A common misconception about government agencies is they all work according to the same set of rules. This misunderstanding becomes painfully clear when individuals attempt to use the annual gift tax exclusion of $15,000 as a planning strategy for asset protection for long-term care.
Most people have heard that each individual is allowed to gift $15,000 per year to another person without paying a gift tax. But exactly what the gift tax is, and the consequences of going beyond $15,000, are less clear.
To better understand the exclusion, we have to take a look at what we are excluding this amount from. With some exceptions, the IRS allows each person the ability to give away a total of $11.7 million in gifts during his or her lifetime and after death without incurring a tax on the gift. However, the first $15,000 given to each person within each calendar year is excluded from the total amount counted.
For example, if a woman gives her three children each $15,000 per year for five years, although she has given away $225,000, this amount is not deducted from the $11.7 million that she is allowed within her lifetime non-taxable gift limit.
Consider, however, that if the same woman gives her children instead $16,000 each year for five years, the extra $3,000 per year must be deducted from her lifetime non-taxable gift limit. Unless she reaches the $11.7 million limit after her death, her estate will still pay no taxes on the gift. She will merely be required to file a form each year letting the IRS know that she is reducing her limit.
While the $15,000 exclusion each year simplifies individuals’ ability to give gifts without cumbersome reporting requirements, it causes major problems when used in an attempt to create Medicaid eligibility.
The Medicaid program is designed to provide for low-income individuals and generally is recognized as a major source of payment for nursing home care.
Because Medicaid is based on financial eligibility, an applicant’s assets must be considered, including any transfers made within the “lookback” period. Every state other than California has enacted a five-year lookback period. This simply means Medicaid will include uncompensated transfers made within the past 60 months as if the gifted assets still should be available to the applicant.
Medicaid does not allow the IRS’ gift tax exclusion to be used for the lookback period.
Consider the previous example of a woman who gives her three children each $15,000 per year. If she goes into a nursing facility in the fifth year, after giving her final set of gifts, the IRS will not count any of the gifts made against her lifetime gift tax exemption. However, Medicaid will count the full $225,000 as if the assets were, or should be, available to pay for her care, likely triggering a significant penalty period. This can be a devastating realization for families simply trying to navigate confusing regulations.
For individuals who would like to continue to take advantage of the annual gift tax exclusion, a safer option is to use an Intentionally Defective Grantor Trust to hold assets. This special hybrid trust separates assets from the grantor just enough to begin the five-year lookback period. However, it holds property within the grantor’s taxable estate, allowing for the continued ability to take advantage of the annual gift tax exclusion without triggering a new five-year lookback at each gift.
The IRS and Medicaid operate under two vastly different sets of rules. Understanding the different requirements can ensure that goals are met without triggering unintended and costly consequences.