When Medicaid Planning Turns Into Estate Litigation
9.30.2024
As we all know, Medicaid planning is often a crucial strategy for many individuals seeking to protect their assets while qualifying for Medicaid benefits. One common tool used in this planning is the Medicaid Asset Protection Trust. While this type of trust can be highly effective, it sometimes leads to unforeseen complications that turn into estate litigation. This article explores how and why this happens and what can be done to mitigate the risks.
Understanding Medicaid Trusts
A Medicaid Asset Protection Trust, which is an irrevocable trust, is designed to help individuals qualify for Medicaid while preserving their assets for their heirs. A Medicaid trust is often an intentionally defective grantor trust. Typically, the grantor places their real property, and sometimes a brokerage account or other investments, into this type of trust. The trust usually provides for income to the grantor but not access to principal to avoid the asset being deemed available for Medicaid eligibility purposes.[1] (Distributions of principal are allowed to the grantor’s issue or other family members at the trustee’s discretion.) The trust typically contains grantor trust provisions, which then allow the income taxes on trust assets to flow through and be reported on the grantor’s independent tax return. The trust also, at times, contains a limited power of appointment so that the transfer to the trust can be considered an incomplete gift, thereby providing a step up in cost basis on assets inside the trust upon the death of the grantor. The trustee is an individual other than the grantor to provide sufficient relinquishment of incidents of ownership.
When assets are placed in this type of trust, they are no longer considered countable resources for Medicaid eligibility purposes once the five-year lookback is cleared from date of funding. This can prevent the spend down and depletion of assets due to long-term care costs and therefore lead to preservation of assets for beneficiaries.
Benefits of Medicaid Trusts
Given the nature of this type of trust, it can be very beneficial to individuals seeking to protect their hard-earned assets while also availing themselves of government benefits. Highlights of the benefits are:
- Asset Protection: Assets in a Medicaid trust are shielded from being counted and impacting Medicaid eligibility.
- Estate Planning: Efficiently passing on assets to beneficiaries without the need for probate.
- Tax Advantages: Structured as intentionally defective grantor trusts, they can also offer certain tax benefits, such as avoiding estate taxes.
Common Issues Leading to Estate Litigation
Despite the benefits, Medicaid trusts can sometimes lead to estate litigation. Here are some common scenarios where problems arise:
- Lack of Capacity, Undue Influence, Fraud or Duress
Claims that the trust was created when the grantor lacked capacity, was unduly influenced or coerced can lead to estate litigation and legal challenges. This is particularly common in cases involving elderly or vulnerable individuals who are taken to the estate planning attorney by their child, some of the children or even a caregiver. For example, when one of the children starts contacting the estate planning attorney, starts providing all of the information to the attorney on what the trust should say, is the responsible billing contact, is the person who signs the retainer (whether individually, or even as an agent under a power of attorney), sits in on the meetings and/or is there during the execution, then questions can arise later about capacity or undue influence.
- Beneficiary Disputes
Disagreements among beneficiaries regarding the distribution of trust assets can lead to litigation. This is often seen in cases where the terms of the trust are ambiguous, when there is a perception of unfairness or when some of the children or family members are excluded to the exclusive benefit of one child. If all of the previous estate planning documents directed for equal distribution among all the children and suddenly the Medicaid trust directs distribution to the exclusion of certain children, then there will be an increased likelihood of beneficiary disputes.
- Trustee Mismanagement
Trustees have a fiduciary duty to manage the trust in the best interests of both the income beneficiaries and the remaindermen. Allegations of mismanagement, such as improper investments or failure to follow the trust terms, can result in litigation. In a Medicaid trust, typically the trustee has full and unfettered discretion to distribute trust assets among a class of beneficiaries. If the trustee exercises their authority and distributes to one beneficiary over another, questions can arise regarding the legitimacy and propriety of these distributions.
- Withholding the Trust
At times, the trustees of the trust are different from the beneficiaries of the trust. When the trustees of the trust withhold copies of the trust for whatever reason, the beneficiaries of the trust become suspicious and tend to think that the fiduciary is mishandling assets or making inappropriate distributions of estate assets, leading to litigation.
- Improper Trust Formation
If the trust is not properly drafted or executed, it can be contested. Issues such as unclear terms, lack of proper funding or failure to meet legal requirements can lead to disputes.
The Mechanics of Estate Litigation
Many people think that when they execute an irrevocable trust, they avoid court and legal proceedings. That is incorrect. There are certainly proceedings that can be brought in Surrogate’s Court where trusts can be challenged:
- Proceeding to Compel Production of a Trust pursuant to SCPA 2102.
- Proceeding to Compel Trust Accounting pursuant to SCPA 2205.
- Proceeding to Set Aside a Trust.
- Proceeding for Limited Letters and then to Conduct Turnover Proceeding pursuant to SCPA 2103.
Each of the above proceedings serve as a different vehicle for obtaining information about a trust and, when appropriate, instituting proceedings to set aside the trust.
To be successful in an action or proceeding seeking to set aside a lifetime trust on grounds that a party lacked the mental capacity, the burden is on the party asserting lack of capacity to establish that the grantor did not understand the nature of the transaction.[2] Similarly, the burden of proof of undue influence is on the person alleging it.[3]
How To Prevent Medicaid Planning From Turning Into Estate Litigation
To minimize the risk of estate litigation, several preventative measures can be taken:
- Identifying the Client and Communicating Only With the Client
Although it may be simple to take instructions from the child, the child is not the client. The client is the person who is creating the trust. The client is typically the person with the assets who is doing the estate planning. Avoid taking instructions from the child. Avoid meeting with the child. Avoid speaking on the phone with the child and the parent, especially when there are multiple children who are not part of the conversation. When dealing with clients with diminished capacity, it is important to follow New York State Bar Association’s Rule 1.14 of the Rules of Professional Conduct.
- Discuss With Client the Pros and Cons of Discussing the Medicaid Plan With the Children
There are often reasons why parents, with full capacity, decide to unevenly distribute estate assets. Perhaps it’s because one child doesn’t need the money or because the parent trusts one child less. Perhaps it is because the parents have made gifts to one child during lifetime. If there is an open conversation or, even better, a written explanation, then at times estate litigation can be avoided.
- Proper Trust Drafting
Ensure the trust is clearly and precisely drafted, with unambiguous terms and conditions. This can help prevent misunderstandings and disputes among beneficiaries. If there are three children and one child lives at home, drafting a trust where the house is equally divided among the three children will likely lead to a partition or drawn-out litigation because the adult child who spent his or her entire life living at home is not likely to move out.
- Lifetime Gifting to a Child
A parent may want to make an outright gift of assets to the child. This is a good way to demonstrate intent. When a sizable gift is made, a 709 should be filed with the IRS to solidify the intent. If a lifetime gift is being made, the gift should be made by the parent, rather than by an agent under a power of attorney.
Conclusion
While Medicaid trusts are powerful tools for asset protection and Medicaid planning, they can sometimes lead to estate litigation due to various issues. Proper drafting, understanding your client and maintaining clear communication are key strategies to minimize the risk of disputes.
Regina Kiperman is the managing attorney with RK Law, a boutique New York City trusts, estates and elder law firm. She focuses on guardianship and estate litigation, probate and estate administration and estate planning.
This article appears in a forthcoming issue of Elder and Special Needs Law Journal, the publication of the Elder Law and Special Needs Section.
Endnotes
[1] 18 N.Y.C.R.R. § 360-4.5(b)(1)(ii). See Amended Decision FH 8461099Q (NYC, April 27, 2023).
[2] Vultaggio v. Vultaggio, 2015 N.Y. Misc. LEXIS 4780 (Surr. Ct., Nassau Co. Dec. 3, 2015).
[3] Oakes v. Muka, 69 A.D.3d 1139 (3d Dep’t 2010).
