INCOME TAX EFFECTS OF PAYING FOR THE LONG-TERM CARE EXPENSES OF A DEPENDENT FAMILY MEMBER
Adult children or other family members who are contributing to the long-term care costs of an aged parent or other relative will want to take full advantage of all the income tax benefits for which they may be eligible as a result of such payments.
In sum, such taxpayers may be able to claim a dependency exemption for the parent or other relative. In addition, some or all of the payments for long-term care may be deductible as a medical expense; in the alternative, the expenses may entitle the taxpayer to use the dependent care tax credit. This article will discuss these points in detail.
■ CLAIMING A DEPENDENCY EXEMPTION FOR AN OLDER PERSON WHO IS BEING SUPPORTED
A taxpayer can claim a federal income tax exemption for a parent or other person whom the taxpayer is supporting if the following three tests are met:
Test #1. No Joint Return
The individual being supported cannot have filed a joint return with his or her spouse for the taxable year beginning in the calendar year in which the taxable year of the taxpayer begins.
Test #2. Income Limit
The individual being supported must have gross taxable income of less than the applicable exemption amount ($4,000 for 2015). “Gross income” is defined to mean all forms of money, property, and services that are not exempt from tax. Tax-exempt income, including the excluded portion of social security payments, is not counted for this purpose.
Test #3. Dependent of the Taxpayer
The individual being supported must be classified as the taxpayer’s “dependent” as defined in the Internal Revenue Code. The dependency test is based on the following three criteria:
RELATIONSHIP. The individual must either:
✔ Live with the taxpayer for the entire year as a member of the taxpayer’s household.
✔ If not living with the taxpayer, be the taxpayer’s “qualified relative.”
“Qualified relative” includes a parent, grandparent, or other direct ancestor, or a stepfather, stepmother, father-in-law, or mother-in-law. (A foster parent is not a “qualified relative.”) Any of these relationships that were established by marriage are not ended by death or divorce.
CITIZEN OR RESIDENT
The recipient must be a U.S. citizen or resident, or a resident of Canada or Mexico, for some part of the calendar year in which the taxpayer’s tax year begins.
Generally the taxpayer must provide more than one-half (1/2) of the individual’s total support during the calendar year. Countable support, whether provided by the individual or the taxpayer, includes:
✔ Food, shelter, clothing, medical care, and similar benefits;
✔ Benefits provided in-kind, such as the fair rental value of in-law quarters in the taxpayer’s home; and
✔ Social Security benefits, but not Medicare, Medicaid, or private health insurance reimbursements.
Once the the total amount spent for the individual’s support during the year has been determined, the taxpayer then calculates how much of that support he or she provided (or his or her spouse, if filing jointly).
If the taxpayer contributed more than 50% of the total, the individual qualifies as a dependent.
Multiple Support Agreements
The support test is not necessarily failed if the taxpayer contributes less than one-half of the individual’s total support, as long as:
✔ The taxpayer contributes at least 10% of the support,
✔ No single person contributes more than one-half of the support, and
✔ The taxpayer and the other contributors as a group provide more than one-half of the individual’s total support.
In that event the contributors may agree among themselves as to who among them will claim the personal exemption for a particular calendar year. Each other contributor who has contributed at least 10% of the support must sign a declaration renouncing his or her right to claim the exemption. This renunciation is usually made on IRS Form 2120 (Multiple Support Declaration).
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A taxpayer can deduct some or all of the expenses paid in connection with a parent or other relative’s “qualified long-term care services.”
Limitation on Amount of Deduction: New 10% Floor for Medical Expenses
Since long-term care expenses are generally treated as a form of medical expense, they will be deductible only to the extent that in any year the taxpayer’s total medical expenses (including eligible long-term care expenses) for all qualified persons exceed ten percent (10%) of the taxpayer’s adjusted gross income, and only if the taxpayer can itemize his or her deductions.
For taxpayers who are age 65 and older, the deduction threshold will remain at 7.5% through 2016.
In addition, the deduction is limited to only those expenses that are not reimbursed by insurance or otherwise.
Older Person Must Be a Dependent of the Taxpayer
For the qualified long-term care service expenses incurred on behalf of a parent or other relative to be eligible for the medical expense deduction, the individual must qualify as the taxpayer’s “dependent,” which is described in Test #3 in the preceding topic.
However, the medical expense deduction will be available even if the taxpayer cannot claim a dependency exemption for the individual due to one or both of the other tests not being met (for example, if the individual has more than $4,000, for 2015, of gross income).
Multiple Support Agreement
As discussed in the preceding topic, two or more eligible taxpayers who jointly support a qualified relative can agree on which one of them will be entitled to claim the relative as a dependent for such year and take the deduction for the medical expenses that he or she has individually paid for that year.
The others must furnish the taxpayer with a signed statement in which they waive their right to claim the relative as a dependent or take the deduction on their own tax returns.
By this method, they can take turns each year in claiming the relative as a dependent and deducting the medical expenses paid.
Definition of “Qualified Long-Term Care Services”
The Health Insurance Portability and Accountability Act of 1996 (“HIPAA,” also known as Kennedy-Kassebaum) enacted detailed rules covering the deductibility of long-term care expenses. Under HIPAA, the costs of providing “qualified long-term care services” for a “chronically ill individual” are deductible as a medical expense. Qualified expenses are deductible whether provided in a facility or in a private residence.
Qualified long-term care services means:
✔ Necessary diagnostic, preventative, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services which are required by a chronically ill individual, and
✔ Provided pursuant to a plan of care prescribed by a licensed health care practitioner.
Chronically ill individual
The dependent relative is “chronically ill” under the Internal Revenue Code if within the previous 12 months he or she has been certified by a licensed health care practitioner as:
✔ Being unable to perform (without substantial assistance from another individual) at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for a period of at least 90 days due to a loss of functional capacity,
✔ Having a level of disability similar to the level of disability described above, or
✔ Requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.
■ EXAMPLES OF LONG-TERM CARE EXPENSES
Nursing Home Expenses
A taxpayer can deduct as a medical expense the costs of medical care received by a dependent in a nursing home or home for the aged. This expense can include the cost of meals and lodging in the home if the main reason for the individual’s being there is to receive medical care.
However, if the reason for the individual being in the home is personal, the part of the cost allocable to medical or nursing care is deductible, but the cost of meals and lodging is not.
Capital Expenses Spent on Home
If the dependent is living with the taxpayer, a medical expense deduction is available for amounts paid for special equipment installed in the taxpayer’s home or for improvements made to the home, provided that their main purpose is medical care for the dependent.
The cost of permanent improvements that increase the value of the property may be partly included as a medical expense. The cost of the improvement is reduced by the increase in the value of the property. The difference is a medical expense.
If the value of the property is not increased by the improvement, the entire cost is included as a medical expense.
Fully Deductible Home Improvements
Certain improvements, if made to accommodate the taxpayer’s home to the disabled condition of the dependent individual who is living with the taxpayer, do not usually increase the value of the home, and thus their cost can be fully included as a medical expense. Examples of such home improvements include:
✔ Constructing entrance or exit ramps
✔ Widening doorways at entrances or exits
✔ Widening or otherwise modifying hallways and interior doorways
✔ Installing railings, support bars, or other modifications to bathrooms
✔ Installing porch lifts and other forms of lifts (but generally not elevators)
✔ Modifying stairways
✔ Modifying areas in front of entrance and exit doorways
✔ Grading the ground to provide access to the residence
Costs Must Be Reasonable
Only reasonable costs to accommodate a home to a disabled condition are considered medical care. Additional costs for personal motives, such as for architectural or aesthetic reasons, are not deductible.
Advance Payments for Lifetime-Care
The taxpayer can include in the medical expense deduction a portion of a life-care fee or founder’s fee the taxpayer pays either on a monthly basis or as a lump sum under an agreement with a retirement home. The deductible part is limited to the amount properly allocable to the dependent’s medical care.
The agreement must require the taxpayer to pay a specific fee as a condition for the home’s promise to provide lifetime care for the dependent that includes medical care.
Wages and other amounts paid to an attendant for nursing services provided to a dependent can also be included in the medical expense deduction. The attendant is not required to be a licensed nurse, as long as the services rendered are of a kind that a nurse would generally perform.
Services must relate to caring for the individual’s condition, such as giving medication or changing dressings, as well as bathing and grooming. Services can be provided in the home or at a care facility.
NOTE: No Deduction If Attendant Is Relative of Older Person
The deduction for nursing expenses is disallowed if the attendant is the dependent’s spouse, lineal descendant (e.g., a child or grandchild), brother, or sister, unless the attendant is a licensed professional with respect to the services being provided. See IRC §§ 213(d)(11) and 152(d)(2). Under the Code’s definition of “relative,” payments to a niece, nephew, or cousin of the dependent would be deductible.
Generally, only the amount spent for nursing services is a medical expense. If the attendant also provides personal and household services, these amounts must be divided between the time spent performing household and personal services and the time spent on nursing services.
Part of the amount paid for that attendant’s meals are also deductible. Additional amounts paid for household upkeep on account of the attendant can also be included as a medical expense.
The taxpayer can include as part of the medical expense deduction any social security tax, FUTA, Medicare tax, and state employment taxes the taxpayer pays for a nurse, attendant, or other person providing medical care to the dependent.
Premiums Paid on Long-Term Care Insurance Policies
The Internal Revenue Code includes in the definition of deductible medical expense the cost of “eligible long-term care premiums” paid under a “qualified long-term care insurance contract.”
While “eligible long-term care premiums” are now deductible, they cannot exceed the limitations determined for the applicable taxable year. For 2015, the limits are as follows:
Age of Taxpayer at Year-End 2016 Deductible Limit
40 or younger $390
More than 40 but not 50 $730
More than 50 but not 60 $1,460
More than 60 but not 70 $3,900
More than 70 $4,870
As an alternative to the medical expense deduction, a tax credit is available for qualified dependent care expenses paid on behalf of a parent or other relative, if the expenses are incurred to enable the taxpayer (or his or her spouse, if filing jointly) to be gainfully employed or in active search of gainful employment.
The taxpayer is given a choice between the credit and the medical expense deduction, so that any amount taken as a credit cannot also be counted towards the medical expense deduction.
Eligibility for Dependent Care Credit
To be eligible for the dependent care credit, the individual receiving care must:
✔ Reside in the taxpayer’s household,
✔ Be classified as the taxpayer’s “dependent” under the Internal Revenue Code, and
✔ Be physically or mentally incapable of self-care.
Definition of “Incapable of Self-Care”
The individual must be unable to care for his or her own hygiene or nutritional needs, or must need the full-time attention of another person for the individual’s safety or the safety of others. An individual who is physically handicapped or mentally defective, and for such reason requires constant attention of another person, is considered to be physically or mentally “incapable of self-care.”
Qualified expenses eligible for the credit include, if the care is provided in the home, the costs of a personal attendant and other household care allocable to the individual’s needs. If incurred for care provided outside the home, the expenses must be paid to an approved dependent care facility, excluding any costs of transport to the facility.
If services are provided by an outside facility, the credit is available only if the individual spends at least eight hours each day in the taxpayer’s home.
Amount of the Dependent Care Credit
For taxpayers paying $3,000 or more in qualified expenses, the maximum amount of the credit is $1,050 (or 35% of qualified expenses). However, the credit is reduced as adjusted gross income increases, so that for taxpayers with adjusted gross income of $43,000 or more, the credit will be limited to $600.00 (or 20% of qualified expenses).
PRACTICE TIP: Medical Expense Deduction Better Than the Credit
Because of these limitations on the amount of the credit, in most cases taxpayers who are eligible for the medical expense deduction will save more in tax by taking the expenses as a deduction rather than as a credit.