AUGUST 3, 1998 VOLUME 6, NUMBER 5
Few nursing home residents have large incomes. Most, of course, are living on retirement and Social Security, and a few may have at least some investment income. Income tax liability will seem like an irrelevant issue for most long-term care residents. Still, income tax issues can be important and may present an opportunity for financial planning for long-term care recipients and their families.
Thanks to new legislation adopted by Congress two years ago, the costs of long-term care are a deductible expense. In most circumstances, that will include care provided either in a nursing home or at home, though there are some limitations on the benefit of the tax break.
To be deductible, the care must meet one of three conditions:
- The patient must be unable to perform at least two of the "activities of daily living" (the ADLs include eating, toileting, transferring, bathing, dressing and continence), OR
- The patient must meet regulations to be adopted by the IRS (these regulations are not yet proposed), OR
- The patient must be so cognitively impaired as to require supervision to protect him or her from threats to health and safety.
Like all medical expenses, the costs of long-term care are deductible only to the extent that they exceed 7.5% of the taxpayer's income. For a wealthy patient, however, the value of the deduction should not be overlooked. Many tax preparers and financial advisers are unaware of the availability of the deductions, particularly in the case of home care.
There are other circumstances in which the costs of long-term care can become important for tax reasons, as well. When children provide most of the care for a parent in the home or a nursing home, they may be able to claim the parent as a deduction. In order to qualify, the child must provide more than half the total cost of care, and the parent's annual income (excluding Social Security) may not exceed $2,650. If the parent's Social Security exceeds $25,000 per year, the deduction is no longer available.
Even if the child can not claim the parent as a dependent, nursing care costs provided by the child may be deductible. The maximum income rules do not apply, so the only requirement is that the child provide at least half the total cost of the parent's support.
Tax law also permits deductions for most long-term care insurance payments, whether for the taxpayer or a dependent parent. Of course, the tax deduction is not likely to be useful for most policy holders--it is limited to the amount by which total medical expenses exceed 7.5% of income. For most healthy taxpayers, long-term care insurance will only be deductible in years when there are also family medical catastrophes.
Once a long-term care insurance policyholder begins to receive payments, another set of tax issues comes into play. Under the new rules, most patients receiving insurance benefits will have no income tax effect. In order to receive that benefit, however, the policy itself must qualify under new rules. If it does not, the payments made by the policy may be treated as income.
Most observers have assumed that the income from long-term care insurance is not a very important concern, since there will always be substantial costs incurred by the recipient. While tax experts disagree on the rules in this complicated area, it may in some circumstances be necessary to declare the long-term care insurance payments as income, but not possible to deduct the corresponding long-term care costs from that income. This dilemma only affects recent purchasers of long-term care policies which are not "qualified" by the federal government, but should be considered when analyzing any new policy.