's total nonexempt assets; or (3) the amount transferred by a court order or established by a fair hearing.

Example 7: H has nonexempt assets of $100,000 and W has nonexempt assets of $70,000. The CSRA is calculated as follows: (1) the state minimum is $90,660; (2) the lesser of $90,660 or one half of the couple's nonexempt assets is $85,000 ($170,000/2); (3) there is no amount transferred by a court order or fair hearing. The greatest of these amounts is $90,660, which is the CSRA.

Any excess resources over the CSRA are considered Medicaid available under Section 1396r-5(c). Exempt assets are not counted.

According to 20 CFR Section 416.1202(a), the IRA and Keogh accounts of one spouse are generally not considered resources available to the other spouse. However, the New Jersey Supreme Court has held, in spite of this regulation, that a husband's IRA is a countable asset for the purpose of determining his wife's Medicaid eligibility when the wife enters a nursing home, but the husband remains in the community. (20) Retirement funds are generally not countable assets if the retiree can elect either a lump sum or a periodic payment and he or she elects the latter.

Several strategies exist for maximizing the amount of assets in the "snapshot" of each spouse's assets taken on the institutionalized spouse's first day of care. One of these strategies is to postpone debt payment and delay major expenses (such as home repairs) until after the first day of institutionalization. This includes postponing any spend-down of resources. In addition, a couple can have the community spouse take out a loan on an exempt asset (such as a home equity loan on their principal residence) prior to institutionalization to increase total assets. The community spouse can then later pay back the loan as part of his or her spend-down. If the couple's assets equal or exceed twice the CSRA, the above techniques for maximizing the snapshot may not be needed.

As a result of the snapshot taken of each spouse's assets on the first day the institutionalized spouse enters the nursing home, the resources of the community spouse acquired after the first day of institutionalization do not count as available resources.

After institutionalization, the institutionalized spouse's assets should be used to pay for his or her care. In addition, the community spouse should hold title to all assets acquired after the snapshot is taken. If the CSRA is greater than the community spouse's assets, Section 1396r-5(f)(2) provides that the institutionalized spouse may transfer sufficient assets to the community spouse to bring the community spouse's share up to the CSRA.

Because the institutionalized spouse may be too ill to make such a transfer, the adviser should counsel the spouses, as early as possible, to exercise a financial POA, as described earlier. Provided the POA includes the power to make gifts, the attorney-in-fact (usually the other spouse, but sometimes the individual's child or trusted friend) can make a gift to bring the community spouse's share up to the CSRA. However, if the community spouse requires long-term nursing care, the CSRA will no longer apply; his or her assets will have to be substantially reduced to qualify for Medicaid benefits:

Often, the best Medicaid planning will conflict with the best estate tax or income tax planning. For example, if an institutionalized spouse transfers assets to a community spouse or other donee to avoid a Medicaid lien, the community spouse or other donee will lose the advantage of a stepped-up tax basis for the asset at the institutionalized spouse's death.

Using the Community Spouse's Income Allowance

Udder Section 1396r-5(d), the community spouse is entitled to income up to the minimum monthly maintenance needs allowance (MMMNA). The MMMNA is set by each state and ranges from a minimum of $1,493 to a maximum of $2,267 per month for 2003. This amount is adjusted annually for inflation. Section 1396r-5(e)(2)(B) provides that the community, spouse has a right to a fair hearing if there is exceptional hardship that justifies a higher figure.

If the community spouse's income is less than the MMMNA, he or she may obtain a deduction from the institutionalized spouse's income to bring his or her income up to the MMMNA. Alternatively, under Section 1396r-5(e)(2), the community spouse may request a fair hearing to increase his or her CSRA (i.e., by transferring income-earning assets from the institutionalized spouse). Some states require that the institutionalized spouse's current income be transferred first to the community spouse before any income-earning assets, which reduces the opportunity to protect family assets through a transfer. The definition of income can also vary among the states.

Creating a Testamentary Trust 

Under Section 1396p(d)(2)(A), a community spouse can create a testamentary trust without jeopardizing the institutionalized spouse's Medicaid eligibility. In addition, the community spouse may have to leave the minimum statutory share to the institutionalized spouse. However, advisers must draft and administer trust provisions carefully to avoid payment of income or principal directly to the institutionalized spouse. Thus, payments from the trust should be made directly to third parties. In any event, advisers should consult applicable state law for any restrictions on the use of such trusts for Medicaid eligibility purposes.

Terminating the Marriage

A community spouse can divorce the institutionalized spouse to insulate his or her income from being deemed available to the institutionalized spouse. The divorce will also insulate the community spouse's assets from Medicaid. This planning technique is rarely used; it generally applies only to couples with significant assets who cannot obtain long-term care (LTC) insurance to cover a prolonged period of nursing home care.

Example 8: R and S, married, are ages 75 and 71, respectively. Throughout their marriage, R was self-employed and made substantial Keogh contributions. R now has a $1 million balance in his Keogh account. S worked for a small company that did not have a retirement plan. She has an IRA with a $100,000 balance. R is in poor health, and will soon need nursing home care. He cannot transfer his Keogh assets to S or their children without being subject to income tax.

A qualified domestic relations order (QDRO) is an order issued as part of a divorce proceeding that divides up retirement plan assets. A QDRO does not disqualify a retirement plan, under Secs. 401(a) (13) (B) and 414(p).Thus, a distribution can be made under a QDRO (and possibly rolled over into an IRA), so that each spouse will have separate retirement plans on divorce.

Example 9: The facts are the same as in Example 8, except that R and S decide to divorce. Under a QDKO, R's Keogh plan is directed to distribute $450,000 to S. S takes the distribution and rolls it into her IRA. Thus, R has $550,000 in his Keogh and S has $550,000 in her IRA. S's IRA is not a resource available to R for Medicaid purposes.

Divorce as a Medicaid planning tool has obvious drawbacks. First, there are the emotional and psychological factors; marriage and divorce are more than just economic arrangements. Second, there is the loss of the marital deduction. However, because Medicaid has a claim against the estate, the net estate most likely will not be large enough to be subject to estate tax.

In the event a couple does decide to divorce to preserve their collective assets, each should have a separate attorney. Otherwise, if a guardian ad litem is later appointed for the institutionalized spouse, the guardian may have the right to void the divorce judgment and its property division.

The divorcing couple will likely want to transfer a greater share of marital assets to the community spouse. Some states (e.g., New York) require specific written reasons for an unequal property division. (21) If one of the reasons given for distributing property to the community spouse is to minimize Medicaid-available assets, the court may balk at approving the proposed property distribution. Thus, non-Medicaid reasons should be found for any unequal asset distribution.

Miscellaneous Planning Techniques

Transfer home to community spouse: The home is an exempt asset. However, as discussed above, it may be subject to a Medicaid lien and estate recovery. Also, a sale of the home will convert the exempt home into Medicaid-available funds.

If, however, the institutionalized spouse transfers his or her interest in the home to the community spouse, the latter can later sell the home. The conversion of the exempt home into nonexempt cash will take place after the Medicaid snapshot has been taken, so the funds should not be Medicaid-available, although they may later be subject to estate recovery.

Convert cash to exempt assets: As discussed above, this is a useful technique for all individuals. Married individuals can convert the institutionalized spouse's assets into exempt assets, while leaving the community spouse's assets liquid.

Purchase an annuity: A couple may purchase an annuity for a community spouse to bring his or her income up to the MMMNA. If this is a transfer for full and fair consideration, it may not affect Medicaid eligibility. (22) In addition, the annuity contract should be irrevocable and without a cash surrender value. However, caution is needed, as states tend to attempt to exercise estate recovery on annuities.

Plan for terminal illness of a community spouse: Depending on an individual's particular medical problems, one spouse may require extended nursing home care, while the other may be terminally ill, but not require such care. In that case, it is important to try to divert the community spouse's assets from the institutionalized spouse.

The community spouse may use a testamentary trust (described earlier) to restrict the availability of funds to the institutionalized spouse. Also, the community spouse should change all beneficiaries on insurance policies and retirement plans to a party other than the institutionalized spouse. Finally, the community spouse should change all joint bank accounts, stock accounts, etc., to remove the institutionalized spouse's name.

Use joint bank accounts: Some individuals set up joint bank accounts with spouses or friends to facilitate banking as they become older. Section 1396p(c)(3) treats any withdrawal by the community spouse from a joint bank account owned by the institutionalized spouse and the community spouse as a transfer of assets for Medicaid purposes. As long as the funds are used solely for the institutionalized spouse, a withdrawal will not be considered such a transfer. Otherwise, the withdrawal is deemed a transfer subject to the 36-month lookback period.

Conclusion

Advisers have many opportunities to preserve a client's family assets when LTC is required. Despite unconstitutional attempts to legislate against Medicaid planning, many clients will benefit by properly timing a Medicaid application, knowing the effect on Medicaid eligibility of transfers made during the lookback period, and understanding which assets are exempt. As with any estate planning, advance preparations are the most successful.

In addition to the techniques described, clients should explore various LTC insurance plans. Advisers should caution clients about plans that do not provide for inflation or are insufficient for the expected cost of LTC. Also, the plan's cost is important. If a client waits to purchase the insurance until he or she needs LTC, the insurance may be very expensive (or even unattainable).

Advisers should he aware that the Medicaid rules change often; state variations are common and rule changes may even be retroactive. Further, they should explain to clients the adverse income, gift and estate tax aspects of Medicaid planning and allow them to make an informed choice as to each planning technique.

EXECUTIVE SUMMARY

* In addition to direct transfers and trusts, an individual has a variety of ways to protect assets from Medicaid, including powers of attorney, disclaimers and life estates.

* The planning techniques for married persons include all the techniques for singles, plus others.

* Advisers should explain to clients the adverse income, gift and estate tax aspects of Medicaid planning and allow them to make an informed decision as to each technique.

(16) In the Matter of Walter Anson, 406 NYS2d 916 (3d Dep't 1978).

(17) Walter Morgan, 168 Conn. 336 (1975).

(18) See the states' rules governing intent to return home, which may include presumptions against such intent.

(19) In referring to a married couple, the "community spouse" is the one who continues to live in the community; the "institutionalized spouse" is the one who receives care.

(20) Sophie Mistrick, 154 NJ 158 (1998).

(21) See NY Dom. Rel. Law Section 236B(5)(d)(1)-(10) (McKinneys 1995).

(22) See Correira, "Using Private Annuities and Installment Notes in Medicaid Planning," 25 Est. Pln'g 381 (October 1998) (sidebar includes state-by-state interpretations on annuities in the Medicaid context).

Terry W. Knoepfle, J.D., CPA 

Associate Professor of Taxation and Business Law

College of Business Administration

North Dakota State University 

Fargo, ND