THE DEFICIT REDUCTION ACT OF 2005 AND ITS IMPACT ON PLANNING FOR THE ELDERLY OR DISABLED CLIENT
By Thomas J. Murphy
Signed into law on February 8, 2006, the Deficit Reduction Act of 2005 ("DRA"), Public Law No. 109-171, is a controversial measure designed to cut costs in the $86 billion Medicaid program by eliminating coverage to an estimated 120,000 individuals over the next five years.
Medicaid is a massive federal program that partners with the states to provide health care coverage and long-term care assistance to over 39 million people in low-income families and an additional 12 million elderly and disabled people. Medicaid pays for 17 percent of all national health care spending, to include 43 percent of all long-term care services. In Arizona, the Medicaid program is administered by the Arizona Health Care Cost Containment System ("AHCCCS"). AHCCCS provides coverage to approximately 1,044,000 individuals (out of a population of approximately 5.7 million) at an annual cost slightly in excess of $5 billion.
In an attempt to slow the growth of the Medicaid budget, sections 6011 through 6021 of the DRA contain the statutory changes designed to limit or delay Medicaid eligibility. Set forth below are the major changes that will adversely affect many of our elderly or disabled clients.
Lookback period extended to five years
The new section 42 USC 1396p(c)(1)(B) extends the lookback period to five years for any transfer of assets for less than fair market value. The prior rule had generally been three years. As before, the lookback period will begin on the date of the application.
This will make planning much more difficult since a) any planning will have to begin earlier to get the five year clock running, b) a person will have to wait out the longer five year period before applying for AHCCCS and c) many unfortunate events, such as a serious decline in health, can happen in five years. This also means that caseworkers will now need to review, and applicants will need to keep, 5 years' worth of financial records.
It may also affect long-term care policies. Until now, the conventional wisdom was that coverage should not exceed three years since proper planning would ensure Medicaid eligibility by the end of the three year lookback period. With the new law, an insured will want to consider extending coverage to five years.
Penalty period begins at date of application
Under prior law, a penalty was imposed for any gifts that, in Arizona, collectively exceeded $4,500.00 in any one month. The penalty period was deemed to begin when the gift was made. The conventional wisdom was to wait until the penalty period had run and then apply for Medicaid. This will no longer work. The new section 42 USC 1396p(c)(1)(D)(ii) delays the start of a penalty until the person would have had "an approved application for such care but for the application of the penalty period". This, in effect, greatly extends the penalty period.
An example is the best way to understand this. Suppose a parent gifted $50,000 to a child. Under prior law, this would have rendered the parent ineligible for AHCCCS benefits for a period of eleven months. The parent would then wait eleven months to apply if the parent was otherwise eligible. Under the new law, the parent will apply once, after the gifting is done, the parent has spent down to $2,000.00 in non-exempt assets. (Exempt assets generally are the home, a business, an automobile, personal belongings, life insurance with no or little cash surrender value and a pre-paid burial plan.) The eleven month penalty period will not begin to run until the application date.
The penalty will apply to any gift including those that are favored by the income tax code, such as gifts to a charity or as payment for a grandchild's tuition bill. It will also include contributions for political campaigns or helping a child on a down payment for a home. Medicaid law has always allowed for gifts that are made exclusively for purposes other than to qualify for Medicaid, but this is often very difficult to prove, especially if these gifts are made close to the date of admission to a care facility or an AHCCCS application.
Care facilities are likely to get whipsawed. Federal law prohibits the discharge of a patient without an adequate care plan in place upon discharge. What happens to the elderly resident who has run out of money before the penalty period has run? The facility will not be able to place a resident who is unable to pay the new facility. Many commentators have referred to the DRA as the Nursing Home Bankruptcy Act.
The big winners here are the annuity companies since short-term immediate annuities can be used to ride out any penalty period. For instance, rather than gifting $50,000 to a child, a parent will only gift $25,000 to the child and use $25,000 to purchase an immediate annuity for a term of six months. The parent's assets have decreased by $50,000. (Under AHCCCS rules, an annuity is treated as income rather than as an asset.) The $25,000 gift to the child will create a five month penalty period. If the parent is otherwise eligible, the parent then applies for AHCCCS and the penalty period now begins to run. The five-month annuity can then be used to pay for care while the penalty period is in effect. While such short-term annuities have not been common, expect to see these become more readily available.
Another new and similar tactic will be the "gift plus large loan" strategy. Rather than purchasing an annuity, the funds are loaned to a child. The DRA requires that the note cannot be treated as a receivable or asset as long as it is repaid over the life expectancy of the parent. Under Medicaid law, the repayment in full over the lender's life expectancy is considered to be "actuarially sound", an important concept as discussed later in this article. For, say, a 78 year old woman, the repayment period cannot exceed nine years if it is to be "actuarially sound". With a large loan, the monthly repayments can be large enough to pay for care during the penalty period.
Other planning options that have always existed will receive more attention. Caregiver agreements with children, in writing and with reasonable terms, will proliferate. Leaving the home to a caregiver child residing in the home or to a blind or disable child, always beyond AHCCCS's reach, will happen more often.
All transfers are aggregated with no rounding down
Section 6016(a) creates a new 42 USC 1396p(c)(1)(E) that mandates that a state aggregate all uncompensated transfers during the lookback period.
This provision will probably have the biggest impact on my clients. Prior law allowed for monthly gifting that did not exceed the average cost of care as computed by the Center for Medicaid and Medicare Services (CMS). For Maricopa County, that is currently $4,507.06. This meant that a person could transfer up to $4,507.06 each month with no penalty. This was a simple, easy way to protect $50,000 per year.
This is now gone. As of the application date, all transfers made during the lookback period are totaled and then divided by the average cost of care. The penalty is then imposed beginning at the application date.
The new statute also prohibits rounding-down. To use my earlier example, a $50,000 gift would create an eleven month penalty period ($50,000 divided by $4,507.06). The actual computation is 11.09 months. The new statute will now make this a twelve month penalty since a state is prohibited from rounding down.
Home equity cap
Section 6012(a) of the DRA imposes a $500,000 cap on the equity of a home owned by an AHCCCS applicant. States are given the option to increase the cap to $750,000. It is not known if the Arizona legislature will approve such a measure. The cap will be indexed with the Consumer Price Index but not until 2011.
However, this cap does not apply if the AHCCCS applicant is married. It also will not apply if the applicant has a minor child or a child who is blind or disabled and who resides in the home.
Using a reverse mortgage or home equity loan to reduce the equity is expressly authorized in the new statute.
This provision has its own effective date of January 1, 2006, separate and apart from the rest of the DRA.
Under the prior law, there was no limit on the principle residence. This is now gone.
Annuities
Section 6012(a) adds a new 42 USC 1396p(f) & (e). The main change is that there is a new requirement that if an unmarried AHCCCS patient owns an annuity, then the state must be named as the primary beneficiary up to the total amount of medical assistance that AHCCCS has provided on behalf of the patient. If the patient is married or has a disabled child, then the state must be named the first contingent beneficiary after the spouse or child.
If this is not done, then the statute treats the purchase of an annuity "as the disposal of an asset for less than market value". In other words, it creates a penalty period. The statute does not state how this amount will be determined. The commentators that I have seen believe it will be the purchase price of the annuity.
There are two other exceptions to this. One is if funds from an IRA, SEP or Roth IRA are used to purchase the annuity. The other exception is for an "actuarially sound" annuity that is irrevocable, nonassignable and that has equal periodic payments (ie, no balloon annuities). This has always been the case in Arizona. The life expectancy tables for the Social Security Administration, not the IRS or HCFA Transmittal 64, are to be used. They are available at www.ssa.gov/OACT/STATS/table4c6.html. For someone age 65, the life expectancies are 16.05 male, 19.06 female. For someone age 70, the life expectancies are 12.75 male, 15.35 female. For someone age 75, they are 9.83 male and 11.97 female.
The annuity must be disclosed to the state, which shall notify the annuity company of the state's right to be a beneficiary. The state can also require the annuity company to disclose to the state any change in the amount of principal or income that is being withdrawn from the annuity.
Most commentators are of the opinion that these rules only apply if the AHCCCS patient is the annuitant. In other words, the rules do not apply if the healthy spouse purchases and owns the annuity. But this is not entirely clear and, given the tenor of the new statute, it is unlikely that Arizona or any other state will readily concede this.
There may be new planning opportunities with annuitizing IRAs since these appear to be protected assets while a non-annuitized IRA has always been considered an available resource by AHCCCS. And there is no requirement that the State be named a beneficiary. Non-IRA annuities can also be done but the State will have to be named beneficiary.
Promissory notes, loans and mortgages
The DRA creates a new 42 USC 1396p(c)(1)(I) that sets forth a three-prong safe harbor for any notes, loans or mortgages. They require: 1) an actuarially sound repayment term, 2) equal payments (ie, no balloon payments) with no deferrals and 3) no "cancellation of the balance upon the death of the lender".
This provision has received a great deal of attention and has been viewed as creating some new planning opportunities. I have already discussed the "gift and loan" strategy. It has also been noted that the new legislation simply prohibits cancellation of the note. But what if the note contains a term assigning the balance due at death to another party, such as a child? Nothing prohibits this and it has the added advantage of avoiding an AHCCCS estate recovery claim at death. There is also no requirement that a rate of interest be charged. And there is no mention of what will happen if the child/debtor falls behind in repayments or stops paying altogether.
"Income First" approach mandated.
When a married person is on AHCCCS, the healthy spouse is entitled to a minimum monthly income of at least $1,603.75 up to a maximum of $2,488.50. This is known as the minimum monthly maintenance needs allowance or MMMNA. If the MMMNA of the healthy spouse is less than the minimum income, there have been two options. One option has been to give the healthy spouse additional income-generating assets to make up the shortfall. The other option is to allocate some of the nursing home spouse's income to the healthy spouse.
The first option has always been more preferable to the spouse since the assets would continue to provide for the healthy spouse after the death of the nursing home spouse. This option has now been eliminated under section 6013 of the DRA. Under the new 42 USC 1396r-5(d)(6), all states must now use the "income first" methodology.
However, these rules only apply to "individuals who become institutionalized spouses on or after" the February 8th enactment date. Those AHCCCS applicants who are married and who entered the nursing home before February 8th, even if they apply years later, will still have the first option available to them.
There is also a question as to whether Social Security income or Veterans benefits can be considered given the anti-alienation protection afforded them. Courts have had difficulty with this since the United States Supreme Court's decision in the Keffeler case. 537 US 371 (2003). See, for instance, Bianconi v. Preston, 383 F Supp 2d 276 (D Mass, 2005)
Life estates
The new 42 USC 1396p(c)(1)(J) treats the purchase of a life estate as an uncompensated transfer unless the purchaser resides in the home for at least one year. For instance, if a parent is going to move into a child's home, a very effective planning tactic is to have the parent purchase a life estate in the child's home. But this provision of the DRA is one more attempt to limit the use of life estates. Many states, to include Arizona, have taken aggressive action against the use of life estates since it can be an effective way to accelerate eligibility while avoiding estate recovery. Until last year, AHCCCS limited its estate recovery to assets passing through a deceased patient's probate estate. A life estate avoided probate. AHCCCS has never made any secret of its hatred of this technique and the new TEFRA lien rules issued in 2005 greatly limit the use of life estates. (See my article in the March/April 2005 edition of AZCPA that gives a detailed explanation of the TEFRA liens.)
Yet, the new statute creates a safe harbor with the one year residency requirement. Any funds paid to the child escapes adverse treatment of the one year test is met. However, this must be read in conjunction with the still-existing TEFRA liens. The bottom line is that, for married couples, the purchase of a life estate in a child's home remains a very plausible planning technique that must be given serious consideration.
One potentially troublesome issue concerns valuation of the life estate. In other words, how much must the parents pay the child for this to pass AHCCCS's muster? It is not clear if the HCFA (CMS) or IRS tables must be used. Another issue is that the sale of the life estate to the parent will diminish the child's IRC 121 capital gains exclusion.
Undue hardship
Section 6011(d) amends 42 USC 1396p(c)(2)(D) to allow for standards and procedures that a state must implement to allow for undue hardship exceptions to the new DRA rules. A state must have some procedures in place to address any situation where the rules would "deprive the individual of medical care such that the individual's health or life would be endangered or of food, clothing, shelter, or other necessities of life". What exactly this procedure will be is each state's determination.
AHCCCS has always taken a very strict stance on this and hardship waivers have been very difficult to obtain. The DRA does not provide any criteria as to what constitutes a hardship.
It is noteworthy that the new statute now allows the care facility, in addition to the patient, to file an undue hardship request and allows the facility to be paid for an additional 30 days.
Expansion of LTC Partnership program
To encourage to purchase of long term care insurance policies, section 6021(a)(1)(A)(i) of the DRA permits states to establish partnerships with LTC insurance carriers that allows a state to "disregard any assets or resources in an amount equal to the insurance benefit payments that are made to or on behalf of an individual who is a beneficiary under a long-term care insurance policy". As an example, if a person purchases an LTC policy with $200,000 in coverage, then that person can retain $200,000 in assets and still be eligible for Medicaid. Note that it is the amount of coverage, and not the amount of premiums paid, that controls and that the amount is also protected from estate recovery.
This partnership program has existed for many years in California, Connecticut, Indiana and New York but has only seen limited success. Among the problems have been that the person must be insurable and that the policies have not been portable across state lines when a person moves to another state.
New requirements for proof of citizenship
Section 6036 of the DRA creates a new 42 USC 1396(b)(i)(22) that places restrictions on all states regarding the documents that a Medicaid applicant must have to prove citizenship. All Medicaid applicants must provide a birth certificate, a United States passport or an INS Certificate of Naturalization or US Citizenship (Forms N-550, 570, 560 or 561). The statute also authorizes the Secretary of HHS to issue regulations that provide "a reliable means of documentation of personal identity" but no such regulations have yet been issued.
Patient advocates have been vocal in their opposition to this portion of the DRA. Their concerns are that patients who are homeless, mentally ill, chronically ill or suffering from dementia will be denied Medicaid coverage because of an inability to obtain the requisite documentation. There is also concern that it may take weeks or months to obtain a new birth certificate or similar document.
The new statute only provides for very limited exceptions and it applies to all first-time applicants as well as all Medicaid patients when they submit their annual recertification.
Effective date
Section 6016(e) allows states to amend their Medicaid state plan by "the first day of the first calendar quarter beginning after the close of the first regular session of the State legislature that begins after the date of enactment of this Act".
The new rules on annuities and the income-first rule are effective on the date of enactment, February 8th. The home equity cap takes effect for any application submitted after January 1, 2006.
But how exactly does Arizona or any other state implement and administer these new rules? AHCCCS has informally told certain elder law practitioners that it will attempt to implement the DRA by July 1st. AHCCCS is apparently of the opinion that no new legislation needs to be enacted because the AHCCCS eligibility statute, ARS 36-2934, essentially states that Arizona simply adopts and follows the applicable federal law on eligibility. However, it is not known what rulemaking procedure AHCCCS will follow (ie, the period for public comment and the like).
Thomas J. Murphy is an estate planning, probate and elder law attorney practicing in the Ahwatukee section of Phoenix. He can be reached at 480-838-4838 or at tom@murphylawaz.com.
