Thursday, June 14, 2012

Medical Expense Deduction Threshold Set to Increase on January 1, 2013

Section 9013 of the Health Care Reform law modifies the tax treatment of medical expenses. The threshold for the itemized deduction for unreimbursed medical expenses is currently 7.5% of the taxpayer’s Adjusted Gross Income (AGI). Section 9013 raises that threshold from 7.5% of AGI to 10% of AGI effective for tax years beginning after Dec. 31, 2012. However, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the close of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI. In 2017 the 10% threshold will apply to all taxpayers.

The deduction of medical expenses can be particularly valuable for older taxpayers who incur large expenses meeting their long term care needs. For example, care in a skilled nursing facility in Pennsylvania can easily cost $90,000 a year or more. There are limits on Medicare and Medicaid coverage of nursing home costs and most private insurance policies do not pay for long term care. Seniors may end up paying privately for most of the cost of their nursing home care stay.  To raise the funds needed they frequently must cash in their IRA or other tax deferred retirement accounts. Fortunately, the negative income tax effects of cashing in a retirement account can be mitigated by the medical deduction.

Care received in a skilled nursing facility will normally be deductible as a medical expense on a taxpayer’s income tax return. (Amounts paid for qualified long-term care services are deductible as medical expenses under IRC Sections 213(d)(1)(C) and 7702B). For a taxpayer receiving long term care the income tax liability generated by the distribution of a retirement account can be offset by the medical deduction. This reduces the care recipient’s income tax liability and thus frees up more money to pay for their care needs. The scheduled increase in the deduction threshold will reduce the money available to pay for care and thus more quickly shift the burden of the cost of care to the Medicaid program, the safety net program that pays nursing home costs for seniors who no longer have the resources to pay privately. 

The taxpayer is not the only one who will be hurt by this increase in the deduction threshold. States will be hurt because Medicaid is partly funded by each state. The sooner the taxpayer goes on Medicaid, the sooner the state has to pay. Nursing homes and other care providers will be hurt by this change, because Medicaid payment rates are almost always lower than private payment rates.    

In some situations, a child who pays for a parent’s care can deduct the parent’s medical expenses on the child’s return. See my blog post Hidden Financial Breaks for Caregiver Children.  The change in the law will reduce the benefit of the tax deduction for those children effective in 2013.   

Further Information:

Section 213 of the Internal Revenue Code (currently allows for the deduction of medical expenses paid by a taxpayer for himself, spouse, and dependents to the extent that the expenses exceed 7.5% of the taxpayer’s adjusted gross income).


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