July 2001
Medicaid Eligibility Aspects of Disclaimers
By Douglas Schnapp, Esq., CPA
Financial planners may be unaware of the issues surrounding the New York State Medicaid eligibility when dealing with post-mortem disclaimers. When an individual, including a surviving spouse with a right of election, has a right to a share of an estate and renounces or disclaims such interest, it is considered a transfer for Medicaid eligibility purposes.
A common scenario involves one spouse that is well and living at home while the other spouse resides in a nursing home receiving Medicaid benefits. If the well spouse dies first and does not leave the surviving spouse enough to qualify as that spouse’s elective share (the greater of $50,000 or one-third of the estate), the local Medicaid agency may start a court proceeding to have a guardian appointed for the surviving institutionalized spouse so that the guardian can then exercise that spouse’s right of election. As a result, part of what may be Medicaid-oriented planning should include both spouses, only if they have the requisite mental capacity, executing waivers of their right of election. This is preferable, because there is mutual consideration when both spouses are capable of acting.
Unfortunately, Medicaid has not delineated a firm policy on whether it will honor such joint waivers. Therefore, when mutual waivers are executed and there are unequal assets, Medicaid may view it as a transfer, because the poorer spouse did not give any consideration. This may also be Medicaid’s position if one spouse has already transferred assets. It is also unclear whether the date that such a waiver is deemed effective for computing the Medicaid penalty period is the date the waivers are signed or the date the first spouse dies.
Sometimes a renunciation by a guardian will not affect Medicaid eligibility, such as when one spouse as guardian for the other spouse renounces, resulting in a transfer to such a guardian/spouse, because Medicaid does not restrict transfers between spouses.
Ins
and Outs of Charitable Remainder Insurance Trusts
By Henry Rubin
A charitable remainder insurance trust begins when a donor contributes an existing or new life insurance policy to a charitable remainder trust. This entitles the donor to an income tax deduction; the beneficiary or beneficiaries receive income after the donor’s death; and a charity is the remainderman. The trust is then designated the owner and beneficiary of the policy. The donor contributes a tax-deductible premium to the trust each year. After the donor’s death, the insurance company distributes the policy’s death benefit to the trust. The trustee invests the death benefit and distributes the annuity in a percentage amount predetermined by the donor to a spouse or other beneficiary for life. The charity receives the remainder upon the beneficiary’s death.
Benefits
The assets within the charitable remainder trust are removed from the reach of creditors. The death benefit is converted from a lump sum, which may be subject to dissipation, into annuity payments to the donor’s spouse or children for their lifetimes or a term certain. Properly structured, the death benefit will also be shielded from estate taxes.
The trust instrument may have a clause that allocates gains to income. That income is passed to the beneficiaries as capital gain, after the ordinary income is paid out, subject to the trust’s limitations on distributions.
In Private Letter Ruling (PLR) 7928014, the IRS approved an inter vivos charitable remainder unitrust that was funded with a $50,000 permanent life insurance policy, named the trust as owner and the donor’s wife as sole income beneficiary, and contained a net income provision that would pay the spouse the lesser of trust income or 5% of the trust assets. In approving the unitrust, the IRS ruled that the donor’s premium payments would be deductible as additional contributions to his unitrust—calculated according to the present value of the charity’s interest in each premium at the time of the payment.
What does the IRS require for an approved charitable remainder insurance trust? Life insurance policies that have a cash surrender value are suitable for transfer to a charitable remainder trust. Nevertheless, the trust should not be obligated to pay any premiums unless an explicit prior ruling has been obtained from the IRS [Treasury Regulations section 1.664-2(a)(4), 1.664-3(a)(4); see also PLR 9227017].
The charity must also be the owner of the policy under Treasury Regulations section 1.664-1(a)(4). In the above ruling, the IRS noted that the donor is treated as the owner of any portion of the trust whose income may be applied to the payment of premiums on policies of life insurance of the life of the grantor or grantor’s spouse—except policies irrevocably payable for charitable purposes.
In PLR 8745103, the IRS ruled that buying insurance would not limit the trustee’s investment discretion. Nor would it violate the Treasury Regulations section 1.664-3(a)(4) prohibition of payments to noncharities, assuming the value of the policy is full and adequate consideration for the amount paid. Borrowing against the policy for investment purposes will, however, generate unrelated business income (UBI) to the trust, which will accordingly lose its tax-exempt status [Treasury Regulations section 1.664-1(c)].
The IRS requires a written appraisal to substantiate the fair market value of the insurance policy. The appraisal should be included with the tax return for the year the gift was made. The trust is tax-exempt and must file information Form 5227 with the IRS each year.
Before trust income can be distributed, accumulated prior losses must be covered in ordinary income and capital gain tiers. To ensure that the charity receives its remainder portion, the IRS requires that the present value of the donor’s contributions leave at least 10% to the charity. This limits the payout to the donors, based upon the payout and the projected term of distribution.
What if the donor stops paying the annual premiums? As with any insurance policy, the charitable remainder insurance trust affords the flexibility to increase or decrease the annual premiums, policy values, and death benefits. To the extent that the policy is fully paid and the dividends are applied to premiums, there may be no need to continue to make premium payments.
What kind of deduction will the taxpayer receive? If the donor’s policy is fully paid, the deduction will be based upon the policy’s replacement value. If premiums remain to be paid, the deduction will be based upon an amount slightly in excess of the cash surrender value, as evaluated by an appraisal, minus the amount reserved for the spouse or other beneficiary, as validated by an appraisal. In each case, however, the amount of the deduction cannot exceed the pro rata portion of the actual cost in the policy.
Editor:
Milton
Miller, CPA
Consultant
William Bregman, CFR,
CPA/PFS
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