Strange but True: Deduct Expenses That Others Paid
In a 2010 decision that is worth reviewing this tax season, the U.S. Tax Court concluded that a daughter could deduct medical expenses and real-estate taxes on her Form 1040 even though they were covered by gifts from her mother. The gifts were in the form of direct payments by the mother to the medical service providers and local government entities.
The Tax Court’s decision (Judith Lang, TC Memo 2008-286) may surprise you, because you probably think a taxpayer can never deduct expenses that were paid by someone else. Not necessarily true!
Since it is now tax-return time, let’s put this in the context of how it might affect your 2014 Form 1040.
Medical Expenses
For the 2014 tax year, you can generally deduct medical expenses to the extent they exceed 10% of your adjusted gross income (AGI), or 7.5% of AGI if either you or your spouse was age 65 or older as of Dec. 31, 2014. AGI is the number at the bottom of the first page of your Form 1040; it includes all taxable income items and selected deductions such as the ones for alimony paid, self-employed health-insurance premiums and moving expenses.
In this Tax Court case, the Internal Revenue Service argued that the daughter couldn’t deduct the medical expenses because she didn’t pay for them with her own money. The Tax Court disagreed. The facts of the case demonstrated that the mother intended the medical-expense payments to be gifts to her daughter. Therefore, the Tax Court characterized the transactions as gifts from the mother to the daughter followed by payment of the medical expenses by the daughter with the gifted funds. So the daughter was allowed to count $24,559 of medical expenses that were actually paid by the mother plus some expenses the daughter paid with her own funds in calculating her medical-expense deduction.
Thanks to the tax-law exemption for gifts that are made in the form of direct payments to medical service providers, the payment of the daughter’s medical expenses had no gift-tax consequences for the mother.
Important point: When you directly pay medical expenses for a person who is your dependent (meaning you pay over 50% of that person’s total support), you can add the expenses you pay for the dependent to your own expenses and claim a deduction for the total to the extent it exceeds the applicable percent-of-AGI threshold. In the Tax Court case, the daughter was evidently not the mother’s dependent, so the deduction for the daughter’s expenses belonged to the daughter rather than the mother.
Real-Estate Taxes
The daughter in the Tax Court case was also allowed to claim an itemized deduction for $5,508 of local real-estate taxes that were paid by the mother plus some taxes that the daughter paid with her own funds. Thanks to the annual federal gift-tax exclusion (currently $14,000), the mother’s payment of the real-estate taxes had no gift-tax consequences, because the amount involved was less than the gift-tax exclusion that applied for the year in question.
Seller-Paid Points for a Home Mortgage
Assuming you itemize deductions, you can write off points (including loan-origination fees) that you pay to take out a mortgage to buy your principal residence. Surprisingly enough, you can also deduct mortgage points paid by the seller to sweeten the deal. In fact, IRS Revenue Procedure 94-27 actually requires you to claim the deduction. Don’t ask why! Just follow directions and claim that deduction, even though the seller paid for it.
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