Long-Term Care, Residential Retirement Communities, Etc.
Tax Court Determines the Deductible Portion of Retirement Community Fees. – Independent
living units in continuing care residential retirement communities generally are available to
retirees without medical impairments serious enough to prevent them from caring for
themselves. Because residents of these units are generally entitled to long-term medical care,
a portion of the fees paid by the residents is generally deductible as a medical expense (subject
to the overall statutory limitations on medical deductions).
The Tax Court has now spelled out the method for determining the deductible portion of monthly
fees paid by the residents during a tax year. The first step is to compute a “medical services
percentage.” Generally, this percentage is equal to (a) the medical expenses incurred by the
retirement facility divided by (b) the total expenses incurred by the facility. The second step is to
compute the “average fees paid per resident” by dividing (c) the total monthly fees paid by all the
residents during the year by (d) the total number of residents.
Each resident may then deduct as medical expense (subject to normal overall limitations) an
amount equal to (e) the average fees paid per resident multiplied by (f) the medical services
percentage. Baker v. Commissioner, 122 T.C. 143 (2004). Although a resident may reasonably
expect the retirement facility to make these computations, the resident may want his or her tax
advisor to review the computations for accuracy. See Chapter 16 of the treatise for a discussion
of continuing care retirement communities..
Medical Deduction Denied for Entrance Fee Paid to Residential Retirement Community. – As
discussed above, many retirees reside in retirement communities that provide both residential
facilities and long-term medical care in return for a one-time entrance fee and subsequent
monthly fees. It is clear these retirees may take medical deductions for the portions of their
monthly fees allocable to the medical expenses of the facility. However, a deduction for a portion
of an entrance fee may be a bit more difficult to sustain. Based on the particular facts of a case,
a federal district court denied any medical deduction for an entrance fee on grounds the fee (1)
was primarily paid for the cost of the retirement community’s physical facilities and (2) had
many of the attributes of a loan to the community. (Finzer v. United States, ___ F. Supp. ___ (N.
D. Ill. July 20, 2007).) See Chapter 16 of the treatise for a discussion of continuing care
retirement communities.
Taxable Interest Not Imputed on Most Retirement Community Fees. – Contracts with
continuing care residential retirement communities frequently require community residents to
pay a substantial portion of their fees in advance. The tax law may construe some of these fee
arrangements as being, in substance, interest-free loans by residents that require the residents
to report imputed interest income for tax purposes. Fortunately, however, legislation has
substantially expanded a previously existing tax provision that limited the imposition of imputed
interest on the fees.
For years after 2005, a resident who is age 62 or older before the end of the tax year need not
report imputed interest income on fees the resident pays to a “qualified continuing care facility”
under a “continuing care contract.” The tax law defines the terms in quotations expansively
enough that most fees paid under contracts with continuing care residential retirement
communities will qualify for the exemption from imputed interest. (Tax Increase Prevention and
Reconciliation Act of 2005, Pub. L. No. 109-455, § 209; I.R.C. § 7872(h).) See Chapter 16 of the
treatise for a more complete discussion of residential retirement communities.
Tax Treatment of Long-Term Care Insurance Included in an Annuity or Insurance Contract. –
Qualified long-term care insurance generally provides income protection for chronically ill
individuals and reimbursement for the cost of qualified long-term care services. Qualified long-
term care services include personal care services prescribed by a physician, registered nurse,
or licensed social worker for a chronically ill individual. For example, the services provided in a
nursing home would normally constitute qualified long-term care services.
After 2009, the Pension Protection Act generally treats as a separate contract any qualified long-
term care insurance included in an annuity or life insurance contract (whether included by rider
or otherwise). However, this separate treatment will apply only to personally purchased
contracts, and not to contracts acquired in connection with employment. For post-2009 years,
application of the cash value of such a personally purchased contract to the cost of embedded
long-term care insurance will generally not be taxable. Instead, the reduction in cash value will
reduce the taxpayer’s investment in the contract. (As a consequence, the taxpayer will not be
able to take a medical expense deduction for the reduction.)
After 2009, the Act also authorizes the tax-free exchange of a life insurance, endowment, annuity,
or qualified long-term care contract for a separate or different qualified long-term care contract.
In addition, the tax law will continue to allow the tax-free exchange of (1) a life insurance contract
for an annuity or another life insurance contract and (2) an annuity or endowment contract for an
annuity contract. For all these purposes, a contract will qualify as an annuity or life insurance
contract (but not an endowment contract) even though it includes qualified long-term care
insurance.
See Chapter 16 of the treatise for a more complete discussion of long-term care insurance.
(Pension Protection Act of 2006, Pub. L. No. 109-280, § 844(a), (b), (c), (g); I.R.C. §§ 72(e)(11),
1035(a), 1035(b), 7702B(e).)
Trusteed Plans for Retiree Medical Expenses. – Some employment contracts provide for the
establishment of trusteed plans designed to pay medical expenses of retirees and their
families. Employers fund the plans with mandatory withholdings from pre-retirement wages.
The IRS generally treats the withholdings as employer contributions excluded from employee
gross income. Retirees, in turn, may exclude from their gross incomes any plan payments of
medical expenses or medical insurance premiums for them or for their spouses or
dependents. (Ltr. Rul. 200846011.) See Chapter 13 of the treatise for a discussion of employer
medical and dental plans for retirees.
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Tax Court Determines the Deductible Portion of Retirement Community Fees. – Independent
living units in continuing care residential retirement communities generally are available to
retirees without medical impairments serious enough to prevent them from caring for
themselves. Because residents of these units are generally entitled to long-term medical care,
a portion of the fees paid by the residents is generally deductible as a medical expense (subject
to the overall statutory limitations on medical deductions).
The Tax Court has now spelled out the method for determining the deductible portion of monthly
fees paid by the residents during a tax year. The first step is to compute a “medical services
percentage.” Generally, this percentage is equal to (a) the medical expenses incurred by the
retirement facility divided by (b) the total expenses incurred by the facility. The second step is to
compute the “average fees paid per resident” by dividing (c) the total monthly fees paid by all the
residents during the year by (d) the total number of residents.
Each resident may then deduct as medical expense (subject to normal overall limitations) an
amount equal to (e) the average fees paid per resident multiplied by (f) the medical services
percentage. Baker v. Commissioner, 122 T.C. 143 (2004). Although a resident may reasonably
expect the retirement facility to make these computations, the resident may want his or her tax
advisor to review the computations for accuracy. See Chapter 16 of the treatise for a discussion
of continuing care retirement communities..
Medical Deduction Denied for Entrance Fee Paid to Residential Retirement Community. – As
discussed above, many retirees reside in retirement communities that provide both residential
facilities and long-term medical care in return for a one-time entrance fee and subsequent
monthly fees. It is clear these retirees may take medical deductions for the portions of their
monthly fees allocable to the medical expenses of the facility. However, a deduction for a portion
of an entrance fee may be a bit more difficult to sustain. Based on the particular facts of a case,
a federal district court denied any medical deduction for an entrance fee on grounds the fee (1)
was primarily paid for the cost of the retirement community’s physical facilities and (2) had
many of the attributes of a loan to the community. (Finzer v. United States, ___ F. Supp. ___ (N.
D. Ill. July 20, 2007).) See Chapter 16 of the treatise for a discussion of continuing care
retirement communities.
Taxable Interest Not Imputed on Most Retirement Community Fees. – Contracts with
continuing care residential retirement communities frequently require community residents to
pay a substantial portion of their fees in advance. The tax law may construe some of these fee
arrangements as being, in substance, interest-free loans by residents that require the residents
to report imputed interest income for tax purposes. Fortunately, however, legislation has
substantially expanded a previously existing tax provision that limited the imposition of imputed
interest on the fees.
For years after 2005, a resident who is age 62 or older before the end of the tax year need not
report imputed interest income on fees the resident pays to a “qualified continuing care facility”
under a “continuing care contract.” The tax law defines the terms in quotations expansively
enough that most fees paid under contracts with continuing care residential retirement
communities will qualify for the exemption from imputed interest. (Tax Increase Prevention and
Reconciliation Act of 2005, Pub. L. No. 109-455, § 209; I.R.C. § 7872(h).) See Chapter 16 of the
treatise for a more complete discussion of residential retirement communities.
Tax Treatment of Long-Term Care Insurance Included in an Annuity or Insurance Contract. –
Qualified long-term care insurance generally provides income protection for chronically ill
individuals and reimbursement for the cost of qualified long-term care services. Qualified long-
term care services include personal care services prescribed by a physician, registered nurse,
or licensed social worker for a chronically ill individual. For example, the services provided in a
nursing home would normally constitute qualified long-term care services.
After 2009, the Pension Protection Act generally treats as a separate contract any qualified long-
term care insurance included in an annuity or life insurance contract (whether included by rider
or otherwise). However, this separate treatment will apply only to personally purchased
contracts, and not to contracts acquired in connection with employment. For post-2009 years,
application of the cash value of such a personally purchased contract to the cost of embedded
long-term care insurance will generally not be taxable. Instead, the reduction in cash value will
reduce the taxpayer’s investment in the contract. (As a consequence, the taxpayer will not be
able to take a medical expense deduction for the reduction.)
After 2009, the Act also authorizes the tax-free exchange of a life insurance, endowment, annuity,
or qualified long-term care contract for a separate or different qualified long-term care contract.
In addition, the tax law will continue to allow the tax-free exchange of (1) a life insurance contract
for an annuity or another life insurance contract and (2) an annuity or endowment contract for an
annuity contract. For all these purposes, a contract will qualify as an annuity or life insurance
contract (but not an endowment contract) even though it includes qualified long-term care
insurance.
See Chapter 16 of the treatise for a more complete discussion of long-term care insurance.
(Pension Protection Act of 2006, Pub. L. No. 109-280, § 844(a), (b), (c), (g); I.R.C. §§ 72(e)(11),
1035(a), 1035(b), 7702B(e).)
Trusteed Plans for Retiree Medical Expenses. – Some employment contracts provide for the
establishment of trusteed plans designed to pay medical expenses of retirees and their
families. Employers fund the plans with mandatory withholdings from pre-retirement wages.
The IRS generally treats the withholdings as employer contributions excluded from employee
gross income. Retirees, in turn, may exclude from their gross incomes any plan payments of
medical expenses or medical insurance premiums for them or for their spouses or
dependents. (Ltr. Rul. 200846011.) See Chapter 13 of the treatise for a discussion of employer
medical and dental plans for retirees.
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The author intends that this website provide accurate and authoritative information on the subject matter
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
covered. However, the information provided on this website is not a substitute for the advice of an attorney,
accountant, or other professional; and the author is not offering legal, accounting, or other professional
advice. The material presented on this website is not intended for use, and may not be used, to avoid tax
penalties. If you need legal advice or other professional help, you should seek (from an independent
attorney, accountant, or other competent professional) advice based on your own particular circumstances.
Key Tax Developments Affecting Retirees
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