SEPTEMBER 5, 2011 VOLUME 18 NUMBER 31
Queens (New York) resident Lillian Baral was in her early 90s. She lived at home, but she required full-time assistance with her care. In 2007 she paid two caretakers a total of $49,580 for live-in care (one lived with her for five weeks while the primary caretaker took a vacation). Were the payments deductible on her income tax return?
The short answer, according to the U.S. Tax Court: yes. Not surprisingly, the more complete answer is complicated and depends on the specific facts of Ms. Baral’s case.
Ms. Baral had been diagnosed as suffering from dementia as early as 2004, three years before her long-term care costs became a tax issue. In December, 2006, her physician wrote an evaluation of her then-current mental status. He found her to be confused, unable to communicate clearly and at risk of falling in her home. Because of her memory deficits she would require assistance with the activities of daily living, he wrote. She needed full-time assistance and supervision for medical and safety reasons if she was going to stay at home.
Ms. Baral’s financial affairs were being handled by her brother David, relying on a power of attorney she had signed some time before. He paid all her bills, handled her checking and other accounts, and hired the nursing service to care for her in her home. By the end of 2006, in an effort to save money, he had discharged the nursing service and hired one of their caretakers directly to live with his sister and oversee her care.
Mr. Baral did not, however, remember to file his sister’s income tax returns for 2007. The Internal Revenue Service noticed, and near the end of 2009 they filed a “substitute for return” based on records available to the IRS. The form indicated that her income for 2007 had been $94,229; after including a personal exemption and a standard deduction, the IRS calculated that Ms. Baral owed $17,681 plus interest and penalties.
By the time the IRS sent out its notice, Ms. Baral had died. Her brother had been appointed as personal representative of her estate; he argued that (a) she had not been required to file a tax return at all, and (b) she was entitled to a medical expense deduction for the long-term care costs she had incurred. The IRS disagreed on both scores.
The dispute ultimately found its way to the United States Tax Court, which hears claims and defenses regarding income tax returns (along with other tax-related proceedings). The Tax Court ruled that the key legal question was whether Ms. Baral was a “chronically ill individual.” If she was, then her caretakers’ salaries would be “qualified long-term care services” and therefore deductible. The court noted that there are three ways to identify a “chronically ill individual”:
- Was Ms. Baral unable to perform at least two of the six “activities of daily living”? The six ADLs are: eating, toileting, transferring, bathing, dressing, and continence. Although her physician had said that she required assistance with her ADLs, he had not identified which ones — and therefore the court could not determine whether she was deficient as to only one, or as to two or more. She did not meet this standard.
- Did Ms. Baral have a level of disability “similar to” the ADL standard? Again, the court found that the physician’s evaluation was not clear.
- Did Ms. Baral require substantial supervision to protect her from threats to her health and safety because of “severe cognitive impairment”? Applying this test to Ms. Baral’s condition and circumstances was a little easier for the court. Because her physician had described her as demented, and at risk for falls or failure to take prescribed medication, Ms. Baral met this test.
Fortunately for Ms. Baral’s tax situation, only one of the three standards had to be met. Because of the evaluation by her primary care physician in 2006, the cost of her live-in caretakers would be a legitimate deduction on her income taxes — or at least it would be deductible to the extent that it exceeded 7% of her adjusted gross income.
Ms. Baral’s brother had also argued that he should be able to deduct the $760 paid in 2007 to her physicians (the Tax Court agreed) and the $5,566 she paid to caretakers for reimbursement of expenses they incurred on her behalf. The Tax Court denied the deduction for reimbursement, since there was no evidence that the payments were for medical items. If Mr. Baral had been able to show that they were, for example, co-payments on prescription medications, or over-the-counter medications at the direction of her physician, or medical supplies, they would have also been deductible. Estate of Baral v. Commissioner, July 5, 2011.
What does Ms. Baral’s case tell us about tax issues surrounding home care? Several things:
- Keep good receipts. To the extent possible, segregate clearly deductible expenses from questionable or non-deductible expenses, and make sure the purchases are identifiable.
- Get a good doctor’s letter. Ask the attending physician for a letter that specifically addresses ADLs, the need for caretakers to protect the patient’s safety AND a general description of limitations on the patient’s abilities.
- If you are in charge of the patient’s finances, file their income tax returns. Someone with $95,000 of income — even if much of it is Social Security and pension income — is almost certainly going to need to file a return. Mr. Baral would have had a much easier time if he had filed the return claiming the deductions, rather than having to argue about the IRS’s “substitute for return” after the fact. Note that the IRS action was delayed, too — it can be that much harder to prove the taxpayer’s condition two (or three, or four) years after the fact, and it is not uncommon to be addressing these issues after the taxpayer’s death.