In the field of estate planning, there are revocable trusts, and there are trusts that cannot be revoked. When you have a revocable living trust, you would act as the trustee and the beneficiary, and you could dissolve the trust entirely and take back direct personal possession of the assets.
Because of the fact that you have total control, for tax purposes, the assets belong to you. As a result, if you were to convey appreciable assets into the trust, and they do in fact rise in value considerably, you would incur capital gains tax responsibility.
Things are very different with an irrevocable trust. When you sign assets over to this type of trust, you are surrendering incidents of ownership, because you cannot touch the principal or rescind the trust.
It becomes a separate entity for tax purposes with its own tax identification number. If assets in the trust appreciate, and they are sold by the trustee, the profits would not be looked upon as capital gains. They would be contributions to the corpus, and they would essentially become part of the principal. With a simple irrevocable trust, all the profits would be distributed to the beneficiary annually, and they would be taxed at the beneficiary’s regular income tax rate.
Value of Irrevocable Trusts
There are a number of different situations that can call for the creation of an irrevocable trust, and one of them is the special needs planning scenario. People with disabilities are typically going to require costly medical care throughout their lives. In most cases, they cannot work, so they do not have health insurance through their places of employment.
If you can’t earn income, you are not going to be able to afford to pay for health care insurance out-of-pocket. Fortunately, there is a health insurance safety net for people with disabilities. Medicaid is a federal/state government program that is available to individuals with very limited financial resources. In Ohio where we practice law, the asset limit is just $2000.
There is another government program that many people with special needs rely on called Supplemental Security Income. The name is self-explanatory: SSI provides a modest but steady stream of income for people that have little to no personal earning power.
When you have someone with special needs that is enrolled in these programs on your inheritance list, you have to take pause, because an influx of money could cause a period of ineligibility. To account for this, you could establish a supplemental needs trust.
You name a trustee to act as the administrator, and the person that you want to help would be the beneficiary. The government benefits do not satisfy all of the needs of a benefit recipient, and these are referred to as supplemental needs. This is why the trust is called a supplemental needs trust.
The trustee can use assets in the trust to satisfy these needs without jeopardizing benefit eligibility. After the passing of the beneficiary, the Medicaid program is required to seek reimbursement from assets that may remain in the estate of the deceased person.
If you establish a special needs trust for the benefit of someone else, it is a third-party trust, and the assets would be protected from Medicaid recovery efforts. Anything that is remaining in the trust would be transferred to the secondary beneficiary that you name when you establish the trust.
Income-Only Medicaid Trusts
There is another reason why people establish irrevocable trusts with Medicaid eligibility in mind. The majority of seniors will require help with their activities of daily living at some point in time, and a significant percentage of them will spend their final days in nursing homes. These facilities are very expensive, and Medicare does not pay for a stay in a nursing home.
Medicaid will pick up the tab if you can qualify. To gain eligibility, you can convey assets into an income only Medicaid trust. You would lose access to the principal, but you would continue to receive income that is earned by the trust until and unless you apply for Medicaid.
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