Tax Savings for Nursing Home Residents

There are three significant opportunities for minimizing the tax burden of a nursing home resident:

1. The availability of the one-time exclusion of gain from the sale or exchange of a principal residence under Section 121, which was liberalized by The Taxpayer Relief Act of 1997 (TRA).

2. The exceptions to penalties for early withdrawals of qualified plan assets under Section 72.

3. The deductibility of nursing home care costs as a medical expense under Section 213.

SALE OF PRIMARY RESIDENCE

Section 121 provides for sales after May 6, 1997, a married couple can elect to exclude tax on a home sale gains of up to $500,000 ($250,000 for singles or married couples filing separately) of gain realized on the sale or exchange of a primary residence.

To qualify for the exclusion, a taxpayer must have owned and used the home as a principal residence for at least two of the five years before the sale. To the extent, your taxable gain exceeds the threshold; your gain is taxed at no more than 20%.

As a general rule, the home sale exclusion may be used an unlimited number of times, but not more often than every two years.

EARLY WITHDRAWALS FROM QUALIFIED PLANS

Section 72(t) (1) provides that distributions from qualified plans, including annuity plans and individual retirement accounts (IRAs), made before age 59 ½ are subject to a 10% additional tax on early withdrawal, unless the distribution falls into one of the following categories:

1. Distribution due to disability. Disabled means the inability to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment that can be expected to result in death or be of long continued and indefinite duration. The taxpayer must furnish proof of the disability.

A statement from his or her attending physician indicating that the resident is “disabled” as described in Section 72(m)(7) should be retained in the taxpayer’s records to substantiate the basis on which the penalty tax is being avoided.

2. Distribution made to a beneficiary, or the individual's estate on or after the death of the individual. IRC Section (t) (2) (A) (i).

3. Distribution made after 1996 for medical care, but only to the extent allowable as a medical expense deduction for amounts paid during the taxable year for medical care. IRC Section 72(t) (2) (B), 72(t) (3) (A). Only amounts in excess of 7.5% of the individual's AGI escape the 10% penalty.

4. Distribution made after 1996 by unemployed people for health insurance premiums.

5. Distribution made in tax years beginning after 1997 for academic periods beginning after 1997, to pay "qualified" higher education expenses for the taxpayer’s child or grandchild.

6. Distribution as part of a series of substantially equal periodic payments made (at least annually) for the life expectancy of the individual and his or her designated beneficiary. If the series of payments are modified later for reasons other than death or disability, other tax liabilities may apply.

7. Distribution of up to ten thousand dollars ($10,000) for first time purchase of a home for spouse, child, grandchild or ancestor of the individual or spouse.

There would seem to be a little more flexibility for withdrawals from other types of retirement plans, if the early retirement or medical expenditure exceptions can be met. Even for such plans, however, it would be prudent to obtain a physician’s statement if the taxpayer meets the definition of disabled.

NURSING HOME CARE COSTS

Since nursing home care costs will likely exceed 7.5% of the taxpayer’s adjusted gross income (AGI) and are usually not reimbursable by private insurers, it is essential to determine whether fees and expenses incurred by or on behalf of a nursing home resident are deductible medical expenses.

Section 213(d) (1) (A) defines medical care to include amounts paid for the “diagnosis, care, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.” To what extent, if any, a nursing home resident’s costs of care are deductible is a question of fact, to be determined under Reg. 1.213-1(e) (1) (v) (a).

Where an individual is a resident because their condition is such that the availability of medical care is a principle reason for their presence there, and meals and lodging are furnished as a necessary incident to that care, the entire cost of the medical care, meals, and lodging while the resident requires continual care constitutes a medical expense. But, where the availability of medical and nursing services is not a principal reason for the residency, only a portion of the costs of care may be deductible under Section 213 provided the institution has such services available, has dedicated a portion of its budget to those costs and is obligated to provide them to the resident when needed.

CONCLUSION

These three areas illustrate the tax planning opportunities available to nursing residents and those responsible for managing their affairs. A greater awareness of these provisions will better enable residents and their families to meet the costs of care.

Source: www.IRS.gov



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