Powers of Attorney & Medicaid Planning

Elder law attorneys may advise that an individual give away resources either to minimize potential estate tax or accelerate Medicaid eligibility. However, in order to make gifts, a potential donor must have donative capacity, i.e. the cognitive wherewithal to understand the nature and effect of gratuitous transfers. While seldom an issue for healthy people who live independently, donative capacity may be compromised by dementia, frailty, and other conditions seen all too often in typical elder law practices.

Theoretically, incapacitated persons can make gifts through guardians, but state guardianship laws typically don’t empower guardians to give away a ward’s property except with court approval. Until fairly recently, courts often were loathe to authorize gifts, particularly to qualify for Medicaid. Apparently, many judges believed that family assets rather than taxpayer funded Medicaid should pay for nursing home care whenever possible. This sentiment is typified in a passage from an unpublished New Jersey trial court ruling denying a guardian’s request to transfer a jointly owned marital home to the wife after the husband suffered a devastating stroke necessitating full time care:

It is not fair to the public to transfer the home to her sole name during the joint lives of the parties free of any interest of the incompetent (and the public). Such a transfer might result in a situation in which she predeceases the incompetent and leaves the house to the parties’ adult children free of claims of the public. This would be unjust. (Matter of Labis) by Judge Stanton of the Superior Court of New Jersey (Morris County)

In the past decade or so, more progressive courts have begun to authorize guardians to make Medicaid planning gifts for incapacitated wards based on the theory of substituted judgment. Matter of Cooper, 618 N.Y.S.2d 449 (1994) and In Re. Guardianship of F.E.H., 453 N.W. 2d 882 (Wis. 1990). Thus, Judge Stanton was reversed by New Jersey’s Appellate Division, which said,
The common law equitable doctrine of substituted judgment encompasses the view that a court has inherent power to deal with the estate of an incompetent in the same manner as the incompetent would if able to function at full capacity…. Concepts of equal protection and inherent fairness dictate that an incompetent should be given the same opportunity to use techniques of Medicaid and estate planning as others more fortunate. Matter of Labis, 314 NJ Super 140 (App. Div., 1998).

Previously, courts recognized that it sometimes is appropriate for a guardian to give a ward’s assets to the natural bounty of the ward’s affection to save potential estate tax. In Re. Guardianship of Christianson, 56 Cal. Rptr. 505 (Ct. App., 1967) and In Re. Trott, 118 NJ Super 440 (Ch. Div. 1972). In fact, New Jersey’s Appellate Division based its recent favorable Labis Medicaid ruling largely on its perception that guardianship statutes enacted by New Jersey’s Legislature after Trott incorporated the doctrine of substituted judgment enunciated in Trott.

While many courts have embraced the principle that guardians should be permitted to make gifts that a ward probably would endorse if competent, some judges remain hostile. For instance, despite Labis, supra, various New Jersey courts recently have turned down applications by guardians to make gifts. (E.g. Matter of Annette Swett, Docket No A-4116-99T1 (App. Div., Jan. 18, 2001) not published, affirming trial court ruling that denied guardian’s application to make Medicaid planning gift.) Nevertheless, the Supreme Court’s In Matter of Keri 181 N.J. 50 (2004) decision would permit guardians to make Medicaid planning gifts in many cases.

Even if guardians could be certain judges would authorize them to make gifts, other techniques are preferable. Invasive, embarrassing, and often fostering bad feelings within a family, guardianship proceedings should be a last resort, particular considering their high cost and the potential to lose thousands of dollars in tax or Medicaid savings opportunities while waiting for court approval to implement a guardianship gift plan. Even judges, who favor gifts by guardians will require proof that a git is appropriate. This may not be so easy to show, especially if the proposed donee isn’t the incapacitated person’s spouse or child. Courts also may require wards to retain greater amounts than comport with optimal estate or Medicaid planning. For instance, in both Labis and Trott the guardians retained substantial amounts to provide for the incapacitated person whereas more aggressive gifts may have yielded greater savings.

Elder law attorneys often advise clients to give power of attorney before incapacity strikes so that there will be no need to rely on guardians to implement Medicaid and estate planning gift programs. However, this excellent advice may not bear fruit if the lawyer prepares the power of attorney by merely filling in blanks on a form. Many power of attorney forms do not, in fact, authorize attorneys in fact to make gifts, and those that do may unwittingly trigger substantial tax.

A power of attorney is a written document whereby a principal authorizes an agent to deal with the principal’s property. While a power of attorney may be limited in scope and duration (e.g. closing the sale of a home), general and durable powers of attorney normally are used in estate and Medicaid planning. A power of attorney is durable if the attorney in fact’s authority continues after the principal becomes disabled. State law governs the formalities that must be observed to establish a general and durable power of attorney.

Under the common law, powers of attorney traditionally were construed narrowly. For this reason, IRS generally considers gifts made by an attorney in fact to be voidable unless the power of attorney (or a state statute) authorizes gifts per power of attorney. Townsend, 95-1 USTC 60, 75 AFTR 2d 95-1947 (D. Neb. 1995). A voidable gift is taxable in the donor’s estate because the donor’s executor has a legal right to recover the gift. While the author isn’t aware of similar Medicaid cases, the same logic should permit aggressive Medicaid authorities to treat as a donor’s countable resources gifts by his attorney in fact. Responding to IRS’ position, at least one state, Virginia, enacted legislation to permit most attorneys in fact to make tax planning gifts. Taking the opposite tack, some states seek to protect principals against unscrupulous attorneys in fact by requiring explicit authorization to make gifts. While favorable facts (such as donor’s gift history) may overcome the presumption that an attorney in fact’s gifts are voidable, why not foreclose this issue by explicitly authorizing gifts whenever a power of attorney may be used for Medicaid or estate planning?

Simple blanket gift provisions– e.g. “My attorney in fact may make gifts of my personal and real property.”– are sufficient to authorize an attorney in fact to make gifts, but they have inherent problems. On its face, a blanket gift provision would permit a child named as attorney in fact to favor himself over the principal’s other children, but the common law prohibition against fiduciary self dealing may prevent such favoritism. On the other hand, a blanket gift clause may be construed to waive the self dealing prohibition by implication. However, if it applies, the fiduciary self dealing proscription also may preclude child who serves as attorney in fact from making gifts to himself or his family. None of these constructions is likely to implement a principal’s intent in giving power of attorney to his child.

Blanket gift provisions also are subject to hidden tax traps. Under Internal Revenue Code sections 2041 and 2514, a power of attorney confers a general power of appointment when it authorizes an attorney in fact to make gifts to himself without limitation. This can trigger substantial unanticipated gift and estate tax should the attorney in fact exercise or release the power of appointment or die while it is in effect. Income tax also can arise if an attorney in fact makes gifts via power of attorney to a person to whom the agent owes a duty of support (typically his spouse and minor children).

Fortunately, careful drafting can minimize self dealing and power of appointment concerns. Self dealing should not be an issue so long as a power of attorney states whether and to what extent an attorney in fact may make gifts to himself and his family. Unfortunately, it isn’t quite so simple to draft around Code sections 2041 and 2514.

Several techniques are available to keep a power of attorney from triggering gift and estate tax. Gifts to the attorney in fact and his creditors may be prohibited except to the extent gifts qualify for the annual gift tax exclusion under Code section 2503 or are needed for the attorney in fact’s health, education, support, or maintenance. Nevertheless, this straight forward alternative usually won’t work in an elder law practice because the principal wants the agent to make large gifts to himself if the principal requires long term care. There is inherent tension between a principal’s twin goals to permit the largest possible gifts to his attorney in fact if the principal should need long term care but avoid unnecessarily triggering gift and estate tax. A solution may be to permit gifts to the attorney in fact only if they are approved by a person possessing a substantial interest in the property subject to the power, which would be adversely affected by gifts to the attorney in fact. However, this alternative probably won’t be realistic where the attorney in fact is the principal’s sole heir.

Clients whose needs can’t be met by avoiding a power of appointment altogether may be candidates for a compromise approach. A compromise power of attorney would prohibit gifts to the attorney in fact beyond the gift tax annual exclusion and his health, education, and support needs while the principal is reasonably healthy but lift the limitations if the principal develops a need for long term care. This should prevent the attorney in fact from realizing a power of appointment while he has no need for unfettered gift authority. However, since the principal wants the attorney in fact to make large Medicaid planning gifts to himself anyway once the principal needs long term care, the principal shouldn’t be unduly concerned with conferring a general power of appointment at that time.

Clients needs can rarely be met when elder law attorneys prepare powers of attorney as mere “fill in the blank” forms. Applicable law may not permit an attorney in fact to make gifts even though the principal’s primary purpose in giving power of attorney is to facilitate Medicaid and estate planning upon incapacity. Using “one size fits all” form powers of attorney may trigger a large tax bill by unwittingly imparting a general power of appointment. In turn, substantial legal malpractice claims may result since thoughtfully drafted powers of attorney usually can avoid these shortcomings. Thus, well drawn powers of attorney may start out as forms, so long as lawyers understand when to deviate from their models.

Lawrence A. Friedman, with offices in Bridgewater, NJ is Certified as an Elder Law Attorney by the A.B.A. accredited National Elder Law Foundation and holds an LL.M. in Taxation from New York University School of Law. He chaired the New Jersey State Bar Association Elder Law Section and frequently lectures and writes on elder, disabilities, and tax law. He has received the New Jersey State Bar Association’s Distinguished Legislative Service Award for authoring legislation to facilitate special needs trusts.