We get people who come into our office all the time who have made substantial gifts of cash, vehicles or even their home to loved ones because they believe that is what they should do to protect those assets in the event that they go into a nursing home. They take action on the advice of family, friends, the morning coffee clutch, their financial advisor, the register of deeds, their tax preparer and sometimes even their family attorney who is not an elder law attorney.
They have heard that they can gift up to $10,000 per year without having to report or pay tax on it. As is the case with most legal and tax advice you hear from non-experts, it is well intentioned, but only partly true.
It is true that pursuant to the Federal gift tax laws, you can gift up to $14,000 (up from $10,000) per person, per year in 2016 without having to report or pay tax on it for Federal gift tax purposes. With gift splitting, a husband and wife can gift up to $28,000 per year per person.
What is also true is that you can give more, much more, to your loved ones without paying any gift taxes. In 2016, your gifts in excess of the annual exclusion amount are not subject to Federal gift tax unless your total lifetime taxable gifts exceed $5.45 million. For a married couple, with gift splitting, this amount is $10.9 million in 2016. For most Americans, you can give away everything you own and there will be no Federal gift tax. But should you?
Although these gifts are not taxable for Federal gift tax purposes, in other circumstances, these gifts are fully reportable and countable. For example, you need to report any gifts you or your spouse have made within the last five years of an application for Medicaid to pay for nursing home care. There is no minimum gift which is excludable. Every single one of those gifts, no matter how small, must be counted and reported as divestments.
These gifts will create a divestment penalty period during which Medicaid will not cover your nursing home care. That penalty period is calculated taking the sum of all countable divestments and dividing it by the Michigan Department of Health and Human Services (DHHS) divestment penalty divisor, which is $8,282 in 2016.
For example, if you made a gift to your family of $28,000 in 2013 and applied for Medicaid for your nursing home care in 2016, then that gift would create a divestment penalty period of 3.4 months. During the 3.4 month penalty period, Medicaid would not pay for your nursing home costs. Your family would have to cover those costs with their own money or use the gift money to pay for your care.
So, couldn’t you just give everything away today if you don’t think you will need nursing home care in the next five years? Yes, so long as you do not go into a nursing home and need to apply for Medicaid within five years of the gifts.
The good news is that if you do not go into the nursing home for five years, you do not have to report any gifts made more than five years from the date you applied for Medicaid. The bad news is you no longer have those assets for yourself or for your care. They are gone. Your assets are now owned by your children or others and are no longer available for your own needs.
If you can guarantee that you will not need nursing home care in the next five years and that you will not ever have a need for your assets for the rest of your life, then go ahead and give everything away. But you cannot guarantee that. If you are like most people, you will need your assets for the support of you and/or your spouse. So what can you do?
It used to be that you could make monthly gifts up to a certain amount that would not considered a divestment when you apply for Medicaid. You also could have purchased “Medicaid friendly” annuities that would be protected. These types of pre-planning are no longer appropriate.
I generally recommend that you only make gifts in three circumstances: 1) You are just generous and want to give to your favorite charitable passions or favorite persons; 2) You have a taxable estate over $5.45/$10.9 million in 2016 and you want to disinherit the IRS; or 3) You or your spouse have entered, or are about to enter a nursing home and you want to protect assets for the well spouse or other loved ones.
If you or your spouse enters a nursing home, there are certain assets that you can keep without disqualifying Medicaid from paying for the nursing home care. These assets are called exempt assets and include your home up to a certain value, one vehicle, prepaid funerals and burial plots for the both of you and certain life insurance. All of your assets that are not exempt assets are considered countable assets. Your home must be properly titled in order to be considered exempt and to avoid the Medicaid payback estate recovery after the nursing home resident’s death.
Nursing home residents and their spouses can only keep a certain amount of countable assets when applying for Medicaid to pay for nursing home care. You may think that you have to spend down all of the excess countable assets on nursing home care before you apply for Medicaid, but this is not true. There are lots of things that you can spend the excess countable assets on without creating a divestment penalty, such as home improvements, paying down loans or buying a new vehicle.
If you are married, all of the excess assets can be gifted to the well spouse without creating a divestment penalty. The well spouse can then take those excess countable assets and purchase a special “pension” in the form of a certain Medicaid qualifying annuity or promissory note. Those assets in the spousal “pension” would be considered the well spouse’s income. The nursing home spouse could then immediately apply for Medicaid to pay for nursing home care.
If you are single and enter a nursing home, you can similarly protect assets for your loved ones. You can gift approximately one-half of your excess assets to your loved ones, which would create a divestment penalty period. You then use the other half of your excess assets to purchase a special “pension” which would be your income to pay for your nursing home care during the divestment penalty period. The entire gifted amount would be protected for your loved ones.
However, if you are in the nursing home, you may be incapacitated and be unable to personally do this planning and make these gifts. How do you make sure that those gifts can be made? The best way is to prepare and sign a durable financial power of attorney with broad gifting powers that allow your power of attorney agents to make gifts to anyone, including themselves.
I often see financial powers of attorney that either have no power to gift or have limited the gifting powers, such as prohibiting gifts in excess of the annual Federal gift tax exclusion or a pre-existing gifting plan. With financial powers of attorney that either have no gifting powers or limited gifting powers, your agent cannot protect your assets for your loved ones. Your assets would have to be spent down for your nursing home care.
When naming your financial power of attorney agents, be careful. We all have heard stories about children or grandchildren with powers of attorney who steal assets. Make sure that the person to whom you give these powers can be trusted.
It is important to discuss these matters with your loved ones. That way, everybody understands what your wishes are and what they need to do. To make sure that you do not have any unintended results, you should consult with competent tax and elder law advisors before making any gifts for asset protection purposes.
By Matthew M. Wallace, CPA, JD
Published edited October 2, 2016 in The Times Herald newspaper, Port Huron, Michigan as: Get proper advice before gifting