With such significant increases in nursing home costs in recent years, it can make sense to structure estate assets in such a way as to shield them from Medicaid effectively.
We discuss many trust types. But one that gets often overlooked is the Medicaid Intentionally Defective Grantor Trust (“MIDGT”). In the right situation, this trust can be a home run.
What is an Intentionally Defective Grantor Trust, and how does it work?
Simply stated, a Medicaid Intentionally Defective Trust allows a person to legally separate assets for Medicaid planning, while still maintaining an interest in the assets of the trust.
As such, a Medicaid Intentionally Defective Trust allows a grantor to benefit from legal strategies that support Medicaid planning, while still retaining an interest in the trust assets.
If a trust is considered to be a “grantor trust” under Sections 671-678 of the Code, the grantor will be treated (or considered) as the owner of the trust property for income tax purposes, and all of the income of the trust will be taxed directly to the grantor. In basic terms, a trust is considered a grantor trust if it is revocable, if the grantor retains the power to control the ultimate beneficial enjoyment of the trust property or the income it produces, or if the grantor has retained certain administrative powers.
Interestingly, the grantor trust rules for income tax purposes are not consistent with the estate tax transfer provisions requiring the inclusion of trust property in the grantor’s gross estate. This gives rise to a planning opportunity whereby an irrevocable trust designed to be outside of the grantor’s estate for estate tax purposes is made “intentionally defective” so that it is a grantor trust for income tax purposes. By doing this, the grantor has retained the obligation to pay the income tax liability attributable to the trust property and will, in effect, be making ongoing tax-free gifts to the beneficiaries of the trust.
An intentionally defective grantor trust (or IDGT) is an estate planning structure that effectively eliminates specific assets for estate tax purposes but still allows the benefits of individual income tax rates. The IDGT is carefully structured as a grantor trust. But it will enable the grantor to continue paying income taxes on the trust assets. The income tax laws do not recognize that those assets have been gifted away by the individual.
Since the grantor is responsible for paying the taxes on trust income, the trust assets can grow tax-free. In addition, it can avoid gift taxation for the beneficiaries of the grantor. Thus, it is a unique loophole that can be used to lower estate tax exposure.
Medicaid Asset Protection Trust
Many clients have used a Medicaid Asset Protection Trust (in one of its forms) to shelter assets from the increasing cost of long-term nursing home care.
It is a type of irrevocable trust that protects the person making the gift and prevents assets from being siphoned off to pay for nursing home care. These benefits make such gifts to the trust a much better option than typical outright gifts to children.
But it gets better. Many clients now utilize a relatively new estate planning tool I would call the combo plan. It is the Medicaid Asset Protection Trust and the Intentionally Defective Grantor Trust (IDGT).
Intentionally Defective Grantor Trust Medicaid
Any assets transferred directly to the MIDGT would still be protected from nursing care facility spending after the gifting Medicaid ineligibility period. But there is another nice feature.
The person who made the gift to the MIDGT must pay the tax on the earnings. The trust does not pay it. The grantor may want to pay the tax in many situations rather than having the trust pay the tax.
When paying the tax on the trust income, the grantor allows the Medicaid Asset Protection Trust to continue to grow without being reduced by tax payments. In addition, they will usually pay a lower rate on their personal taxes compared to trust tax rates.
As a further benefit, medical care costs are usually tax-deductible to people. These expenses can be significant and may be utilized to offset any gains generated in the MIDGT. If the Trust was liable for the tax, the individual’s medical costs could not have been deducted.
Even though we love the MIDGT, it is not the best solution for many people. The grantor must be willing to give up the right to the income paid from the Trust and simultaneously pay the income tax. This may require some careful tax planning with your CPA and estate attorney. This is just one of the powerful planning tools available when the goal is to avoid using assets from nursing home care spending.
How to Set Up a Medicaid Intentionally Defective Trust
Use these five steps to set up your MIDGT:
- Locate a qualified attorney
Most attorneys are not familiar with these trusts. Make sure you find a lawyer that understands how these trusts work and can offer Medicaid planning services.
- Review your assets and liabilities
Determining your assets and income is a critical step in the planning process. Examining your income streams will help you understand whether or not you can qualify and help determine if you even need a MIDGT.
- Examine Medicaid qualifications
The Medicaid rules and regulations are constantly changing. Take a look at the current guidelines to determine eligibility.
- Contact your state
Medicaid is administered at the state level. So make sure you contact state officials to clarify any issues.
- Sign the trust document
Once your attorney has drafted the trust document, make sure that you review and sign. At that point, you can set up the applicable accounts for the income streams.
Intentionally Defective Grantor Trust Medicaid strategies are essential to folks looking to shield assets. But the structure is not always easy to set up. Each situation is unique and you should carefully review your situation with a knowledgeable estate attorney and CPA.