Elder Law Planning: Deciphering the Puzzle

View in PDF:  Tax News & Comment — February 2013

Elder Law Planning:  Deciphering the Puzzle

I.       Social Security

The Social Security program, begun during the Great Depression under President Roosevelt, is the forerunner of Medicare and Medicaid. The largest program under the Social Security Act is that which provides for retirement benefits. The monthly retirement benefit is a function upon two variables: the recipient’s earnings record (which is tracked by the Social Security Administration automatically) and the age at which the recipient chooses to begin receiving benefits. The recipient’s monthly income benefit is based on the highest 35 years of the recipient’s “covered earnings.” Covered earnings in any year cannot exceed the Social Security Wage Base, which is also the maximum amount of earnings subject to the FICA payroll tax. In 2013, that amount is $113,700.

FICA (Federal Insurance Contributions Act) imposes a Social Security withholding tax of 6.2 percent on employers and employees alike. During the tax years 2011 and 2012, the employee’s contribution was temporarily reduced to 4.2 percent. Wages in excess of $113,700 though not subject to FICA are subject to a separate payroll tax of 2.9 percent. Liability for the amount above FICA is divided equally between the employer and the employee, with each paying 1.45 percent.

If a recipient has fewer than 35 years of covered earnings, the number of years required to reach 35 years are assigned a zero value. Nevertheless, the formula utilized in calculating benefits is progressive and significant benefits can be achieved even if the recipient has far fewer than 35 covered years. The earliest time at which Social Security benefits become payable to a covered worker is age 62. A person who chooses to begin receiving benefits at age 62 will receive only about 75 percent of the amount which the person would have received had payments been deferred until age 66. A person who defers benefits past age 66 will earn delayed retirement credits that increase benefits until age 70. Past age 70, no further benefits will accrue. These benefits will inure to the surviving spouse.

Married couples may also take advantage of spousal benefits. Under current law, a spouse cannot claim a spousal benefit unless the main beneficiary claims benefits first. Once full retirement age is reached at age 66, a beneficiary can “file and suspend.” By doing this, the beneficiary’s spouse can claim a spousal benefit, but the beneficiary’s own retirement benefit will continue to grow until age 70.

Spouses are entitled to receive 50 percent of the benefits of a covered employee. If a beneficiary age 66 is entitled to receive $2,000 per month, his spouse would, at age 66, be entitled to receive $1,000 per month in spousal benefits. If spouse had not worked, or the benefits that spouse would have received are less than $1,000 per month, it might make sense for the couple to follow this strategy. This strategy will (i) allow one spouse to receive benefits in excess of that which he or she would have received based upon his or her own entitlement; (ii) allow the benefit to continue to grow at 8 percent per year up to age 70; and (iii) allow the benefit of the spouse taking spousal benefits to continue to grow until that spouse also reaches 70, at which time he or she can begin claiming retirement benefits based on his or her own record.

Surviving spouses are also entitled to Social Security Benefits. The benefits of a surviving spouse depend upon when the covered worker began taking benefits: If the covered worker takes benefits at full retirement age, the surviving spouse may take 100 percent of the benefits provided he or she is also at full retirement age. If the covered worker takes benefits before full retirement age, then the surviving spouse — again provided he or she was of retirement age — would take 100 percent of the (reduced) amount that the covered worker was taking.

A surviving spouse need not wait until full retirement age to take survivor benefits: A surviving spouse may elect to begin receiving benefits as early as  age 60, or age 50, if he or she is disabled. However, those benefits will be reduced. Divorced spouses are eligible to receive benefits if the marriage had lasted at least 10 years. (Survivor benefits will not be available to same sex partners, since same sex marriages are not recognized under federal law.) The benefits received by a divorced spouse have no effect on the benefits of the current spouse. Unmarried children, as well as dependent parents, may also qualify to receive survivor benefits.

Social Security benefits were historically not subject to income tax. However, in order to avoid projected insolvency of the Social Security system, 50 percent of the portion of benefits were potentially subject to income tax in 1984. In 1994, 85 percent of Social Security benefits became subject to income tax.

II.     National Health Care

The Affordable Health Care Act established a national health insurance program. Under the Act, the existing Medicare program will be expanded to include all U.S. residents. The goal of the legislation is to provide all residents access to the “highest quality and most cost effective healthcare services regardless of their employment, income, or healthcare status.” Every person living or visiting the United States will receive a United States National Health Insurance (“USNHI”) Card and ID number upon registration.

The program will cover all medically necessary services, including primary care, inpatient care, outpatient care, emergency care, prescription drugs, durable medical equipment, long term care, mental health services, dentistry, eye care, chiropractic, and substance abuse treatment. Patients have their choice of physicians, providers, hospitals, clinics, and practices. No co-pays or deductibles are permitted under the Act.

The system will convert to a non-profit healthcare system over a period of fifteen years. Private health insurers will be prohibited from selling coverage that duplicates the benefits of the USNHI program. However, nonprofit health maintenance organizations (HMOs) that deliver care at their own facilities may participate. Exceptions from coverage will also be made for cosmetic surgery and other medically unnecessary treatments. The National USNHI will (i) set annual reimbursement rates for physicians; (ii) allow annual lump sums for operating expenses for healthcare providers; and (iii) negotiate prescription drug prices. A “Medicare for All Trust Fund” will be established to ensure constant funding for the program. The Act also requires states to expand Medicaid or face the loss of federal funds.

Advocates of universal health care believe that lower administrative costs will result in savings of approximately $200 billion per year, which is more than the cost of insuring all of those who are now uninsured. A “single-payer” system is said to reduce administrative costs because it would not have to devote resources to screening out high-risk persons or charging them higher fees. Critics argue that the nationalization of health care will raise taxes for higher-income individuals, and note that the government has a poor track record in effectively managing large bureaucratic organizations (e.g., the Postal Service and AMTRAK). In June of 2012, the Supreme Court, in an opinion written by Chief Justice Roberts, narrowly upheld the Constitutionality of the Affordable Care Act as proper exercise of the federal government’s power to impose tax.

II.       Medicare

Medicare is a federal insurance program that provides health insurance to persons age 65 and over, and to persons under age 65 who are permanently disabled. Medicare and Medicaid were signed into law by President Johnson in 1965 as part of the Social Security Act. Medicare is administered by the federal government. In general, all five-year legal residents of the U.S. over the age of 65 are eligible for Medicare. Medicare consists of four parts, A through D.

Medicare Part A covers inpatient hospital stays of up to 90 days provided an official order from a doctor states that inpatient care is required to treat the illness. For days 1 through 60, a $1,184 deductible is required for each benefit period in 2013. For days 61 through 90, a daily copay of $296 is required. After 90 days, a daily co-pay of $592 must be paid for up to 60 “lifetime reserve days.” Once lifetime reserve days have been exhausted, Medicare hospitalization benefits will have terminated.

Part A also covers stays for convalescence in a skilled nursing facility (SNF) for up to 100 days following hospitalization. To be eligible, (i) the patient must have a qualifying hospital stay of at least three days (and have unused days); (ii) a physician must order the stay; and (iii) the SNF facility must be approved by Medicare. No copay is required for the first 20 days. Thereafter, a daily copay of $148 is required until day 100.

Part A is funded by the separate payroll tax of 2.9 percent, and the recently enacted 3.8 percent Medicare surtax.

Medicare Part B covers physician and some outpatient services. Eligibility depends on satisfying requirements for Part A, and the payment of monthly premiums, which range from $100 for those with adjusted gross income of up to $85,000, to $319, for those with higher incomes. The patient is responsible for 20 percent of physician’s fees. Medicare pays only the “approved” rate. A patient may seek care from a nonparticipating doctor and pay the rate differential.

Private Medicare supplement (Medigap) insurance is available to those who have Medicare Part A and Part B. This insurance will cover such items as copays and deductibles. Those without a Medigap policy are required to pay these costs out of pocket.

Medicaid Part C consists of plans offered by private companies (“Medicare Advantage”) that contract with the government to provide all Part A and Part B benefits.  By law, these plans must be “equivalent” to regular Part A and Part B coverage. Some Part C plans provide prescription drug coverage. Medicare Advantage supersedes Medigap coverage; if a person is enrolled in a Medicare Advantage Plan under Part C, Medigap will not pay.

Medicare Part D provides prescription drug benefits. Under Part D, a patient pays an initial deductible of $325 and is subject to a co-pay of 25 percent for amounts up to $2,970. The patient must pay all costs incurred between $2,970 and $4,750, but is required to pay only 5 percent of drug costs over $4,750.

III.     The Intersection of Medicare to Medicaid

Without planning, the elderly are at significant risk of losing an entire life’s savings in the event of catastrophic illness following the expiration of Medicare hospitalization and nursing care benefits. At that point, the choice for extended care is in general either Medicaid or payment out of pocket. Many who opt for private payment of long-term care costs will risk exhausting their resources. This loss will have implications for other family members as well. (It should be noted that long term health care insurance has generally been less than effective in managing these costs, for a variety of reasons.)

The principal difference between Medicare and Medicaid is that Medicaid is need-based and Medicare is (theoretically) entitlement based. While Medicare is federally funded and administered, Medicaid is a federal program jointly funded and administered by the states. Financial resources play no role in determining Medicare eligibility. Medicaid eligibility is limited to persons with limited income and limited financial resources. Medicaid covers more health care services than Medicare and unlike Medicare, will cover long-term care for elderly and disabled persons who cannot afford such care.

IV.      Medicaid Eligibility

Elderly and disabled persons are more likely to require continuing long-term care not covered by Medicare. For example, a serious illness such as a stroke could require a long period of convalescence, the costs of which are not covered by Medicare. Medicaid will cover many long term health costs that Medicare will not. Medicaid now pays for about half of all nursing home costs incurred in the country.

Ownership of substantial assets or in some states the right to monthly income above certain thresholds (“resources”) will preclude Medicaid qualification. Before qualifying for Medicaid, a person with substantial assets would be required to deplete (“spend down”) those assets.

To avoid the scenario in which nearly all of one’s assets might be required to be paid to a nursing home before becoming eligible for Medicaid, some persons choose to transfer in advance assets that would impair Medicaid eligibility. Such transfers might be outright to a spouse, or to other family members such as children, or to a trust.

Recognizing the increased cost to the government of intentional transfers made to become eligible for Medicaid, Congress, in the Deficit Reduction Act of 2005 (DRA), created a five-year “look back” period relating to the transfer of assets either outright or in trust. Essentially, any transfers made during the five-year period preceding a Medicaid application are ignored for purposes of determining eligibility. Despite the existence of a five year look-back period, courts have upheld Medicaid planning as an appropriate objective, and have held that such transfers do not violate public policy or constitute fraudulent transfers.

Under pre-DRA law, the five-year period of ineligibility began on the date of the transfer. Under DRA the period of ineligibility does not commence until the person is in the nursing home and applies for Medicaid. Therefore, if within five years after making a transfer of assets to qualify for future Medicaid a person requires Medicaid assistance, the transferred assets must be “repaid” before Medicaid payments will commence. The upshot is that if long-term care appears likely in the foreseeable future, transferring assets to qualify for future Medicaid eligibility may actually be counterproductive, as it will trigger a penalty.

Transfer penalties are based on the monthly cost of nursing home care in the applicant’s state. If the cost of nursing home care in New York is $7,000 per month and the person transferred $70,000, he would be ineligible for Medicaid for a period of ten months (i.e., the amount transferred divided by the cost per month of nursing home care). An exception provides that transferring assets, including one’s house, to a spouse will not trigger the transfer penalty.

Nursing homes will generally be unaware of the transfer prior to admission. As a result, the facility may have no source for reimbursement during the penalty period. Federal law prohibits a nursing home from discharging a patient unless it has found replacement care.

Determining the appropriate amount of assets to transfer is important. Transferring many assets, while helpful for future Medicaid eligibility purposes, may leave future applicant with insufficient assets. Transferring too few assets will create a larger reserve to be “paid down” after the five year look-back period ends and Medicaid would, but for the reserve, begin to pay.

Federal law requires states to investigate gifts made during the look-back period. New York does not specify a threshold amount, but some counties will examine all transfers over $1,000. Even common gifts, such as those made for birthdays, for tuition, or for weddings may be considered an available asset for Medicaid purposes. Care must be taken to ensure that gifts made under a power of attorney do not have unintended and deleterious Medicaid implications.

V.    Medicaid Exempt Assets

Certain resources are exempt in determining Medicaid eligibility.    New York Medicaid exempts up to $786,000 in home equity. If the residence is worth substantially more than this amount, the home may be gifted, but the five-year look back period will apply.

If the home is gifted but the transferor retains a special power of appointment, the transfer will achieve the objective of starting the commencement of the five-year look-back period. In addition, although the transfer will be complete for Medicaid purposes, it will be incomplete for federal estate tax purposes. This means that children will benefit from a stepped up basis at the death of the parent.

A spouse may also transfer title to the other spouse without risking Medicaid eligibility. A residence may also be transferred to a sibling with an equity interest who has lived in the residence for more than one year, or to a child who has been a caregiver and lived in the home for at least two years before the parent enters a nursing home. There are advantages to using a trust. If an irrevocable income-only trust is used, the parent may continue to live in the house, or sell it. (See discussion below.)

A retirement account may also be an exempt asset if it is in “payout” status.  So too, an automobile may be an exempt asset. If the applicant is in a nursing home, the applicant’s residence remains an exempt asset provided the applicant has a “subjective intent” to return to his home.

Exempt assets may be transferred without penalty because such assets would not impair Medicaid eligibility even if not transferred. Therefore, if government assistance will be required within 60 months, excess resources could be converted into exempt assets. For example, a residence could be improved, a mortgage on the residence repaid, or other exempt assets could be purchased.

New York may impose a lien on a personal residence even though ownership of the residence would not impair Medicaid eligibility. However, no lien may be imposed unless the person is permanently absent and is not reasonably expected to be discharged. N.Y. Soc. Serv. Law §369(2)(a)(ii); 18 N.Y.C.R.R. §360-7.11(a)(3)(ii). Prior to filing a lien, New York must satisfy notice and due process requirements, and must show that the person cannot reasonably be expected to return home. 42 U.S.C. §1396p(a)(2). If the person does return home, the lien is vanquished by operation of law. 18 N.Y.C.R.R. §360-7.11(a)(3)(i).

Conversion of cash into an annuity may reduce the available resources available that would otherwise be required to be “paid down” before becoming eligible for Medicaid. Such annuities must be structured so that (i) their payout period is not longer than the actuarial life of the annuitant; (ii) payments are made in equal installments; and (iii) the annuities are paid to the state following the death of the annuitant to the extent required to reimburse the state for amounts paid for Medicaid benefits.

VI.    Recovery From Estate

New York has the right to recover from the estate exempt assets that had no bearing on Medicaid eligibility. However, no recovery from an estate may be made until the death of a surviving spouse. N.Y. Soc. Serv. Law §366(2)b)(ii). For purposes of New York Medicaid recovery, the term “estate” means property passing by will or by intestacy. No right of recovery exists with respect to property passing in trust, by right of survivorship in a joint tenancy, or to the beneficiary of a bank or retirement account. Therefore, to avoid recovery of estate assets, avoidance of probate and intestacy are paramount.

The amount that may be recovered from an estate for a lien against a personal residence cannot exceed the value of services provided while the Medicaid recipient was absent from the home. N.Y. Soc. Serv. Law §369(2)(a)(ii). A lien may be waived in cases of undue hardship. N.Y. Soc. Serv. Law §369(5).

VII.      Medicaid Trusts

A Medicaid trust provides income to the grantor or to the grantor’s spouse. Transfers to a Medicaid trust may facilitate eligibility for Medicaid since assets so transferred are excluded when determining Medicaid eligibility (provided the five year look-back period is satisfied). Furthermore, transfer to an irrevocable trust will effectively bar any right of recovery by New York if a lien had been placed on the residence or other asset.

Most trusts created to facilitate Medicaid planning will be drafted to be irrevocable, since assets transferred to a revocable trust can be reacquired by the settlor, and Medicaid can reach anything the settlor can reach. Therefore, avoidance of probate is not enough: The transferor must also be unable to reacquire the assets.

If a residence is transferred to a Medicaid trust, the “income” permitted to be paid to the grantor will consist of the grantor’s retained right to reside in the residence. If the Medicaid trust is structured as a grantor trust, the capital gains exclusion provided by IRC §121 will be available if the residence is sold by the trust.

The grantor of a Medicaid trust will want the assets to be included in his or her estate at death in order to receive a basis step up under IRC §1014. This can be achieved if the grantor retains a limited power of appointment. Retaining a limited power of appointment will also enable the grantor to retain the ability to direct which beneficiaries will ultimately receive trust assets.

Irrevocable trusts granting the trustee discretion to distribute income or principal pursuant to an ascertainable standard are effective in asset protection, but are ineffective for purposes of Medicaid: Federal law treats all assets in discretionary trusts in which the applicant or his spouse is a discretionary beneficiary of principal or income as an available resource for purposes of determining Medicaid eligibility. The trust may provide that the grantor or spouse has a right to a fixed income amount, but that will be considered an available resource.

The trust may provide for discretionary trust distributions to beneficiaries (other than the grantor or the grantor’s spouse) during the grantor’s lifetime or at death, and  may provide that upon the death of the grantor, the trust corpus will be distributed outright to beneficiaries, or held in further trust.

Inclusion of trust assets in the estate of a Medicaid recipient will ordinary not be problematic since the federal estate tax exemption is $5 million and the NYS lifetime exemption is $1 million. If outright gifts and transfers to a Medicaid trust are both anticipated, transferring low basis property to the trust will be preferable, since a step up in basis will be possible with respect to those assets if the trust is includible in the applicant’s estate (unless the trust has been structured as a grantor trust). The recipients of lifetime gifts, on the other hand, will take a transferred basis in the gifted assets.

The trustee of a Medicaid trust should be persons other than the grantor or the grantor’s spouse. However, the trust may allow the grantor to replace the trustee. Since assets transferred to a Medicaid trust are transferred irrevocably, it is important that the grantor and his or her spouse consider the nature and extent of assets to be retained, since assets must remain to provide for daily living expenses.

VIII.     Special Needs Trusts

A Special (or “Supplemental”) Needs Trust (SNT) established for a person with severe and chronic disabilities may enable a parent or family member to supplement Medicaid or Supplemental Security Income (SSI), without adversely affecting eligibility under these programs, both of which impose restrictions on the amount of  “income” or “resources” which the beneficiary may possess. 42 U.S.C. § 1382a. Assets owned by the SNT will not be deemed to be owned by the beneficiary.

Federal law authorizes the creation of SNTs that will not be considered “resources” for purposes of determining SSI or Medicaid eligibility where the disabled beneficiary is under age 65, provided the trust is established by a parent, grandparent, legal guardian, or a court. Thus, personal injury recoveries may be set aside to supplement state assistance. The beneficiary’s income (which includes gifts, inheritances and additions to trusts) will reduce available SSI benefits.

The SNT may be created by either an inter vivos or testamentary instrument. If an inter vivos trust is used, the trust may, but is not required to be, irrevocable. Provided the beneficiary may not revoke the trust, trust assets will not constitute income or resources for SSI or Medicaid purposes.

A revocable inter vivos trust could permit the parent or grandparent, for example, to modify the trust to meet changing circumstances. If the trust is revocable the trust assets will be included in the settlor’s estate under IRC §2038. The trust may be funded with life insurance or gifts, or bequests.

An SNT may be established at the death of a surviving parent for a disabled adult child. Such trust may be established either by will or by revocable inter vivos trust. An SNT may even be formed by a court. In Matter of Ciraolo, NYLJ Feb. 9, 2001 (Sur. Ct. Kings Cty), the court allowed reformation of a will to create an SNT out of an outright residuary bequest for a chronically disabled beneficiary. Neither the beneficiary nor the beneficiary’s spouse should be named as trustee, as this might result in a failure to qualify under the SSI and Medicare resource and income rules. A family member or a professional trustee would be a preferable choices as trustee.

The trustee may make disbursements for items not paid by government programs. These could include dental care or clothing, or a case manager or companion.

EPTL 7-1.12 expressly provides for special needs trusts and includes suggested trust language. The statute imposes certain requirements for the trust. The trust must (i) evidence the creator’s intent to supplement, rather than impair, government benefits; (ii) prohibit the trustee from expending trust assets that might in any way impair government benefits; (iii) contain a spendthrift provision; and (iv) not be self-settled (except in narrowly defined circumstances).

EPTL 7-1.12 further provides that notwithstanding the general prohibition imposed on the trustee from making distributions that might impair qualification under federal programs, the trustee may have discretionary power to make distributions in the best interests of the beneficiary. However, distributions should not be made directly to the beneficiary, as this could disqualify the beneficiary from receiving governmental assistance.

A “payback” provision mandates that on trust termination the trustee must reimburse Medicaid for benefits paid to the beneficiary. Only a “first-party” (self-settled) SNT, which is an SNT funded by the beneficiary himself, must include a payback provision. However, a first-party SNT funded by a personal injury award will not be required to pay back Medicaid.

A “third party” SNT is a trust created by a person other than the beneficiary (e.g., a parent for a developmentally disabled child). Third party SNTs do not require a “payback” provision. Inclusion of a payback provision requiring Medicaid reimbursement in a third party SNT is unnecessary, and its inclusion where none is required could result in a windfall to Medicaid at the expense of remainder beneficiaries.

The purpose of a special needs trust will be obviated if the beneficiary receives gifts or bequests outright. Therefore, it is imperative that the beneficiary not receive gifts, bequests, intestate  legacies, or be made the beneficiary of a retirement account. No trust should be established for these purposes under the Uniform Transfer to Minors Act. All of these intended gifts (except an intestate legacy) should instead be made payable directly to the SNT.

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