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Tax Planning for Elderly Clients

With the percentage of the population over age 65 growing rapidly, tax practitioners need to be aware of the tax benefits available to elderly clients.

August 2008
by Ezra Huber/The Tax Adviser

The demographic profile of America is rapidly changing. There are currently more Americans over age 65 than under age 25. One person in eight is now over 65 years old. The figures for Americans even older are equally astonishing. In 1900, only 0.16 percent of the population was age 85 or older. Today that figure is 10-times higher — 1.7 percent. By 2020, the figure is expected to reach 2 percent; by 2050, 4.9 percent of the population will be 85 years or older.

As their number of elderly clients swells, tax practitioners will need to become familiar with the special issues that affect tax compliance and planning for the elderly. In many respects the income tax return of an elderly person is not very different from that of other tax filers. The differences may be slight: less earned income, more dividends and interest and fewer itemized deductions. But there are a few issues that the tax practitioner must know when dealing with an elderly client. This article looks at two areas of special concern: the deduction of medical expenses and tax benefits available to children who care for their parents.

Medical Deductions

All taxpayers may, of course, deduct as itemized deductions medical expenses actually paid (and not reimbursed by insurance or other sources) on their own behalf or on behalf of their spouses or dependents, to the extent that the expenses exceed 7.5 percent of the taxpayer's adjusted gross income (AGI). Although the calculation of the medical deduction for an elderly taxpayer is no different from that of other taxpayers, the benefit is usually greater because of higher medical expenses and lower annual income.

If a married couple files separate tax returns, each may deduct only the medical expenses he or she actually paid. The IRS considers payments made from a joint account as being made one-half by each spouse, with the burden of proof on the taxpayer to prove otherwise. A married couple should consider filing separate returns if one spouse has more income and the other spouse more medical expenses, than the other.

Example 1: H's income was $90,000 last year while his wife, W, earned only $10,000. However, W had $7,000 of medical bills. Considering that the couple may only deduct medical expenses over $7,500 (7.5 percent of AGI), W should consider filing a separate return. Because 7.5 percent of her income is $750, she would be able to deduct $6,250 of medical bills when otherwise the couple could not deduct any of the expenses.

Planning tip: In determining whether a married couple should file separate returns, remember that only one-half of the amount of bills paid from a joint account may be deducted on each return. If possible, recommend that the medical bills of a very ill spouse be paid from his or her own separate account.

Under some circumstances, a married couple may want to create a separate account for the ill spouse. As for the source of the money, remember that one spouse may make an unlimited tax-free gift of money or property to the other. There is no rule on how this gifted money may be spent or that it may not be spent on medical bills.

Note that rules in a community property state are slightly different. Medical expenses paid out of community property are divided equally in such a case. Medical bills paid from separate funds may be deducted by the spouse paying them.

A taxpayer may also deduct medical bills incurred by dependents. A three-part test determines whether a person is a dependent for purposes of the medical expense deduction:

  1. The person must meet the relationship test in Sec. 152(d)(2);
  2. The person must have been a U.S. citizen or resident or a resident of Mexico or Canada for part of the year; and
  3. The taxpayer must have provided over half of that person's total support for the calendar year.

A taxpayer may deduct the medical bills of a dependent even if that person cannot be claimed as an exemption on the taxpayer's return.

What Medical Expenses May Be Deducted

The list of items that a taxpayer may deduct is available from various sources, including the IRS. Generally, a taxpayer may deduct the costs of medical care, the costs of transportation to receive medical care, the premiums for health insurance policies, the cost of medication and other medical-related expenses. However, a few items that often arise in the case of an ill elderly client bear closer examination.

Household help: Many elderly persons require assistance at home. The cost of pure household chores is not deductible, however. This is so even if the patient's doctor recommends such assistance.

Deduction of capital home improvements: Tax preparation lore is full of stories of people deducting the cost of an indoor swimming pool because their doctor prescribes "hydro-therapy" for their aching backs. The Service frowns on such overreaching. In the case of the elderly, it is likely that questions about deductibility will arise with the installation of equipment that no one would want in their home but for their frailties.

The general rule with regard to the deductibility of capital expenditures is that an individual may deduct as a medical expense any capital expenditures for equipment installed in the home if its main purpose is medical care.

The costs of the following items have been permitted as deductions:

  • Elevating lifts (but not the installation of elevators);
  • Railings or support bars in the bathroom or elsewhere;
  • Modification of hallways and doorways to accommodate a wheelchair; and
  • Any other modification, such as lowering counters or moving electrical outlets.

In calculating the deductible portion of the capital expenditure, the cost of improvements is reduced by the increase in the value of the property.

Deduction for Nursing Homes and Home Nursing Services

At one point, practitioners were not in agreement about the deductibility of medical expenses for long-term care, whether the care was provided in the patient's home or in a nursing facility. Certain services, such as those provided by registered nurses or licensed practical nurses, were clearly deductible whether provided in a nursing home or at home. Less certain were those services, particularly nursing home services, that were custodial in nature. Custodial services are those that assist the patient with what are known as the activities of daily living, such as feeding, dressing, toilet rituals, moving about or bathing. Custodial services are normally provided by a personal care attendant (PCA) either in a private home or in a custodial care nursing facility.

The Health Insurance Portability and Accountability Act of 1996, P.L. 104-191 (HIPAA) established rules governing the deductibility of the costs of long-term care. Most of these rules were effective beginning in 1997. HIPAA established that long-term care (LTC) insurance premiums are deductible as medical expenses and that the receipt of insurance proceeds from an LTC policy is excludible from gross income.
 
HIPAA also amended the Code to make clear that the costs of long-term care for a "chronically ill individual" are deductible as medical expenses if they are provided pursuant to a plan of care prescribed by a licensed health care practitioner. Deductible expenses include those necessary for diagnostic, preventive, therapeutic, treating, mitigating, rehabilitative and maintenance or personal care services.

Deductibility of Long-Term Care Insurance

Before HIPAA, there was great uncertainty about the tax deductibility of LTC (i.e., nursing home) insurance premiums. It was unclear whether insurance for nursing homes could be deducted if the benefits ultimately paid out were nondeductible medical expenses (as, for instance, the payment of a fixed daily amount when the patient was in a nursing home, without distinguishing whether these amounts were for the medical or the room and board components of the stay).

HIPAA contains detailed provisions on the tax treatment of both LTC insurance and benefits received. The tax practitioner should be familiar with the following provisions:

  • Premiums for LTC insurance are deductible as a medical expense and are treated as premium payments for the purchase of insurance;
  • Benefits are excluded from gross income;
  • Both the premium deductibility limitation and the benefit exclusion limitation are adjusted for inflation; and
  • There are limits to the deductibility of premiums and exclusion of benefits as income.

Deductibility is based on the insured's age. See Exhibit 1 for the applicable rules.

Conclusion

As the number of elderly Americans continues to grow, the tax benefits described in this article will become available to more and more taxpayers. Although some taxpayers will be aware of the full extent of these benefits, most will not. All CPAs who provide tax advice to individuals must be well versed in the rules for these benefits and that they actively consider whether the rules will apply to their clients.

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Ezra Huber, J.D., Ezra Huber & Associates, P.C., Mineola, NY, is a contributing writer for The Tax Adviser. His views as expressed in this article do not necessarily reflect the views of the AICPA, The Tax Adviser or the Wealth Management Insider.

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