In 2007, the last full year of her life, Lillian Baral suffered from dementia. She paid $49,580 for home health aides, $5,556 for health-related supplies and $760 in unreimbursed medical bills. She had an adjusted gross income of $94,229 that year but failed to file an income tax return. After her death the IRS determined that she owed $21,397.43 in tax, interest and penalties. The executor of her estate sought a deduction for medical expenses. That deduction was initially denied. The executor also asserted that the decedent’s dementia excused her failure to file her income tax return and that the burden of proof on this issue was on the IRS. At the Tax Court he conceded these issues leaving open only the question of whether a medical deduction for her home care expenses was appropriate.

People who are paying privately for long-term care at home frequently overlook the valuable income tax deduction for unreimbursed medical expenses. This deduction can ameliorate the high cost of care. The average cost for home health care in the New York City is $19 per hour, according to the John Hancock Cost of Care Survey 2011. If the patient requires 12 hours of care per day, the cost would be $83,220 per year. Confusion about this issue is largely based upon the fact that these expenses are not covered by Medicare or traditional health insurance because the care can safely be given by someone without a medical degree. This is called custodial care.

The IRS does not have a similar rule and permits a medical deduction for custodial care under the proper circumstances. The U.S. Tax Court opinion in Estate of Lillian Baral v. Commissioner of Internal Revenue1 is instructive on this issue but makes it clear that the requirements are strictly interpreted and complete documentation is necessary.

Custodial Care Payments

Custodial care payments can qualify for the unreimbursed medical expense income tax deduction. The basis for the income tax deduction for custodial care is found in the Internal Revenue Code (IRC) §213(d) which defines medical expenses to include amounts paid for qualified long-term care services. The statutory provisions that define long-term care lay out the specific requirements that must be met to satisfy this deduction. A prospective understanding of the rules will be more successful than a retrospective attempt to comply with the requirements. Anyone contemplating such a claim would be well advised to study the provisions as they provide a step-by-step road map that can be followed in anticipation of a future claim.

Qualified long-term care services are defined as “necessary diagnostic, preventative, therapeutic, curing, treating, mitigating, and rehabilitative services and maintenance or personal care services which are (A) required by a chronically ill individual and (B) provided pursuant to a plan of care prescribed by a licensed health care practitioner.” IRC section 7702B(c)(1). The key words in this section are “personal care services.” This is the specific language that allows a deduction for custodial care.

The term “maintenance or personal care services” is defined as any care the primary purpose of which is the provision of needed assistance with any of the disabilities as a result of which the individual is a chronically ill individual (including the protection from threats to health and safety due to severe cognitive impairment).

Chronically ill individual is defined in IRC §7702B(c)(2) as “any individual who has been certified by a licensed health care practitioner as (i) being unable to perform at least two of six specified activities of daily living [ADL] (eating, toileting, transferring, bathing, dressing and continence) for a period of at least 90 days due to a loss of functional capacity; (ii) having a level of disability similar to the ADL level of disability as determined under regulations prescribed by the Secretary [of the Treasury] in consultation with the Secretary of Health and Human Services; or (iii) requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment.”

Baral was able to document that she had been under the care of a doctor since 2002. He diagnosed her as suffering from dementia. He prescribed Aricept and Namenda, drugs that are commonly prescribed for individuals with dementia. Her hospital records from 2004 documented a diagnosis of dementia and contained an entry that she was not taking her medication properly. A second hospitalization in 2004 noted that she was evaluated to determine whether she could live alone safely due to her apparent inability to remember to take her medication properly. The tax court opinion quotes from her doctor’s medical summary in detail to demonstrate that in December of 2006:

(1) decedent’s ability to communicate orally was impaired, (2) she was confused, (3) she required assistance with activities of daily living, (4) she required supervision due to her memory deficit, (5) she was at risk of falling and, therefore, could not be left alone, and (6) she required baseline homecare services.

The court opinion is replete with references to Baral’s medical condition and highlights the importance of such a record. The need for good medical documentation is also illustrated in the objections raised by the IRS in this case. The IRS objected to the allowance of the medical deduction and argued that “expenses incurred which are merely beneficial to the general health of an individual are not deductible” citing Gardner v. Commissioner, T. C. Memo. 1983-541. The IRS also questioned whether Baral’s “significant body functions” were impaired during the year in question. The court rejected these challenges based upon the thorough medical documentation of Baral’s condition. That documentation proved the compliance with the statutory requirements.

Plan of Care

The care must be under a plan of a health care professional. A licensed health care practitioner means “any physician, registered professional nurse, licensed social worker or other individual who meets the requirements prescribed by the Secretary,” IRC Section 7702B(c)(4). In the Baral case the IRS argued that the care was not provided pursuant to a plan established by a qualified health care professional. The opinion notes that Baral’s physician made a medical determination that she required 24 hour-a-day assistance and supervision based upon her dementia. The medical records were essential to the proof that Baral met the statutory requirement. It would be prudent to ask the treating medical professional to establish a plan of care for a custodial care patient and to order its implementation in writing.

Documenting Expenses

The expenses must be documented out-of-pocket costs that are not reimbursed by insurance or any other source. The amounts that Lillian Baral paid in 2007 to her caregivers, for medical supplies and to her physicians and New York University Hospital Center were not reimbursed. The opinion states that the caregivers provided receipts to Baral for the supplies they purchased but those receipts were not provided to the court. Nor was there substantiation that the supplies were for medical expenses. The Tax Court held that there was inadequate documentation of the payments for supplies and that expense was disallowed. The necessity for fastidious record-keeping is demonstrated by the rejection of this expense. The $760 paid for medical care was allowed.

The IRS also objected to payment for the full cost of a home care worker arguing that room and board costs (for patients who require 24-hour-a-day care that is provided by a single home health care worker) are not deductible, citing Borgmann v. Commissioner, 438 F.2d 1211 (9th Cir. 1971). The court found that the $59,580 paid to the caregivers was a deductible medical expense.

Deductible Expenses

Only those expenses that exceed 7.5 percent of the taxpayer’s adjusted gross income are deductible. Baral’s adjusted gross income for 2007 was $94,229; 7.5 percent of that figure is $7,067. Therefore, she was not entitled to a medical deduction for the first $7,067 of her medical expenses for 2007.

The medical deduction is about to be devalued. Pursuant to the Patient Protection and Affordable Care Act (PPACA) at section 9013, the threshold for deduction of unreimbursed medical expenses will increase from 7.5 percent to 10 percent beginning 2013. A waiver will exempt those age 65 and over from the increase through 2016. This provision is found under the “Revenue Off-Set Provision” section of the law.

Conclusion

The elder law attorney is frequently called upon to help clients evaluate their financial options when faced with a custodial illness. A careful analysis must include the bottom line cost of paying privately by taking into account the possible deduction for unreimbursed custodial care expenses. The advice should also include a checklist of the individual IRS requirements and information about the importance of documenting each element.

Daniel G. Fish is a principal in Daniel G. Fish LLC.

Endnote:

1. Estate of Lillian Baral v. Commissioner of Internal Revenue, U.S. Tax Court 137 T.C. No 1 (July 5, 2011).