A promissory note is normally given in return for a loan and it is simply a promise to repay the amount. Classifying asset transfers as loans rather than gifts can be useful because it sometimes allows parents to "lend" assets to their children and still maintain Medicaid eligibility.
Before Congress enacted the Deficit Reduction Act (DRA) in 2006, a Medicaid applicant could show that a transaction was a loan to another person rather than gift by presenting promissory notes, loans, or mortgages at the time of the Medicaid application. The loan would not be counted among the applicant's assets, unlike a gift. Congress considered this to be an abusive planning strategy, so the DRA imposed restrictions on the use of promissory notes, loans, and mortgages.
In order for a loan to not be treated as a transfer for less than fair market value (and therefore not to interfere with Medicaid eligibility) it must satisfy three standards: (1) the term of the loan must not last longer than the anticipated life of the lender, (2) payments must be made in equal amounts during the term of the loan with no deferral of payments and no balloon payments, (3) and the debt cannot be cancelled at the death of the lender. If these three standards are not met, the outstanding balance on the promissory note, loan, or mortgage will be considered a transfer and used to assess a Medicaid penalty period.
It's good practice when lending money to use a promissory note, whether or not the loan is related to Medicaid. To learn more about using promissory notes in Medicaid planning, contact your elder law attorney.