Thursday, January 23, 2014

Tax Strategies for Parents of Kids with Special Needs

Tax Strategies for Parents of Kids with Special Needs – Updated for Obamacare
December 1, 2013
By Regina M. Levy, CPA

The Patient Protection and Affordable Care Act (PPACA), known as OBAMACARE, has some significant implications for special needs families. While we are just beginning to see how far reaching this act is, I am going to limit my remarks to how this act specifically affects tax deductibility of medical expenses typically incurred by families with special needs. If you need assistance with understanding or accessing the insurance marketplace, I suggest you speak with a knowledgeable insurance agent. This article supersedes a similar article I wrote in February of 2011. Changes due to OBAMACARE are so noted.
The information in this article is educational in nature and is not to be considered tax advice. Please contact a qualified tax professional to discuss how these concepts may or may not apply to your personal situation.

Medical Expense Deductions
The IRS code allows medical deductions per section 213:
“The term `medical care,’ as used in this subsection, shall include amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body.”
This is a pretty broad definition of medical care. The nature of the IRS code is that it is refined by both revenue rulings and tax court cases, such that the phrase ‘any structure or function of the body’ includes both mental and physical functions. Accordingly, medical care can include tutoring and special schooling for learning disabilities but does not include things like elective plastic surgery for purely aesthetic reasons. There are some very specific circumstances when legal fees can qualify as a medical deduction if they were incurred to access medical care.

INCREASE in limitation for medical expenses
For 2012 and prior years, medical expenses for most taxpayers were limited to the amount in excess of 7.5% of Adjusted Gross Income (AGI). For those subject to Alternative Minimum Tax, that limit was 10%. 

OBAMACARE increases the AGI limitation to 10% for ALL taxpayers.
There are many out-of-pocket costs may cause you to exceed that limitation. Costs that can be deducted include:
  • Special Schooling including tuition or tutoring by someone especially trained to meet the child’s needs. The purpose and primarily reason for the choice of school must be to alleviate or remediate the disability.
  • Typical preschool education as the primary purpose is for socialization required because of developmental delays, not education.
  • Aides required for a child to benefit from regular or special education.
  • Special instruction, training or therapy such as OT, Speech, remedial reading, etc.
  • Diagnostic evaluations by qualified personnel.
  • Exercise program if recommended and monitored by qualified medical personnel to treat a specific condition, includes yoga, dance, horseback riding, etc.
  • Transportation: Mileage to and from special schools or therapy sessions. MEDICAL MILEAGE RATE WILL INCREASE TO 24 CENTS PER MILE FOR 2014. Also parking fees. Airfare for parents and child to obtain treatment or testing.
  • Lodging required to obtain medical treatment, limited to $50 per night, per person. Meals during medical travel are not deductible.
  • Diapers – if toilet training is delayed due to a medical condition.
  • Equipment or devices used primarily for the alleviation of a person’s illness – examples would be specially designed bedding, car seats, etc. Rev Ruling 76-80.
  • Home Improvements – costs are deductible to the extent they exceed any increase in the home’s fair market value [Reg. 1.213-1(e) (1) (iii)]. Certain improvements (e.g., altering the location of or otherwise modifying electrical outlets and fixtures are deemed to have no affect on the home’s fair market value and thus, the full cost can be claimed as a medical expense [Rev. Rul. 87-106, 1987-2 CB 67].
  • Lead Paint Removal – The cost of removing the paint can be deductible if the child has lead poisoning from the paint. Lead poisoning can resemble and complicate other conditions, such as autism.
Parents’ attendance at a disability related conference. This good news came in May 2000, in IRS Revenue Ruling 2000-24. Parents who attend conferences primarily to obtain medical information concerning treatment for and care of their child may include the following admission and transpiration costs. Related books and materials are deductible. Attendance is considered to be primarily for and essential to the care of the dependent if:
  • Attendance at the conference has been recommended by a medical provider treating the child. AND
  • The conference provides medical information concerning the child’s condition – specific issues not just general wellbeing. AND
  • The primary purpose of the visit is to attend the conference.
  • BUT … Costs of food and lodging are generally NOT deductible.

Special Diets

Many people do not realize that the additional costs of following a specifically prepared medical diet such as the gluten-free, casein-free diet can also be considered medical expenses. On March 24, 2011, the office of the Chief Counsel of the IRS issued a letter clarifying this issue.
“Specifically, the excess cost of specially prepared foods designed to treat a medical condition over the cost of ordinary foods which would have been consumed but for the condition is an expense for medical care…. Therefore, if a taxpayer can establish the medical purpose of the diet, such as through a physician’s diagnosis, then to the extent the cost of the food for the special diet exceeds the cost of the food that satisfies a taxpayer’s normal nutritional needs if the special diet were not required, the excess cost is an expense for medical care under section 213(d).”

Here is an example of a GFCF Diet Deductible Worksheet. You can also claim mileage expense for the trip to the health food store and postal costs on gluten-free products ordered by mail. Specific products used only for a gluten-free diet such as xanthan gum are 100% deductible. You should save all cash register tapes, credit card receipts, and canceled checks to substantiate your gluten-free and or casein-free purchases. You will need to prepare a list of typical foods at typical grocery store prices to arrive at the differences in costs. You need not submit your documentation or computations with your return, but do retain them with your other tax records.

Very Important – Attach a letter from your doctor to your tax return. This letter should state that your child suffers from a medical condition which requires a special diet.

Legal Expenses
Legal expenses incident to medical care have been allowed as a medical expense deduction only when the legal expenses are “necessary to legitimate a method of medical treatment” Levine v. Commissioner [83-1 USTC ¶9101].
This means that attendance at IEP meetings is not a deductible legal or medical expense. However, if you have to engage a lawyer to enforce an IEP or IFSP, that may be deductible, especially if you are suing the school to hire appropriate personnel.

Things to Consider:

Subsequent Reimbursement
If you anticipate reimbursement from a school district or insurance company for any of these costs, that reimbursement will be includable as income when received if the deductions are taken. That could raise your AGI in the subsequent year causing you to lose other deductions. Deciding when or if to take deductions is an important reason to see a qualified tax professional.

401K/IRA Funds
Medical expense, it can also be used to justify a “hardship” withdrawal from a 401(k) retirement plan [Reg. 1.401(k (-1(d) (3) (iii) (B)]. However, the amount not subject to the additional 10% tax penalty is only the amount over 10% of AGI. Regular tax must still be paid on all IRA/401K withdrawals. Generally withdrawing retirement funds is not a good idea due to increased taxes and penalties.

Cafeteria Plans
If your employer offers a cafeteria plan; you can use the funds in that account to pay for treatments for your child. All the items noted above under medical expenses (schooling, tutoring, therapy, conferences, etc.) may be paid out of such an account. Tax-wise this is the most advantageous option as you are paying for these items with pre-tax dollars and are not subject to the 10% limitation. But, OBAMACARE limits the annual contribution to $2,500.

Even better than deductions, credits reduce $ for $ the amount of tax owed.

Child and Dependent Care Credit
Covers work related expenses for dependents of taxpayer. Dependent must be under the age of 13. If the child requires supervision due to a disability, the age limit no longer applies. A dependent is considered to be physically or mentally incapable of self-care if the dependent is incapable of caring for his or her hygienic or nutritional needs, or requires full-time attention of another person for his or her own safety or the safety of others [Reg 1.44A-1(b)(4)].

Covered expenses – up to $3,000 per year per dependent are allowed, max for all dependents is $6,000. Amount does not need to be equal among children. Regular childcare, after-school programs and day camp qualify. Sleep-away camps do not. Credit is calculated at 20-35 percent of expenses, based on AGI. The maximum credit per dependent is $600 for one child, $1,200 for 2 or more.

Planning strategy – use the first $3,000-$5,999 of special schooling costs to claim this credit; any remaining costs can be deducted as medical expenses. At least $1 must be for the other child to claim more than $3,000.

Earned Income Credit

Families with AGIs under $51,567 may qualify for EIC depending on number of children and filing status. EIC is normally limited to children under age 19. If the child is 19-23 and a full-time student, then he or she also qualifies. As long as a severely disabled child lives with his or her parent, there is no age limit for EIC.

Higher Education

Tuition Credits
American Opportunity Credit is up to $2,500 per student, per year for first 4 years of post-secondary education. The credit can be up to 40% refundable. The student must be pursuing an undergraduate degree or other recognized educational credential, enrolled more than 1/2 time, and have no felony drug convictions. This credit has been extended to 2017.

The Lifetime Learning Credit is a maximum of $2,000 per return, for all post-secondary education and courses to acquire or improve job skills, unlimited number of years, no degree required. Unlike the American Opportunity Credit, the felony drug conviction rule does not apply.  The credit is computed as 20% of first $10,000 = $2,000.  However, there are limitations based on AGI. These benefits begin to phase out for higher income taxpayers at the lower number and are eliminated when AGI reaches the upper number.
American Opportunity Credit – $160,000 – $180,000
Lifetime Learning Credit – $100,000 – $120,000

Educational Expenses
Educational expenses may also be taken as a deduction. Tax return preparation programs generally maximize either credit or deduction. Maximum deductions are as follows:
  • $4,000 – AGI < $130,000
  • $2,000 – AGI < $160,000
  • None if AGI > $160,000
529 College Savings Plans
Contributions to a 529 College Savings Plan grow tax free until a child uses the funds. Qualified expenses include computers, software, room and board, which do not qualify for the above noted educational credits. Proper planning can maximize the use of educational credits, scholarship funds and withdrawals from 529 plans.

Important Limitation: If filing as Married Filing Separately, neither the education credits nor tuition and fees deductions apply. Also interest on student loans is not deductible.

IHSS Services (CA Only)
Your child may qualify for In Home Supportive Services. In which case, the State of California funds your child to employ you to take care of your child. You will receive a W-2 listing your child as your employer. As such, this income is not subject to Social Security or Medicare taxes but is subject to Federal and California income taxes. Do make sure you have adequately withheld for the income taxes.

NEW FOR 2014 – IHSS payments will no longer be subjected to Federal Tax. Read more here.

Respite Care (CA Only)
If you are a parent provider of respite care, you may receive a 1099 from the Regional Center. Attach a statement to your return showing the amount received, and the amounts paid to others, include any net amount on line 21 (other income) of your form 1040. If you paid more than $600 to any other provider, you should provide them with a 1099. If you paid household employees, there are additional payroll forms and taxes that if not filed can result in significant penalties, another reason to consult a qualified tax professional.

About Regina M. Levy, CPA
A CPA and a mother to a child with autism, she has been in private practice in West Los Angeles since 2002. She is a passionate advocate for increasing the quality of services for special needs children, especially those with autism. She is available for personal consultation and can be reached at

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