How Are Taxes Filed if One Spouse is on Medicaid and the Other Spouse Has an Irrevocable Trust? And Does Getting Social Security Change How Taxes Get Filed?

Q. Thank you again for working with our family last year to protect our parents’ assets, get our father approved for nursing home Medicaid, and set up an irrevocable Living Trust Plus for our mother. Now that it’s tax time, we have numerous questions. I’m helping my mother this year for the first time given all the changes that have occurred and given that my father used to assist with tax filing, and I’m not sure if this is something we can do on our own or whether we need a CPA

A1. How to file taxes when one spouse is receiving Medicaid

Medicaid long-term care coverage is effectively the nation’s public long-term care insurance program for seniors to help pay for the catastrophically high costs of long-term care. The program is the principal source of long-term care coverage for people in the United States, covering five in eight nursing home residents.

According to James M. Jaxtheimer, CPA, Senior Tax Attorney, who is Of Counsel to the Farr Law Firm, “Medicaid qualification alone does not change the filing status of a married couple; they may continue to file as ‘married filing jointly.‘ But this isn’t always the best course of action, and each case must be independently evaluated.

The income that is paid toward long-term care to the facility is of course reportable as income but can be deducted as an unreimbursed medical expense to the extent that the total unreimbursed medical expenses exceed 7.5 percent of adjusted gross income (AGI).

Jaxtheimer continues by pointing out that “large unreimbursed medical expenses for the institutionalized spouse may, in some cases, serve as a reason to file as ‘married filing separately.‘ If the community spouse has significant income, some or all of the tax deduction for unreimbursed medical expenses of the institutionalized spouse may be lost due to the 7.5 percent of AGI threshold for the medical deduction. So, if the institutionalized spouse has less income, it could be beneficial to file as married filing separately. This decision requires careful analysis to determine the net tax benefit of filing jointly versus filing separately. Most professional tax preparation software, including mine, will automatically calculate the tax liability as married filing jointly and married filing separately in order to make the greatest use of the medical expense deduction.”

A2. Are Medicaid benefits subject to income tax?

The Medicaid benefit, after the institutionalized spouse pays his or her required income, is neither income nor a deductible medical expense. Despite the fact that Medicaid is paying a huge amount to the nursing home each month on your father’s behalf, this is not taxable income to your father or to your mother.

A3. How do taxes work on the assets in an irrevocable Living Trust Plus?

Most of our Living Trust Plus asset protection trusts (except the version using two trusts for Military Veterans) are grantor trusts as to the settlor of the trust, meaning that all income, deductions, and credits, are reported on the settlor’s 1040 income tax return along with a grantor trust statement, which is also attached to a very simple 1041 with a stamp on it explaining that the Living Trust Plus is a grantor trust.

Here is a sample fillable 1041 for tax year 2023 with a stamp on it explaining that the Living Trust Plus is a grantor trust. Here is a sample grantor trust statement/letter that you may download and use. If you would prefer to have our firm prepare these documents for you, please call the office as soon as possible to schedule a time to meet with Jim Jaxtheimer. For a more complete article about taxes and the Living Trust Plus, click here.

A4. Does receiving Social Security change how you file taxes?

None of your mother’s Social Security income has to go to the nursing home or to Medicaid. Although Medicaid looks at all assets of married couples during the application process, Medicaid does not consider the income of the community spouse.

About 40 percent of people who receive Social Security must pay federal income taxes on their Social Security benefits. This usually happens if you have other substantial income in addition to your Social Security benefits. Substantial income can include wages, earnings from self-employment, interest, dividends, and other taxable income that must be reported on your tax return.

You pay tax on your Social Security benefits based on Internal Revenue Service (IRS) rules under the following circumstances:

• If you file a federal tax return as an “individual” and your income is:
  • Between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your Social Security benefits.
  • More than $34,000, you may have to pay income tax on up to 85 percent of your Social Security benefits.
• If you file a joint return, and you and your spouse have combined income that is:
  • Between $32,000 and $44,000, you may have to pay income tax on up to 50% of your Social Security benefits.
  • More than $44,000, you may have to pay income tax on up to 85% of your Social Security benefits.
• If you are married and file a separate tax return, you probably will have to pay taxes on your Social Security benefits.
• If you do have to pay taxes on your Social Security benefits, you can choose to have federal taxes withheld from your benefits to avoid or reduce owing tax in the future.

Refer to your Social Security Benefit Statement (Form SSA-1099 or SSA-1042S) that was mailed by the Social Security Administration showing the amount of benefits you received in the previous year. You can use this Benefit Statement when you complete your federal income tax return to find out if your benefits are subject to income tax. If you misplaced or didn’t receive a Form SSA-1099 or SSA-1042S for the previous tax year, you can request the forms by setting up an account or logging in at www.ssa.gov/myaccount.  

If Social Security is your only income and you’d like more information on filing taxes, please read my article, Do You Need to Pay Taxes if You Are Only Collecting Social Security?

Contact Farr Law Firm for Help Filing Taxes

For assistance with filing taxes, consider hiring a tax preparer, such as the professionals at the Farr Law Firm. Jim Jaxtheimer, Of Counsel to the Farr Law Firm, has been a Certified Public Accountant since 1994 and a tax attorney since 2004, and is licensed to practice law in Virginia, Maryland, and the District of Columbia. Given the annual crunch during tax time, please call the office to schedule your appointment with Jim as soon as possible, before time slots are filled.

Planning for Long-Term Care

If have a loved one who may need long-term care in the not-so-distant future, Medicaid Asset Protection Planning can be started while your loved one is still able to make legal and financial decisions or can be initiated by an adult child acting as agent under a well-drafted Power of Attorney, even if your loved one is already in a nursing home or receiving some other type of long-term care. To plan for long-term care, please call us to make an appointment for an initial consultation:

Elder Care Rockville: 301-519-8041
Elder Care Fairfax: 703-691-1888
Elder Care Fredericksburg: 540-479-1435
Elder Care DC: 202-587-2797