The Listen to Lawrence Letter: What happens to the income generated in a Medicaid Irrevocable Trust?

March 16, 2022
Dear Clients and Friends:
Ever wonder what happens to the income generated in your Medicaid Irrevocable trust? This is what the following client is wondering about.
CLIENT QUESTION:
I have a Medicaid irrevocable trust created by you 4 years ago, funded with certain securities. The trust was issued a trust tax ID number rather than my social security number. This way the earnings income from the securities is not included in my personal income.  If I have to go into a nursing home the earnings income will not be taken by Medicaid. If the earnings income is included in my personal income, is it correct to say that Medicaid will apply this income to pay for the nursing home expenses?
MY RESPONSE:
Oh boy, let’s peel back the onion here because it’s complicated. The statement within the question is largely WRONG! The answer is NO! Read on…
Whenever I create these trusts, I have to figure out what I want to happen to the income generated in the trust. Sometimes (although relatively rare these days), I design the trust to pay back the income to you. This income would actually be paid to you and you will pay the income tax on it. If you need Medicaid someday, you will be required to use the income for your care before Medicaid will pay anything. Why would you do this? Because you wanted the income to live on and that security was more important than saving the income for your children.
For most clients, I have the income stay in the trust each year, as most clients (but not all) do not need the income from their investments to meet their monthly bills. They live on their social security, pensions, and RMDs from their retirement plans.
In either event, I design the trust to be a grantor trust. A grantor trust is one where I purposely have you retain “too much control” over the trust. In such cases, the IRS ignores the trust as if it does not exist.  Therefore, you will be taxed on the income whether you receive the income or not. When we do this we have the choice of issuing a Tax ID# for the trust or using your social security number; it does not matter which we choose. When a husband and wife create a trust we USUALLY issue a Tax ID# but not always.
No matter how we design it, the fact that you are TAXED on the income has nothing to do with whether your income must be applied to pay for your medical bills ahead of Medicaid.
In the above question, although the trust received a Tax ID# rather than a social security number, it is likely (without actually reviewing the trust) that the trust income will remain in the trust and still be taxable to you, but will also be protected from Medicaid.
I hope this helps! Please forward this information to your friends and relatives to share these informative answers to some very commonly asked questions.
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Until next time,
peace, health and happiness,
Lawrence Eric Davidow