Over the years, LWP has become known for its MIT, FIT and KIT trusts for asset protection and long-term care benefits planning, but few understand the KIT and its flexibility. Let's do a quick review…
A MIT Trust, or “My Income Trust,” is an income-only irrevocable IPUG asset-protection trust that allows the client to maintain control of assets, benefit from them to the extent they're willing to put them at risk, and modify or change the trust in all regards at any time other than in regards to the protection of which they seek.
The FIT Trust, or “Family Irrevocable Trust,” is an irrevocable IPUG asset-protection trust that allows the client to be in control of the assets, manage them and identify who gets distributions from it and when, but the client does not retain any rights to the income or principal.
Finally, the KIT Trust, or “Kids Irrevocable Trust,” is created by the children of the benefit of the MIT or FIT client where assets have already been conveyed to the children prior to being educated as to the benefits that the MIT or FIT could provide for the client's assets. The typical use of the most difficult form of KIT Trust is when mom and dad transfer the family farm (or other major assets) to avoid losing them to the nursing home. The KIT Trust is a strategy to protect assets that have already been conveyed to the kids (or others) before the client got to you.
How do KIT Trusts work?
A transfer of assets by individuals to their children may protect the assets from their long-term care costs and other risks, but it puts them squarely at risk from the creditors and predators of the children to whom they were transferred. For example, if one of the children that the farm was transferred to gets divorced, sued or dies, that child's ownership interest is no longer subject to the client’s influence, but rather is subject to the child's estate plan, or worse, lack of an estate plan.
That's why the KIT Trust is a great tool to use when assets have already been conveyed to the children. A properly designed KIT Trust will be created by the children as co‑grantors, and it will be an irrevocable IPUG asset protection trust, which allows the children to be a sole trustee or co‑trustee with their parents in the management of assets transferred to the trust.
Once it is created and the assets are transferred to it (typically the assets the children received from their parents), the assets are protected from the children's creditors and predators. In fact, as a third-party trust, it is not even countable in mom and dad's Medicaid eligibility calculation if they were named beneficiary of the trust. The question is how to properly create a KIT irrevocable trust.
The key point when creating a KIT Trust is understanding that the children become the client in the context of the trust creation. The KIT Trust is a grantor trust, but to the children. Therefore, all income generated by the trust, regardless of whom it’s distributed to, will be passed to the children who created it, so ensuring a proper investment strategy that works well with the children's tax planning is essential.
Another key element with a KIT Trust is identifying the beneficiaries. Can you make mom and dad the income or principal beneficiary of the KIT Trust? Well, the answer is yes, but it's up to each attorney and their comfort level. I have successfully named parents beneficiaries of the income and principal of a KIT Trust for years without it becoming an available resource when determining their Medicaid eligibility.
The key distinction is the fact that it is a “third-party trust,” not a trust created by the parent as Medicaid applicants, but rather, by a third party, their children. Many raise the issue of it being funded with assets that were the parents', but that is not a fact at issue, as the children are not applying for Medicaid and the assets of the irrevocable trust are not subject to the look-back period related to parent eligibility.
Again, although it is permissible, some attorneys are not comfortable naming the parents principal beneficiary. In reality, it may not be necessary to name the parents as principal beneficiary, since it was evident by the giving up of the asset to the kids that they no longer needed to have access to them. A more conservative approach is to allow them access to income only, but it is in no way reckless to permit access to principal.
The final question in creating a KIT Trust is what to do when mom and dad die. Since the trust is created by the children (siblings), there can be an inherent gift upon the funding of the trust if the children transfer the asset from the parents to the KIT Trust, depending on how it’s created. Presumably, upon mom and dad’s death, the kids get back their share of the remaining assets, but a complete gift will occur during the parent’s lifetime whenever a distribution is made from the trust. In addition, even if the children receive equal shares upon the death of mom and dad, under tax law it is not presumed that the share they receive was the share they put in.
So, by creating a KIT Trust, if it is not properly designed, there could be inherent gift tax issues between the children upon the funding of the trust and upon the termination of the lifetime trust after the death of the parent. One way to alleviate this concern is to set up separate shares and ensure that all distributions to any beneficiary are made equally from each separate share, and at the termination of the lifetime trust, each child gets their separate share balance back. This should mitigate any risk of gift tax issues and offer the opportunity to convert the KIT Trust to a separate MIT Trust or FIT Trust for each of the children's separate shares upon the death of the parent. It all requires a clear knowledge of the subject and a software system to keep your practice aware of the key issues.
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David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center
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