It is commonplace for senior citizens looking to preserve their assets to make gifts of the assets to their adult children. These transfers are typically made to "start the clock" running on the five-year "look back" period applicable to nursing home Medicaid eligibility. That is, if the parent does not need nursing home care for at least five years after the transfer of assets, all the transferred assets are deemed "exempt" if the parent subsequently applies for nursing home Medicaid coverage.
But as demonstrated by a just-issued United States Bankruptcy Court decision, parents engaging in asset transfers to their adult children have more than just Medicaid risks to consider. The case, In Re Woodworth (Bankr. E.D. Va., No. 11-11-51-BFK, Feb. 6, 2013), presents a straightforward set of facts. In 2002, Dorothy Stutesman transferred assets in an investment account valued at $142,742 to her daughter, Holly Woodworth. Mrs. Stutesman testified before the Bankruptcy Court that she was unsophisticated about finances, and that she transferred the assets to her daughter to both protect the assets from potential "scammers," and to enable her "to be eligible for Medicaid and other public benefits, should there come a time when she needed such benefits." Mrs. Stutesman testified that at all times she considered the funds to be her own assets and not her daughter's, notwithstanding that they were titled in her daughter's name. Holly similarly testified that she always considered the assets as her mother's assets.
After experiencing losses in the financial markets, in 2010 -- eight years after the assets were put in Woodworth's name -- Mrs. Stutesman and her daughter agreed to move the funds to a new financial adviser. The new advisers convinced the women to put the assets into a trust "designed to reduce creditor risk, eliminate probate and eliminate estate tax." Holly was the creator (grantor) of the trust.
Unfortunately for Mrs. Stutesman and her daughter, Holly owned an investment property that lost value in the real estate crash, and was ultimately worth less than the mortgage balance. In February 2011 Ms. Woodworth filed a Chapter 7 petition for bankruptcy.
During the course of the bankruptcy proceeding, the bankruptcy Trustee correctly identified the $142,742 of trust assets as a fraudulent transfer under the Federal Bankruptcy Code. However, Mrs. Stutesman and her daughter argued that the trust assets were never actually Holly's property, but were simply being held in trust for Mrs. Stutesman, and therefore should not have been included as part of the bankruptcy estate. In legal parlance, the women argued that Ms. Stutesman retained "equitable title" rather than "legal title."
The Bankruptcy Court did not buy the women's argument. The Court stated that after the assets were transferred in 2002 to Ms. Wooworth's personal investment account, she had full control to do with those assets as she wished. In citing Mrs. Stuteman's own testimony, the Court stated,
Ms. Stutesman can't have it both ways--she can't part with title for purposes of Medicaid eligibility, and at the same time claim that she retained an equitable title to the asset. To allow this kind of secret reservation of equitable title would be to sanction Medicaid fraud.
As a result of the Court's complete rejection of Mrs. Stuteman's and Ms. Woodworth's arguments, the entire $142,742 in the investment trust was ordered payable to the Bankruptcy Trustee to be distributed to Ms. Woodworth's creditors.
This case highlights one of the dangers of parents making outright transfers of their assets to their children, and why we almost always recommend against that strategy. However, there is a technique by which Mrs. Stutesman could have appropriately protected her assets from a potential Medicaid spend down without exposing those assets to her daughter's creditors. Specifically, in 2002 Mrs. Stutesman could have created and funded her approximately $142,000 of assets into an irrevocable income-only trust, with her daughter designated as the Trustee. Funding that trust in 2002 would have started the five year Medicaid look back period, which would have then run its course by 2007. Mrs. Stutesman could have retained access to the income derived from the trust assets, with the principal remaining protected. It is noteworthy that there is nothing in the decision indicating that Holly at any time gave any of the gifted assets back to her mother, which implies that Mrs. Stutesman was able to live comfortably on her income; this is typical of the vast majority of our clients seeking to preserve their assets from a Medicaid spend down.
Fast-forward to 2011, when Holly filed bankruptcy. Had she merely served as Trustee of her mother's trust, rather than as the owner of the gifted assets, the assets in the income only trust would have been completely excluded from Holly's bankruptcy proceeding, and the assets would have been preserved during her mother's lifetime. Just as powerful, such a trust could have been structured to provide that, upon Mrs. Stutesman's death, the assets could have remained in a trust for Holly's benefit, with those assets to be further protected from Holly's current and future creditors!
Unfortunately, it appears from a reading of the Court's decision that at no time did Mrs. Stutesman or her daughter seek the counsel of an elder law attorney to help them through the complex issues that surrounding estate and asset preservation issues. Had they done so, the story would almost surely have resulted in a much happier ending for them; instead, the only ones left smiling in this case were the Bankruptcy Trustee -- and Holly's creditors!