The 2009 tax filing season for tax professionals was both challenging and rewording. An issue that appears to be seen with increasing familiarity is Medical Deductions for
Seniors.
The considerations go beyond the normal Itemized Deductions, the alternative to the Standard Deduction, for medical which are traditionally the cost of out of pocket prescription drugs, medical insurance, including long-term care and medical bills such as doctors, dentists, clinics, etc.
All of medical remains subject to the 7.5% exclusion from income. Example: Single
taxpayer with $10,000 in medical expense has $100,000 in adjusted gross income. The
first $7,500 (7.5% of adjusted gross income) is non-deductible and only $2,500 is
deductible on Schedule A – Itemized Deductions, provided the taxpayer has sufficient
deductions to exceed the Standard Deduction.
Many Seniors are entering into Continuing Care Retirement Communities, CCRCs.
These communities provide four type of care:
1. Independent living;
2. Assisted living;
3. Alzheimer’s care; and
4. Skilled nursing care.
Typically, residents of the CCRCs must be at least age sixty-two years when becoming a resident. However, the average age of entry to a CCRC is seventy-five and the average age of CCRC residents is eighty-four.
In fee-for-service CCRC facilities there is an entry fee plus a monthly fee or a Class A
CCRC.
In some cases the CCRC has a feature where a portion of the entrance fee is refundable, without interest, if the resident leaves the CCRC and to the estate if the residence dies while residing at the CCRC.
Other entrance fees see the refund of a portion of the fee going back to the resident when they leave the facility.
It is a challenge to the tax professional community that works with Seniors to determine how much of the entrance fee to a CCRC is deductible as a medical expense in the year paid.
It is a two-step process.
It must first be determined how much of the entrance fee is a cost and second, it must be determined what proportion of the cost is deductible.
If any of the entrance fee is refundable, the IRS considers this an interest free loan and
not a deductible medical expense.
If the entrance fee is partially refundable when the resident leaves, the entire entrance fee is deductible and upon return is taxable to the resident or to the resident’s estate.
In the case of the CCRC assisted living a percentage method of calculation for medical
cost is used. After carefully analyzing the costs incurred a percentage of the costs for
medical care gives a percentage of the cost of entrance and monthly fee costs that are
eligible for medical deductions.
In the case of Alzheimer and skilled nursing care, the entire amount is deductible as a
medical expense.
An example of the percentage method:
Mr. and Mrs. Whitlock are new residents of an independent living residence at
Whispering Oaks CCRC. The entrance fee is $500,000 and 90% is refundable to the
Whitlock’s should they leave or refundable to their estate should they die while residing
at Whispering Oaks.
In addition to the entry fee, there is a monthly fee of $5,000 – $4,000 of which is for the
first resident, Mr. Whitlock, and $1,000 for the second resident, Mrs. Whitlock.
They take all their tax information to their tax professional to have their taxes prepared.
They believe they will have a huge medical deduction this year.
The tax professional must look to the accounting records of Whispering Oaks CCRC to
see what is deductible to the Whitlocks.
In 2008, Whispering Oaks had total expenses of $10million of which $5Million was the
total medical expenses for all residents.
The allocation is calculated as follows –
Medical Expenses divided by Total Expenses equals applicable percentage.
$5Million divided by $10Million = 0.50%
There were 200 residents living in independent living at Whispering Oaks in 2008 with
$5.5Million in collected fees..
First, their entrance fee – $500,000 X 10%, the non-refundable portion, is $50,000.
Deductible medical costs from the entrance fee ($50,000 X .50) is $25,000.
Second, the total medical expense allocated is $5.5Million X 0.50 = $1.10Million.
Cost per resident is calculated at $1.10Million divided by 200 residents = $5,500.
Deductible medical costs for 2008 are $5,500 X 2 (individuals) = $11,000
Total medical expense ($25,000 + $11,000) is $36,000.
There is an additional method to calculate the deductible medical cost, however it is quite complex and often does not result in a more favorable outcome.
In Delbert and Margaret Baker v. Commissioner No 448-02 USTC 2004, February
9,2004 Tax Court found that taxpayers are free to choose the method that benefits them. With more and more Seniors moving to CCRCs, the tax problems will magnify for tax professionals.
While the issue of whether medical expense is deductible is overridden with the fact that
most medical is not deductible due to the exclusion of 7.5% of adjusted gross income.
In the case of the Whitlock’s, their deductible medical paid to Whispering Oaks was
$36,000, however with an adjusted gross income of $250,0000 the 7.5% made $18,750
ineligible for deduction, leaving only $17,250 available for deduction.
In future years, without the entrance fee, and no other medical costs paid, it is highly
doubtful that the Whitlock’s will be able to deduct any medical expense paid to
Whispering Oaks.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.
480-895-0611