TAX CONSIDERATIONS IN PLANNING FOR LONG-TERM CARE
by: Begley Law Group
by Thomas D. Begley, Jr., CELA
Long-term care in New Jersey is expensive. According to Genworth, in 2017 monthly costs of care in New Jersey were as follows: homemaker services – $4,195, home health aide – $4,385, assisted living facility $5,811, semi-private room in nursing home – $10,038, and private room in nursing home – $10,798. Many clients plan for long-term care. Tax considerations are vital when doing this planning.
Tax Impact of Long-Term Care Planning Strategies
The strategies involved in qualifying for Veterans benefits and Medicaid involve spending down and transferring assets. However, there are a number of tax consequences, which must be considered in long-term care planning. These include, but are not limited to, the following:
- Medical Deduction. The new tax law left, in effect, a medical deduction. Most long-term care qualifies for the medical deduction. To be eligible for the exemption, the aggregate medical expense for the filer for the year must exceed 7.5% of adjusted gross income.
- Medical Deduction – Relative. A person can claim a medical deduction for medical expenses paid on behalf of a relative, if the person provided over half of the relative’s total support for the calendar year.
- Carryover Basis. In determining which assets to transfer and which assets to retain, consideration must be given to the fact that the donee of a gift receives “carryover basis.” This means that the cost basis of the donee is the same as the cost basis of the donor. Therefore, when the transferred assets are sold, the donee must pay capital gains tax. The best strategy is, usually, to transfer unappreciated assets to the donee, and reserve appreciated assets for the donor to use for payment for care or transfer the appreciated assets to a Grantor Trust designed to make the assets unavailable. That way, any gain on the sale of the appreciated assets can be offset by deducting the cost of the nursing home from income tax.
- Step-Up In Basis. Assets forming a part of the estate of a decedent are included in that person’s estate for federal estate tax purposes. The beneficiary of the estate receives a “step-up” in basis with respect to those assets so that the beneficiary’s new basis is the fair market value of the assets as of the date of the death of the decedent.
- Retirement Plan. If a person has a retirement plan, such as an IRA or savings plan, the withdrawal of funds from that account is a taxable event. If some period of private payment for long-term care services is required, it makes sense to use the money in the retirement plan for this purpose. The medical deduction for the qualified long-term services can be used to offset the taxable income resulting from the withdrawal from the retirement plan.
- Deferred Annuity. The withdrawal of funds from a deferred annuity is a partially taxable event. That portion of the payment representing the initial purchase price of the annuity is a return of principal and is non-taxable, but the accrued income is taxable. If some period of private payment for long-term care services is required, it makes sense to use the money in the annuity for this purpose. The medical deduction for the qualified long-term care services can be used to offset the taxable income resulting from the withdrawal from the annuity. Transfer of ownership of an annuity to a third party triggers the tax on the deferred interest.
- Interest on Series E, EE and I Bonds. At the time a person redeems Series E, EE, or I bonds, the person will have to pay an income tax on the accumulated interest.281 The same is true if that person transfers the bonds to another person. The transfer triggers the tax on the deferred interest. All other things being equal, it would be better not to cash in the bonds until the proceeds of sale of the bonds are needed to pay for long-term care because the medical deduction for the long-term care expense will offset the taxable income from the redemption of the bonds.
- Domestic Help Income and Withholding. Income paid to a caregiver for services is ordinary income. Whether the income is characterized as income from employment or from self-employment depends on whether the caregiver is an employee or an independent contractor. If the caregiver is treated as an employee, the employer pays the employer’s share of the employment tax. If the caregiver is an independent contractor, he or she is self-employed and pays the self-employment tax. Withholding of Social Security and Medicare taxes is required of all domestic employees receiving cash wages of $2,000 or more in a calendar year.
- Gain on Sale of Home. There is an exclusion from gross income for the sale of a principal residence if the property was owned and used by the taxpayer as the taxpayer’s principal residence for two of the five years preceding the date of the sale. The amount of the gain excluded is $250,000 for a taxpayer filing individually and $500,000 for taxpayers filing jointly. In the case of married couples, the ownership requirement can be met by either spouse, but both spouses must meet the use requirement, and neither spouse can have claimed the exclusion during the two-year period ending on the date of the sale.
- Gift Tax. If transfers are made in excess of $15,000 per person per year, then a Gift Tax Return will have to be filed by April 15th of the calendar year following the date of the gift. There is an annual exclusion for gifts of $15,000 per person per year or less. There is a unified estate and gift tax exemption equivalent of $11,180,000 for an individual and $22,360,000 for a married couple, therefore no tax will be due for gifts that do not exceed the amount of this exemption equivalent. There is no tax due from the recipient of the gift. The annual exclusion gift is indexed for inflation.