Medicaid and family loans: when a promissory note counts as a gift

A lot of family loans move money between generations: a parent lends a child the down payment on a house, or a grown child lends a parent money to cover bills. Nobody is thinking about nursing homes when the check is written. Years later, when the parent applies for Medicaid to cover long-term care, the loan can come back as a problem, because Medicaid treats some family loans as gifts.

The reason is the look-back period. Medicaid pays for nursing home care only after an applicant's countable assets are spent down, and to stop people from giving everything away first, it reviews every transfer the applicant made in the 60 months before applying. A transfer for less than fair value during that window, like a gift to a child, triggers a penalty period during which Medicaid won't pay for care. The penalty is the total uncompensated value of the transfers divided by the average monthly cost of private nursing home care in the state, so each chunk of money given away buys a set number of months without coverage.

A loan isn't a gift, in principle, because the lender gets a promise of repayment back. But families used to write loans that were never really going to be repaid: no payments for years, a balloon due long after the lender's life expectancy, or a clause forgiving the balance at death. Congress closed that door in 2006.

The three requirements

Under federal law, 42 U.S.C. 1396p, money used to purchase a promissory note, loan, or mortgage counts as an asset transfer unless the note meets all three of these conditions:

1. An actuarially sound repayment term. The note has to be scheduled to be fully repaid within the lender's life expectancy, measured using actuarial tables from the Social Security Administration's Office of the Chief Actuary.
2. Equal payments with no deferral and no balloon. Payments have to be made in equal amounts over the whole term. An interest-only stretch, a few skipped years, or a large final payment would each fail this test.
3. No cancellation at death. The note has to prohibit canceling the balance when the lender dies. Whatever is unpaid stays owed to the lender's estate.

A note that fails any one of them is valued at its full outstanding balance as of the date of the Medicaid application and treated as a transfer for less than fair value. That's the number that goes into the penalty calculation.

A typical installment note with level monthly payments already meets the second requirement. See how to build an amortization schedule. The third requirement conflicts with something families often want, which is forgiving a loan to a child in a will. A note that cancels at death fails, and so does one where the balance is quietly forgiven along the way; see forgiving a family loan.

Meeting the federal rules isn't the end of the analysis. States run their own Medicaid programs within these rules, and some treat a note that can be sold as a countable resource of the applicant, which can affect eligibility separately from the transfer penalty. The treatment of income from the note varies too. This is one of the few lending situations where the right move is to talk to an elder law attorney in your state before the note is signed, not after the application is filed.

There are also good records to keep no matter what. Make payments on schedule by check or bank transfer, never in cash, and keep a ledger that shows every payment. A note that meets the rules on paper but was never actually paid will look like a gift to a caseworker. See keeping a payment ledger.

For loans made long before any care is on the horizon, the same advice still applies: a written promissory note with real terms, payments that actually happen, and a clear record. It protects the family loan whether or not Medicaid ever comes up. See lending to family or friends and advances on an inheritance.

Sources

• 42 U.S.C. 1396p, Liens, adjustments and recoveries, and transfers of assets (Legal Information Institute)