Whole Ball of Tax 2003

More Aid for Younger Dependents than Older Dependents

SANDWICH GENERATION FINDS LIMITED HELP IN TAX LAWS

(RIVERWOODS, ILL., January 2003) – A generation that has benefited from a wide variety of child-oriented tax breaks may soon be clamoring for new kinds of tax benefits as they find themselves increasingly responsible for their aging parents, according to CCH INCORPORATED (CCH), a leading provider of tax information and software. Many baby boomers now feel sandwiched between children who are not yet fully independent and parents who are becoming less so.

"The baby boom generation has grown up using the tax laws to help pay for their children’s day care, buy their homes and shelter their retirement funds. It’s only logical that they’ll look to the tax laws to help them shoulder the burden of supporting aging parents as well," said Mark Luscombe, JD, LLM, principal federal tax analyst for CCH.

The tax code currently provides a raft of benefits designed to offset the financial burdens of raising and educating children. From birth, children provide their parents with an extra personal exemption, which on 2002 returns knocks $3,000 off the family’s taxable income for each dependent child. The exemption lasts as long as the child remains a dependent.

The child tax credit directly reduces families’ tax burden by $600 for each eligible child in 2002 and, under some circumstances, can even produce a "refundable" credit. Children are eligible for the credit until they reach age 17.

Dual-income households and single parents benefit from the dependent care credit, which eases the cost of day care, nannies and pre-school. Many employers offer flexible spending arrangements that allow employees to pay for dependent-care expenses with pre-tax dollars.

There is an entire rainbow of education savings plans, credits and deductions to help parents defray the costs of educating their children. They start with Coverdell Savings Accounts, providing tax-free earnings on money set aside for education from kindergarten through graduate school. Then there are Section 529 savings plans for higher education, the Hope and lifetime learning credits, a deduction for higher education expenses and a deduction for student loan interest expense.

The law is less helpful to families caring in one way or another for aged relatives. Some relief is available for some expenses, but only after the taxpayer has cleared some fairly high hurdles. The first set of hurdles has to do with claiming a parent as a dependent, which entitles the taxpayer to claim an extra personal exemption and, perhaps, deduct the parent’s medical expenses.

To claim a parent as a dependent, the parent’s gross income cannot be greater than the personal exemption amount. Gross income is calculated in much the same way as it is in figuring the parent’s income tax, so all or part of their Social Security benefits will be excluded. Still, with the personal exemption at $3,000 for 2002 taxes, there will be some seniors with modest incomes who are nevertheless excluded by this test.

The second test has to do with support. To claim a parent as a dependent, the child must furnish more than half of the support for the parent during the year. Here, the full amount of the parent’s Social Security benefits is usually taken into account, not just the portion that is included in gross income for income tax purposes. On the other side of the ledger, if the parent lives in the child’s home, the child can count the fair market rental value of the parent’s lodging as part of the support they provide.

The law offers some help to families where brothers and sisters pitch in to help with their parent’s expenses, but where no individual sibling contributes more than 50 percent of their parent’s support. An individual can claim the parent as a dependent as long as he or she provided at least 10 percent of the parent’s support, no one else provided more than 50 percent of the support and everyone else who provided 10 percent or more of the support signs a declaration that they won’t claim the exemption.

If both tests are passed and if the parent is a U.S. citizen or lives in the United States, Canada or Mexico and, in addition, doesn’t file a joint return, the child can claim the parent as a dependent and take an additional personal exemption.

"The personal exemption helps in many cases where adult children provide major support to an aged parent or grandparent, but many people with serious expenses are not helped," Luscombe said. "Where both parents are living and file a joint return, for example, the dependent exemption is not available."

Establishing that a parent is a dependent is the precondition for another potential tax benefit – the ability of adult children to deduct the money they lay out for a parent’s medical expenses.

Even with Medicare, seniors can rack up significant medical expenses from items not covered, such as drugs and many of the expenses that are considered "qualified long term care" and are deductible as medical expenses, but are not reimbursable by Medicare.

The care needed by someone unable to bathe themselves or eat without assistance, for example, would normally qualify as deductible, but would be considered non-reimbursable "custodial care" under Medicare.

But there are hurdles to be crossed on the way to taking a medical deduction, as well. First of all, the taxpayer must itemize, which means that total itemized deductions have to exceed the standard deduction amount – $7,850 for 2002 returns – to receive any benefit.

Second, total medical deductions must exceed 7.5 percent of the taxpayer’s adjusted gross income before any deduction can be taken. So, for example, if a family had $60,000 in adjusted gross income and paid a total of $8,000 in medical expenses, including the medical expenses of one of their dependent parents, they could deduct only $3,500 – the amount by which their medical expenses exceeded the $4,500 "floor" established by 7.5 percent of their adjusted gross income.

Taxpayers who try to anticipate the need for long-term care – both for themselves and for their parents – face additional problems. Long-term care insurance typically covers the cost of care given either in a private home (home health care) or in a nursing home or similar facility. The tax laws currently limit the amount that can be deducted for this type of insurance, based on the age of the person being covered.

For 2002, you can deduct no more than $240 a year in premium expense to cover someone age 40 or less, $450 for those 41 through 50, $900 for those 51 through 60, $2,390 for those 61 through 70 and $2,990 for those 71 or older. The figures are adjusted annually for inflation.

Although many long-term care policies have premiums that fall within these limits, some, with high benefit levels and special features, may not be fully deductible. And although a child can purchase long-term coverage for a parent, the premiums for such a policy are deductible by the child only if the parent meets the tests for being a dependent. In addition, even if a policy is fully deductible in theory, a taxpayer still has to clear the usual hurdles for deducting any medical expense.

"It’s something of a Catch-22 situation," Luscombe remarked. "You probably want to line up long-term care insurance for your parents before they become dependent, and to keep medical costs from eating up their assets, but it’s not deductible then."

There is one other benefit available for people whose dependent adult parents live in their home. If the adult child works and has to pay for care of the parent to make their own employment possible, the expenses can qualify for the dependent care credit or for pre-tax payment through an employer-sponsored flexible spending arrangement.

"Just as with dependent care expenses for children, you have to decide whether the tax credit or pre-tax payment is more advantageous in your individual situation," Luscombe observed. "It may seem odd that paying someone to look after your mother while you go out to work is subsidized by the tax code, while caring for her yourself in your home is not, but it is consistent with how the law views caring for child dependents."

Measures to give more help to families faced with the expense and strain of providing care for aged relatives have been put forward in the recent past, but none have been passed into law so far. As a candidate, President George W. Bush proposed an additional personal tax exemption for each spouse, parent or relative that a caregiver tends to in his or her own home. He also endorsed making long-term care insurance 100-percent deductible by establishing an "above the line" deduction available to itemizers and non-itemizers alike. A bill to give caregivers a tax credit of up to $1,200 a year for each person cared for was introduced in the House in 2001, but died in committee.

All of the measures would address the major limitations imposed on the limited tax help currently available. None would require that the person being cared for be a "dependent" of the caregiver. All would avoid the requirement to itemize a deduction and the 7.5-percent "floor" for deductibility of medical expenses.

"The problem is there are many other areas where tax cuts have been proposed, and the federal deficit is growing," Luscombe observed, "However, the generation that’s affected is a significant segment of our society, and their concerns may well be addressed in any new tax legislation."

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, legal, securities, insurance, human resources, health care and small business markets. CCH is a wholly owned subsidiary of Wolters Kluwer North America. The CCH web site can be accessed at cch.com. The CCH tax and accounting destination site can be accessed at tax.cchgroup.com.

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