Quarterly Newsletters

June 2011: Gift Tax: The Mouse That Roared

If I had to list the top five questions I hear from clients, questions about gift tax would definitely be on that list. People are fascinated with gift tax. I find people's fascination with gift tax a bit humorous because so few people are affected by the tax. I would say that less than one-half of one percent of people pays gift tax, yet I think nearly 100% of the population believes that if they receive or make a gift of significant value gift tax issues are implicated.

The other day, a client asked me if her parent could split up a gift I recommended the parent make because her accountant told her that her mother could only gift $13,000. I've heard such statements attributed to accountants before, which always causes me to wonder whether the accountant really made the statement or if I'm only receiving half the story.

The fact of the matter is, an individual can gift $13,000 a year to an unlimited number of people without reducing his lifetime exemption against gift tax. So, for instance, Mr. Smith could give $13,000 to 100 of his friends and relatives without reducing his lifetime exemption against gift tax, and he could make those gifts each and every year of his life.

This $13,000 exclusion is called the "annual exclusion amount." The annual exclusion amount has risen in recent years. The amount was $10,000 for the longest time, and then it went to $11,000, then $12,000, then $13,000. It is the annual exclusion concept that has given rise to the thought that an individual can only gift $13,000 a year.

But what happens if a person gifts more than $13,000 in any one year to any one individual? In that case, the gift-giver's lifetime exemption amount is reduced by the amount that the gift exceeds $13,000.

So, how much is the lifetime exemption amount? It's only $5,000,000, meaning that an individual would have to gift more than $5,000,000 before he would ever pay gift tax.

For instance, if Mr. Smith gave his son $23,000 this year, Mr. Smith's lifetime exemption amount against gift tax would be reduced from $5,000,000 to $4,990,000. Only if Mr. Smith made a gift of $5,014,000 would a taxable event occur, because only then would Mr. Smith use up his annual exclusion amount and his lifetime exemption amount.

And it is Mr. Smith who would pay the gift tax. The gift-giver pays the gift tax, not the recipient of the gift. The receipt of a gift is never a taxable event. Now, say the recipient of the gift receives $100,000, and he invests that $100,000 in a money market account. The recipient will pay income tax on the interest that the $100,000 earns in his money market account, but he will not pay tax on the $100,000 gift.

The fact that the lifetime exemption amount is $5,000,000 (it was $1,000,000 before 2011) is why I find people's concerns with gift tax to be so misplaced as to be humorous. Obviously, most people are never going to receive a gift of $5,000,000.

In addition to the $5,000,000 lifetime exemption and the annual exclusion amount, an individual can also make unlimited gifts to charities and pay a relative's medical bills and costs of education directly to the provider of those services.

If a person does gift more than $13,000 in any one year to any one person, he should file a federal gift tax form, which is form number 709; however, the penalty for failing to file the return is based upon the gift tax that would have been owed, which in most cases is $0.

The fact of the matter is, not even the Internal Revenue Service is interested in a non-taxable gift from an individual whose estate would never be subject to gift tax. For instance, if your mom, who has a total net worth of $500,000, gives you $300,000, the IRS doesn't care because mom's estate would never be taxable.

PLAN EARLY

Would paying $12,000 a month for your care bother you? Many of the people who come to my office for a consultation are faced with care costs of $12,000 a month because a family member is in need of nursing home care.

Medicare and private health insurance do not pay for long-term care costs. Only Medicaid pays for long-term care costs, but Medicaid is only available to a person who has a limited amount of assets.

Because Medicaid is only available to individuals who have a limited amount of resources, Medicaid punishes people who dispose of their assets in an attempt to impoverish themselves artificially. Medicaid looks at all uncompensated transfers that an individual made within a certain period of time prior to applying for Medicaid.

This period of time is called the lookback period. Prior to February 2006, the lookback period was three years. Now, the lookback period is five years. What this means is that when an individual applies for Medicaid, the Medicaid Office looks back five years from the date of the application to see if the person has made any uncompensated transfers of assets.

An uncompensated transfer occurs when the applicant transfers an asset and does not get its monies-worth back. For example, assume that Mr. Smith gives his son his car, worth $5,000. Mr. Smith has made a $5,000 uncompensated transfer. Assume that Mr. Smith sells his house, worth $100,000, to his son for $50,000. Mr. Smith has made a $50,000 uncompensated transfer. If Mr. Smith owned a $30,000 bank account jointly with his son, and Mr. Smith's name was removed from the account, a $30,000 transfer would have occurred.

Medicaid aggregates all transfers that occurred during the lookback period. So, for instance, if Mr. Smith made a $2,000 uncompensated transfer in each of the years preceding the date of application, Medicaid would aggregate all five of those transfers and punish Mr. Smith for having made a $10,000 transfer.

Medicaid punishes an applicant by making him ineligible for Medicaid benefits. The more valuable the uncompensated transfer, the longer the period of ineligibility.

Medicaid calculates the period of ineligibility by taking the value of the uncompensated transfer and dividing that figure by a divisor number. The current divisor number is $7,282, which is supposed to represent the average cost of a nursing home room. The $7,282 figure is set by the State, and the State likes to keep the divisor number artificially low, because the lower the divisor figure the longer the period of ineligibility that results for an uncompensated transfer.

So, for instance, if Mr. Smith transferred $72,000 during the lookback period, he would be ineligible for approximately 10 months. If Mr. Smith transferred $144,000, he would be ineligible for approximately 20 months.

If a person has made any uncompensated transfers during the lookback period, a penalty will be assessed based upon the aggregate of all transfers made during the lookback period, and only if the applicant receives all of the transferred money back will Medicaid eliminate the penalty. So, if Mr. Smith transferred $144,000 during the lookback period, a 20 month penalty would be assessed. If Mr. Smith received $140,000 of this money back, Medicaid would still assess a 20 month penalty. Only if Mr. Smith received all of the money back would the penalty be eliminated.

So, what is the lesson to be learned: Plan early. People typically need care when they are in their 80's, so I suggest that people begin transferring assets when they are around 70 years of age. By transferring assets early, the person can avoid the lookback on those transfers so Medicaid cannot assess a penalty.

I do not, however, necessarily recommend transferring assets to children directly. Giving a child your money exposes the money to all of the child's potential problems: divorce, death, creditors. Many of these issues can be avoided with the proper use of a trust.

POWER TO THE PEOPLE

In recent years, I've heard a lot of politicians talking about empowering people by giving people more health care choices. Greater choice might include the ability to purchase health insurance over state lines. Greater choice might be giving people an amount of money they can spend on their health care insurance.

There is no doubt that our federal deficit is out of control. There is also no doubt that Medicare and Medicaid, which are national health insurance programs, account for a very large percentage of the federal budget. I recently heard one comedian describe the United States as a health insurance company with an army, because most of our federal budget is spent on defense and Medicare and Medicaid.

But I think people should understand what "empowering" people and offering people more "choices" really means, because being empowered and having greater choices sound like really good things.

Medicare is a federal health insurance program. Medicare is available to most people who are either over the age of sixty-five or disabled. Those of us who work pay into the Medicare program.

Medicare has certain co-payments and deductibles, as do many private health insurance programs. The federal government permits private insurance companies to issue health insurance plans that pay these co-payments and deductibles, or gaps in Medicare coverage. These insurance policies are commonly known as Medigap policies of insurance. Many elderly and disabled people purchase Medigap policies.

Medicaid is a federal and state health insurance program. Medicaid is available to people who are over the age of sixty-five or disabled and who have insufficient means with which to pay for their health care.

Medicaid may or may not have co-payments depending upon the Medicaid program in which the person is enrolled. Some health care providers do not accept Medicaid.

Medicare and Medicaid are not perfect programs, but the programs are pretty darn good. There is no doubt that these programs cost the federal government a lot of money, though, so are the "empowerment" solutions good solutions. Let's briefly examine these solutions.

One empowerment solution is the ability to purchase health insurance across state lines. Currently, you have to purchase a health insurance plan from a company that has had the health insurance plan it is offering approved by a New Jersey state agency. The plan must satisfy New Jersey's criteria for coverage and meet with the State's approval as to the amount charged for the plan. Most, if not all other states, have similar rules in place.

So what would happen if you could, for instance, purchase a plan that has never been approved in New Jersey but was approved in Arkansas or another state? I can assure you of one thing, every health insurance company would open shop in the state that permits them to offer health insurance plans with the least amount of regulation and oversight. You would then end up purchasing a "health insurance plan" that you thought would cover you when you were sick, but won't.

Remember, for health insurance companies, this is their business and those companies understand the ins and outs of that business. You, on the other hand, are a neophyte.

Another empowerment solution is to turn Medicare into a voucher program, meaning that people won't have a nationally-sponsored health insurance program. Instead they'll be given a fixed amount of money with which they can buy health insurance. Sounds nice, sounds like "choice" and "empowerment." But what health insurance company is going to offer the type of coverage Medicare provides to an elderly or disabled person.

If we didn't have the elderly and disabled, we wouldn't have a health care coverage crisis because those are the people who require a lot of medical intervention. But it is exactly because we do have those people that we created Medicare in the first instance.

EQUALITY AT HOME

Medicaid is a medical assistance program for needy individuals. In other words, Medicaid provides health insurance to people who cannot afford to pay for their healthcare. Unlike most health insurance programs, Medicaid pays for the costs of long-term care, such as care in a nursing home, assisted living residence, or a home health aide at home.

Medicaid is a federal and state program. Both the federal and state governments contribute towards the costs of Medicaid. In reality, the federal government pays much more for Medicaid than the states.

Because Medicaid is a federal and state program, there are federal laws that govern the Medicaid program and state laws. The state laws must comply with the federal laws.

In order to qualify for Medicaid, an individual must have a limited amount of resources and income. His income must be insufficient to pay for the cost of his care. His countable resources must be below $2,000. The term "countable resources" includes all resources except a home, a car, personal goods and household effects, and certain prepaid funerals.

I use the word home to describe one non-countable resource and specifically do not use the word house, because the real estate must serve as a home for it to be exempt. The real estate must be the home of the Medicaid beneficiary, the Medicaid beneficiary's spouse, or the Medicaid beneficiary's dependent relative.

So, for instance, if Mr. Smith is single and lives in a nursing home, his house is no longer his home and the real estate loses its non-countable status. If Mr. Smith is married and his spouse continues to reside in the real estate, then the house is a home to Mrs. Smith and remains a non-countable resource. If Mr. Smith's disabled son lives in the real estate, then the house is a home to the disabled son and remains a non-countable resource.

If the house loses its status as a non-countable resource, then it must be sold. If Mr. Smith resided in a nursing home and owned nothing other than his house, he could qualify for Medicaid benefits on the condition that he listed his house for sale and actively sought to sell his house. When the house sold, Mr. Smith would go off Medicaid benefits until such time as he spent down the proceeds of sale on his care.

In September of 1996, then-President Bill Clinton signed into law the Defense of Marriage Act or DOMA. DOMA is a federal law that defines a marriage as being between a man and a woman. In addition, DOMA permits one state to refuses to recognize a same-sex marriage from another state.

In New Jersey, for instance, we have the legal concept of a "civil union," which is designed to afford same-sex couples all the benefits of marriage. Because of DOMA, however, any federal law that grants special consideration to a married couple cannot recognize a civil union or a same-sex marriage.

So, for instance, if Mr. Smith went into a nursing home and his civil union partner lived in Mr. Smith's house, Medicaid could not recognize the house as a home. The house would have to be sold and all of the proceeds paid to the nursing home.

DOMA has been a major obstacle to the various states, such as New Jersey, that are passing laws treating same-sex couples in the same manner as opposite-sex couples. For instance, if a same-sex partner must completely impoverish himself, leaving his spouse absolutely destitute and homeless while an opposite-sex partner could leave his spouse with the home and a certain amount of cash assets, where is the equality in that?

Recently, the Obama Administration announced that it would not enforce DOMA in the courts, and even more recently the Centers for Medicare and Medicaid Services, the federal agency that administers the Medicaid program, announced that it would permit a same-sex partner to retain the home when the other partner resided in a nursing home.

DIVIDED LOYALTY

For the past several years, I have been writing about how the increasing complexity of the Medicaid application process is going to cause people problems. In 2006, the federal government increased the Medicaid lookback period from three years to five.

The "lookback period" is the period of time that the Medicaid Office looks at to determine if an applicant for benefits has transferred assets for less than fair market value. When an applicant makes transfers for less than fair market value, called an "uncompensated transfers," the applicant is ineligible for Medicaid benefits for a period of time.

This period of ineligibility for Medicaid benefits is called a "penalty period." If an applicant has a penalty period assessed against him, he must private-pay the nursing home in which he resides until the penalty period has expired. For instance, if Mr. Smith transferred $14,000, he would be ineligible for Medicaid benefits for two months and would have to find some source of assets from which to pay the nursing home for that two-month period of time.

Only uncompensated transfers that occur during the lookback period are penalized. So, if Mr. Smith transferred $1,000,000 ten years ago, the Medicaid Office could not institute a penalty period against him for that very large transfer; however, if Mr. Smith transferred $10,000 two years before applying for Medicaid benefits, the Medicaid Office could institute a penalty period against him.

By the way, most people who come to see me think that the Medicaid Office asks for the money back. This is untrue. The Medicaid Office merely tells a person "yes, you are eligible for benefits" or "no, you are not eligible." The Medicaid Office does not force the recipient of the gift to return the gift; Medicaid is more than happy to simply deny your application for Medicaid benefits.

The Medicaid Office will not institute a penalty period until such time as the applicant is eligible for Medicaid benefits but for the penalty period. In other words, Mr. Smith will not have a two-month penalty period assessed against him for his $14,000 uncompensated transfer until such time as he has less than $2,000 in assets. So, here's the rub for the nursing home in which Mr. Smith resides: If Mr. Smith is ineligible for two months and has less than $2,000 in assets, how is he going to pay the nursing home?

You might think, well, the nursing home will just kick Mr. Smith out for non-payment. But you'd be wrong. While, legally speaking, the nursing home could kick Mr. Smith out for non-payment from a practical standpoint; the nursing home cannot discharge Mr. Smith. The nursing home would have to find a place that would accept Mr. Smith because Mr. Smith needs the care that a nursing home provides, and since no other nursing home will accept Mr. Smith, the nursing home in which he resides is stuck with him.

Because of these facts, nursing homes are getting more and more aggressive when it comes to Medicaid applications. Many nursing homes are referring families to agencies that process Medicaid applications or law firms that also represent the nursing home. Some of the agencies that handle these applications are telling family members that the family must use their services.

While referrals are nice, sometimes referrals can mean divided loyalty. For instance, if I am the law firm for the nursing home, the same law firm that makes money suing families that have failed to pay their bills to the nursing home, to whom do you think I'm going to be loyal? If I am a non-attorney agency that processes Medicaid application and receives a substantial amount of my business from nursing home referrals, to whom do you think I'm going to be loyal.

Medicaid is complex enough. Families should not have to worry about the loyalty of the advocate they retain to represent them in the process of applying for benefits.