It’s tax season again. With that in mind, I noticed several incongruities between long-term care Medicaid rules and tax rules that every advisor should know and understand. So before you get too busy filling out your 1040, I thought I’d recap some good ways to make sure you and your clients are ready.
Three years of tax returns vs. five-year look back
Two recent cases brought up the same issue. In one case, I was talking to a financial accountant who does taxes and investments for her clients. Her client needed five years of statements for the Medicaid caseworker. “I only tell my clients to keep three years of statements,” she said, “because that’s what the IRS requires.”
I just shook my head.
In the second case, someone said to me, “The IRS only requires three years of back financials and Medicaid has a five-year look back. Since the IRS is a federal program and Medicaid is run by the state, doesn’t the federal rule prevail?”
After that, I had to chuckle.
To each, I have the same basic reply: “If you want Medicaid to pay, you’ve got to play by their rules.” In 2006, the Deficit Reduction Act established the five-year look back for transfers of assets. This is used to determine if the applicant has transferred or gifted any assets for less than fair market value.
How do they look back?
They ask for bank statements or financial statements for each account owned by the applicant during the five-year period. If you didn’t keep the statements, you’ll likely have to go to the financial institution and have them order copies. Most financial institutions do this for free, but some charge a fee. In one case, a bank charged $5 a statement and the client had two accounts. For 120 statements, it would cost the client $600, and the bank was unsympathetic with the client’s need for the statements.
The better solution: Stop telling your clients to only keep three years of statements! Instead, be a smarter advisor and understand why they need to keep five years of statements.
Gift tax exclusion vs. Medicaid divestment penalties
One of the classic myths of Medicaid planning is that you can give away $14,000 a year per person without a penalty. That’s just not true! The $14,000 limit comes from the annual gift tax exclusion. Over $14,000, you either pay a gift tax or use up part of your exclusion (discussed more fully below). But just because the same Congress passed the tax code and the Medicaid code, don’t think that the two actually agree with each other.
Medicaid will look back five years and add up all gifts or transfers. Unless they were made to an exempt transferee (e.g., a disabled child), Medicaid takes the total amount and divides it by the average cost of care per month in the applicant’s state or region to determine how many months they will be ineligible for Medicaid.
Gift and estate taxes are usually the least of most people’s true worries, but by thinking that the $14,000 exclusion applies, many people give this gift annually thinking there will be no negative consequence.
When lecturing to a bar association’s tax section recently, I gave the example of a lady who gave her daughter $14,000 a year and ended up in a nursing home where the cost of care quickly drained her remaining resources. She files for Medicaid and they ask her if she transferred or gave away any money and she says yes, $14,000 a year. That totaled $70,000.
Then Medicaid does the math: $70,000 ÷ $7,000/month = 10 months. So in this case, the woman would be ineligible for Medicaid for nearly a full year. Medicaid will require her to get the money back from her daughter and use it for care expenses. If the daughter won’t or can’t cough it up, most states require that the applicant “seek all legal remedies” to get the money back before they’ll grant a hardship waiver.
What a mess! But this mess can be avoided. It starts with the advisor understanding and communicating the difference between the Medicaid rules and the tax code. A good advisor should caution clients against gifting without a long-term care strategy.