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How an Irrevocable Trust Can Protect Your Assets

- AlerStallings

What if I told you there was a way you could protect one of your biggest assets from the nursing home and the Medicaid “spend-down.” For many seniors, learning that there is a way to shield their house or their family farm from the cost of long-term care is some of the best news they have received in years.  AlerStallings has a trust instrument which is designed to help seniors protect their home and to have something of significant value to leave as a legacy for their loved ones. That trust’s technical name is an “Intentionally Defective Grantor’s Trust (IDGT).” We call it the “Heritage Trust.” The Heritage Trust is derived from a specific section of the tax code. This type of trust has been permitted under federal law since the passage of the Omnibus Budget Reconciliation Act of 1993. Below is a brief summary of how our trust operates within Medicaid & the Internal Revenue Code (“IRC”)




An Intentionally Defective Grantor Trust is one that is created under §671-679 of the IRC. A trust can be made into an IDGT through several drafting mechanisms:


1. The grantor or his/her spouse retains the power to recover the trust assets by exchanging the assets for property of equal value (i.e. mom and dad can buy back the assets from the irrevocable trust);


2. The grantor or his/her spouse can or does benefit from the trust income (the grantor or a non-adverse trustee can sprinkle income for the benefit of the spouse);


3. The grantor or spouse possesses a reversionary interest worth more than 5% of the value of the trust upon creation;


4. The grantor or spouse controls to whom and when trust income an principal is distributed, or has other administrative powers which are beneficial to the grantors;


5. The beneficiary has a power to withdraw the trust income or principal to himself or herself (Crummey power); and/or


6. The grantor and/or a non-adverse trustee has the power to apply trust income to the payment of premium for insurance on the life of the grantor or spouse.



The tax code explicitly allows any of the above mechanisms to be employed to make a trust instrument an intentionally defective grantor’s trust. Our Heritage Trust utilizes #4 above, the limited power of appointment approach.


Limited Powers of Appointment

Examples of limited powers of appointment which may be retained through these types of trusts include: – The power to remove and replace the trustee; and – The power to change beneficiaries among a class of possible beneficiaries.


Retention of a limited power of appointment, such as through our Heritage Trust, is often important to clients. These powers allow the grantor to maintain indirect control over the assets in the trust. Think of this power as keeping some strings tied to the trust assets. By reserving this power, our Heritage Trust allows clients to respond to changing family circumstances and changing financial needs. Furthermore, the power to change beneficiaries avoids the giving of a “completed gift” for gift tax purposes. This allows for a step-up in tax basis upon the grantor’s passing.




Income Tax 


Making a trust intentionally defective results in the grantor, for income tax purposes, still being deemed the owner of the assets and therefore liable for the income tax attributable to those trust assets. § 677 of the IRC establishes the guidelines whereby a trust is considered a grantor’s trust if the grantor is liable for any taxable income generated by assets held in the trust. Practically, this benefit is applicable for income producing assets moved to the Heritage Trust, whereas, many times we are transferring real property (residence). That being said, this is still an important benefit because if the grantor moves money or securities over to the Heritage Trust, they are typically retired and thus their income tax bracket is lower and the result is less tax exposure. This is in contrast to transferring a client’s assets to a typical irrevocable trust (not defective) which would most likely result in higher income tax due by the trust, given the nature of the tax rates for trusts.


Gift Tax 


The transferor is NOT required to file a gift tax return for his/her transfer to the Heritage Trust because the IRS deems such gift “incomplete.” This is due to Grantor’s ability to change the trust beneficiaries via the limited power of appointment at any point during his/her lifetime. See Treas. Reg. §25.2511-2(b).


Capital Gains Tax


Due to the incomplete nature of the gift, this is not considered a lifetime transfer. Therefore, when an asset is transferred to the trust it does not inherit the cost basis (like a typical irrevocable trust), but instead is afforded a step-up in basis when the trust distributes its assets to the beneficiaries at the grantor’s passing. See IRC §2036 and Treas. Reg. §20.2036-1. Because the Heritage Trust is designed so that the assets are included in grantor’s estate, the trust beneficiaries will receive a step-up in tax basis to the fair market value of the assets.




Although the assets are attributable to the transferor for income tax purposes, the grantor is not considered the owner for Medicaid purposes after the expiration of the 5-year look-back for any transfer due to the irrevocable transfer language of the trust. As a result, the Heritage Trust can be used to shield assets held by the trust from the Medicaid spend-down process. Under Section 505 of the Uniform Trust Code, as long as the grantor retains the rights to income only, then the underlying assets are protected from creditors, and are non-countable assets for Medicaid purposes.




Given any real property or other assets pass via trust to the beneficiaries (not by will or intestate), there will be no probate expenses regarding such assets. The Heritage Trust, therefore, is an excellent tool to use as a part of a plan to avoid probate.




The Heritage Trust is one of our most important tools when it comes to Asset Protection planning. Contact an AlerStallings attorney to learn more about this exciting trust instrument and to begin creating your Asset Protection plan.


“A Lifetime Accumulating Wealth, An Afternoon Preserving It”


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