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The Taxation of the Medicaid Asset Protection Trust

The EC Medicaid Asset Protection Trust® (MAPT) is a powerful tool used in elder law planning. The MAPT can be used both in a proactive planning case or in a crisis planning case. Let’s take a look at when the MAPT would be used in each type of case, and how a MAPT intersects with estate tax, gift tax, and income tax.

A proactive planning elder law case means that there isn’t currently a crisis to attend to and plan around. There isn’t an immediate need for Medicaid. Instead, there is time to proactively plan to protect assets and ensure Medicaid eligibility, should the need arise after any applicable look-back period. For long-term care Medicaid benefit applicants, each state has a look-back period. In all but California, the look-back period is five years. In California, it is three years. This means that the state will scrutinize any transfers during this time. If there was a transfer for less than fair market value that does not qualify under an exception, the state will impose a penalty period upon the applicant. The applicant will not be eligible for Medicaid benefits until after the penalty period has expired. The MAPT is often used in a proactive planning case. The MAPT is created and funded, the applicable look-back period runs, and thereafter assets in the MAPT are not countable when determining eligibility for long-term care Medicaid benefits.

A crisis planning elder law case arises when there is an immediate need for Medicaid. If a client will need long-term care in the near future but needs planning done before being eligible, crisis planning needs to be employed. As a part of this planning, a MAPT can be used as an alternative to outright gifting. Outright gifting can have many downsides – the recipient of the gift can spend the money however they want, the gift can be subject to a recipient’s divorce or creditors, or the gift could jeopardize public benefits of the recipient. Instead, the gift can be made to the MAPT to eliminate these drawbacks.

So, the MAPT can be a formidable tool used in both proactive and crisis planning elder law cases. But how does the MAPT intersect with taxation? Let’s take a look at the estate tax, gift tax, and income tax implications of the MAPT.

Estate tax

A practitioner will usually want to design the MAPT so that the assets therein are includable in the Grantor’s estate for estate tax purposes. Because the current estate tax exclusion is at $11,580,000, it is unlikely that many clients will be subject to federal estate tax. However, in including the MAPT assets in the Grantor’s estate for estate tax purposes, a basis adjustment will be achieved. How can a MAPT be designed to ensure a basis adjustment on assets upon the death of Grantor? The Grantor must retain some incident of control over the trust assets that is sufficient enough to pull them back into the estate at the death of the Grantor. This is accomplished through a testamentary limited power of appointment that allows the Grantor to change beneficiaries in a writing that is effective upon the Grantor’s death. For married MAPT Grantors, this is the option to appoint assets to the spouse or descendants, but not to creditors or to the estate.

Trust assets in an individual MAPT where the Grantor retains a power of appointment, receive a step up in basis at the death of the Grantor. In a joint MAPT when each spouse retains a power of appointment, then there is a step up on ½ of the property at the first spouse’s death, and a step up on the remaining ½ at the second spouse’s death. There is an example of how this works in the Trust Summary and Funding Letter in ElderDocx. This letter is a powerful resource for both clients and practitioners.

Gift tax

Gift tax rules are often confused with estate tax rules. When an asset is transferred to a MAPT, the question becomes whether it is a completed gift for gift tax purposes. If the transfer is a completed gift, then gift tax must be contemplated at the time of the transfer. If the transfer is an incomplete gift, then gift tax must be analyzed when distributions are made from the MAPT.

Under the applicable regulations, a transfer is complete only to the extent that the donor “has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another.” Treas. Reg. § 25.2511-2(b). If a practitioner wants to make transfers to the MAPT incomplete for gift tax purposes, then she can retain one or more of the following for the Grantor: right to reside in the residence (only affects the gift of the residence), an income right, or the retention of the right to add charitable beneficiaries. A Grantor’s testamentary power of appointment may also make the gift incomplete.

If the practitioner wants to cause transfers to the MAPT to be considered completed gifts for gift tax purposes, this can also be accomplished in ElderDocx. Use the long form MAPT and do not retain a testamentary power of appointment, income interest, or right to reside in the residence. But beware – if the transfers to the MAPT are completed for gift tax purposes, this generally means that trust assets will not be included in the Grantor’s estate. Exceptions include if the Reciprocal Trust Doctrine applies, or if the Grantor is trustee.

Income tax

To discuss the income taxation of the MAPT, grantor trust status must be discussed. Grantor trust status allows one to achieve certain tax advantages over either ordinary income, capital gains, or both. Treasury Regulations Section 1.671-2(e)(1) says, "[A] grantor includes any person to the extent such person either creates a trust, or directly or indirectly makes a gratuitous transfer (within the meaning of paragraph (e)(2) of this section) of property to a trust." Generally, if the Grantor creates and funds a trust and retains certain powers, then grantor trust status is achieved, and income of the trust is attributed to him or her. Under most circumstances, a Grantor also includes the Grantor's spouse.

If grantor trust status is achieved in the MAPT, then ordinary income or capital gains (or both), generated by trust assets is taxed to the Grantor, no matter who receives the income. Grantor trust status can also achieve other tax benefits – the IRC 121 exclusion is preserved and property tax exemptions are likely preserved. If grantor trust status is not achieved, then any undistributed MAPT income is taxed at trust rates and distributed income is taxed to the recipient.

Conclusion

The EC Medicaid Asset Protection Trust is a powerful tool used in elder law planning, in both proactive and crisis planning cases. In a proactive planning case, assets can be transferred into the MAPT, the applicable look-back period passes, and thereafter the assets in the MAPT are not countable for Medicaid eligibility purposes. In a crisis planning case, a MAPT can be used to curtail the many downsides of outright gifting. In addition to these benefits, the MAPT can preserve many tax benefits, such as a basis adjustment at death, preservation of the IRC 121 exclusion of gain, and taxation at individual levels. However, it is imperative for practitioners to know the difference between estate, gift, and income taxes, and how the provisions of the MAPT will impact each one. 

EC Medicaid Asset Protection Trust Document Preview

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