Return of Entrance Fee

[Kram BergGold]

We deducted part ($93,000) of an assisted living entrance fee as a medical expense in 2014. In 2016 my client left the facilty and got back all but $72,000. To me the $21,000 difference is taxable. Does anyone think it may be permissible to amend 2014 by reducing the medical deduction or does the $21,000 have to be reported in 2016 when received?

[TAXNJ]

Think cash basis taxpayer would report in year received

[Nashville]

Cash Basis

I think it is cash in, cash out with the IRS as long as it is in their favor. There is a clear mathematical advantage to deducting only the $72,000 and not reporting the $21,000 at all. The deduction when paid had to 1)Be subject to 7.5% of AGI 2)Be an itemized deduction meaning only the excess over std deduction could benefit and 3)If sufficiently large, the $93,000 could have created an NOL if it wasn't an itemized deduction.

Yet, the $21,000 is pure income "above the line" and not offset by the conditions outlined above.

Sounds like just a bad deal from the IRS, Mark.

In order to make the amended return work, you would have to show the original $93,000 was a mistake to begin with. And you might just have a reason, because cash basis taxpayers are not supposed to deduct cash payments where more than 12 months in expense are paid. In other words, on the 2014 return, the only amount available to deduct would have been the amount which prepaid the expense through 12/31/15.

Maybe an illustration? Person enters facility Sept 1 and is told to prepay $4,000 per month, so taxpayer pays $92,000 for 23 months plus a $1,000 processing fee. 23 months pays the person up to August 31, 2016, but the deduction, even on a cash basis, is limited to pay through 12/31/15, or 15 months. Only 61,000 can be deducted in 2014. (15 months plus the nonrefundable processing fee).

If no further expenses are taken in 2015, and patient is released in Feb of 2016, then there is a substantial refund. However, the foregone deduction is $32,000 if nothing further was taken in 2015. Taxpayer may receive refund of up to $32,000 without being taxable.

Interesting to hear what others think.

[Burke]

The entrance fee is a one-time charge up front and is fully deductible on that year's tax return to the extent of its percentage allowed as a medical expense (per documentation from the life care facility.) Depending on the type of contract signed, it could be non-refundable, or pro-ratably refundable over a period of time based on the length of stay for a limited period of time, or refundable at death to the estate. It can be 100% refundable (not common), 90% refundable, 50% refundable, etc. depending on how much the initial payment is. Amending would be nice, but that is for an error. Pub 525 instructions state if you deduct a medical expense in one year, and receive reimbursement in another year, you report it as income on Line 21 in that later year. This type of situation would be a good court case on Nashville's theory of pro-ratability.

[Nashville]

Weak Court Case

I am confident that no more than an extended 12 months can be deducted as a general rule, but it sounds like there is a special directive which would "trump" my suggested treatment. Both concepts are sanctioned by the IRS, but IRS would press with their special treatment and defeat the taxpayer in Tax Court. Don't know if there is a chance in USDistrict Court to reverse the Tax Court or not, but I doubt it. Plus going to court is an extremely expensive and grueling thing to do.

[Roland Slugg]

Recoveries of amounts deducted in a prior year are taxable in the recovery year, except to the extent that the deduction didn't reduce the income tax (or the AMT) imposed in the earlier year. (Code §111(a)) This is the "Tax benefit rule." When the recovered expense was an itemized deduction, and especially when it was a medical deduction, the calculation can get tricky. There is the 7½% haircut to consider, the "itemized deductions versus standard deduction" alternative to keep in mind, plus the possibility of other unrelated tax items that were affected by the deduction in the earlier year ... especially credits.

The best way to calculate the taxable amount in the recovery year, IMO, is to re-do the tax return for the earlier year, as a worksheet, to see what the earlier year's deduction (and credits) would have been if the amount recovered had not been deducted in the first place. That deduction should be the portion of the recovery that is taxable in the recovery year.

You should prepare and attach a schedule to the recovery year's return clearly explaining what the recovery was and showing all the calculations.

If the deduction was a legitimate one in the earlier year ... and I don't know if it was or was not ... there is no justification for filing an amended return for that earlier year.

[New York Enrolled Agent]

... but IRS would press with their special treatment and defeat the taxpayer in Tax Court. Don't know if there is a chance in USDistrict Court to reverse the Tax Court or not, but I doubt it.

The U.S. District Courts are NOT the venue for appeals of Tax Court decisions. Only 12 of the 13 Circuit Courts of Appeals (The Federal Circuit is excluded) are authorized to review TC decisions. IRC §7482

[TAXNJ]

Good point about the "tax benefit rule". Some tax software will allow one to make a second file copy then one can make adjustments to arrive at any benefit answers for support.