Chronic illness is more prevalent than many believe. Cognitive decline can occur suddenly as a result of an accident, or subtly over time; in either case, advance planning can avoid problems later. CPAs are uniquely positioned to help individuals prepare financially for the unexpected onset of chronic illness and to protect them after a diagnosis. The author suggests several critical measures, including the establishment and management of trusts as well as planning for the tax consequences.
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Chronic illness is far more common than most people realize; 130 million Americans live with some form of long-term malady. More than 5 million Americans have Alzheimer’s disease (which accounts for approximately 70% of dementias in Americans age 71 or older), more than 400,000 live with multiple sclerosis (MS), and as many as 25 million Americans may be living with chronic obstructive pulmonary disease (COPD). Furthermore, 22% of the population is estimated to be living with two or more different chronic illnesses. The incidence of these conditions will only become more common as the U.S. population ages.
Helping individuals deal with the challenges of chronic illness and aging requires professional advisors to provide more than just routine tax compliance services. Many CPAs involved in estate planning presume that if a client has a financial power of attorney (to address financial, tax, and legal matters if the client is disabled) and a healthcare proxy (to address healthcare decision making if the client is incapacitated), planning for disability and aging is complete. These steps, while certainly essential, barely scratch the surface of what individuals with chronic illness need.
Being the Trusted Advisor
In repeating the refrain that CPAs are the most trusted business advisors, the AICPA has pointed out the many roles and services that CPAs can and should provide to individuals facing chronic health challenges. Paramount among these is the maintenance of books and records. Elder financial abuse is epidemic, and by organizing and maintaining financial records, CPAs can provide an objective safeguard from such abuse, hopefully identifying it in its earliest stages and acting to stop it.
Many aging individuals rely on successor trustees under a revocable trust or an agent under their power of attorney to manage their assets. Generally, these people are family members who have little or no financial background. Few have any idea that they are required to maintain records to meet their fiduciary obligations. Even apart from legal requirements, maintaining records is essential to proper tax reporting, budgeting, and minimizing the concerns of other family members. CPAs should encourage all aging or infirm clients to permit them to begin reviewing, and eventually maintaining, financial records before it becomes absolutely necessary. This will give a CPA the opportunity to develop records and guide the individual before problems arise. It will also minimize the financial risks when a successor trustee or agent eventually takes over the financial reins. This passing of the baton often marks the point at which elder financial abuse or other problems occur.
Elder financial abuse is epidemic, and by organizing and maintaining financial records, CPAs can provide an objective safeguard from such abuse.
Some CPAs dismiss the above services as bookkeeping work or limit such work to ultra–high-net-worth individuals receiving family office services. This is too narrow a view, and one that is detrimental to the individuals involved. The write-up work for an elderly or chronically ill individual is vital to that individual’s security and should over time expand to include more value-added services like bill payment and review. For example, an elderly or ill client will often not understand his property, casualty, and liability coverage. Unless the insurance agent or a proactive wealth manager is involved, vital protection needs may be missed. Furthermore, if the individual requires home health aides, are they being paid properly? If the aides work overtime, is that addressed? Does the individual have an appropriate workers’ compensation insurance policy? What about an employment practices policy? These are all important questions.
What might have begun as a simple 1040 account can grow through phases to become a bookkeeping account, bill paying account, and a later life-consulting account. Even many clients that are sensitive to fees on a 1040 preparation may not be so on later services as they become more tailored and personalized.
The use of a revocable trust naming a trust protector will be a common planning tool for these individuals. This role has been commonly used to provide a check and balance on the trustee charged with protecting an aging individual. A CPA with a long history and knowledge of the client, family finances, and the family is ideal for this role. This role may also be a good fit for senior partners who retire, as it can be done on a part-time basis, it requires the knowledge and personal life experience such a partner is likely to have, and it does not compete with any of the services provided by the partner’s former firm.
Income Tax Considerations and More
Many common deductions, credits, and income inclusions and exclusions have special income tax rules that are often favorable but complex and not always well known. While many of these may be affected by future tax legislation, currently there is a broad array of issues affecting chronically ill or aging individuals. When CPAs explore these questions, they will often find that no one, not a family member nor other professional advisor, has broached such issues with the client. Even when the discussion begins with income tax considerations, it can lead to a broader, more meaningful conversation.
Can an individual claim an ill parent or other loved one confined to a nursing home as a dependent? If the individual is the aging or infirm parent, can or should an adult child or other person providing financial assistance claim her as a dependent? Be alert to the relationship and manner of financial assistance offered. If one of three children is providing financial help, does the individual’s will address that disparity? Are there independent records of the help provided to deflect a challenge by the other children that the child providing financial help really acted in a calculated manner to enrich himself?
Long-term care costs.
Are the costs that the infirm individual is incurring for qualified long-term care, including nursing home care, deductible as medical expenses? What planning can be done to maximize the deductions? Does the individual have long-term care insurance coverage? What arrangements have been made to avoid a lapse in the coverage for failure to pay the policy? The lapse rate on long-term care coverage is surprisingly high, and the major cause is incapacity, the very reason for purchasing the coverage. If there is coverage, when was the policy last reviewed? Does the individual understand what it provides for? Too often, the consultant who sold the policy loses contact, leaving no one to assist with monitoring the policy.
Medical expense deductions.
What affirmative steps can an individual take to enhance the likelihood that certain expenditures will qualify as deductible medical expenses for tax purposes? How can a taxpayer prove that an otherwise personal expense is for medical care? What is the motive or purpose for incurring the expense? Has a physician recommended the item or expense to treat a diagnosed medical condition? Has this been confirmed in writing? Can the taxpayer establish that the item would not have been bought but for the disease or illness? The “but for” requirement is not something many people understand, and often modest planning can enhance a deduction (see IRC section 213). If there are significant medical expenses, has the individual properly applied for insurance reimbursement? Does the individual understand the healthcare coverage? Some aging or ill clients may benefit from an evaluation of these matters by a care manager.
If a disabled taxpayer buys a car specifically designed to compensate for her disabilities, the portion of the price attributable to its special design is a medical expense (Revenue Ruling 76-80, 1976-1 CB 71). Another consideration for aging or ailing individuals is whether they should be driving at all. Has someone tested the individual’s vision to determine that, for example, night driving should be avoided? Who is guiding the individual on these matters?
Tuition and adult-dependent children.
The cost of a special school for a handicapped dependent may be deductible as a medical expense if the principal reason for attendance is the institution’s special resources for alleviating the handicap; room and board supplied by a special school are included as deductible expenses [Treasury Regulations section 1.213-1(e)(1)(v)(a)]. If the dependent child is an adult, has he signed a power of attorney and health proxy authorizing someone to assist? If he lacks the ability to do so, has or should an adult guardianship proceeding be brought to ensure that someone has the legal authority to assist? Often when parents care for a child with special needs, they overlook the legal implications of the child becoming an adult.
A taxpayer can deduct the cost of special equipment and home improvements if the main purpose is for medical care.
A taxpayer can deduct the cost of special equipment and home improvements if the main purpose is for medical care. These can include adding an accessible entrance ramp, installing a lift, widening doorways, building handrails, and modifying cabinets. The deduction is limited if the improvements increase the value of the home or were for personal motives such as aesthetic reasons. Many individuals have done little to make their home or apartment safer to live in; often simple and obvious steps that can have a huge impact with limited cost are overlooked. If the individual faces significant challenges, suggest hiring a care manager to do an in-home assessment. This can help in the formulation of a care plan and provide specific recommendations of home safety measures. Few infirm individuals understand the broad and significant role a care manager can play, instead often believing (incorrectly) that a care manager is only necessary to determine whether the individual should be admitted to a nursing home.
Home sale exclusion.
The general rules of exclusion for a home sale are modified to provide flexibility in the event of illness. In the case of a taxpayer who becomes physically or mentally incapable of self-care, owns property, and uses such property as the principal residence for periods aggregating at least one year during a five-year period, such property is treated as the taxpayer’s principal residence during any time during such five-year period in which the taxpayer owns the property and resides in any licensed facility (including a nursing home) to care for an individual in the taxpayer’s condition [IRC section 121(d)(7)].
Certain disability-related payments, such as Veterans Administration disability benefits and Supplemental Security income, may be excluded from gross income. Gross income also does not include amounts received on account of personal physical injuries or physical sickness [IRC section 104(a)(1)]. This includes amounts received under workmen’s compensation acts, the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments), and amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance).
Planning for individuals living with chronic illness is quite similar to the planning appropriate for aging individuals.
Impairment-related work expenses of an employee with a physical or mental disability limiting employment may be deductible. These costs are deducted as business expenses instead of medical expenses, which avoids the 7.5% limitation that might otherwise prevent a deduction. The expenses must be necessary for the taxpayer to work, and are claimed on Form 2106 for an employee and Schedule C for the self-employed [IRC section 67(b)(6)].
It is important to address the income taxation of settlements proactively, preferably prior to settlement. Suits brought against an employer or partners for discrimination, damages, or back wages are common, and the amounts must be allocated to each tax category, as the tax impact can be significant. Legal fees may be deductible, avoiding the AMT trap that would otherwise eliminate a deduction. IRC section 62(a)(20) may permit deduction against adjusted gross income. When an individual is negotiating a settlement, a CPA should be certain that all possible economic arrangements have been considered. Is the individual also subject to an employment agreement, separate buy-sell agreement, or personal disability policy? All arrangements that might be implicated should be reviewed.
Lack of Capacity
Chronic illness and aging may lead to cognitive declines that can affect an individual’s need for services, as well as her ability to retain and interact with professional advisors. This is an area of vital importance that is often marked by misconceptions. Cognitive decline is too often erroneously viewed as an on/off matter—that is, the client is competent, then the client is incapacitated. The reality is that, barring an acute medical event or a traumatic injury, cognitive decline occurs over the course of many years, or even decades, through slow and often imperceptible declines. The fact that a client cannot balance a complex brokerage statement does not mean that the client cannot make other life decisions. Therefore, safeguards should be put in place before they are needed.
The determination of capacity is a legal matter, not a medical matter, although the attorney making that determination may rely on medical documentation and opinions. Thus, if a CPA wants to corroborate a major client decision (e.g., to sell a life insurance policy, or even to retain the CPA firm), obtaining the opinion of the client’s attorney is the ideal approach.
Undue influence is also often confused with a lack of capacity. The individual may have sufficient capacity to make financial and other decisions, but a home health aide, overreaching child, or other person may be unreasonably and inappropriately pressuring him to make biased or inappropriate decisions. In such cases, it is important to help the individual protect his interests, and identify and remove the malefactor. CPAs must of course also take care not to become undue influences themselves.
A Chance to Help
Planning for individuals living with chronic illness is quite similar to the planning appropriate for aging individuals. Thus, as the U.S. population ages over time, an increasing number of people will benefit from similar planning services. For CPAs, this can provide a valuable practice development opportunity. This will require the marketing and provision of new services, and consideration of alternate billing methods. CPAs, as the most trusted professional advisors, can meet many of these needs.