As we discussed last month, irrevocable trusts are legal documents that you cannot remove assets from and whose terms you cannot change the trust is established. These are most often created for Medicaid planning to remove assets from a person’s estate, since assets held in an irrevocable trust are not considered available to the Medicaid applicant if they need Medicaid to pay for nursing home care.
However, as we also discussed, transferring assets into a trust will create a penalty period where the Medicaid applicant will not be eligible for Medicaid for a period of time. Any transfers made to a trust within five years of applying for Medicaid are subject to a penalty period – a trap for the unwary. There are also many other aspects of trust planning that require specialized knowledge and that can cause problems if not handled correctly.
Trust taxation is one of those areas. Trusts can be taxed in several ways and understanding trust taxation before engaging in trust planning is essential. Typically, a trust is a separate taxpaying entity and it gets its own tax identification number and must file its own income tax return. However, depending on the type of trust, income taxes may be paid at the trust level or they may be paid by the beneficiaries of the trust. Trusts reach the highest tax rate at a much lower income level than do individuals so choosing the right type of trust to minimize income taxes is very important.
There is even a type of trust, called a “grantor” trust, where the income taxes are paid by the individuals who created the trust even though they no longer have any access to the assets held in the trust. A “grantor” trust is often used in Medicaid planning.
A special needs trust is also not considered a resource for Medicaid purposes so it is also used for Medicaid purposes. Although the assets held in a special needs trust may be used for the Medicaid recipient, they are not a countable resource because of special laws applicable to this type of trust.
Special needs trusts come in many varieties. One type of special needs trust is called a third-party special needs trust and it is often used by parents to hold the assets left to a special needs child to keep him or her from being disqualified from Medicaid and other government benefits. Another type is called a first-party special needs trust and it is used for holding the assets of someone already receiving benefits who inherits assets outright in their own name (when a third-party special trust was not used). And finally, there is a special needs trust that is created in a will for a spouse who is receiving nursing home care so that all of the assets inherited by the spouse do not have to be paid to the nursing home.
Trusts may also be used for those applying for VA Aid and Attendance benefits. Like Medicaid, Aid and Attendance is only available to those who have limited assets and trusts are often used to meet the asset requirements for this program. In 2018, the VA implemented a 3-year look back period for gifting “excess” assets to other family members like Medicaid does so it is important to plan well ahead of time if you are a veteran and intend to qualify for VA Aid and Attendance benefits.
Trusts are not “one size fits all” and a trust that may work for Medicaid planning may not work for VA planning. Additionally, complicated tax rules apply to trusts so they must be carefully drafted and administered if they are to work as intended. Although trusts are important planning tools for protecting assets from the high costs of long-term care, I cannot overemphasize how important it is to consult with professionals well-versed in trust law and taxation before engaging in any type of trust planning to protect your family and your assets.
The information provided is not intended to be legal advice and does not constitute any attorney/client relationship. You should consult with an attorney for individual advice regarding your own situation.
Ms. Melancon is an attorney with Legacy Estate & Elder Law of Louisiana, LLC with offices in Baton Rouge, Lake Charles, and New Orleans. The primary focus of her practice is estate planning, probate, special needs planning, and elder law. For more information or to attend an upcoming estate planning seminar, call her office at (225) 744-0027.