We often organize thoughts and ideas into broad categories. Such generalizations can make life easier to navigate, even though we know there are exceptions to the general rules.
Because of their complexity, legal ideas are frequently generalized in this fashion in attempts to simplify and make things understandable. Trusts, which are simply sets of rules, are often generalized in this way. However, trusts should not be generalized in the context of nursing home/long-term care planning.
Revocable versus irrevocable
Typically, trusts can be categorized into two types: revocable and irrevocable. Usually, revocable trusts can be amended or revoked, and completely irrevocable trusts cannot be either amended or revoked.
Irrevocable trusts are most often used in our region for Medicaid/nursing home planning. An irrevocable trust that is effective for Medicaid/long-term care planning must prohibit every direct or indirect way of accessing the assets in the trust to pay for long-term care expenses.
Despite the simple dichotomy of revocable versus irrevocable, some trusts include rules that can be amended and some other rules that cannot be amended. Is such a trust a revocable trust or an irrevocable trust? As with many aspects of the law, the title is much less important than the substance of the trust rules.
Trust taxing sorts trusts differently
Most of the time, irrevocable trusts are taxed alone or as if they are “real people” (essentially becoming taxable entities) and are taxed at very high rates. Because of the near 100 percent consistency of this rule of thumb, many accountants and attorneys simply conclude that the law requires that all irrevocable trusts be taxed as stand-alone trust tax entities.
However, the law is not that simple. Any trust that includes some ability of the trust creator (legally called the trust “grantor”) to make certain changes to the trust rules is called a “grantor trust.”
The assets in grantor trusts are considered “owned” by the grantor/owner of the trust, so the trust is not taxed alone as a trust tax entity. And, grantor trusts can help avoid capital gains taxes.
Thus, all revocable trusts are grantor trusts because all revocable trusts are amendable. Revocable trusts, not because they are called revocable trusts but because they are grantor trusts, are not taxed as stand-alone trust tax entities and can help avoid capital gains taxes.
Similarly, irrevocable trusts that are completely non-amendable cannot be grantor trusts. Regardless of their titles, these completely non-amendable trusts’ status as not being amendable at all (therefore not being grantor trusts) means that they are taxed stand-alone trust tax entities.
Win-win ‘mixed’ trusts
However, as explained above, any particular trust might be partly amendable and partly non-amendable.
The most frequent “mixed trust” is irrevocable (in common parlance and in title) because the rules that prohibit access to the trust assets for long-term care expenses are unamendable rules. However, that same trust can include sufficient amendable rules/provisions to allow it to be a grantor trust. This irrevocable grantor trust is the best of both worlds for purposes of Medicaid protection and tax treatment.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at Lee@LeeSchroeder.com or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.