Elder Law attorneys hear this question constantly. Typically, once people reach a certain age there is an invisible pressure to transfer assets out of one’s name and into that of their children. Some people feel that if they do not do this, the “State” will take their money either in taxes or for the costs of long term care. Along with the the real issues that seniors should be considering regarding transferring their property, there are many myths.
The first issue that seniors worry about is that they should give away assets before they pass away to avoid taxes. Currently, the Federal Estate Tax exemption is $5,340,000.00 per person, indexed for inflation. That means that each person can leave $5,340,000.00 to anyone without a tax consequence. Married couples can leave $10,680,000.00 together, and the surviving spouse can use any unused portion of the first spouse’s exemption. This is known as portability. The New York State Estate Tax exemption is currently $2,062,500.00 per person, and is set to increase by about $1,000,000.00 each year until it matches the Federal Estate Tax exemption amount in 2019. Unlike the Federal Estate Tax system, New York State does not have portability. Therefore, if the first to die spouse does not use their exemption, it is lost forever and the surviving spouse will only have their own exemption.
In light of the foregoing, the average person does not have to worry about taxes. However, if there is a chance you will have a taxable estate, there are some techniques estate planning attorneys use that may reduce your estate tax burden, but it is rarely advisable to merely transfer your assets to your children while you are still living. While New York State does not impose a tax on gifts made during your lifetime, there is a three year “clawback” which means that any asset transferred to an individual or trust within three years of the date of death will be brought back into the estate for estate tax calculation purposes. This rule basically eliminates what used to be known as death bed transfers. Secondly, even if the design of your estate plan includes periodic gifting to your children or other individuals to reduce your estate, the transfer should be made to a trust for the benefit of that individual, not to them directly. This will ensure that the property remains protected by keeping it out of reach of your beneficiary’s creditors. If properly designed, the gift into a trust can also avoid estate tax inclusion in your child’s estate, thereby preserving wealth for generations to come.
It should be noted that, to the extent possible, any lifetime gifting to a trust for your children should be of assets with low appreciation. This is because assets transferred during your lifetime are transferred using your cost basis, meaning the amount at which you purchased the asset. If your child’s trustee later sells the property and it is highly appreciated, there will be a sizable capital gains tax. Assets that are likely to appreciate a large amount throughout your lifetime are better off being transferred to your beneficiaries after death, stepping up the cost basis to the date of (your) death value of the asset.
With the Federal and State exemptions being so high, many people are less worried about estate taxes. This brings us to the second issue about which most seniors are rightfully concerned: asset protection for the cost of long term care. The Medicaid program in New York will pay for the cost of long term care in a nursing home facility or for care in the home. For nursing home care, Medicaid requires the applicant to have no more than $14,550.00 in assets and there is a five year lookback. This means that a penalty period will be assessed for any assets transferred for less than fair market value within five years of the submission of an application for Medicaid. While it is true that the five year lookback applies whether or not you transfer assets directly to your children or to a trust, the negatives of an outright transfer far outweigh the convenience and low cost.
First of all, once you transfer assets to your children, those assets belong to your children and are subject to their creditors. For instance, if you transfer your house to your child who then incurs a large debt, the creditor can come after your home. If your child passes away before you, the house will be part of their estate and their spouse will have an interest in your home. Moreover, if you later decide to sell your home, it is your child who must agree. Lastly, as described above, if your child does sell your home there may be a large capital gains tax due because they take the property at your cost basis and cannot use the $250,000 exemption if the property is not their primary residence.
For all the foregoing reasons, the prudent way to protect assets for Medicaid is to use a trust. Unlike the trust described for tax planning above, the grantor of a Medicaid Qualifying Trust will retain many rights over the property during their lifetime. For instance, the grantor is entitled to exclusive use and occupancy of any property in the trust and any income generated in the trust. The grantor may also change the trustees and/or the beneficiaries at any time. Lastly, when the grantor passes away the property in the trust gets a full step-up in basis to the date of death value. Accordingly, if the child sells the property they inherit, there will be little or no capital gains tax due.
Transferring assets is a complicated matter. While the notion that assets are vulnerable to creditors is a reality for everyone, it is typically not the best plan to make outright transfers to your children. Before transferring anything, consult an Estate Planning attorney in your area to learn more about what kind of planning best suits your individual needs.