Baker v. IRS Commissioner – Medical Expense Tax Deduction for Continuing Care Payments

Baker v. IRS Commissioner – medical expense tax deduction for continuing care payments. The IRS has challenged Continuing Care Resource Center (CCRC) residents who have taken a medical expense tax deduction for entrance and monthly fees. Hence this post to help navigate those shoals and push back on government over reach in these regards.

Background

While certain medical expenses paid by residents of retirement communities may be deductible, it’s important to note that neither the IRS nor the Court has issued definitive guidance on how the deduction should be calculated. The Baker case highlights this lack of clarity, showing that the IRS has not decided on a single appropriate method. Therefore, this post provides information to help you estimate the portion of your fees, if any, that may be eligible for a medical expense deduction if you claim such a deduction.

Facts

• Section 213 of the Internal Revenue Code (the “Code”) allows the deductibility of medical expenses on an individual’s income tax return, subject to the limitations and provisions of the Code.
• Internal Revenue Rulings, including but not limited to Revenue Rulings 75-302 and 76-481, address the deductibility of fees paid to retirement facilities for medical care.
• In March 2004, the U.S. Tax Court addressed specific aspects of this concept in Baker vs. Commissioner of the Internal Revenue Service No. 448-02 (2-19-2004).
• In July 2007, the United States District Court for the Northern District of Illinois addressed the treatment or entrance fees paid to a Continuing Care Retirement Community (Classic Residence by Hyatt at The Glen) in Finzer 1· United States 196 F.Supp. 2d 954 (N.D. Ill. 2007).

Reviewing these cases, notably Baker, helps determine the deductibility of any portion of these fees.

In the Baker case, the Tax Court considered two methods for calculating the portion—if any—or fees paid to a continuing care retirement community related to medical care.

Historical Costs Method

The Tax Court in Baker addressed the tax treatment of specific fees paid to a Continuing Care Retirement Community (CCRC).

In that case, the court applied a “percentage method,” which is based on historical costs and assumes that the medical care portion of monthly fees paid by a taxpayer to a CCRC is the same portion or percentage as the CCRC’s medical expenses are to total costs.

A calculation using this method generally estimates the cost of operating the care center as a percentage of the total costs of running the entire community during the tax year.

If you choose to follow the guidance in the Baker case, the data points needed in writing from the CCRC are:

• Facility’s historical cost percentage
• Weighted average monthly fee per resident.
• Weighted average entrance fee per resident.
• Lowest entrance fee
• The non-repayable portion of the lowest entrance fee

The weighted average fees paid by all community residents are used to calculate the portion of your costs that may be eligible for a medical expense deduction.

Please note that in Baker, the court stated that it was more appropriate for the percentage calculation to apply to an average fee paid by all residents rather than to the actual expenses paid by any resident.

Actuarially Determined Cost Method

This method calculates the present value of the estimated cost of the projected future usage of medical facilities compared to the present value of the estimated total future cost of operating the community to determine an applicable percentage of deductibility.

The percentage determined using this method is applied against the fees paid during the year.

It should be noted that while this method is based on actuarially determined costs, actuaries may use alternative methods to calculate the medical expense deduction, which could generate substantially different results from those described in this post. 

If you choose to apply the actuarial method described above, the percentage enumerated would be used against the weighted average fees paid by all residents in the community to calculate the portion of your costs that may be eligible for a medical expense deduction.

Conclusion

In the Baker case, the court stated that the residents were not required to use the actuarial method used by the IRS but could choose to use the percentage method.

The court did not find that the actuarial method could not be used in all cases but rather that it was inappropriate under the facts of that case.

Information sources:

26 U.S. Code § 213 – Medical, dental, etc., expenses

Baker vs. Commissioner of the Internal Revenue Service No. 448-02 (2-19-2004).

Finzer 1· United States 196 F.Supp. 2d 954 (N.D. Ill. 2007)

Revenue Rulings

Revenue Ruling 54-457 – if a student pays a lump sum fee which includes his education, board medical care, etc., and no breakdown is made of such fee as to the amount allocable to medical care, no specific part of the tuition fee charged may be considered to be an amount paid for medical care within the meaning of section 23(x) of the Internal Revenue Code of 1939 deductible by individuals in computing net income for Federal income tax purposes. However, suppose such a breakdown is provided or readily obtainable from the university. In that case, that portion of the fee allocated to medical care will constitute a proper deduction under section 23(x) of the Code.

Revenue Ruling 67-185 – where the taxpayers, a husband, and his wife, pay a monthly life-care fee to a retirement home and prove that a specific portion of the fee covers the costs of providing medical care for them, that portion of the payment is deductible by the taxpayers as an expense for medical care in the year paid, subject to the limitations prescribed in section 213 of the Code.

Revenue Ruling 68-525 – attributable amounts to the construction of the infirmary and apartment and is not to provide medical care are not deductible.

Revenue Ruling 75-302 – the portion of the lump-sum life-care fee payment made by the taxpayer under a contract that was adequately allocable to his medical care is deductible as an expense for medical care in the year paid, subject to the limitations prescribed in section 213 of the Code.

Revenue Ruling 76-481 – fees were calculated without regard to any similar contracts with other patients at the institution and were not medical insurance. The agreement further provided that if the taxpayers chose to terminate their residence, they would, under certain circumstances, be entitled to a refund of a portion of the founder’s fee. A specified formula with a penalty provision would compute such a refund.

Internal Revenue Service Publication 502 Medical and Dental Expenses

Contact me for more on Baker v. IRS Commissioner – Medical Expense Tax Deduction Continuing Care.