By Wayne L. Kaplan and Jonathan C. Sullivan
Currently, over one million Americans live in more than 28,000 assisted living facilities across the United States. Residents and their families often bear the costs of assisted living facilities from their own financial resources. Even though assisted living facilities continue to seek new ways to deliver the highest quality services at reasonable costs, many residents and their families continue to endure significant financial hardships. In 1996, Congress passed the Health Insurance Portability and Accountability Act (HIPAA), which may ease this financial burden by permitting tax deductions for qualified long-term care services. Certain payments to assisted living facilities may be deductible under this provision. The HIPAA legislation also provides favorable tax treatment to qualified long-term care insurance contracts. All residents of assisted living facilities and their families should be aware of the potential tax deductions associated with qualified long-term care services and qualified long-term care insurance contracts.
I. Qualified Long-Term Care Services
Prior to the passage of HIPAA, the IRS Code defined medical care expenses as including amounts paid “for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure of the body.” This definition covers what most people would consider to be medical care expenses. The HIPAA legislation, however, broadened the definition of “medical care” to include amounts paid for “qualified long-term care services.” It is under the rubric of qualified long-term care services that certain payments to assisted living facilities may be deductible. In order to take advantage of these deductions, however, a taxpayer must be entitled to make deductions for medical care expenses and those expenses must satisfy the definition of qualified long-term care services.
The rules governing who is entitled to make deductions for medical care expenses are relatively clear. Taxpayers can deduct medical care expenses for the taxpayer, his or her spouse and dependents. In order to make these deductions, however, the taxpayer must be entitled to itemize his or her deductions. Furthermore, deductions for medical care expenses are only available to the extent that they exceed 7.5% of the taxpayer’s adjusted gross income and are not compensated by insurance or otherwise. The rules governing deductions for the medical care expenses of dependents are of particular interest to taxpayers who bear the costs of placing a parent in an assisted living facility. Generally, a taxpayer can deduct the medical care expenses of his or her parent if the taxpayer provides more than 50% of the parent’s support costs and the taxpayer’s parent is a United States citizen or a resident of the United States, Canada, or Mexico.
The rules governing what services satisfy the definition of qualified long-term care services, however, are more complicated. Qualified long-term care services are defined as “necessary diagnostic, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services.” This provision significantly broadens the definition of “medical care” to include amounts paid for these services, which are likely to be provided by an assisted living facility. Deductions for these services are only available when the services are provided to an individual who is “chronically ill” pursuant to a plan of care prescribed by a licensed health care practitioner.
Only certain residents at assisted living facilities will qualify as “chronically ill.” In order to qualify as “chronically ill,” a licensed health care practitioner must certify that the individual is unable to perform at least 2 activities of daily living without “substantial assistance” from another individual for a period of at least 90 days due to a loss of functional capacity. Activities of daily living include eating, toileting, transferring, bathing, dressing and continence. The IRS has issued interim guidelines which indicate that “substantial assistance” means both “hands-on assistance” and “standby assistance.” An individual needs “hands-on assistance” if they are unable to perform an activity of daily living without the physical assistance of another person such as a personal aide. An individual needs “standby assistance” if they require “the presence of another person within arm’s reach of the individual that is necessary to prevent, by physical intervention, injury to the individual while the individual is performing the [activity of daily living].” Examples of “standby assistance” include being ready to catch an individual who is getting into or out of a bathtub or being ready to help an individual who is susceptible to choking while eating.
An individual is also considered “chronically ill” if a licensed health care practitioner certifies within the preceding 12 month period that the individual requires “substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.” The IRS interim guidelines indicate that “severe cognitive impairment” means a loss or deterioration in intellectual capacity as occurs with Alzheimer’s and similar forms of irreversible dementia. The “severe cognitive impairment,” however, must be measured by standardized tests “that reliably measure impairment in the individual’s (i) short-term or long-term memory, (ii) orientation as to people, places, or time, and (iii) deductive or abstract reasoning.” The interim guidelines define substantial supervision as “continual supervision (which may include cuing by verbal prompting, gestures, or other demonstrations) by another person that is necessary to protect the severely cognitively impaired individual from threats to his or her health or safety (such as may result from wandering).” These services are also likely to be provided by many assisted living facilities.
In order to qualify for the deduction, the qualified long-term care services must also be “provided pursuant to a plan of care prescribed by a licensed health care practitioner.” Licensed health care practitioners include physicians, registered professional nurses, and licensed social workers. This provision exemplifies the importance of communicating with the health care practitioner that cares for the assisted living facility resident. The health care practitioner is in a position to both certify that the individual is chronically ill and to develop a plan of care for that individual.
The definition of qualified long-term care services includes a number of services. Of particular interest for residents of assisted living facilities and their families is the inclusion of “maintenance or personal care services.” Maintenance or personal care services are 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).” This definition appears to cover many of the services offered by assisted living facilities. There is even some authority that maintenance and personal care services include meal preparation, household cleaning and similar services that the chronically ill individual is unable to perform. The determination of whether a particular service is a qualified long-term care service is likely to be very fact sensitive. Until the IRS issues new regulations further clarifying the definition of maintenance and personal care services, however, it is essential that the assisted living facility resident is certified as chronically ill and that the services that the taxpayer is seeking to deduct are provided pursuant to a plan of care prescribed by a health care practitioner.
Residents of assisted living facilities and their families may find it difficult to determine what portion of their bill is allocable to qualified long-term care services. Most assisted living facilities charge a single rate, which includes expenses for services that are potentially deductible. If a personal aide provided qualified long-term care services in a private home, it would not be difficult to determine what costs the taxpayer is entitled to deduct. It would likely be the salary paid to the personal aide. Payments made to assisted living facilities, however, are likely to include cost components that do not satisfy the definition of qualified long-term care services, such as food and lodging. Assisted living facilities can facilitate tax deductions for residents and their families by identifying the costs of qualified long-term care services on their bills. If residents of assisted living facilities and their families are having difficulty determining what portion of their bill is allocable to qualified long-term care services, they should be encouraged to discuss their concerns with the assisted living facility. It is essential, however, that the taxpayer is entitled to make deductions for medical care expenses and that the qualified long-term care services are provided to a chronically ill individual pursuant to a plan of care prescribed by a licensed health care practitioner.
II. Qualified Long-Term Care Insurance Contracts
Residents of assisted living facilities and their families should also be aware of the favorable treatment of qualified long-term care insurance contracts under the IRS Code. Pursuant to the HIPAA legislation, the IRS Code generally treats qualified long-term care insurance contracts as accident and health insurance contracts. Accordingly, certain payments received from qualified long-term care insurance contracts are excludable from gross income, subject to specified per diem limitations. The HIPAA legislation also expanded the definition of deductible medical care expenses to include amounts paid for qualified long-term care insurance contracts. The IRS Code, however, establishes several requirements which must be satisfied before long-term care insurance contracts will qualify for favorable tax treatment.
Premiums paid for qualified long-term care insurance contracts are deductible to the extent that they do not exceed certain caps based upon the age of the taxpayer. The current limitations are as follows: individuals who are 40 years old or younger are entitled to deduct $230; individuals between the ages of 40 and 50 are entitled to deduct $430; individuals between the ages of 50 and 60 are entitled to deduct $860; individuals between the ages of 60 and 70 are entitled to deduct $2,290; and individuals over the age of 70 are entitled to deduct $2,860. As with all medical care expense deductions, however, the taxpayer must be entitled to itemize deductions and can only deduct medical care expenses to the extent they exceed 7.5% of the taxpayer’s adjusted gross income.
A long-term care insurance contract will only qualify for favorable tax treatment if it meets all of the requirements established by the IRS Code. The long-term care insurance contract must only provide for qualified long-term care services. Therefore, its benefits must be limited to necessary diagnostic, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services for a chronically ill individual provided pursuant to a plan of care prescribed by a licensed health care practitioner. These are the same requirements that must be met before a taxpayer can make a deduction for qualified long-term care services.
Furthermore, the long-term care insurance contract must be “guaranteed renewable;” must not provide for a cash surrender value that can be paid, assigned, or pledged as collateral for a loan, or borrowed; must provide that any refunds or dividends will be applied to reduce future premiums or to increase future benefits; and must not pay or reimburse expenses that are reimbursable under Medicare. The long term insurance contract must also satisfy several consumer protection provisions. Failure to meet these requirements will result in a loss of favorable tax treatment.
This article is not intended to constitute individual tax or legal advice. Individuals should consult with their tax consultants and/or legal advisors to determine whether or not they are entitled to make deductions for qualified long-term care services and qualified long-term care insurance contracts.
Jonathan C. Sullivan is an associate in the firm’s Health Law Department and Seniors’ Housing Group.