Welcome to CPA at Law, helping individuals and small businesses plan for the future and keep what they have.

This is the personal blog of Sterling Olander, a Certified Public Accountant and Utah-licensed attorney. For over thirteen years, I have assisted clients with estate planning and administration, tax mitigation, tax controversies, small business planning, asset protection, and nonprofit law.

I write about any legal, tax, or technological information that I find interesting or useful in serving my clients. All ideas expressed herein are my own and don't constitute legal or tax advice.

Medicaid Eligibility for a Married Individual

Medicare is a federal entitlement program available to seniors regardless of need and works like health insurance. In contrast, Medicaid is a health benefit program for low-income individuals. "Medicaid planning," normally refers to qualifying for long-term care benefits under Medicaid. Long-term care costs thousands of dollars per month and coverage is not available under Medicare and most health insurance plans. This post will focus on Medicaid qualification in Utah for a married individual.

In order to be eligible for Medicaid, an applicant cannot have more than $2,000 in assets. However, some assets do not count toward this limit; moreover, some "countable" assets can be converted to "non-countable" assets. First, an in-state residence is not a countable asset unless the applicant does not intend to return home and no spouse or dependent lives there. The cash value of a life insurance policy up to $1,500 is exempt, as is up to $1,500 that is specifically designated as a funeral fund. Irrevocable prepaid funeral plans, cemetery plots, and household items are also exempt. It is generally permissible to purchase these items or pay down a mortgage or other debts in order to reduce countable assets and qualify for Medicaid. However, the applicant cannot have more than $525,000 of equity in a residence.

In addition, spouses of applicants who live at home can keep some assets. A Medicaid worker will value all of a couple's countable assets and divide by two. The spouse can keep half, with a minimum of around $23,000 and a maximum of around $114,000 (which changes each year). The applicant is still limited to $2,000 of assets, meaning that if the couple has more than $25,000 in total non-exempt assets, the excess attributable to the applicant spouse must be spent down before they will qualify for Medicaid. In addition, the non-applicant spouse can keep some of the income of the applicant spouse once the applicant spouse is in a nursing home.

Certain transfers of assets do not affect Medicaid eligibility, such as transfers to a spouse or certain transfers to disabled individuals. However, nearly all other transfers made within five years prior to applying for Medicaid are of no benefit for eligibility purposes because applicants must report all such transfers made for less than fair market value. Making transfers of non-exempt assets within this timeframe will be detrimental due to the Medicaid sanction rules.

It is critical that an individual consults with a Medicaid expert before applying in order to avoid making transfers that will result in sanctions or spending assets they would have been allowed to keep. Proper planning will allow a spouse remaining at home to be more financially secure.

The state will seek to recover funds paid by Medicaid from the estate of a recipient after the death of the recipient and the surviving spouse, so long as there is no minor or disabled child. Even though an asset may have been exempt for Medicaid qualification purposes, it will not be exempt from estate recovery. For more information, including the sources for this post, see the pamphlets provided by the Utah Department of Health entitled “Estate Recovery Information Bulletin”, DWS 05-994, "Nursing Home Information, May we be of service to you?” DWS 05- 969, and “Assessment of Assets” DWS 05-992.

Captive Insurance Companies

Insurance does two things: First, it shifts a risk from an insured to the insurance company. Second, it distributes the risk taken on by the insurance company among a pool of like risks with a predictable number of risks that will materialize. In other words, from the insured’s perspective, insurance shifts risks; and from the insurer’s perspective, insurance distributes risk.

This is the view of insurance from a tax perspective and helps explain why historically, the IRS challenged "captive" insurance companies, or insurance companies owned by the insured. The IRS argued that true risk shifting and distribution could never occur within the same "economic family" and that as such, deductible premiums by the insured were really non-deductible contributions to a reserve fund.

Beginning with the case of Humana v. Commissioner, 88 T.C. 197 (1987), which was discussed at length in the recent case of Rent-A-Center, Inc. v. Commissioner, 142 T.C. No. 1 (2014), the IRS started consistently losing this argument. Eventually, in Rev. Rul. 77-316, the IRS announced that it would no longer rely on its economic family argument. Currently, there are a few safe harbors that taxpayers can rely upon to obtain the expected tax treatment of their captive insurance companies and payments made thereto. However, as Rent-A-Center makes clear, the IRS can still litigate based on facts and circumstances of individual scenarios.

Rev. Rul. 2002–89 and Rev. Rul. 2002-90 stand for the following two safe harbors: If a captive insurance company either (1) receives at least 50% of its income from a non-parent or (2) provides insurance for at least twelve subsidiaries, with no subsidiary accounting for less than 5% or more than 15% of the total risk underwritten, the IRS will normally concede that adequate risk shifting and distribution has occurred and not challenge the captive arrangement. 11 Mertens Law of Fed. Income Tax'n § 44:24.

Firms who market and help clients establish captive insurance companies can help clients pool with third parties in order to meet these requirements. The viability of this strategy assumes that the captive is operated as a bona fide insurance company in every respect.

While captive insurance companies provide clear asset protection benefits, the tax benefits are substantial as well. If the captive qualifies and elects to be taxed as a "small company" under section 831(b) of the Internal Revenue Code, it will be taxed only on taxable investment income, not underwriting income. A captive insurance company can receive up to $1.2 million in annual premiums and still qualify under section 831(b). Effectively, this means that by establishing a captive insurance company, a taxpayer can reduce taxable income by deducting premiums of $1.2 million, while recognizing no taxable income to the captive. Assuming a good claims history, the premiums accumulate tax-deferred and are available to be withdrawn later as dividends or long term capital gains.

The IRS Audit and Appeals Process

After taxpayers file their tax returns, the IRS computer system analyzes the returns to verify that income, deduction, gain, and loss amounts reported to the IRS by third parties are properly reported on the taxpayers' returns. The system also gives each return a numeric score based on certain factors that the IRS has identified as indicative of error. Returns that have a high probability of error are screened by IRS personnel and in this manner, selected for audit. The first step in an audit is a letter from the IRS to the taxpayer providing notification that the return has been selected.

Examinations can be conducted through the mail or face-to-face. A taxpayer can represent themselves, but it is wise to have a good CPA or tax attorney assist. Hiring a reputable professional to assist with tax return filing and significant transactions in the first place can often prevent the kinds of problems that trigger IRS scrutiny of a tax return in the first place.

At the end of the audit, the IRS will provide the taxpayer a written explanation of any proposed changes to the tax return. If the audit results in a lower assessed tax (which is possible), the taxpayer will get a refund. If not, and the IRS takes the position that additional tax is owed, the taxpayer has a choice: Pay the additional tax, or contest the proposed changes.

If the audit meeting takes place at an IRS office, the taxpayer can immediately request a meeting with the examiner's supervisor. If the meeting takes place elsewhere or no agreement with the supervisor can be reached, the examiner will forward the case for processing. The IRS will prepare an examination report detailing the proposed adjustments as well as a "30 day letter."

The 30 day letter will inform the taxpayer of their right to an appeal from within the IRS to an independently-operated IRS Appeals office. A written request must be filed with the IRS office indicated in the letter in order to have the matter brought before the IRS appeals officer. Many matters can be settled with an IRS appeals officer, although the taxpayer can take the matter to court without IRS appeals.

If the taxpayer does not respond to the 30-day letter or an agreement cannot be reached, the IRS will send a Notice of Deficiency, or 90 day letter. The Notice of Deficiency gives the taxpayer 90 days to file a petition with the U.S. Tax Court. If no petition is filed, the IRS assesses the proposed tax and bills the taxpayer for the deficiency. Alternatively, the taxpayer can pay the disputed tax in full and file a claim for refund with the IRS. If the refund is denied, the taxpayer can file suit for refund in a Federal District Court or the Court of Federal Claims.

Throughout this process, there are a number of resources and options available, such as Taxpayer Advocate Service, Offers in Compromise, installment agreements, Alternative Dispute Resolution, etc. After the taxpayer's protest options have been exhausted, and if they are unable to pay, the collections process will commence. That will be the topic of a future post.