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February 24, 2005
TAXES – CLAIMING A PARENT AS A DEPENDENT
Last week I gave a talk to the National Academy of Elder Law Attorneys about tax issues affecting the elderly. One of the interesting questions raised was; How to claim a parent as a dependent which allows the child to be able to claim the parent’s medical expenses as a medical deduction on the child’s income tax return.
Claiming your parent as a dependent entitles you to their personal exemption ($3,100 for 2004) as well as being able to deduct their medical expenses. You must meet all of the following five dependency tests to claim your parent as a dependent:
1) Member of Household or Relationship Test. - A parent qualifies under the relationship test, however, a foster-parent does not. The parent does not have to live with the child.
2) Citizen or Resident Test – This test simply requires that the parent be either a resident or a U.S. Citizen. If the parent is in the United States, you pass this test.
3) Joint Return Test – This test requires that the parent not file a joint return. If there is a spouse, they would have to file as married filing separate.
4) Gross Income Test – Generally, you cannot take an exemption for a dependent if that person had gross income of $3,100 or more. For this purpose, gross income does not include social security income and other tax-exempt income.
5) Support Test – You must provide more than half of a person’s total support during the calendar year to meet the support test. More on this later.
The first three tests are fairly easy to pass for elders who are considered single for tax purposes. The Gross Income test is really the first hurdle that you have to clear. If the elder has a pension plan that pays him/her more than $3,100, you can stop reading, because you don’t qualify. Social security as well as other tax-exempt income is not counted as gross income.
PLANNING IDEA - Let’s say the elder has $3,500 in interest income and social security of $12,000 per year. Because the interest income is more than $3,100, the elder does not qualify as a dependent. But….change the investment to a Mass municipal bond fund and the income becomes exempt and now the senior will qualify.
Passing the support test is the next hurdle. Keeping accurate records is important to support the deduction in the event of an audit. The basic idea is to figure out how much the elder actually spent on their support, then figure how much the child has spent for the parent’s support. If the child has spent more than 50% of the total, the test is passed. If the parent also gets support from the Commonwealth, this also becomes part of the parent’s total support.
To figure out how much the parent spent on support, probably the simplest way is to add up their annual income and then subtract the amount of money that they saved and gave away. The balance would be the amount of money that they spent on themselves. If the parent owns the home they are living in, you must include as part of their self-support the fair market rental value of their home. This is considered support that they provided for themselves.
The child needs to keep track of checks that were paid to the parent or for their benefit. The IRS maintains that only expenditures necessary for essential support; food, housing, clothing, education, health and transportation qualify toward the 50% support test. If the parent lives in the child’s home rent free, the child is considered to have provided support in an amount of the fair market rental value of the property.
If the parent receives benefits from the Commonwealth for items such as food stamps or a housing allowance, these would be considered support provided by the Commonwealth and taken into consideration in determining total support.
If you have been able to pass all of these five tests and claim the parent as your dependent, you are now also entitled to deduct all of the medical expenses that you paid for their benefit.
EXAMPLE: Mary is 86 years old and is residing in an assisted living facility. Mary is doing fairly well but due to a stroke she needs some assistance with her activities of daily living. Mary’s rent is $4,000 per month. Because she needs assistance with at least two of the activities of daily living all of the expenses of the assisted living facility are considered medical expenses. Her annual income consists of $12,000 for social security and $3,400 of Mass Municipal bond interest that was all spent on her own support. Danny, Mary’s son, lives with his wife and file a joint tax return. Their combined income is $100,000. Danny has paid $35,000 to the assisted living facility toward Mary’s rent in 2004.
In order for her son, Danny, to claim Mary as his dependent and claim all of her medical costs the five support tests must be passed. The first three tests are easily passed. Because all of Mary’s income is tax-exempt, she passes the gross income test. Now comes the support test. Mary is considered to have spent all of her income, $15,400 on her support. Danny has paid $35,000 of Mary’s assisted living costs. Because Danny has provided more than one-half of Mary’s support, he may claim her as a dependent and claim the $35,000 paid to the assisted living facility as a medical deduction on his tax return.
Danny is in the 25% tax bracket for federal income taxes and 5% for state taxes. Medical expenses are deductible on both the federal and state income tax returns. Danny’s tax savings would be computed as follows:
Medical expense $35,000
Personal exemption 3,100
Total additional deductions $38,100
Tax rate 30%
Tax Savings $11,430
As this example shows, the potential for tax savings is significant and would apply to many families that have a parent who is chronically ill and receives financial aid from a child. This situation could arise when the chronically ill parent is living at home, in assisted living or in a nursing home. The potential for the parent’s children to get this tax break is just one of many factors to be considered in estate planning for elders living in Massachusetts. For more information about claiming a parent as a dependent, see IRS Publication 501, Exemptions, Standard Deduction and Filing Information.
This article gives general information and not specific advice on individual matters. Persons wanting individualized advice on matters discussed should contact an advisor experienced in those matters. To the extent this article provides information on legal matters, it is based on law in effect in Massachusetts on the date of posting (laws in effect in other states are often quite different).
Ronald H. Surabian is a CPA and attorney who works at the Elder Law Center in Saugus, Ma. He also holds a masters in accounting and a masters in tax law. He currently serves on the board of directors of the Massachusetts Chapter of the National Academy of Elder Law Attorneys.