In many families, younger members help care for older members for at least a brief period. Care can take several forms. It could involve financial help for at-home services or residence at an assisted living or other facility. Care also could involve personally providing a person’s needs in either the caretaker’s home or in the cared-for person’s home.
There are financial and tax consequences to each form of care. Families should pay attention to the details and rules partly to ensure they receive maximum benefits and partly so each member will feel he or she is treated fairly.
When financial assistance is provided tax benefits might be available. For example, it might be possible to claim a dependency exemption for the relative or to deduct medical expenses paid.
Suppose Max Profits is helping his mother, Minnie. Max can claim Minnie as a dependent if several tests are met. Minnie’s taxable income cannot exceed the exemption amount ($3,650 in 2009).
Social Security benefits and tax-exempt interest generally are not included in the income test. If Minnie has savings or investments, Max might qualify for the exemption if Minnie switches investments from taxable instruments to tax-exempt bonds or mutual funds.
In addition, Max must provide more than half of Minnie’s support for the year. Support is living expenses such as clothing, housing, education, medical expenses, recreation, and transportation. If Minnie lives with Max, the fair market rental value of the housing is included in the support amount.
The Profits will have to keep track of the amounts spent on Minnie’s support during the year and might have to plan payments near the end of the year so Max meets the 50% test. For a list of which expenditures qualify as support, check free IRS Publications 17 and 501, available at the web site www.irs.gov. Minnie also must be a U.S. citizen or resident of North America.
Max can claim a relative as a dependent even if the relative does not live with him. Relatives for this purpose are parents, step-parents, parents-in-law, grandparents, great-grandparents, and aunts and uncles. Anyone else can be a dependent only if he or she is a full-time member of the household during the year.
Minnie also cannot file a joint tax return with another taxpayer, unless the return is filed only to receive a tax refund and there is no tax liability for the year.
If Max qualifies for the exemption, it is phased out if he is a high income taxpayer. The phaseout begins in 2009 for married couples filing joint returns with adjustable incomes above $250,200 and single taxpayers with incomes above $166,800. No exemption is allowed to taxpayers who are subject to the alternative minimum tax.
When several siblings share the support of someone, none might meet the 50% support test. In that case, it still is possible for one of them to claim the exemption. All the siblings must sign IRS Form 2120, Multiple Support Declaration, agreeing on which one of them may claim the exemption. That person files the form with his or her tax return. Each signer of the form must contribute at least 10% of the person’s support for the year. The siblings can adjust their contribution amounts to reflect that one of them will benefit from the exemption.
The sibling claiming the exemption can be rotated each year, or the same person can claim the exemption. Be sure that a high-income person or one subject to the AMT is not designated to take the exemption.
If a taxpayer can claim a dependent exemption for someone, the taxpayer also can deduct medical expenses he or he paid for that person. Medical expenses paid also might be deductible even if the person for whom they were paid cannot be claimed as a dependent.
Let’s go back to Max and Minnie. Suppose Minnie qualifies as Max’s dependent except for the income test. In that case, Max cannot claim Minnie as a dependent. But he can deduct any of Minnie’s medical expenses that he pays. To ensure the deductions, Max should pay the medical providers directly instead of reimbursing Minnie.
When Max qualifies to deduct Minnie’s medical expenses, he adds those expenses to the rest of his and his family’s medical expenses. If he itemizes deductions, then he deducts those that exceed 7.5% of his adjusted gross income. When siblings have a multiple support agreement, the one claiming the exemption should pay and deduct the medical expenses, because the others won’t be allowed to deduct any medical expenses they pay.
There are more than tax deductions to consider. In many cases an adult child will care for a parent in one of their homes. This form of help is likely to increase in the current economic environment, since fewer families will be able to pay for home care or a residential facility.
Even when one family member cares for another, there usually is some financial exchange. Sometimes the caregiver is paid directly and on a regular basis. Other times there is an agreement that the caregiver will receive special treatment in the will.
When a family member is a caregiver for another, there should be a written caregiver agreement. The agreement ensures there are no misunderstandings, everyone in the family knows the terms, and tax benefits are maximized. An agreement is important in every case but is especially important when there are siblings of the caregiver.
When a family member cares for another and there is a financial payment of any sort, the payments are not tax-free gifts. Any payments are compensation for services and must be included in the gross income of the recipient. This is true whether the payments are made periodically like a salary, in a lump sum, or as an additional inheritance.
The agreement also is important if the person cared for hopes to qualify for Medicaid nursing home treatment some day. Medicaid is available only to people with income and assets below certain levels. Gifts made in the five years before the Medicaid application are added to the person’s net worth to determine if the asset limit is reached. But compensation for personal care is not a gift. Compensation paid to a relative is not considered a gift by Medicaid if the payments are made under a caregiver agreement that was written in advance and the compensation amounts are reasonable and arms-length.
Thus, caregiver agreements are a way to eventually ensure eligibility for Medicaid.
The written agreement also helps avoid an IRS finding that the transfers were gifts. Gifts above the annual exclusion amount ($13,000 in 2009) are taxable or reduce the lifetime gift and estate tax credit.
A caregiver agreement, also known as a personal service or personal care contract, should have a number of elements.
The duties of the caregiver should be specified. Spelling out the details is a way of proving the compensation is reasonable and reducing misunderstandings over services to be performed. The amount of compensation must be stated as well as the frequency and form of payment.
Typical services include preparing and serving meals, making sure medication is taken, keeping the house clean and maintained, paying bills, and running errands. There needs to be an agreement over which tasks will be personally performed by the caregiver and which will be performed by others but arranged and supervised by the caregiver. It must be clear who will pay for third party services.
The compensation should be reasonable and based on the average hourly rate charged by others in the locality for similar services. There can be a family discount from the market rate but not a premium. The compensation also should be reasonable based on the caregiver’s skills. The hourly rate for a registered nurse cannot be used for someone without the credentials. Some family members want only to be paid for their out-of-pocket costs plus a small amount for their time, and that is reasonable.
The payor of the compensation might be required to withhold and report Social Security and other taxes. The recipient will report compensation as gross income. The details will determine if the caregiver is an employee or independent contractor, and that changes the withholding and reporting responsibilities.
The agreement should be discussed with other family members for input and to avoid misunderstandings. While having the agreement drafted, be sure the person cared for has an estate plan, including a financial power of attorney, medical care power of attorney, will, and other appropriate documents.