How To Protect The Elderly Client’s Assets

Presented to the Conference on Resolving Legal and Financial Issues in Elder Care
Sponsored by National Business Institute
May 9, 2011
By Thomas J. Murphy
Murphy Law Firm, Inc.



There are five areas that I typically discuss with any elderly client when estate planning and elder care issues are involved. They are:

Healthcare issues and costs – both client and spouse. This involves exposure to nursing home costs and health care coverage not covered by Medicare.

Incapacity issues – both present and in the future

Streamlining transfer of title issues after death – avoiding probate

Influence and expectations of adult children or other friends or loved ones — especially if there are prior marriages

Taxes – federal and state estate, gift and income


Do not tiptoe around this issue. The elderly are constantly talking about their health. It is usually their foremost concern. They have no problem having a frank discussion about it.

Confirm any current conditions. Ask them what medications they are on and what they are for. This may tip you off to potential issues of incapacity or susceptibility to undue influence. Ask about any hospitalizations or significant medical treatments in the previous several years. Are there any future major treatments in the foreseeable future?

Confirm what all this is costing them and compare this to their finances. Where is this heading? Are these costs greater or expected to be greater than their income? How is the shortfall met (ie, from what assets and how often)? If there is a shortfall and unless the estate is well into six figures, the elder law practitioner must consider the issue of participation in the Arizona Long Term Care System (ALTCS) program.

Medicare – the basics

Getting a sense of our elderly clients’ medical expenses requires a working knowledge of the Medicare rules. Individuals are automatically entitled to Medicare if they are eligible for Social Security and are 65 years of age and older or if they are receiving Social Security disability benefits (“SSDI”, not “SSI”) for not less than 24 months. If not automatically eligible for SSA (ie, less than 40 quarters of work history), then the individual must apply and pay a monthly premium of $248 (30-39 quarters of Social Security coverage) or $450 (29 or fewer quarters of Social Security coverage)

Part A – covers inpatient care in hospitals, hospice, some care in skilled nursing facilities and some home health care.

Hospice – in home, palliative care for the terminally ill (ie, doctor certification that death is expected to occur within six months if condition runs its normal course).

Home care – qualification can be tough. Must be “homebound” defined as where “leaving home requires a considerable and taxing effort”. Only covers part-time or “intermittent” nursing care – services required less than every day and only for skilled care.

Part B – covers, on an 80/20 percentage basis, outpatient doctor visits and hospital care, clinical lab services, durable medical equipment (such as wheelchairs, hospital beds, oxygen, and walkers) and some other medical services that Part A does not cover, such as physical and occupational therapists.

While eligibility is the same as Part A, everyone pays a premium that is withheld from the individual’s SSA check. For 2011, the standard premium is $115.40 per month. Once an individual’s adjusted gross income exceeds $85,000 ($170,000 for couples), an additional premium is added of $46.10 and increases up to $253.70 for AGIs over $214,000/428,000.

Part D – prescription drug benefit. All Part D plans must establish their own list of medications included in their plan that are called formularies. These formularies must include categories and classes of drugs that cover all customary disease states. But formularies do not cover all drugs or all drugs for a particular condition – only some of them. People are limited to the drugs on their plan’s formulary, but may request an exception to have a non-formulary drug covered.

As for how the medications are paid for by our clients, the following schedule applies to all Part D participants unless the plan calls for more generous terms:

  • Annual Deductible of $310.
  • After meeting the deductible the person pays 25% of the next $2,530 ($632.50).
  • Once the plan and the person have together paid the Initial Coverage Limit of $2,840 ($310 + $2,530 = $2,840), the person hits the donut hole. Person pays for 100% of the next $3,607.50 in formulary drugs.
  • Once the person has spent a total of $4,550 ($310 + $632.50 + $3,607.50= $4,550), person pays 5% of the cost for formulary drugs, or $2.50 for generics and $6.30 for brand name drugs, whichever is greater. Persons who meet the $4,550 out-of-pocket threshold remain at this level for the rest of the calendar year. The process begins over again the next year.
  • Beginning in 2011, persons in the Donut Hole will get a 50% discount on brand name drugs and a 7% discount on generic drugs. These discounts will gradually increase each year until everyone is paying a flat 25% for drugs in 2020.

Medicare (with no supplemental coverage) will NOT cover:

  • Deductibles, coinsurance, or copayments when you get health care services.
    • $1,132 for each hospital stay of 1-60 days.
    • $283 per day for days 61-90 of a hospital stay.
    • $566 per day for days 91-150 of a hospital stay (Lifetime Reserve Days).
    • All costs for each day beyond 150 days
  • Cosmetic surgery.
  • Custodial care at home or in a nursing home
  • Dental care and dentures
  • Eye care and most eyeglasses
  • Health care while traveling outside of the United States
  • Hearing aids and hearing exams.
  • Long term care (ie, nursing home) unless skilled (as opposed to custodial) care is needed.       If so,
    • Medicare pays in full for first 20 days.
    • Coinsurance is $141.50 per day for days 21 through 100 each benefit period (ie, spell of illness).
    • All Medicare coverage ends after 100 days.
  • Orthopedic shoes.
  • Podiatry and other routine foot care

Supplemental coverage

Most elderly clients will have some form of supplemental insurance coverage purchased privately that will cover some or all of the gaps in Medicare coverage (hence the name “Medigap” insurance). Under federal law, these are “guaranteed issue” for those over age 65 – everyone is eligible regardless of their health and with no pre-existing condition exclusion. There are twelve standardized benefit policies are labeled A through L.  Policy A contains the basic or “core” benefits.  The other eleven policies contain the core benefits plus one or more additional benefits.  The following is a list of the benefits that are contained in the core policy and that must be contained in all new Medigap policies:

  • Part A Hospital Coinsurance for Days 61-90 ($2 67/200 9);
  • Part A Hospital Lifetime Reserve Coinsurance for Days 91-150 ($ 534/200 9);
  • 365 Lifetime Hospital Days Beyond Medicare Coverage;
  • Parts A and B Three Pint Blood Deductible;
  • Part B 20% Coinsurance.

Additional benefits are offered in policies B through L but they, and the premiums charged, can greatly vary.  Each plan offers a different combination of these benefits in addition to the core benefits.  Among the additional benefits are:

  • Part A Skilled Nursing Facility Coinsurance for Days 21-100 ($1 33.50/200 9);
  • Part A Hospital Deductible ($ 1068/200 9);
  • Part B Deductible ($13 5/2009);
  • Part B Charges above the Medicare Approved Amount (if provider does not accept assignment);
  • Foreign Travel Emergency Coverage;
  • At-Home Recovery (Home Health Aid Services);
  • Preventive Medical Care.


It is estimated that four to five million people have some form of dementia. Three percent of all persons age 65 to74 suffer from dementia. It escalates to 19% for persons 75 to 84 and 47% for those over 85. But the pathology of the disease is much more subtle and sinister, beginning 10 to 20 years before the earliest symptoms are detected. There is no proven genetic link to dementia, although there continues to be considerable research in this area.

Counsel need to be familiar with the various forms of dementia and how it impacts capacity. There are many excellent sources. One is the newly published Assessment of Older Adults With Diminished Capacity: A Handbook for Lawyers by the American Bar Association in conjunction with the American Psychological Association. Another is Assessing Competence to Consent To Treatment; A Guide For Physicians and Other Health Professionals by Paul Appelbaum and Thomas Grisso, published by Oxford University Press.

Less technical books geared toward the general public are The Forgetting by David Shenk and The 36-Hour Day by Nancy L. Mace and Peter V. Rabins.

Yet, in spite of these wonderful resources, the exact prerequisites that encompass the term “incapacity” are often overlooked and can vary slightly depending on the context – making a contract, executing a deed, signing a will, etc. My materials elsewhere in this presentation deal with this in detail.


There are a number of fairly simple maneuvers that can make the transfers of title much easier. One is a payable on death designation on any bank or brokerage account. This is widely used but I am still surprised how many people do not know about it.

Likewise, the POD designation for Arizona real estate can be accomplished by means of a beneficiary deed. See my article in the June 2002 edition of Arizona Attorney for drafting tips.

Updating beneficiary designations can also save much time and trouble. Check to make sure that all retirement plans and insurance policies have correct beneficiaries, especially as to contingent beneficiaries. With the innumerable mergers of financial institutions, do not assume that these designations are current or even exist. Lost designation forms are becoming increasingly common. And clients frequently forget to update the forms after a death or divorce.

Make sure you have a well-drafted durable financial power of attorney to authorize a spouse or other family member to make these updates.


Sooner or later, someone other than the clients will be reviewing your work and it may not be a pleasant experience. Many children or other family members do not understand the post-mortem administrative issues and too many simply view this as a lawyer’s opportunity to line his pockets with unnecessary legal work.

Many children and family members also labor under gross misunderstanding of their parents’ estate. They think it is either much larger or smaller than it really is. This can lead to all sorts of outsized expectations that will never come to fruition. Too often, the attorney becomes the person on which their frustration is vented. Do not stand for this treatment. See my materials elsewhere on this.

Unequal or unusual bequests have trouble written all over them. My practice is to have the client execute a series of wills over an extended period of time, usually one year, to eliminate the argument that the testator was acting impulsively when a will was executed. And make sure there is something in your file or stated in the will that explains why the bequest was made, ie a “forgotten” loan that was not forgotten by the testator.

Also, protect the caregiver child. Unfortunately, there are a number of lawyers in the Phoenix area who have made a niche practice out of manipulating the financial exploitation statute, ARS 46-456 so that the caregiver comes under extreme scrutiny. Even in a more innocent scenario, children who are not involved in the care of their parents’ last illness have no idea how expensive and time-consuming a last illness can be. Warn the client and caregiver that someone will have questions. Keep all receipts and time logs to substantiate any allegations of improprieties.

Likewise, beware of the perils facing the child who is actively involved in having the client draft a new will. The recent case of Mullin v. Brown, 210 Ariz 545 (CA2, 2005) should be setting off alarm bells. It is the first case to discuss the ramifications of Estate of Shumway, 198 Ariz 323 (2000) regarding the shifting of the burden of proof in a will contest. At issue was the following jury instruction, which the Court upheld:

If Chris Mullin Jr. and/or Dr. David Mullin had a confidential relationship with Ralph Mullin; was/were active in procuring the execution of the 1995 will; and was/were a principal beneficiary under its terms, then the 1995 will is presumptively invalid and the defendants must prove by clear and convincingevidence that Chris Mullin Jr. and/or Dr. David Mullin did not unduly influence Ralph Mullin.

Shortly before death, Chris Jr. had his grandfather change his will, leaving the entire estate to him and disinheriting Chris’ brother, who under a prior will was a 50% beneficiary. Chris Jr. also emptied a joint account and had the decedent issue a new deed for certain, unspecified gas and oil interest. The will in question had been prepared by an attorney.

The Court began by noting that “A presumption of undue influence arises when one occupies a confidential relationship with the testator and is active in preparing or procuring the execution of a will in which he or she is a principal beneficiary. See In re O’Connor’s Estate, 74 Ariz. 248 (1952). The precise issue in Mullin was under what circumstances does this presumption cease? The Court emphasized the statement made in Shumway that “`[W]here a confidential relationship is shown the presumption of invalidity can be overcome only by clear and convincing evidence that the transaction was fair and voluntary.”‘ Id. ¶ 16 (alteration in Shumway), quoting Stewart v. Woodruff, 19 Ariz. App. 190, 194 (1973). The court noted that “[t]his is a difficult standard of proof ”.


Under the current law and the unfavorable developments in the investing world, estate taxes are an issue for fewer and fewer clients. Congress has chosen to provide a very limited time frame for planning. The current scenario is the $5M/10M exemption with a 35% tax rate that is only in effect for the 2011 and 2012 tax years. Planning beyond 2012 is anyone’s guess right now.

Most of the estate tax action will involve using the gift tax exemption that has been re-unified with the estate tax and the generation skipping tax. Many practitioners are urging pedal-to-the-medal gifting since there are historically low federal interest rates, relatively low asset values and no legislation at this time restricting the use of various effective wealth transfer tools, such as the Grantor Retained Annuity Trusts (GRATs), Family Limited Partnerships (FLPs), Intentionally Defective Grantor Trusts (IDGTs), Generation Skipping Tax Trusts for Grandchildren and/or valuation discounts on family controlled enterprises.

But there are a few caveats to the new law. Portability from the deceased spouse ends if the surviving spouse remarries. An estate tax return must be timely filed to determine the unused exemption that will be credited to the surviving spouse and the IRS can challenge the valuations taken in that return at the death of the surviving spouse.

Income taxes also need to be discussed although, for most elderly clients, this is not a major concern. Most of Social Security income is not taxable as long as income from other sources does not exceed $44,400 for married couples and $31,948 for unmarried persons. Many elderly do not even file a tax return since their gross income must be at least $10,750 for single individuals or $20,900 for married filing joint or $16,150 for a qualifying widow (ie, for two years following date of death if not remarried).

Minimum required distributions from retirement plans will also have to be taken for year that a client reaches age 70 ½. Using the IRS tables for IRC 409(a)(9), these will initially equate   to 1/26th of the aggregate balance of all qualified money.

Remind clients of the carryover basis rules for gifted property. IRC 1015(a) Explain the consequences of IRC sec 2036 that can be your friend or your enemy. One of the hottest areas in estate tax concerns the applicability of IRC section 2036. That section essentially says that, if you continue to enjoy the use or control of an asset that you have transferred to another, then that asset will treated as your asset for estate tax purposes. In tax parlance, it is included in your estate.

This can be good or bad, depending on the circumstance. If it is a taxable estate, this will usually be bad. This has become a huge issue with family limited partnerships where the IRS has been trying – somewhat successfully – to invalidate the transfers of FLP units to children or other family members by including the gifted shares in the estate of the donor.

If it is a non-taxable estate, this can be very good since inclusion in the estate means a step-up in basis. This can work really well – you can avoid probate since title is in the child’s name but the child gets the stepped-up basis. So, for instance, the remaindermen of a life estate get this favorable treatment.

Do not overlook all costs that may qualify as a medical expense under IRC 213. Most people know that, on your federal income tax return, your medical expenses must exceed 7.5% of your adjusted gross income (ie, the amount at the bottom of the front page of the 1040). But there are two issues that many taxpayers do not know about. One is that, in Arizona, all medical expenses are deductible. There is no 7.5% hurdle.

The other issue is that the term “medical expenses” is a surprisingly broad term that includes many expenses that might not otherwise be considered medical. The Code defines this as “amounts paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or the purpose of affecting any structure or function of the body, or for transportation primarily for and essential to medical care”. IRC 213(e). A huge amount has been written or issued as to what exactly this terms means and what is covered. You can get pretty creative here.

Note that there is no mention of “as prescribed by a doctor”. There are a few instances where a doctor’s prescription is necessary, most notably with medications. Otherwise, it simply must relate to a treatable condition. Expenses that are beneficial to your general health do not qualify.

Some examples of expenses that the IRS has agreed will qualify are: acupuncture, alcohol or substance abuse counseling, bandages, guide dogs, health insurance premiums (to include Medicare B), legal fees necessary to authorize medical treatment, psychiatric care, stop-smoking programs, special foods and dietary supplements if prescribed, specially equipped telephones or televisions for the hearing-impaired, vision correction, wigs and weight-loss programs if prescribed.

The entire costs of a nursing home are deductible if the “availability of medical care” is the “principle reason for his presence there”. If the person is there for “personal or family reasons”, then only the portion of expenses attributable to medical care is deductible (eg, no deduction for room and board). Treas. Reg 1.213-1(e)(1)(v)(a)&(b).

Improvements or modifications made to the home are deductible. Generally, these expenses are only deductible to the extent they do not increase the value of the home. However, the following expenses are deductible regardless of any increase in the home’s value: entrance and exit ramps, widening doorways, installing handrails and grab bars, modifying the kitchen, lifts other than elevators and ground grading.

Travel to and from the hospital or care provider is deductible. You can use a standard rate of 12 cents per mile or actual, out-of-pocket expenses. In addition, under either method, parking fees and tolls are deductible. Lodging that is “primarily for and essential to” medical care while visiting hospitals or similar facilities is deductible up to $50.00 per person, per night.

Drafting the Irrevocable Trust

It has been my experience that the use of irrevocable trusts has decreased dramatically over the past ten years. This is probably due to adverse income tax issues stemming from the 1993 tax bill and the increased popularity of alternative entities such as family limited partnerships.

The primary advantage of an irrevocable trust is that the property owned by the trust will be out of the grantor’s estate for estate tax purposes. If it is unlikely that a grantor will have a taxable estate, then a revocable or testamentary trust will usually work just as well. The other two advantages are that it can provide creditor and other spendthrift or incentive-laced protections for non-grantor beneficiaries and, as with any properly drafted trust, it avoids probate.

There are two primary disadvantages of irrevocable trusts. One that clients often need to be reminded of time and again, is the loss of control by the grantor. IRC 2511. A related problem can be inflexibility. Both of these problems may be ameliorated by the use of a trust protector, a concept that is becoming increasingly popular and has been adopted in the new Arizona Trust Code. See “Trust Protectors” by Alexander A. Bove Jr. in the November 2005 edition of Trusts & Estates.  The other disadvantage is the very high income tax rates applicable to trusts. For 2010, trusts hit the highest 35% bracket at $11,200 of taxable income. By contrast, an individual taxpayer does not hit the 35% bracket until she reaches $373,651 of taxable income. This means that you either fund the trust with non-income producing property (non-rental real estate or shares of stock) or qualify the trust for grantor trust status, as discussed below.

The primary form of an irrevocable trust that most practitioners will use is an irrevocable life insurance trust (ILIT). Irrevocable trusts are also frequently used for minor children or those not able to manage their funds. Other forms of irrevocable trusts commonly used include grantor retained income trusts (GRITs), grantor retained annuity trusts (GRATs), grantor retained unitrusts (GRUTs), charitable remainder trusts (CRTs), charitable lead trusts (CLTs) or qualified personal residence trusts (QPRTs).


There is no magic to drafting an ILIT. The main issue is to avoid being snared by IRC sec. 2036 for estate tax purposes. Sec 2036 allows the IRS to include the trust in the estate of the grantor if the grantor retains possession or enjoyment of the property held by the trust or has the right to designate the person who have possession or enjoyment of the property. As a result of sec 2036, the grantor cannot be the trustee or beneficiary of the beneficiary nor can the grantor have the authority to later name or remove a successor trustee or beneficiary (so be careful with powers of appointment). Because of community property issues, I am reluctant to name the spouse in either of these capacities although many practitioners will disagree with me. This means that, in my practice, an ILIT is for the benefit of the children with another family member or professional fiduciary serving as trustee.

There are three other technical aspects that the practitioner needs to be aware of. One concerns Crummey powers, Crummey v. Commissioner, 397 F2d 82 (9th Cir, 1969), which deals with giving the beneficiaries a present, not future, interest in the trust. A future interest will not qualify as a present interest for gift tax purposes. In order for the contributions made by the grantor to the trust to qualify as a completed gift, the beneficiaries must be given the right to have immediate access to those contributions for at least a reasonable period of time, generally 30 days. See also Estate of Cristofani, 97 TC 74 (1991), Estate of Kohlsaat, TC Memo 1997-212, Rev Rul 81-7 & IRC sec 2503(b)

The IRS hates Crummey powers, so this warrants special attention. The customary Crummey notice will suffice but note that, contrary to the understanding of many practitioners, such notices are not required as long as the beneficiaries are aware of the withdrawal right. Estate of Holland, TC Memo 1997-302.

Also, consider placing a “5&5” limitation on the withdrawal right. If the withdrawal right can exceed that and the right is not exercised (which is usually the case), the lapse is treated as a gift by the beneficiary and all sorts of adverse tax consequences can result under IRC 2514(e) and 2041(b). One solution is that have an accumulating or “hanging” power for those withdrawal rights not exercised. Rev Rul 85-88 & PLR 8901004.

Another technical area involves income taxes for the trust. This has really hurt the usefulness of irrevocable trust since the trusts have extremely high or “compressed” tax rates. This is particularly so if the trust is a dynasty-type trust meant to accumulate rather than distribute income. This tax issue often makes a family limited partnership look very attractive.

The conventional solution is to have the trust qualify as a grantor trust for income tax purposes, in accordance with IRC sec. 671 through 678. The two most common provisions are to allow the grantor to substitute assets of equivalent value or to allow the grantor to borrow assets without requiring adequate security for the loan. Estate of Jordahl, 65 TC 92 (1975), PLRs 9247024 & 9843024. See also Rev Rul 2004-64. Because of the grantor trust status, contributions by the grantor to the trust will not trigger income tax on the appreciation of the asset. PLR 9535026

Another very important use of irrevocable trusts is to maximize the creditor protection afforded to life insurance policies where the spouse is the beneficiary. The problem is the odd wording of ARS 20-1131 that only provides protection from the creditors of “the person effecting the insurance”. My office has had several situations where the husband’s creditors are making demands of the wife based on a community debt theory – that it is her debt as much as her husband’s. Naming a trust as beneficiary with the spouse as the trust beneficiary should avoid this problem. The new Arizona Trust Code solidifies this in ARS 14-10504(e) that provides creditor protection to a beneficiary even if that beneficiary is a trustee as long as the trustee has discretion in making distributions, to include the HEMS ascertainable standard.


These are trusts that must be carefully drafted with a specific tax-saving consequence in mind. A detailed discussion of these techniques, which involve application of IRC sec 2701-4, exceeds the scope of this presentation.

A grantor retained income trust is a trust created by the grantor that provide income back to the grantor for a term of year with the remainder to a third party. A grantor retained annuity trust allows the grantor to receive back income, either in a stated dollar amount or as a percentage of the property FMV at the time the trust was created. A grantor retained unitrust provides income to the grantor as a percentage of the property’s FMV as determined annually.

A charitable remainder trust involves the transfer of highly appreciated assets to a trust administered by a tax-exempt charity. The charity sells the assets without incurring capital gain because if its tax-exempt status and distributes back a predetermined income stream to the grantor. The grantor gets an income tax deduction for the charitable contribution less the present value of the income stream, determined using IRS tables. The grantor also gets the income without realizing any capital gain from liquidating the asset. And the asset is out of the grantor’s estate for estate tax purposes. The charity gets the remainder at the grantor’s death.

A charitable lead trust has the funds going in the opposite direction. The charity gets the income while the grantor is alive. The remainder passes to the grantor’s estate upon grantor’s death.

A qualified personal residence trust is structured to allow the residence to be transferred to a trust that allows the grantor to remain in the home for a set term of years. After that period of time, title passes to the beneficiaries. In order for this to work, the grantor must outlive the term of years.


In Arizona, the Medicaid program is administered by the Arizona Health Care Cost Containment System (AHCCCS). The nursing home portion of this program is administered by a division of AHCCCS, the Arizona Long Term Care System (ALTCS).

The 2006 enactment of the Deficit Reduction Act has greatly changed the transfer rules by greatly extending the lookback period in which those transfers can be penalized. Other presenters will be covering the many challenging planning aspects of this topic.

There is one very important and effective planning tool involving trusts and AHCCCS that is very frequently overlooked by practitioners. This involves creating a supplemental benefits trust that will protect the assets of the first spouse to die from exposure to the nursing home costs of the surviving spouse.

A typical problem concerns a married couple with one spouse (assume it is the husband) in a care facility that is being paid for by ALTCS. Because of the Community Spouse Resource Deduction, the wife can retain one-half of the couple’s assets up to $95,100.00 plus exempt assets such as the home. The problem is what if the wife dies before the husband? If the wife’s estate passes outright to the husband, the previously protected assets are now available assets that will disqualify the husband from ALTCS benefits.

The way to avoid this is to create a supplemental benefits trust that will be funded with the wife’s assets. The terms of the trust essentially state that the trustee has discretion to use the assets for the benefit of the husband. The danger is that AHCCCS may try to claim that the trust is a support trust and that the trustee has an enforceable obligation to pay the health care costs of the husband. The trust’s terms must indicate that the purpose of the trust is to supplement but not supplant AHCCCS and related benefits. I have attached a sample supplemental benefits trust that is usually contained in the wife’s will. For additional guidance, see the excellent book Third-Party and Self Created Trusts: Planning for the Elderly and Disabled Client by Clifton B. Kruse, Jr., 3rd edition published by the ABA.

Note that this is not a special needs trust for the disabled as authorized under 42 USC 1396p(d)(4)(A).


AHCCCS has made no secret of its disdain for deeds creating a life estate with retained powers (LERPs), usually the power to sell. AHCCCS has litigated the issue on a fraudulent transfer theory but the merits of this theory have not been fully addressed since the cases have been decided on technical procedural grounds.

Two recent developments have greatly lessened and probably eliminated the ability to use LERPs. The idea was to avoid estate recovery by having title to the residence pass outside of probate upon death since AHCCCS had been limited to seeking estate recovery against probate assets. But this changed with the enactment of ARS 14-6102 that now authorizes creditors of the probate estate to reach non-probate assets. However, it has been my experience that AHCCCS has not been aggressive in pursing non-probate assets and few practitioners have seen AHCCCS be active in this regard.

However, AHCCCS has been active in issuing liens on the residences of AHCCCS patients. These are known as TEFRA liens and AHCCCS began issuing these in the fall of 2005 as part of its estate recovery plan.

A quick summary of estate recovery.

The new liens are a means to enforce AHCCCS’s estate recovery rights. To understand the liens, a practitioner must understand the nature of AHCCCS’s claim that underlies those liens.

As most practitioners know, a person in a nursing home can qualify for ALTCS coverage regardless of the fair market value of their home. In other words, a person in a nursing home can own a home worth $1 million and, if that is the only asset that the person owns, then that person is fully eligible for ALTCS benefits.

So far, so good but a serious problem can exist at the death of the person that many people do not know about. Once a person dies who has ever received ALTCS or other AHCCCS benefits, AHCCCS is mandated by state and federal law to recoup the cost of the person’s care. This process of asserting a claim against the deceased person’s estate is called estate recovery. It catches many families by surprise since nothing like this exists with other government programs such as Medicare or with insurance policies.

Most spouses and other family members assume these are costs they will never have to bear. Up until now, they did not learn of this problem until well after the death of the ALTCS patient. But with the recent approval of AHCCCS’s new liens, the patient as well as their spouse and family will learn of this peril within months of the beginning of AHCCCS/ALTCS coverage. This is going to cause considerable anguish and fright for family members, especially spouses, who will come face-to-face with an immediate threat to what is often their largest asset. The purpose of this article is to explain to practitioners when they can expect to encounter this situation and how to address it.

How much can AHCCCS claim? AHCCCS can assert a claim to recoup the net amount it has paid for services provided by medical contractors, for Medicare premiums and for insurance co-payments or deductibles. The largest of these will be the payments to medical contractors that, for most nursing home residents, will amount to approximately $2,500 per month.

What assets are subject to estate recovery? According to section 4.17 of the new State Plan, the claim will be asserted against any real estate in which the deceased person had an ownership interest and any other property subject to probate.

What assets are exempt from estate recovery? There are four main exemptions to the estate recovery process. First, federal regulations limit estate recovery to medical services rendered to persons over the age of 55. Second, estate recovery cannot be asserted against a surviving spouse. Third, it cannot be asserted if the deceased person is survived by a child under the age of 21. Finally, it cannot be asserted if the deceased person left a surviving child of any age who is blind or is disabled under the criteria set forth by Social Security. Simply put, AHCCCS can only pursue an estate recovery claim against an unmarried person with no minor or disabled children.

The New TEFRA Liens.

Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), states were authorized to issue liens on the real property of Medicaid (ie, AHCCCS) patients who were over the age of 55 years and who were residing in a nursing home for at least 90 consecutive days. (Transfers from one care facility to another will not interrupt the 90 day period.) Under the new plan, AHCCCS has elected to issue these liens, which it had never done before.

Who is exempt?

Keep in mind that these new liens are simply a new way to enforce claims that AHCCCS has always had but that were not always made known to AHCCCS patients. They do not create any new claims. As a result, the exemptions for estate recovery track the exemptions to the new liens. AHCCCS patients who have spouses, children under the age of 21 or disabled children are exempt.

There are additional exemptions to the liens. First, the liens will only apply to those persons residing in a skilled care facility. This means that persons receiving AHCCCS care at home or in many assisted living facilities are exempt. Second, there is an exemption if the AHCCCS patient has a sibling who has an equity interest in the home and who was living in the home for at least one year immediately prior to admission to the nursing home. A third exemption is if a child resided in the home for two years prior to admission to the nursing home and who provided care to the deceased person that allowed the person to remain in the home rather than be placed in a nursing home.

Hardship waiver.

The new plan authorizes AHCCCS to waive its claim and release the lien if an undue hardship exists for an heir of the estate. The criteria for this are strictly defined and rather limited. It appears that this relief will require an administrative hearing. There are three scenarios were a waiver/release will be granted.

One scenario is where an heir to the deceased person owns a business located on the residential property that has been in operation for at least twelve months prior to the person’s death, that provides at least 50 percent of the heir’s income and that the heir would lose their livelihood if recovery was pursued.

The second scenario is where an heir currently resides in the deceased person’s home, lived there at for at least a 12 month period immediately prior to the deceased person’s death and the heir owns no other residence.

The third scenario is where the heir’s household has gross income below the federal income poverty guidelines and does not own a home or other real property.

How and when will notice of the lien be given?

AHCCCS will send a notice to the AHCCCS patient or the authorized representative at least 30 days before recording the lien. The person then has 30 days after receipt to provide a written request to AHCCCS for an exemption. It is not entirely clear how this will work since there will obviously be problems if the AHCCCS patient is incapacitated. Or ALTCS patients living in a nursing home may never receive it if the notice is mailed to their home.

Can a lien be released?

AHCCCS is required to release its lien within 30 days of satisfaction of the lien. There are two other ways to have the lien released although the AHCCCS claim will continue to exist. One situation will be where the AHCCCS patient has been discharged from the care facility, has returned home and intends to remain there. The other situation is where spouse (presumably married after the lien was issued) attempts to sell the home.

What planning strategies should be considered?

More and more, the conventional wisdom is emphasizing the sale of the home with gifting various portions of the proceeds depending on the situation. Or, at the very least, remove the nursing home spouse from the deed. Make sure the healthy spouse has authority via a power of attorney that authorizes both the sale of the home and gifting. If an unmarried person has entered the nursing home, the house needs to be sold before any lien is issued unless the person is terminally ill or otherwise likely to stay in the facility for a short period of time since the resulting lien will not be large. Or, if the person is paying a high share of cost, this will offset much of AHCCCS’ claim.

If the house is to be sold or transferred to the children, make sure to use the county assessor’s value since this will result in a shorter penalty period. However, a gift to the children will result in a carryover basis and will not qualify for the tax-free treatment afforded by section 121 of the Internal Revenue Code.

Also note that the lien rules do not apply to persons receiving home and community based services.


Elder law and estate planning attorneys are not financial advisors, so we should not be telling our client how to invest. But we can inform them of the tax and other consequences that may effect that decision. Some recent developments have added several planning options that need to be discussed with the client in attempting to protect assets.

Creditor protection

In the 2005 legislative session, the Arizona legislature passed a bill that extended the holding in the case of May v. Ellis, 208 Ariz 229 (2004), that held that insurance policies are protected from creditors of the deceased insured’s probate estate. The legislation amended ARS 20-1131 and 33-1126 by eliminating the prior $25,000.00 cap with unlimited creditor protection for life insurance policies and annuities. The protection also includes cash surrender values on policies that are at least two years old and name a family member as beneficiary. The protection does not apply to policies or annuities that were pledged as collateral for a loan.

This means that for an ill elderly person who may be facing nursing home costs, keeping an insurance policy in force may work wonders for the surviving spouse or children.

Recent federal legislation in the form of the Bankruptcy Abuse and Consumer Protection Act of 2005 contained some very important protection for retirement plans, 529 plans and education IRAs.

All elder law practitioners are well aware of the benefits of tax deferral afforded retirement assets. But a very overlooked benefit of retirement assets is that the funds within such a plan are protected from creditors. This was due to the creditor protection afforded by ERISA and several important decisions rendered in the 1990’s by the United States Supreme Court, most notably Patterson v. Shumate, 504 US 753 (1992). The new bankruptcy bill greatly expands this creditor protection although the draftsmanship leaves much to be desired.

What is protected?

This requires a patchwork analysis. First, there is a new section 541(b)(7) that provides unlimited creditor protection for all deferred compensation plans under section 457 of the Internal Revenue Code (“IRC”) and for all tax-deferred annuities under IRC section 403(b). I most often see section 457 plans with government employees and section 403(b) plans with teachers.

Second, there is a new section 522(b)(3)(C) of the Bankruptcy Code that protects “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under sections 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code”. This is the key provision that will protect most people.   IRC sec. 401 covers all pensions and defined contributions plans. IRC sec. 403 applies to plans administered on behalf of employees of school districts, churches and other tax-exempt entities. IRC sec. 408 covers all IRAs, to include SEPs and SIMPLEs. IRC sec. 408A covers Roth IRAs. IRC sec. 414 applies to plans administered by predecessor employers and certain partnerships and sole proprietorships. Plans under IRC section 457 (deferred compensation) are afforded protection already mentioned. IRC sec. 501 covers plans for employees of tax-exempt entities.

Prior to this new law, there seemed to be a distinction between ERISA assets (ie 401(k)s) and non-ERISA assets (IRAs, SEPs and Keoghs). ERISA assets were clearly protected but it was not clear if this protection extended to non-ERISA assets. This distinction is now gone – as long as the asset is exempt from taxation, it will come within the protection of the new section 522.

Also note that these protections apply to all states. Most states allow or require its residents in bankruptcy to use that particular states’ list of exemptions, so that the federal exemptions are of no consequence. Not so here – debtors in all states must use the exemptions, which they will want to do anyway since the new exemptions are much more generous than that offered under most states’ law.

How much is protected?

It would have been nice if the new legislation had stopped there – creditor protection for any tax-exempt retirement asset. But Congress added a new section 522(n) to the Bankruptcy Code that deals with IRAs. The section begins with limiting protection for IRAs to $1 million but then creates three exceptions to that amount. First, the section does not apply to SEPs or SIMPLEs, which will have unlimited protection like other retirement assets.

Second, the statute states that the $1 million exemption amount is made “without regard to amounts attributable to rollover contributions” from other protected retirement accounts. The conventional wisdom from nearly all the commentators I have read is that this means that rollover IRAs will have unlimited protection so that $1 million plus all rollover IRAs will be protected. But at least one prominent commentator has interpreted this to mean that the aggregate amount of all IRAs is the $1 million. He reasons that the “without regard” language means that it does not matter if the sources of the funds are rollover funds – there is a $1 million cap, period.

The third exception is that the $1 million cap “may be increased if the interests of justice so require”. No criteria, definitions or guidance is given as to what exactly this means.

This bill was enacted less than two weeks after the United States Supreme Court had issued its decision in Rousey v. Jacoway, 125 SCt 1561 (2005) that held that, in bankruptcy, IRAs, which are non-ERISA assets, were afforded the same creditor protection as ERISA plans. The new legislation has made much of Rousey dead letter law but there are situations where the Rousey holding can still be used. Rousey held that an IRA was protected to the extent the funds were “reasonably necessary for the support of the debtor or his dependents”. In most situations, it is difficult to envision situations where the need for support would exceed the $1M statutory exemption. But persons with disabilities or parents with disabled children could conceivably exceed this amount so Rousey remains an important case for them.

The legislation also overrules the controversial Supreme Court holding in Yates v. Hendon, 541 US 1 (2004) that held that there is no creditor protection for retirement assets where the only participants were the business owner and family members. This meant that sole proprietors and other one-person or husband-and-wife businesses lost this protection. The new section 522 ignores this distinction and places these businesses on equal footing with all other qualified plans

Who is protected?

Clearly, plan participants come within the protections outlined above. But what about surviving spouses and other people who inherit an IRA or other qualified plan assets?   It appears that these situations will be afforded protection. The new section 522(b)(4)(D) specifically extends protection to any rollover, so any surviving spouse should be protected. But what about other beneficiaries? As long as the funds remain in a tax-exempt account, the creditor protection should be maintained. But what of funds that are simply withdrawn from the account? An apparent drafting lapse may work to the beneficiaries’ advantage. The new section 522(b)(4)(C) states that “a direct transfer of retirement funds from 1 fund or account that is exempt from taxation…. shall not cease to qualify for exemption…by reason of such distribution”. It seems quite clear to me that the drafters forgot to include the phrase “to another account exempt from taxation” regarding the transfer. Whether this will be subject to a technical corrections bill remains to be seen.

Note that, unlike other provisions, there are no time restrictions on when contributions to retirement accounts can be made. In other words, a person can make maximum contributions to a 401k or a SEP, file for bankruptcy the next day and the funds should be protected.

529 plans and Coverdell education accounts

Another favorable development is the amendments to sections 541(b) & (c) that protect IRC section 529 college savings plans and Coverdell education accounts. Any of these accounts that name a child, grandchild, stepchild or stepgrandchild as a beneficiary will be protected. Any contributions made prior to two years of a bankruptcy filing are protected as long as they did not exceed the amounts that are tax-qualified under the IRC. This will be in the $250,000 range for most 529 plans and, for Coverdell accounts, will be the accumulation of the $2,000 maximum annual contributions per beneficiary. For contributions made within one to two years of filing, only an aggregate amount of $5,000 per beneficiary will be protected. Contributions made within one year of filing will not be protected in any amount.

Trust as beneficiary of retirement plan

One of the more difficult areas of estate planning involves naming a trust as beneficiary while maintaining the status of “designated beneficiary” that will allow for the maximum tax-deferred stretch-out of an IRA or qualified plan asset. Section 1.401(a)(9)-4 of the “Final” regulations, Q&A-3, provides that only individuals may be designated beneficiaries for purposes of section 401(a)(9). A person who is not an individual, such as the employee’s estate, may not be a designated beneficiary. However, Q&A-5 of section 1.401(a)(9)-4 provides that beneficiaries of a trust with respect to the trust’s interest in an employee’s benefit may be treated as designated beneficiaries if the following requirements are met:

  1. the trust is valid under state law or would be but for the fact there is no corpus.
  2. the trust is irrevocable or will, by its terms, become irrevocable upon the death of the employee.
  3. the beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in the employee’s benefit are identifiable within the meaning of A-1 of this section from the trust instrument.
  4. relevant documentation has been timely provided to the plan administrator.

The difficulties come in determining what constitutes a” beneficiary with respect to the trust’s interest” under the trust and which life expectancy of a beneficiary must be used in calculating the minimum required distributions under IRC 409(a)(9). The IRS has provided very little guidance in drafting trusts to qualify for the status as “designated beneficiary”. However, four private letter rulings give some indication of what will pass muster with the IRS, at least in terms of a “see-through” or “conduit” trust that will qualify as a DB. PLRs 200537044, 200528031, 200607031 & 200608032 (available at the IRS website’s Electronic Reading Room at,,id=99705,00.html.

In PLR 200537044, the taxpayer (“TP”) had a trust that had nine subtrusts with each allocated a specific percentage of the IRA. Key point – TP had a beneficiary form naming the nine subtrusts as beneficiaries. Second key point – trust required that distributions from the IRA “be paid to or for the benefit of such individual as soon as possible following the receipt of such amounts by the Trustee”.

IRS rules that the tests for qualifying as a “designated beneficiary” are met so that each individual beneficiary can use his/her own life expectancy to calculate the minimum required distributions.

TP did not make the mistakes in PLR 200317041 that named the “master” trust rather than the subtrusts as beneficiary. Here, the IRA was divided at the beneficiary form level and paid directly to the subtrusts. It did not have to pass through the master trust in order to find its way to the subtrust.

Also noteworthy was that the terms of the subtrust allowed for trust expenses to be deducted prior to the payment to the beneficiary. This feature did not preclude treatment as a conduit trust.

A similar result was reached in PLR 200607031. There, as in PLR 200608032, the IRS quoted language from the trust that qualified as a conduit trust. Both PLRs had language to the effect that:

“Notwithstanding anything herein to the contrary, I direct that such retirement plan benefits may not be used or applied on or after September 30 of the year following my death for payment of my debts, taxes, expenses of administration or other claims of my estate; nor for payment of estate, inheritance or similar transfer tax due at my death”.

PLR 200608032 also had language to the effect that no distributions to charities could be made after Sept 30th as well.

PLR 200607031 also quoted the following language:

Notwithstanding anything to the contrary and in addition to any dispositive provisions of any trust created under this agreement, with regard to any qualified retirement plan that is payable to any trust under this agreement, beginning in the year following my death, my Trustee shall withdraw from such qualified retirement plan the minimum required distribution as defined under section 401(a)(9) of the code and the proposed and final regulations promulgated thereunder. Additionally, the Trustee may withdraw from any Retirement Asset payable to the Trust, so much of net income and corpus as the Trustee shall determine to be necessary or advisable for the benefit of a beneficiary as the Trustee shall determine to be necessary for such beneficiary’s health, education, maintenance or support in such beneficiary’s accustomed manner of living. Notwithstanding anything to the contrary, any and all amounts withdrawn from any Retirement Asset payable to this Trust shall be distributed to the beneficiary of such trust, not less frequently than annually, free of Trust.

The intent of this section is to the extent necessary to qualify any trust under this agreement as a designated beneficiary under Section 401(a)(9) of the code and the proposed and final regulations promulgated thereunder, any Trust receiving a required minimum distribution from a qualified retirement plan shall be considered a conduit trust”.

The key point is to create a separate subtrust and, on the beneficiary designation form, name that particular subtrust as the beneficiary and not the overall or “master” trust. This was the mistake made in PLR 200528031.

There, the decedent, who was married, had an IRA and a qualified plan and had created a trust. The trust had an A/B split but the credit shelter trust (CST) was for the benefit of five nieces and nephews with no benefit to the surviving spouse. The IRA gave a 50% share to the CST and a 50% to the husband’s subtrust. The qualified plan simply named the trust as the beneficiary.

IRS rules that, for the share going to the CST, the life expectancy of the husband must be used even though he is not a beneficiary. This is because he is a beneficiary of the trust even though not of the CST. Unlike the PLR above, the trust, and not the CST, was named as beneficiary so the life expectancy of all trust beneficiaries must be used when computing the MRD.

Also noteworthy in these recent rulings is that, in identical language, the rulings stated that a trustee to trustee transfer is not a prohibited rollover by a non-spouse beneficiary. The rulings stated as follows:

Revenue Ruling 78-406, 1978-2 C.B. 157, provides that the direct transfer of funds from one IRA trustee to another IRA trustee, even if at the behest of the IRA holder, does not constitute a payment or distribution to a participant, payee or distributee as those terms are used in Code section 408(d). Furthermore, such a transfer does not constitute a rollover distribution. .

Finally, Rev. Rul. 78-406 is applicable if the trustee to trustee transfer is directed by the beneficiary of an IRA after the death of the IRA owner as long as the transferee IRA is set up and maintained in the name of the deceased IRA owner for the benefit of the beneficiary. The beneficiary accomplishing such a post-death trustee to trustee need not be the surviving spouse of a deceased IRA holder.

Problems with annuities

Nearly all estate planning and elder law attorneys hate annuities for the lack of flexibility afforded the annuity owner. Low interest rates and poor investment performance haven’t helped either. But what many people and their advisors (to include attorneys) do not understand are the awful tax consequences of annuities under IRC sec. 72.

First, consider that the capital gains rate is only 15% on long-term (ie, one-year) capital gains. For all the tax-deferral hype spouted out by annuity salesman, one has to wonder how much is really being saved when we are only facing a 15% tax rate. In other words, all appreciation in an annuity is taxed at ordinary income tax rates rather than the lower capital gains rates. And, when computing any possible capital gain, remember that there is no step-up in basis at the owner’s death.

Annuities also create many other post-mortem problems that few in the annuity industry are aware of. For instance, determining which spouse owns the contract and who is the annuitant can make a huge difference. What happens when the wife dies and the annuity is owned by the husband but is based on the wife’s life (ie, the wife is the annuitant – the measuring life)? This is not an uncommon scenario but few realize that the annuity contract terminates and all funds must be pulled out of the contract.

Or, suppose the annuity is jointly owned by husband and wife with wife as annuitant but the son is the beneficiary. Husband dies. Who pays the tax on the payout? This one is really lovely – the son as beneficiary gets the proceeds but the wife, as half-owner, may have to pay half of the taxes due on the distribution.

Or, suppose a revocable trust owns the contract and is the beneficiary with the husband as the annuitant. What happens when the wife dies? The annuity will pay out. However, if the trust was an irrevocable, non-grantor trust, then nothing would change by virtue of the wife’s death.

This is a very technical area involving scenarios that none of the parties contemplated.