When Medicaid and tax rules collide

Gift tax vs. gift-and-wait strategies 

For advanced planning, we do a lot of gifting. Most choose to gift and wait out the 5-year look back. For VA benefit planning, we gift and apply for benefits where appropriate because of the lack of a penalty period for gifting. Even in crisis cases, for single patients it is usually advantageous to gift a portion of the assets and buy an annuity or use a promissory note with the remaining assets to help pay through the penalty period. 

See also: Medicaid and veterans’ benefits 

Gifts can be $10,000 or can be $600,000. So what about the gift tax? 

In reality, the gift tax is never a bar to good gifting strategies for Medicaid because of how the gift tax works. The gift tax was the tax code’s attempt to curb gifting to avoid the estate tax. So the two taxes were tied together. If you gifted more than the limit per person, the gift is subject to a tax, but the tax can be offset by using the estate tax exemption. 

So how much can you really gift? In the last few years, Congress increased the estate tax exemption to $5.34 million! That’s a lot of gifting. And practically speaking, if you have $5 million to gift, you probably aren’t too worried about needing long-term care Medicaid. 

The other issue is that recipients think their receipt of a gift is taxable to them. Most people don’t understand that gifts — even if they were taxable — are not taxable to the receiver but to the giver. 

If the new proposed VA rule takes effect adding a three-year look back to gifting for eligibility in the VA Aid & Attendance pension benefit, more people are going to have to execute gifting strategies to take advantage of necessary benefits.

Gifting vs. income 

There are times when you want to pay tax on transfers between a parent and a child so that it won’t look like a gift. This mostly arises when using a personal caregiver agreement to pay a child or close family member for care. Medicaid assumes that if a family member is providing care, then they’re doing it out of love and affection. If a person pays the family member for care, Medicaid — by default — will presume that the payment is a gift and add those gifts up to determine a period of ineligibility for Medicaid. 

To avoid those payments being treated as a gift, Medicaid has a complex set of rules that vary from state to state. For the most part, they require that a valid caregiver agreement be set up between the family members and that the payment is reasonable based on what it would cost for the same services in the local area. 

But what happens when Grandma pays the granddaughter $700 a week to care for her? Most forget to write up a contract. And even if they do, Grandma writes a check for $700 each week to the granddaughter. The granddaughter conveniently forgets to report the pay on her tax return each year because she hasn’t kept any money back to pay taxes. It’s usually not a big problem, because the funds look like a gift and gifts aren’t taxable to the recipient. 

Where the problem comes in is when Grandma goes on Medicaid. If there’s any question about whether or not they have a valid care agreement, whether the caregiver reports the income as taxable or not makes a big difference. When establishing that the payment is not a gift, one of the easiest ways to prove it wasn’t is to see if the recipient reported it as income. When the caregiver granddaughter puts the income on her tax return and treats it as income — even if Grandma was overpaying her to bleed down estate resources — Medicaid is likely to exclude the payments from the transfer penalty calculation because they were treated as payments and income by both parties to the caregiver agreement. 

See also: President’s plans for estate, gift and GST taxes 

Where this is exceptionally helpful is when the person needing care is a veteran. The VA currently accepts caregiver agreements and paid family caregivers as valid care expenses towards eligibility for the VA Aid & Attendance enhanced pension. By paying a family member, the caregiver expenses could trigger a benefit as much as $2,149 in 2015 for a married couple. That money comes in tax-free, but the caregiver has to pay tax on the care payments. Even so, the net plus to the family is in the tens of thousands each year. 

Where many VA benefit planners get it wrong is they advise payment for care but fail to follow through with advice on how to make those payments compliant with the future need for long-term care Medicaid and the IRS. 

Ultimately, the better advisors are aware of these issues and know the subject matter, the better off their clients will be — with far less of a need to dread tax season.