Irrevocable “Income Only” Trusts, commonly called Medicaid Asset Protection Trusts, are used to protect assets and allow people to qualify for Medicaid long-term care if needed. Often spouses will place each of their half interest in their home in the trusts, maybe some liquid assets, name a child as trustee and not think about it for years. This is exactly what is supposed to happen – waiting out the five-year lookback period for nursing home care. But what, if anything, should happen on the death one of the spouses?
Medicaid trusts are typically Grantor Trusts for tax purposes. The trusts can be drafted so that income can be distributed to the Grantor, accumulated in the trust, or distributed to lifetime beneficiaries. Regardless of who receives the income, the income is taxed to the Grantor.
When the Grantor of a Grantor Trust dies, the trust is no longer taxed as a Grantor Trust. Most trusts provide that upon the death of the first spouse, the income interest continues for the benefit of the surviving spouse. If this is a mandatory income interest to the surviving spouse, the trust would be taxed as a Simple Trust. If the Trustee has discretion to pay the income to the spouse, or some other beneficiary, the Trust would be taxed as a Complex Trust.
Typically, a separate tax identification number was assigned to the trust when created, so there is no need to apply for a new tax identification number. If instead, the trust used a spouse’s social security number, then a tax identification number will need to be applied for and assigned to the trust. The tax treatment will have to be revised from Grantor Trust to either Simple or Complex Trust.
In addition to the change of taxation of the trust after the death of a Grantor, this is a good time for the surviving spouse to review his or her estate plan to ensure all goals are still being met by existing documents. All beneficiary designations for assets outside the trust should be reviewed and advance directives updated. It is likely that many bank accounts were jointly held with the spouse are now solely in the name of the surviving spouse. By adding a beneficiary to these accounts, the surviving spouse can avoid probate at death. It may also be prudent to place additional assets in trust to protect them if there has been a large accumulation of additional wealth since the Medicaid trusts were first funded.
Medicaid trusts are designed to protect assets in case Medicaid is needed to cover the cost of long-term care. While the Grantor is entitled to receive the income if they so choose, principal cannot be distributed to the Grantor. Even if the five-year lookback has run, the rules of the trust, namely that your Trustee may not distribute any principal to the grantor, must still be respected in order to protect assets for Medicaid purposes.
- Kimberly Trueman, Esq. and Nancy Burner, Esq.