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May 1991

Protecting the assets of elderly clients.

by Huber, Ezra

    Abstract- Tax practitioners and the elderly must understand that the protection of the assets of the elderly has become more complex, leading to a conflict between traditional estate planning and modern, health care estate planning. Traditional estate planning typically was concerned with preparing a will for the transfer of assets after death, but with the high cost of health care, many elderly people experiencing an illness may lose all their assets or have liens put on their estates, leaving no assets to be transferred upon death. To protect the assets of their elderly clients, tax practitioners should counsel the elderly to transfer their assets either outright to a donee, or in trust with the enjoyment of the assets reserved for the donors for their lifetimes.



The demographic profile of America is fast changing. Currently, there are more persons over age 65 in this country than there are under age 25; in fact, one person in eight is over 65. The figures for people older than that are astounding. Today, 1% of the population is over age 85. By the year 2000 this figure is expected to double.

With the aging of our population, the likelihood of older members requiring some form of long-term medical care increases as well. In 1987, for example, 25% of all persons age 85 and older were patients in nursing homes. Yet, it is surprising how few people ever give much serious thought to how these costs will be paid. Many just assume that Medicare will foot the bill.

The CPA can be of assistance in identifying and counseling clients as to the options available to protect the assets of the elderly against the huge expense of a health care catastrophe.



For a CPA, the first indication of the need for planning may come during tax return preparation based on a tip-off found in Schedules A and B of Form 1040. For example, large amounts of income and dividends or capital gains are a good indication that an elderly client has a substantial amount of capital in liquid form. If the same client has a large deduction for medical expenses, the combination of these factors is clear early warning that some form of planning is necessary.



The average cost of a nursing home in some metropolitan areas is fast approaching $60,000 per year. A hospital bed may cost $500 per day. Many elderly people, however, believe that their Medicare and other insurance will cover all of their health care bills. Nothing could be further from the truth. While most people over age 65 have Medicare and many have supplemental insurance policies, these alone do not cover all the possible costs.

Medicare Coverage

Any person over the age of 65 who is eligible to receive Social Security is also entitled to Medicare. Currently, Medicare pays for up to 150 days of hospital care and, in certain circumstances for up to 100 days in a skilled nursing facility. But the Medicare deductibles--the total "out-of-pocket" expenses not covered by Medicare if a patient receives the full 250 days of coverage--is still nearly $30,000. Most seniors are shocked to learn this but often shrug it off in the belief that they are adequately protected by the supplemental insurance policies they own.

Private Insurance

Most available private insurance policies pay the Medicare deductible amounts but very few cover beyond that. In addition, existing supplemental insurance policies seldom cover two types of care very likely to be needed: custodial nursing home care and home health aides. These services are covered by Medicaid once a person's life savings have been almost totally depleted.


The changes made to the Medicaid program under the Medicare Catastrophic Coverage Act of 1988 lulled people into believing that catastrophic illness no longer equates to being poor. This, regretably, is not true. While, generally, the Medicaid eligibility requirements are established by federal law, the states are given some discretion in setting eligibility standards. There are a variety of options given to the states.

Generally, to receive Medicaid a person must be "categorically eligible," that is he or she must be poor enough to receive Supplemental Security Insurance (SSI). States have the option of extending coverage to the aged, blind and disabled as well. Some states, such as New York, also offer coverage to a class called "medically needy," those being people whose monthly income exceeds the SSI allowance (currently about $438 per month) but whose medical bills nevertheless exceed their income. New Yorkers are permitted to "spend down" their excess income on medical bills in order to qualify for Medicaid.

Contrast this with other states that do not permit such a spend-down. In New Jersey, if the income of a nursing home patient exceeds $1,221 per month, for example, he or she is ineligible for Medicaid and must apply instead to the state welfare program, whose restrictions are governed purely by state law and, in many cases, are more stringent than those permitted under federal law. Because of the differences in state coverage it is important to determine the standards in your state.

Further Illustrations

In order to be eligible for Medicaid in New York during 1991, a single individual may have no more than $3,000 of "exempt" resources (cash equivalents and other assets) plus an additional $1,500 as a burial fund. A single individual living at home is also entitled to a mere $500 per month of income. How much money a married couple may keep depends upon circumstances.

When a couple is separated by reason of the institutionalization of one, the spouse remaining in the community is entitled to keep $66,480 plus up to $1,662 of monthly income. But a husband and wife living together at home may have only $4,300 of liquid assets plus $1,500 each as a burial fund. In addition, as a couple, they may keep $717 of combined monthly income. It makes no logical sense that a couple may keep less than a single spouse continuing to reside in the community while the second is in a nursing home, but this is only one of the inconsistencies in the new law.

The resource and income allowances are indexed for inflation and will, presumably, increase in future years. Again, allowances vary from state to state. In New Jersey, for example, a single individual is only allowed to have $2,000 plus a $1,500 burial fund, and the monthly income permitted is $1,221 for a nursing home resident, $438.25 for a single person living at home, and $635.36 for a couple living together. Where a nursing home patient has a spouse living at home, the community spouse is entitled to keep between $12,500 and $62,500 of the combined marital assets.

In addition to the dollar amounts above, certain other assets are exempt from being counted for Medicaid eligibility purposes. Among them is a "homestead." This homestead can be the primary residence of either the Medicaid applicant, his or her spouse, or members of their family including certain children and other dependent relatives. A house unoccupied by one of the above (i.e., an investment property or vacation home) or even the primary residence, once vacated because the elderly occupant is institutionalized, may not be exempt. It may need to be sold to pay for medical bills.

Despite what appear to be clear eligibility standards, the current Medicaid statute is riddled with inconsistencies. Again using New York as an example, while one part of the statute limits a community spouse to $66,480, another provision allows an unlimited transfer of assets from the institutionalized spouse to the community spouse. (How one spouse may transfer an unlimited amount to the other while the second may only keep $66,480 of that "unlimited" amount defies logic.) Yet another provision permits the community spouse to refuse to contribute any resources or income towards the nursing home spouse, in which case, regardless of the amount of money a community spouse has, the institutionalized counterpart will qualify for Medicaid.

Many advisors are somewhat familiar with the general rules governing transfers but are unfamiliar with the great number of exceptions. As a result of the statute's inconsistencies, however, great care must be taken in counseling clients, particularly when advising them to transfer assets.




Today, estate planners face a dilemma over how to advise a client--the traditional way or the modern way--when asked to prepare or review an estate plan. The traditional method of estate planning has been the preparation of a will whereby assets are inherited upon death. With today's high cost of medical care, however, it is at least as likely as not that an extended illness will cause an individual to consume all of his or her assets before death. Even if a person succeeds in remaining at home--in which case the local Social Services Department cannot force the sale of the homestead during the lifetime of that Medicaid recipient--a lien may be placed against the estate after the death of both the recipient and his or her surviving spouse.

Thus, adequate planning today can no longer include only a will or a tax-wise estate plan. It must consider issues such as the lifetime protection of assets in order to continue to provide an adequate income for the over-65 crowd, while at the same time assuring the passing of principal to the children, free of any lien. The question, of course, is how do we accomplish this?



Generally, in order to protect the assets of an older client, he or she must be counseled to transfer them. There are two basic methods of transfer: 1) outright to a donee; or 2) in trust with the lifetime enjoyment reserved for the donor and the remainder transferred to the donee upon death. Each has its own unique tax consequences. Both methods, however, might result in an ineligibility for Medicaid for a certain period of time.

Formerly the Social Service law prohibited applications for Medicaid within two years of certain transfers. Under the new law, which became effective on various dates depending on the date adopted by each state, a transfer made on or after the effective date may disqualify an individual from receiving Medicaid for certain types of benefits for up to 30 months.

The old law required a minimum waiting period of 24 months. The new law sets 30 months as the maximum. This period is now calculated by dividing the amount of the ineligible transfer by the average monthly cost of a nursing home bed in a given geographic region. Regions may consist of an entire state or a designated area within a state. For example, New York is divided into seven regions each with its own formula amount, while New Jersey is one region with one formula amount.

Example #1: Fred Jones, a resident of New York, where the law became effective October 1, 1989, transferred $40,000 to his son on September 30, 1989, and went into a nursing home on August 30, 1990. On that day, he applied for Medicaid. He is ineligible to receive benefits for two years because his transfer was made while the old law was still in effect.

Example #2: Fred transferred the same $40,000 on October 1, 1989. The monthly divisor for his geographic region is $4,575. As a result, Fred is ineligible for only nine months ($40,000 / $4,575 = 8.7). Thus, when he enters the nursing home in August 1990, he may immediately begin receiving Medicaid benefits.

It should be noted that the law does not penalize all transfers, only those of "non-exempt" resources. So, for example, because cash and cash equivalents of $3,000 or $4,300 may be "exempt," a gift of these would be allowable. Monies transferred in excess of these amounts, however, would not be. Similarly, prior to the effective date of the new law the transfer of an "exempt" homestead would not result in Medicaid denial.

In addition, under the new law, a person may now transfer assets without a waiting period and still receive Medicaid coverage for home care, medication, doctors, nursing care, etc. As a practical matter, only nursing home services (and certain care while a person is awaiting placement into a nursing home) are subject to the limitations on transfers.

The "Rule of Halves"

The practitioner must be aware that sometimes it is inadvisable to transfer all of the elderly's assets. In example #2 above, had Fred transferred only $20,000, his ineligibility period would have been halved, and he would have received Medicaid in five months.

Assuming he needed immediate nursing home care, during the five month waiting period, the $20,000 he retained probably would have been spent on that care. The result would have been the saving of $20,000. Had the full $40,000 been transferred, the cost of care until eligibility would have approached that full amount. As a rule, therefore, if a client's nursing home placement is imminent, half a loaf may be better than none.

Outright Gifts versus Trusts

A decision as to whether to transfer assets outright to children (or others) or into a trust depends upon the donor's own feelings. In many instances the elderly donor is unwilling to make an outright transfer because of a lack of assurances that the donee child will make the funds available if needed. Other concerns include the death of the donee, the divorce or separation of a donee child, and the possible lack of business skills of the donee to whom the gift will be given.

The decision may also hinge upon other practical considerations, such as the amount of control that the donor wishes to maintain after the transfer. A donor has more control with a trust in many ways: it can be centrally managed rather than divided among several children; the donor can compel the trustee to account to him or her, and he or she can reserve the right to fire and replace the trustee.

In instances where the donor's life savings consists in large part of appreciated property, such as securities or investment real estate, a trust may be preferable to an outright gift because IRC Sec. 1015 provides that the outright gift will give the donee the donor's own basis, whereas under a properly drafted irrevocable trust, IRC Secs. 1014 and 2036 provide for a step-up in basis upon the death of the donor/income beneficiary.

Use of Trusts in Health Care

Much has been written on the use of revocable trusts to avoid probate. In addition, such trusts are often touted as a financial management tool or as a method of avoiding the necessity for a conservatorship. While these are certainly valid purposes for revocable trusts, they are a big mistake in the consideration of health care planning for the elderly.

For the purpose of achieving eventual Medicaid eligibility, a revocable trust is ineffective. If all that is required of the settlor of such a trust in order to gain access to his or her money is a revocation, then the local Medicaid agency will require such a revocation as a condition of eligibility.

An irrevocable trust--one which by its very nature may not be revoked- -is the appropriate vehicle for Medicaid planning. Even so, legislation enacted in 1986 as part of COBRA necessitates extreme caution. Prior to June 1, 1986, it was possible to create an irrevocable trust whereby the trustees had a huge degree of discretion as to whether or not to pay the income and/or principal to the settlor. These trusts were established primarily for the purpose of guaranteeing the settlor an unlimited income stream and unrestricted access to the principal. However, when the settlor became ill, the trustee would refuse to invade principal, thus making Medicaid available. COBRA classified such trusts as "Medicaid Qualifying Trusts" (MQT) and imposed restrictions severely curtailing the settlor's ability to provide for discretionary actions by a trustee.

Under COBRA, to the extent that a trustee may pay income or principal to the settlor or settlor's spouse, the trustee must do so. In other words, a provision that formerly would have permitted a trustee to "pay or accumulate" the income would now be read to require payment with no accumulation possible. Similarly, a right to invade principal for the benefit of the settlor would constitute an obligation to do so.

Example #1: A Trust provides that the Trustee may in his or her discretion pay all its income to the Settlor. The Trust earns $20,000 of income, but the Trustee wishes to pay out only $12,000. This is not possible. The full $20,000 is counted in determining Medicaid eligibility.

Example #2: A clause in the Trust permits the Trustee "in his or her discretion to invade principal for the use of the Settlor." All the principal is now counted.

Transfer of Homestead

A special transfer rule applies to a primary residence, called a homestead. An understanding of prior law is useful here. For example, under the law in effect in New York prior to October 1, 1989, a homestead could be transferred to anyone without a resulting Medicaid disqualification. So, if John Smith lived in his home, gave it to his children, and six months later entered a nursing home, the cost of the nursing home could be paid for by Medicaid. Because the transferred asset was an "exempt" property, the 24-month ineligibility period did not apply.

Under the current law, the ability to transfer this homestead without incurring a waiting period has been severely curtailed. Now, a house transfer may result in ineligibility of up to 30 months unless it is transferred to a spouse, a minor child, a disabled adult child, a sibling with an equity interest in the house who has resided in it for a period of one year prior to the institutionalization of the ailing sibling, or a child of the applicant who has lived in the house for a period of two years prior to the institutionalization of his or her parent for the purpose of caring for the parent. In all other cases a transfer of real estate, whether a homestead or not, now comes under the 30-month rule.

This effectively forecloses transfers to those individuals who under the old law were most likely to receive this homestead--adult children who do not reside with the parent in the house.

Life Estate

When the transfer of a homestead is advisable, it may be wise to recommend that the donor reserve a life estate. Not only will this protect the elderly parent against being evicted by the donee children, but permits the donor to maintain any senior citizen's tax abatement and eliminates any liens against the Medicaid recipient's estate after his or her death. A life estate by definition terminates upon death. Thus there is no estate remaining. Also, using a life estate provides the donee (under IRC Secs. 1014 and 2036) with a stepped up basis upon the death of the donor. This appears to be an all-around good strategy. But of course, when things seem to be too good to be true, they often are. The life estate also entitles the holder to all net rental income and, if the property is sold, Medicaid might potentially claim that the life estate holder is entitled to the fair market value of the life estate--both possibilities may provide income which requires further protective planning.

The $10,000 Annual Gift

One of the most commonly asked client questions in response to being told of the 30-month waiting period is: "Aren't you allowed to give away an annual amount of $10,000?" Yes, of course--for gift tax purposes. But the same amount given away by a person who just happens to become ill within the eligibility "waiting" period, can potentially disqualify him or her from receiving benefits. Two different sets of regulations are functioning, and care must be taken to deal with them separately.



Because the CPA is usually the first individual that an elderly person contacts, and because the CPA's advice might be solicited on tax matters, certain "trade offs" must be recognized and considered in assisting a client with making a decision. It is usually advisable that this be done in conjunction with an attorney familiar with Medicaid and Medicare laws so that tax considerations are not favored over other considerations.

Estate and Gift Tax


When a client is in the enviable position of being able to reduce an estate by giving gifts, the primary consideration may be the gift or estate tax. The $600,000 lifetime estate/gift tax credit and the $10,000 annual exclusion are well known to CPAs. More often than not, therefore, an individual seeking tax counseling will be told that he or she may give away $10,000 per year, per person. That, in effect, may be what he or she ends up doing. With an ailing client, however, this may be insufficient. One must always evaluate the gift/estate tax (most people do not reach the federal cut-offs and are therefore only concerned with any state amount) compared to the cost of not gifting money. As indicated earlier, many people are hesitant to pay any taxes and will limit their gifting to $10,000 annually. However, perhaps forgotten is the "100% health care tax," because 100% of a person's assets are always available for the payment of expensive medical care, should that become necessary.

A client who has an extensive estate consisting largely of appreciated property or tax deferred account requires special consideration.

Example #1: Mary Brown, 92 years old and in failing health, has $300,000 in securities for which she paid $30,000 and an IRA rollover worth $200,000. Her annual income from all sources, including Social Security is $60,000. Considering her age and health, the CPA must evaluate whether the capital gains tax to be paid by her donees on the resulting $270,000 profit (remember: no step-up in basis for a gift), the income tax due on distributions from the IRA, and state gift tax due are likely to cost more than doing nothing and letting Mary's assets be consumed for nursing home care.

Example #2: Jack Frost, 72 years old, has $100,000 in cash. He is in fair health now, but may require a nursing home within a few years. The cost to him of not transferring his property will clearly outweigh the cost of keeping it: it will all be gone within two years of nursing home residency. In this case, with no gift tax being due, it would be foolish to hold this money (except, of course, to the extent that Jack's dignity and independence require it).

As you can see, the particular facts--age, health, nature and extent of assets--may change the picture.

Tax Considerations of

Irrevocable Trusts

Normally, when the settlor creates an irrevocable trust to protect assets, he or she does not wish to give up full control and usually reserves the right to receive income. Thus, while a taxable gift is made, it is only of the remainder. The income continues to be paid to and taxed to the settlor.

Because the settlor keeps a life interest, he or she is deemed to have incidents of ownership at death, so the entire value of the trust is counted in the estate under IRC Sec. 2036. This results in a step-up in basis of appreciated property under IRC Sec. 1014.

A gift tax may be due upon transfer of a remainder interest when the trust is created and funded. This, of course, is credited against the ultimate estate tax. Even this might be avoided with the grantor's reservation of a special power of appointment.

When an irrevocable trust requires all income to be distributed to the settlor, it qualifies as a simple trust or, more likely, as a grantor trust with the result that it acts as a conduit for funds; there is no double taxation at the trust level and then at the individual level. In fact, it may not even be necessary to file Form 1041.

Income Tax Considerations

In addition to estate or gift issues, the CPA should be familiar with three specific areas of income taxation affecting the elderly.

IRAs. We are a nation of conflicting laws, and IRAs provide a clear example of this conflict. Congress, in seeking to encourage savings for retirement, authorized the creation of IRAs and Keoghs. However, while their purpose may have been intended by one Congressional subcommittee to provide income for retirement, apparently no one in any of the subcommittees made the connection between the existence of retirement funds and Medicaid eligibility. As a result, although they are a vehicle for deferring income taxation, the IRA or Keogh itself is not an exempt asset for Medicaid purposes. It is subject to invasion for the purpose of providing income for medical expenses. Current law, however, exempts consideration of the pension funds of a non-applying spouse for the use of the institutionalized spouse.

The CPA's role takes on importance in advising a client whether to withdraw the IRA fully, transfer it, and wait out the 30-month period for eligibility or keep the IRA intact, drawing it out over a period of years. Two examples will serve to illustrate the possibilities:

Example #1: A client in reasonably good health desires to plan in advance of the 30-month period. His largest asset is a rollover IRA containing $300,000. If all $300,000 were transferred immediately, not only would there be a substantial income tax, but also there would most likely would be a gift tax as well. Because of the client's good physical health, it might be advisable in this instance to have the money transferred over a period of time.

Example #2: Assume the same facts as in Example 1, except that the client is currently ill and about to enter a nursing home. With the cost of a nursing home approaching $60,000 per year, it might be more advantageous to have the individual withdraw most of the money currently, pay the income taxes, estimate the amount necessary to pay for a nursing facility for the 30-month period prior to Medicaid eligibility, and transfer the rest as a gift. If the gift and income tax is less than the cost of the nursing home, an overall savings might be produced with this strategy. This is particularly true when the medical bills are deductible.

Naturally each client's situation must be evaluated separately because the health, the amount of the retirement fund and the availability of income averaging will dictate the results.

Tax consequence of the sale of a house. As previously discussed, a life estate may result in a stepped-up basis. However, not every donee is willing to wait until a parent's death in order to sell a house. Many times financial hardship or the inability to manage and preserve the property necessitates a sale, particularly if the parent is subsequently institutionalized and the home is vacant. A question constantly confronting the practitioner is whether the $125,000 exclusion under IRC Sec. 121 applies where there is a life estate. The answer is yes. In Rev. Rul. 84-43 it was held that the exclusion is available to a life estate holder as long as that life estate constitutes the totality of the interest held by the life estate holer. Rev. Rul. 85-45 holds similarly in the case where a house is placed into a trust with a life estate reserved for the settlor.

It should also be noted that a 1988 amendment to IRC Sec. 121 reduces the 3-of-5 year residency/ownership requirement to 1-of-5 if the taxpayer becomes physically or mentally incapable of self-care and is forced by virtue of this medical condition to move into a nursing home.

Medical deduction available to children. Oftentimes an adult child will ask whether he or she may deduct a parent's medical bills if he or she is paying them. A deduction is generally available if the parent can be claimed as a dependent or if the parent could have been claimed as such but for the fact that the parent has received more than $2,050 of gross income. A strategy to explore is whether it would be beneficial for the parent to transfer all of the assets to the child, pay any gift tax, and wait 30 months, during which period the adult child pays the medical bills--using the funds just gifted--and takes a corresponding deduction on Schedule A.


CPAs are hired, among other reasons, to protect their clients' financial resources and often go about this creatively. However, proceed very carefully with that creativity when planning for the medical needs of the lederly. Remember than, as in the case of the IRA or the $10,000 annual gift tax exclusion, what may work for tax purposes may cause far more problems for purposes of Medicaid eligibility.

Sale Versus Gift

There is no advantage in terms of Medicaid eligibility to a sale versus a gift. Both require a waiting period of up to 30 months. Although it may not be as apparent in the case of a sale, remeber that if "consideration" passes hands, the consideration belongs to the parent until subsequently transferred, in which case a gift is made anyway. It makes absolutely no difference from a Medicaid standpoint whether appreciated property is gifted directly, or whether it is sold, the proceeds paid to the parent, and the parent then giving the proceeds to the child.

Sometimes when a parent wishes to transfer appreciated property to a child as a gift, the tax advisor may state that a sale is preferable because of the increase in basis to fair market value. While the parent may have to pay an income tax on the gain, it may be less than that paid by a child in a higher bracket, or, in the case of a primary residence (the homestead) where the parent is able to exclude $125,000 of gain. The down side of such a transaction is that there can be no further step up in basis upon the death of the parent.

Installment Sale

A technique often employed in the "sale" of appreciated property, particularly real estate, is the installment sale wherein the parent takes back a mortgage and forgives the indebtedness at the rate of $10,000 per year. While this may work for purposes of producing an annual gift tax deduction, is just delays the 30-month waiting period for Medicaid eligibility because each transfer renews the period. An outright gift is better.

"Faux" Consideration

Sometimes cleverness takes the form of calling a particular service "consideration." For example, a transfer of $50,000 is made and the client then asks: "Can't I say that this money was given in return for my promise to take care of mom or dad?" There are more dangers here than benefits. If done incorrectly the client can be in for a very rude awakening. In one case decided several years ago, a parent, rather than giving a house outright to a child, transferred it pursuant to a "contract" which provided that in consideration for the transfer the child would take care of her mother for life. A subsequent change in the law then made her mother eligible for Medicaid regardless of whether the house had been transferred with or without consideration. While, without this contract the parent would have been eligible for Medicaid, the Appellate Court ruled that the contract was binding and that the daughter's obligation to support the mother was paramount to that of the Department of Social Services. All of her mother's medical bills were her responsibility--even if they exceeded the value of the house that was transferred--a lesson to anyone who tries to overreach.


Planning for the elderly has taken on new and increased sophistication, and is a very necessary part of today's estate planning strategy. Learn to identify the individuals who need such planning and to balance tax considerations with family and health care considerations. You will undoubtedly be rewarded with increased clientele and the warm feeling that you have done something to truly help protect your client's estate.

Ezra Huber, Esq., concentrates his practice in "elder law," counseling clients on financial planning to avoid bankruptcy from catastrophic health care bills or illness. He has lectured extensively for the National Academy of Elder Law Attorneys, the New York State Bar Association's Continuing Education Program and the Foundation for Accounting Education and is the co-author of "Financial Planning for Long-Term Care," copyright 1989 by Human Sciences Press. Mr. Huber is currently completing his second book on this area of practice.

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