Tax Notes CH. 7 Continued (part II)

Ch. 7


c. Tax Payers may also include premiums paid on qualified long-term care insurance contracts in medical expenses. For 2007, the per-person limits range from $290 for taxpayers age 40 and under to $3,680 for taxpayers over the age of 70 ( see IRS publication 502)

12. General Rule – Regardless of the taxpayer’s method of accounting, medical expenses are deductible only in the third year paid.

a. Exception for medical expenses of a decedent. An exception to this rule is contained in sec. 213 © Under this provision, the medical expenses of decedent may be deducted in the year incurred if paid by the estate or surviving spouse within one year of death.

i. Do not conclude, however that all such medical expenses can be deducted on a decedent’s final income tax return.

ii. Ex. Daniel a calendar year taxpayer, died on March, 10, 2007. At the time of his death, Daniel owed 4,200 of medical expenses incurred as follows: 1,200 in 2006 and 3,000 in 2007. If these expenses are paid (either by Daniel’s estate or Daniel’s surviving spouse) within one yea of March 10, 2007, $1,200 can be claimed on Daniel’s 2006 form 1040 and 3,000 on Daniel’s’ final 2007 1040 form.


b. Exception for future medical services. No deduction will be allowed for payment of medical care to be rendered in the future unless the taxpayer is under an obligation to make the payment.

i. Whether an obligation to make the payment exists depends upon the policy of the physician or the institution furnishing the medical care.

ii. The IRS does not allow a deduction for the portion of a lump-sum prepayment allocable to medical care made to a retirement home under a life care plan.

13. Points to Emphasize
a. Expense and reimbursement in same tax year. If the medical expense and its reimbursement occur in the same tax year, the reimbursement must be taken in account in arriving at the medical expense deduction for that year.

b. Anticipated reimbursement. Unlike casualty insurance recoveries, medical expense reimbursements do not have to be anticipated. Consequently though a taxpayer is positive that the medical expense will be reimbursed, the reimbursement is not considered until received.

c. Reimbursement received in subsequent tax year. If the reimbursement is received in a subsequent year, much taxpayer confusion exists as to the proper tax treatment.

i. Undoubtedly, many taxpayers will honestly regard the reimbursement as being devoid of tax consequences. The rationalization might be: “I merely got back what I paid so why should it be taxed?”
ii. Another erroneous approach would be to offset the reimbursement against the medical expenses for the year of reimbursement.


d. Taxpayer Compliance. – Due to the likelihood of taxpayer error, the IRS has for many years urged Congress to require information reporting (e.g. Form 1099) on insurance companies that offer medical coverage.

e. Tax Benefit Rule/ The proper way to handle a subsequent-year reimbursement is to apply the tax benefit rule.

HEALTH SAVINGS ACCOUNTANTS (HSA’s)

14. Certain employees and self-employed taxpayers may deduct payments to HSA’s as deductions for AGI. The HAS must be used in connection with high deductible policies. The purpose of this provision is to assist in the control of health costs.

a. High Deductible policies for tax years beginning in 2007 are those with deductibles not less that $1,100 (In 2006 $1,050) for self-only coverage or @2,200 deducting and other out-of-pocket costs (excluding premiums) under the plan does not exceed $5,500 for self-only coverage ($11,000 for family coverage).

b. HAS distributions are not taxable if used by the recipient to pay for amounts not covered by a high deductible plan, but distributions used for other purposes are included in gross income and are subject to an additional 10% penalty if made before age 65, death or disability. Earnings on HSAs are not subject to taxation unless distributed. Distributions made by reason of death or disability and distribution made after the beneficiary becomes eligible for Medicare are taxed but not penalized.


c. The deductible amount for HAS contributions is subject to limitations.

i. The amount of the monthly limitation for self-only coverage in 2007 is the lesser of one-twelfth of the annual deductible under the high-deductible plan or @,850. For family coverage in 2007, the annual deduction is limited to the lesser of one-twelfth of the annual deductible under the high-deductible plan or $5,650. For an eligible taxpayer who has attained age 55 by the end of the tax year, the limit on annual contributions in 2007 is increased by $800 ($900 in 2008 and $1,000 after 2008)

d. An HAS is portable. Taxpayers who switch jobs can take their HSAs with them.

TAXES

15. A Tax versus a Fee.

a. A fee for personal use is not deductible as a tax under Sec. 164

b. Thus, fees for god licenses, automobile inspection, automobile titles and registration, hunting and fishing licenses, parking meter deposits, postage, etc. are not deductible unless incurred as a business expense under Sec. 162 or for the production of income under sec. 212.

16. Examples of Deductible and nondeductible Taxes

a. The following are examples of deductible taxes: state and local income or state and local sales, personal property, real estate and intangible property taxes.

b. Examples of nondeductible taxes: Social Security, Federal income and estate and inheritance taxes.

c. Taxes incurred in connection with trade or business or production of income activities are deductible, even if the same tax is not deductible as an itemized deduction.

PROPERTY TAXES

17. Timing of Deduction and by Whom.

a. Taxes on real and personal property are generally deductible only by the person against whom the tax imposed.

b. Cash basis taxpayers may deduct these taxes in the year of actual payment, and accrual basis taxpayers may deduct them in the year when economic performance has occurred.

c. Assessments on real property (e.g. for streets, sidewalks, curbing) are not deductible but added to the adjusted basis of the property.