Gift-Tax Exemptions Are Treated Differently by IRS and Medicaid

Most people understand that individuals can gift $15,000 annually to another person without incurring gift tax. However, the precise definition of gift tax and the repercussions of exceeding this threshold remain unclear to many.

A significant complication arises because different government agencies apply distinct rules to identical situations. This becomes particularly problematic for those attempting to leverage their annual $15,000 gift exclusion for long-term care asset protection, often with unfavorable consequences.

Understanding the Gift Tax Exclusion

The IRS permits each person to distribute a lifetime total of $11.7 million in gifts during their lifetime and after death without paying gift tax, with some exceptions. The first $15,000 given to each individual within each calendar year is excluded from this total amount.

For example, if a woman gifts her three children $15,000 each per year for five years, she distributes $225,000 total. This amount does not reduce her $11.7 million lifetime non-taxable gift allowance.

However, if she gave $16,000 to each child annually for five years, the excess $3,000 per year counts against her lifetime exemption. She must file annual forms with the IRS documenting this reduction.

The Medicaid Complication

The $15,000 annual exclusion streamlines gift-giving without burdensome reporting. However, it creates significant and costly problems when applied to Medicaid eligibility planning.

Medicaid, a federally funded program assisting low-income individuals with medical and nursing home care expenses, evaluates assets and financial transactions within a five-year lookback period when determining eligibility. Critically, Medicaid does not allow the gift tax exclusion to be used for the lookback period.

The Costly Difference

Consider the woman from the earlier example who gave her three children $15,000 annually for five years, totaling $225,000. If she enters a nursing facility after the final gifts:

• IRS perspective: None of these gifts count against her lifetime exemption
• Medicaid perspective: The full $225,000 counts as available assets for care payment

Medicaid will impose a penalty period requiring her family to pay for care, potentially lasting five years, despite the IRS treating these gifts favorably.

Solutions and Planning

To safely utilize annual gift tax exclusions while preserving Medicaid eligibility, an estate planning attorney can establish an Intentionally Defective Grantor Trust. This specialized trust separates assets from the grantor sufficiently to initiate the five-year lookback period while maintaining the property within the grantor’s taxable estate. This approach preserves ongoing opportunities to use annual gift exclusions without triggering a new five-year lookback period.

Understanding these divergent regulatory frameworks protects families from expensive and stressful outcomes. Additionally, Medicaid planning techniques vary by state, requiring jurisdiction-specific guidance.

If you need help navigating gift tax and Medicaid planning, contact our office to schedule a consultation.