that may assist in and/or hinder this process. This article focuses on two common resources often utilized in financing medical care: home equity loans and distributions from retirement plans and individual retirement accounts (IRA).

OVERVIEW OF THE MEDICAL EXPENSE DEDUCTION

Only individuals itemizing deductions on their federal individual income tax returns can claim a medical expense deduction. Unreimbursed medical expenses are currently deductible only to the extent they exceed 7.5% of a taxpayer’s adjusted gross income or AGI as of 2017 (Sec. 213(a)). The 7.5% AGI threshold represents a permanent reduction in the AGI threshold as of 2021 under December of 2020’s Taxpayer Certainty and Disaster Tax Relief Act of 2020 (The Tax Cuts and Jobs Act “TCJA” had reduced the threshold for deducting medical expenses from 10% of AGI to 7.5%, but only for 2017 and 2018 originally with extensions of the 7.5% threshold occurring thru 2020.) Alternatively, parents who are eligible to participate in tax-advantaged plans through their employers for funding medical expenses, such as flexible spending accounts or health savings accounts, can set aside limited amounts of money to finance medical care expenses on a pre-tax basis while bypassing the AGI limitation. Unfortunately, pre-tax contributions are currently limited to $2,750 as of 2020, receiving annual indexed adjustments for inflation (Patient Protection Act, as amended by the Health Care and Education Reconciliation Act of 2010).

FINANCING OPTIONS FOR THE MEDICAL EXPENSE DEDUCTION

Treasury Regulation 1.213-1(e)(1)(v) permits the unreimbursed cost of attending a special school for an individual having an intellectual or physical disability as a medical expense deduction if the principal reason for the individual's attendance is to alleviate the disability through the resources of the school or institution. This deduction may also include amounts paid for lodging, meals, transportation, and the cost of ordinary education incidental to the special services provided by the school. Also, any costs incurred for the supervision, care, treatment and training of an individual with

a physical and/or intellectual disability are deductible if provided by the institution. Unfortunately, it is not uncommon for this expenditure alone to exceed tens of thousands of dollars.

Furthermore, qualifying capital expenditures, medical conferences and seminars, prescribed vitamin therapy, therapeutic assistance, various therapies, and special diets can add thousands of dollars to the medical expense deduction annually.

Barring savings, investments, and extended family assistance, many parents caring for children with special needs are often left with few choices for financing their child's medical expenses and resort to home equity loans and retirement plan distributions. These rules also apply to any taxpayer with significant unreimbursed medical expenses.

ARE HOME EQUITY LOANS STILL A VIABLE SOLUTION?

Families commonly borrow against their homes in financing their medical expenses. Although interest expense incurred on a home equity loan is no longer deductible as an itemized deduction, there are exceptions as discussed below.

In general, home equity loans represent borrowings other than the indebtedness incurred in acquiring a principal residence and/or a second home. Under prior law, in order to qualify the interest expense for an itemized deduction, the tax law limited home equity indebtedness to the lesser of:

The $100,000 limit, as well as the $1,000,000 limit on acquisition indebtedness, was applied on a per-taxpayer basis, and not as a per-residence limitation. These are separate limitations. The maximum amount of indebtedness qualifying for a mortgage interest expense deduction was therefore $1,100,000 ($550,000 for married couples filing separately) under prior law (Sec. 163(h)(3)).

Under the TCJA, the rules have changed (See Sec. 163(h)(3)(F): "Special Rules for tax

able years 2018 through 2025"). As of 2018, the home mortgage interest deduction is limited to acquisition indebtedness of $750,000 (from prior law's $1,000,000) for homes acquired after 2017. Further, the home equity loan interest deduction is being suspended through 2025. As of 2018, parents seeking an interest expense deduction for home equity indebtedness will only be permitted a deduction if the loan is to purchase, construct, or substantially improve a residence. A home equity loan interest deduction will be permitted if the parents secure the loan for medical capital expenditures (i.e., substantially improving the home) made to the home in accommodating the child with special needs (with total indebtedness limited to $750,000). However, utilizing a home equity loan to finance ongoing medical care will not result in an interest expense deduction.

EXAMPLE:

Michael Cynthia Plear made a $200,000 down payment and borrowed $550,000 to purchase a residence worth $750,000 in 2015. Their home is currently valued at $925,000 with an acquisition debt remaining of $500,000. In 2020, they borrow $200,000 to provide for the ongoing medical care of their 16-year-old daughter with special needs, and use their residence to secure this note.

They may deduct interest on the $500,000 of remaining acquisition debt only unless the $200,000 home equity loan was utilized to improve the home, such as a medical capital expenditure (e.g., installing an elevator or therapeutic swimming pool, constructing entrance ramps, widening doorways and halls, lowering kitchen cabinets, and adding railings.)

ARE RETIREMENT PLAN AND IRA DISTRIBUTIONS THE ANSWER?

In addition to obtaining home equity loans, families caring for children with special needs often take early distributions from their retirement plans, IRAs, and annuities to finance their medical expenses. Although a 10% penalty exists as a disincentive for early retirement and pre-retirement withdrawals (i.e., prior to age 59 ½), there are exceptions to the penalty for distributions not in excess of the medical expense deduction.