MEDICAL DEDUCTIONS ARE REDUCED by 10 percent of your AGI (or 7.5 percent if you are still under age 65 through December 31, 2016). That makes it pretty hard to generate enough medical expenses to make it worthwhile to even add them up. In fact, as a rule of thumb, for an average household with two jobs earning about $40,000 combined, if unreimbursed medical costs are $4,000 or less, I don’t put them through the exercise of gathering the bills. Yet people use medical expense deductions. When and how?
Tip #117:
You can only include in medical expenses those amounts that were actually paid during the taxable year, for which taxpayer received no insurance or other reimbursement during the year. Some common examples of such expenses include:
Goodness, it does add up, doesn’t it? This is just a small list. IRS Publication 502 has a much longer list (https://www.irs.gov/publications/p502). It includes things that might surprise you.
Deducting costs for a dependent who isn’t a dependent. Sometimes, due to divorce, custody issues, separations or other sad reasons, your child is filing his or her own tax return and you are not entitled to claim your child as a dependent. Despite that, if you pay their medical expenses, you can include medical expenses as deductions on your tax return. You can include medical expenses you paid for an individual that would have been your dependent except for the following:
What constitutes a dependent for medical deductions if they are a dependent? Both of the following requirements must be met:
Tip #119:
Speaking of parking fees and tolls. I’ll bet you don’t have your parking receipts from your doctor or hospital visits. I certainly don’t. But what I do have is my appointment calendar showing which doctor, hospital, lab, and so on that I visited on which days. If you have even one parking receipt from each location (get them now if you don’t have any), then save that. Multiply the usual cost by the number of visits to each facility. Lay it all out nicely and neatly on a spreadsheet or document file. Add it all up and put this into your tax folder each year. Fortunately, while I was going to chemo and radiation, my hospital had a special parking area with an attendant (José took good care of us) reserved for cancer patients. The radiology lab validated for parking, but I paid for parking for all the assortment of doctor’s visits in most other locations. Even so, I didn’t have enough fees to make it worthwhile. But you might.
Tip #120:
In-home nursing care is expensive. Deduct the cost of wages and other amounts paid for nursing services. The services don’t need to be performed by a nurse as long as the services are of a kind generally performed by a nurse. This includes caring for the patient’s condition, giving medication or changing dressings, as well as bathing and grooming the patient. The services can be provided in your home or another care facility. Generally, only the amount spent for nursing services is a medical expense. If the attendant also provides personal and household services, amounts paid to the attendant must be split between the time spent performing household and personal services and the time spent for nursing services. For instance, someone works for eight hours a day. They spend two hours in the morning bathing your mother, changing bandages, providing medication, making sure she’s eating properly, and clearing away the evening’s detritus. The next two hours are spent preparing lunch and tidying up the house. The following two hours are spent taking Mom shopping or to visit friends. The last two hours of the day are devoted to cleaning Mom, providing medications, serving dinner, and getting her ready for bed—even if she does stay up reading or watching television after the attendant leaves. Essentially, the care provider devoted half her time to medically relevant activities. So 50 percent of her entire compensation and payroll taxes count as a medical expense.
Overlooked in-home nursing medical costs. Did you know that the cost of caregiver’s meals can be used as medical expenses? Yup. There’s more! If you had to pay additional amounts for household upkeep because of the attendant, you can include the extra amounts with your medical expenses. This includes extra rent or utilities you pay because you moved to a larger apartment to provide space for the attendant.
Tip #122:
In-home care means payroll or an agency. If you are paying someone directly, you probably have to put the caregiver(s) on payroll. They are considered household employees if you pay any individual $1,900 or more in 2015 or $2,000 in 2016. You will have to register with the IRS and state as an employer and issue W-2s to all the household workers each year. For the IRS, you report the wages and the taxes withheld on Schedule H, which is included in your tax return (https://www.irs.gov/pub/irs-pdf/f1040sh.pdf). However, your state may require regular quarterly payroll tax returns and deposits. The truth is payroll reporting is as detailed, complicated, and time consuming for one employee as it is for 25–50 employees. If just reading this makes you want to tear your hair out, turn this task over to a payroll service or your tax professional. True, it will cost you about $75–$125 per quarter, but it’s worth it to take the pressure off. (Search for “nanny tax.”)
The other option is to hire the attendant through an agency. The agency will put them on their payroll and take care of all the taxes, reports, and so on. Make sure they have a payroll. If not, use a different agency. But using an agency typically means paying at least 25 to 30 percent for their costs and profits. Suppose this person will cost you an extra $25 per day. That could mean as much as $700 extra per month (25 × 365 divided by 12) when your mom or child needs daily care. Frankly, paying $125 per quarter for a payroll service is much cheaper than paying $2,100 extra per quarter to an agency.
Oh yes, if you are using the Schedule H route, remember to increase your federal withholding at work, or raise your quarterly estimated tax payments to cover the additional Social Security, Medicare, and Unemployment taxes that will be due with your ultimate tax return.
Tip #123:
The “Home!” Yup, sometimes you just have no choice. You have to send your loved one to a nursing or convalescent home or facility. It could be due to extreme age, dementia, or to get rehabilitation after an accident or physical event. In this case, practically all the costs are deductible as medical expenses.
Unless! My mother is in her nineties. She called us all a few years back and asked to be moved to the “home.” We thought her residence expenses would be fully deductible—until I read this: “If an individual is able to perform at least two activities of daily living, the rental costs are not deductible. Activities of daily living are eating, toileting, transferring, bathing, dressing, medication management and continence” (https://www.irs.gov/publications/p502/ar02.html#en_US_2014_publink1000178974).
Uh, Mother can do all those things herself. There goes a whopping deduction! Oh well.
On the other hand, if someone is unable to perform at least two activities of daily living without substantial assistance from another individual, or requires substantial supervision to be protected from severe cognitive impairment (a.k.a. Alzheimer’s), then qualified long-term care services will be necessary and deductible.
Even if your loved ones can take care of themselves, if they are getting for medical or nursing care, those costs are deductible. In my mother’s case, the campus has all kinds of doctors. She is constantly being poked and prodded and tested, right on the premises, for a variety of age and pain-related issues. If your loved ones are in a similar situation, you might want to try to get paperwork to define what part of their rent is for the medical care. Whose medical expenses may you deduct? Yours, your spouse’s, and your dependents’. This includes the cost of meals and lodging in the home if a principal reason for being there is to get medical care.
Tip #124:
Medical travel. Let’s look at the basics. Medical travel includes the costs for the patient and a (one) companion/caregiver—up to $50 per night each (no deduction for meals). Medical travel for treatment outside of the country is deductible. Remember to pick up the cost of medical miles if you’re driving and the cost of airfare, shuttles, cabs, and so on if you are not driving.
Tip #125:
Medical travel bonus. Did you know that medical travel outside the country is deductible? Yes it is. That means the airfare to some exotic locale with lodging limited to $50 per night each for the patient and companion. The treatment may require the patient to stay in that country for several weeks until the full set of procedures are complete. The lodging for all those days is allowable if it is impractical to travel back and forth for the treatment. For instance, sometimes you need to get a series of operations or procedures (like dental implants, medical lap-banding, medical cosmetic surgery, or burn treatments). After each procedure, it’s necessary to wait a few days before the next step can be taken safely. In some cases, the treatment, travel, and living expenses are still cheaper than it would cost here in the United States. Speaking of dental work, my friend and I priced the cost of her dental needs here and in India. The costs were so much lower in India. Even after adding in the cost of the airfare, lodging, and meals while waiting for the entire series of operations to be completed, the overall cost was still lower than the US cost at a local dental surgeon’s and facility. The bonus? She got to visit with her family and friends for a month while deducting the whole trip as a medical expense. Naturally, if the main purpose of the trip is a vacation without any real medical validity . . . no deduction. So before hitting the international medical circuit, get a valid prescription or course of treatment, in writing, from a legitimate, licensed US medical practitioner.
Incidentally, some medical facilities around the world are aware of this tax trick. They will make it easy for you to comply with US laws. Since their costs are so much lower, the foreign medical facilities attract patients by providing a full-service facility—medical services, lodging, and meals all rolled into the price. After all, patients need to remain under medical supervision until the physicians are sure everything is properly completed. Do your research. You may be surprised at the high level of competence you find. But beware—there are also charlatans who can do you great harm.
Tip #126:
Not quite a dependent, but almost? These days, we often find ourselves in that sandwich generation—squeezed between helping to support our children and our parents, who are living longer than ever before. In order to claim someone as a dependent, we need to be paying more than half their support. But costs are so high that it might require several people to chip in to cover all the costs to support a particular person. Believe it or not, the IRS has a solution for you. It’s Form 2120, the Multiple Support Declaration (https://www.irs.gov/pub/irs-pdf/f2120.pdf). Enter the name and Social Security number of the person being supported. This person will not claim his or her own exemption on the personal tax return. Then get each person to sign this form every year that you are all jointly supporting someone. Allocate the deduction to you first, since you came up with the idea. Next year, and thereafter, take turns giving the dependency exemption to each person participating in the support.
Tip #127:
When medical expenses are high, reduce regular IRA account and retirement plan balances. When someone dies, the heirs have to pay taxes on all the money in regular IRA accounts and most retirement accounts. Money held in Roth IRA accounts is not taxed to heirs or to the living (after the account has been funded for five years). Suppose you had a way to pull the money out of an IRA or retirement account while you (or your loved one) are alive without paying much, if anything, in taxes. Would you do it? You bet!
Well, one CPA didn’t think to do this for his client. Many years ago, I met the nicest man who was being audited for his high medical expenses. It turned out that his CPA wasn’t paying attention to two issues. The first was that he didn’t tell Wally that the round-the-clock caregivers for his mother, and his own caregiver, all needed to be on payroll. Wally didn’t want to get them into trouble by fixing that for the audit, so he gracefully allowed the IRS to disallow all his expenses. And the second oversight was that Wally had more than half a million dollars in his 401(k) account. The CPA could have been advising Wally to move that money to a Roth IRA for five years or more. By paying his help legitimately, Wally could have rolled over at least $30,000 a year, tax-free. I had Wally start doing it immediately. But he died two years later, leaving more than $400,000 still in the fully taxable retirement account.
Here’s how you can do this for yourself and your heirs:
Tip #128:
This tip provides no tax deduction, but here’s how you can avoid gift and estate taxes when paying someone else’s medical expenses. You may pay anyone’s medical expenses as a gift without any gift tax limitations providing you make the payments directly to the medical provider. Normally, gifts are limited to $14,000 per person, per year (2014–2016) before the giver must face gift taxes. In this case, if you have a friend or family member who needs your help, pay the doctor, hospital, lab, or other medical provider directly. You won’t need to file a gift tax return for these gifts, no matter how much you spend. Since this person isn’t your dependent, you won’t get a medical expense deduction, though. One warning: if the person for whom you are paying changes his or her mind and backs out of the medical services, gets a refund, or gets insurance reimbursements, they must pay you back. If they don’t, even if you don’t know about it, you might be faced with surprise gift taxes. So know your patient well, or never contribute more than $14,000 toward any person’s medical care in any one year.
You need money to help pay your medical bills. Crowdfunding sites like GoFundMe, YouCaring, GiveForward, and others have cropped up all over the Internet. Generally, when you use sites like this, the funds you receive tend to be considered income by the IRS. How can you avoid causing a tax problem when you help someone? Easy, set up the campaign properly. Here are four easy steps to keep you, and the friend in need, out of tax trouble:
If your medical expenses were paid by others or via crowdfunding, do you get to deduct the medical expenses if you didn’t pay them yourself? As it turns out, you may. There is a very clear and specific Tax Court Memo from 2010 that addresses this issue. Should you ever find yourself in this situation and get audited, use this citation to settle your audit. Consider reading it. It’s quite interesting (TC Memo 2010-286, Lang v. Commissioner: http://www.ustaxcourt.gov/InOpHistoric/La5ng.TCM.WPD.pdf).
Tip #131:
You don’t need no stinkin’ medical deduction. There are ways to handle medical expenses without using any deductions at all. The best way to do that is by paying for medical expenses with untaxed income. These are two options, often overlooked, because they are misunderstood:
FSAs are provided by your employer. HSAs can be set up by your employer, or you can set one up for yourself.
Tip #132:
Flexible Spending Accounts (FSAs). This used to be worth $5,000 right off the top of your wages without any taxes at all being taken out. Starting in 2012, Congress dropped this amount. Today, the limit is $2,550. There’s still a tax saving here, but it is literally half the value. So what does all this mean? When you know that your out-of-pocket medical expenses during the year will average $50 per month or more, it’s worth signing up for the FSA. Please be realistic about your medical expense projection. You run the risk of losing your money if you overestimate your expenses. Assuming you figured correctly, it’s a great deal, since you’re spending the money anyway. How do you set it up? During open enrollment, or whenever your company schedule permits, tell your payroll department to deduct up to $2,550 (you decide how much) from your paycheck over the 12-month period. As you pay for eligible medical expenses for yourself, family members, or dependents (or almost dependents, see Tip #118), just send in the receipts to the administrator and get your money back. Meanwhile, for tax purposes, your W-2 will show a lower income amount in all the boxes—wages, Social Security Income, and Medicare Income. Since you’re going to be spending money on these medical expenses anyway, why not skip the taxes altogether?
What happens if you don’t run up enough expenses to get your money back by the end of the year? It’s important to understand this issue. Find out if your employer participates in the two-and-a-half-month extension, allowing you to get medical services and pay medical bills until March 15 of the following year. If they do, you will have two and a half extra months to get your money back. If your employer doesn’t offer that option, review your medical expenditures by October of each year. See how much money you have not yet gotten back. Are there receipts you have not submitted yet, like prescriptions, contact lenses, or routine medical supplies? If yes, submit them immediately. If not, it’s time to get new eyeglasses or contact lenses, or visit the dentist or . . . what do you still need to do? One year, I used up the money by getting those customized shoe inserts, orthotics. It seemed expensive to me, but I had overestimated our medical expenses and this was the only way to get something for our money. As it turns out, in the right pair of shoes, those orthotics are actually quite comfortable. Read more about FSAs in IRS Publication 969 (https://www.irs.gov/publications/p969/ar02.html).
Tip #133:
Health Saving Accounts or Arrangements (HSAs). These are quite a bit more complicated, but they also allow you to stow away a lot more money. Individuals may contribute up to $3,350, and families up to $6,750 (https://www.irs.gov/pub/irs-drop/rp-15-30.pdf) for 2016. Visit the IRS website for update information, since this amount changes each year due to inflation. The money may be funded by an individual or an employer. Once the money is in the HSA (set up as part of the Health Savings Arrangement), if you don’t touch the money, you can leave it there to grow until you get old or face an emergency. Kind of like a second IRA. The contributions to this account can come off the top of your wages if you have a job. Or your employer can pay the money for you without you facing any taxes. If you are self-employed, it will be an adjustment to income. (So the contribution won’t reduce your self-employment taxes.)
On the other hand, the HSA is designed to cover your out-of-pocket medical expenses when you have a high-deductible insurance plan. So you are definitely allowed to use the account to pay for your medical expenses. In fact, the insurance provider can give you a debit card to use in pharmacies, hospitals, and other medical establishments. For 2016, a high deductible health plan means the plan has a deductible of at least $1,300 for individuals and $2,600 for families.
Tip #134:
HSA reporting. The one drawback to this is that the HSA administrator will send you a Form 5498-SA at the end of the year showing how much money you spent from the account (https://www.irs.gov/pub/irs-pdf/f5498sa.pdf). In order to avoid paying taxes and penalties on these expenditures, you must attach a Form 8889 to your tax return (https://www.irs.gov/pub/irs-access/f8889_accessible.pdf). Yes, this is a pain. And ever since this form was created, taxpayer and tax professionals alike have struggled to get it work so that all the penalties are cleared. Definitely see a tax pro if you used your HSA to pay for medical expenses. One more important thing to know about these debit cards: you can use them for anything at all in a pharmacy or certain other places. In other words, you can buy food, beverages, greeting cards, make-up, and so on. The IRS is wise to this. Just showing that the charge took place in a pharmacy, CVS, Walgreens, and so on is not enough. You must have the receipt for the purchase, and it must be for a legitimate medical expense. If not, you will be paying taxes and penalties on the noneligible purchase. Be sure to look at the receipt or invoice carefully. For instance, one client had payments for doctor-prescribed massages. Her masseuse changed the name of her business from “her name, Licensed Massage Practitioner” to something with the word “Euphoria” in it. Boy was that a red flag among the medical receipts. If you face something like that, get a better receipt and/or copy of the doctor’s prescription sending you to this therapist. The client got audited. After the folks at the IRS had a good laugh, they approved all the expenses.
Note: Not all states recognize the HSA, so find out if this works with your state tax laws. Otherwise, your contributions will be taxable on the state level.
HSAs really are more complicated than they should be. There is a lot more to this tax break than I have summarized here. In fact, there are a couple more medical-type tax breaks. Please read more about them in IRS Publication 969 (https://www.irs.gov/publications/p969).
Caregivers, get your money back! Over the years, several of my clients and readers have received income from the government to care for their own family members. Sometimes they provide the care in the caregiver’s home; other times they go to their family member’s home. (I must admit that I always wondered how they even learned about the programs. I think social workers let them know about these opportunities. They are offered through Medicaid. You should be able to find information about these opportunities in your state by searching the Internet.)
OK, let’s focus on the income. For years we reported those payments as taxable income. Then came a time when we tax professionals were getting conflicting information about whether the income was taxable or not. On January 3, 2014, the IRS finally settled the argument. They issued a notice telling us that this income is specifically not taxable (https://www.irs.gov/Individuals/Certain-Medicaid-Waiver-Payments-May-Be-Excludable-From-Income). Yippee! The IRS said they “will treat these Medicaid waiver payments as difficulty of care payments excludable from gross income under § 131 of the Internal Revenue Code.”
What does this mean to you? It means that you don’t have to report this income any longer. Better yet, if you reported this income in the past, you might be able to file an amended return (Form 1040X) to get a refund for the taxes you paid on this income. You can amend a tax return to get a refund within three years of the filing date of the tax return. Or, if you paid the taxes later because you were short of funds, you may get a refund within two years after you paid the taxes if that turns out to be later.
For instance, you finally finished paying $2,000 of your 2011 IRS balance due on September 12, 2014. You can recover this payment until September 11, 2016. Normally, if you filed the 2011 tax return on October 15, 2012, you could only get a refund until October 14, 2015. Sometimes there is an advantage to filing late.