Increasingly, federal and state governments are providing assistance to family members caring for seniors. Some of these programs involve direct payment through Medicaid (MassHealth in Massachusetts), such as for personal care attendants or adult foster care.
The federal government also offers certain tax benefits for children who pay for their parents’ care. These include the following:
1. Medical Expense Tax Deduction
Children who are paying for a parent’s health care may take an itemized deduction for qualifying medical expenses to the extent that those costs and their own medical costs exceed 10% of the child’s adjusted gross income (7.5% if the child is 65 or older). Qualifying medical expenses include those prescribed by a licensed health care practitioner that are necessary, preventative, therapeutic, treating, rehabilitative services, and maintenance and personal care services. The itemized expenses cannot include the cost of general household services (i.e. housekeeping), even if the help is recommended by a doctor.
It can make sense in some cases for the parent to transfer who assets to the child and for the child to then use them to pay for the parent’s care, especially if the parent is in a much lower tax bracket. For instance, a couple earning $125,000 a year is in the 25% tax bracket. If one of them has a parent whose care is costing $40,000 a year and their own family’s medical expenses are $6,000 a year, they can save $8,375 a year in federal taxes (plus a smaller amount in state income taxes) by paying for the parent’s care. Here’s how the calculation works:
$40,000 Parent’s health care costs
+ 6,000 Family’s health care costs
$46,000 Total health care costs
-12,500 10% of adjusted gross income
$33,500 Deductible health care costs
x 25% Marginal tax rate
$ 8,375 Federal income tax savings
2. Medical Flexible Spending Account
Many workers are eligible for medical flexible spending accounts where they can set aside part of their earnings for medical expenses prior to paying taxes on them. Adult children who have this benefit are able to pay for up to $2,500 of medical care for their parents using pre-tax dollars. Depending on the adult child’s marginal tax rate, using this FSA will save the family approximately $1,000 per year. In the example above, the savings would be $625. This cannot be combined with taking the same expenses as an income tax deduction, but can be used where either the parent’s cost of care are not quite as expensive or the child’s income is so high that the tax benefit is eaten up by subtracting out 10% of adjusted gross income. The latter would be the case if the income of the child and his spouse totaled $400,000 or more.
3. Dependent Care Tax Breaks
The child can also elect to enroll in a Dependent Care Account to pay for up to $5,000 of dependent care expenses for the parent using pre-tax dollars. If the family doesn’t have access to a Dependent Care Account through their job, they can take advantage of the Dependent Care Tax Credit, if they are not using it up for their own children’s care. This allows the family to itemize up to $3,000 of dependent care expenses per year per dependent ($6,000 maximum per year). The tax credit percentage is contingent upon income, but most families will receive a tax credit of 20% on those itemized expenses, yielding up to $600 per year for one dependent or $1,200 per year for two or more dependents.
In order to capitalize on the dependent care tax breaks, families must pass the “work-related test,” meaning both spouses must be employed or full-time students. In addition, the parent must be living with the child taking the credit for at least half of the year and be physically or mentally incapable of self care.
4. Taking Parent as a Dependent
In addition to the tax break above, a child may treat a parent as a dependent and take a standard $3,900 deduction (in 2013) just as she would a dependent child, if the following requirements are met:
(a) The parent lives with the child for at least half the year.
(b) The child pays for at least half of the parent’s support.
(c) The parent does not file a joint tax return with anyone else.
(d) The parent’s taxable income is less than $3,900 (in 2013). If the senior’s sole income is Social Security, it is not counted as taxable income.
For our clients in the example above, this would save another $1,000 in income tax payments.
As you can see, significant tax benefits can be obtained by properly structuring payment for services. Where more than one child might pay for a parent’s care, analysis of each child’s income and other available deductions can determine which child will gain the greatest tax advantage by paying for a parent’s care. An accountant or elder law attorney can assist with these calculations.
Margolis & Bloom, LLP, practices estate, long-term care and special needs planning in Boston, Dedham, Framingham and Woburn with a strong commitment to client service. If you have questions about these or other legal matters, do not hesitate to contact us by e-mail by clicking here or by calling us at 617.267.9700.