Frequently Asked Questions: Tax Coverage of Expenses for Personal Assistance Service (PAS). August 2009
Steve Mendelsohn, J.D.
Michael Morris, J.D.
Burton Blatt Institute at Syracuse University
Center for Personal Assistance Services
The following questions and answers have been prepared by Steve Mendelsohn, Michael Morris and Alex Spigelman, a legal research team at the Burton Blatt Institute at Syracuse University, as part of a subcontract with the Center for Personal Assistance Services at the University of California, San Francisco. For answers to individual situations, the authors of this Information Brief recommend you consult appropriate accounting and legal professionals.
- How can I deduct or exclude from income expenses for PAS?
- What are my options to consider for favorable tax treatment?
- Medical Expenses
- Long-term Care (LTC) Insurance Payments Exclusion
- Household and Dependent Care Credit
- Waiver of Retirement Fund Premature Withdrawal Penalties
- Tax Benefits For Employers And Employees - Disabled Access Credit
- Impairment-Related Work Expenses
- Flexible Spending Account
- Dependent Care Assistance Plan
- Must one itemize in order to receive favorable tax treatment for PAS expenses?
- Are the tax benefits employment linked?
- Does it matter where the PAS is provided?
- How could tax policy be improved to better handle PAS expenses?
Q 1. How can I deduct or exclude from income expenses for PAS?
There is no single definition of Personal Assistance Service (PAS) within the Internal Revenue Code, and no deduction for "personal assistance services" as such. But there are eight different Internal Revenue Code provisions that can cover some or all of the services constituting PAS for various people and under various circumstances. The nature of the tax benefit will differ. In some cases the tax benefit will take the form of an itemized deduction; in other cases a personal credit. In still other cases, it will involve the exclusion from taxable income of money received for the purchase of services or of the value of direct services provided by a third party.
Q 2. What are my options to consider for favorable tax treatment?
There are eight tax provisions to consider. They are designed as tax benefits for individuals (provisions (1) through (4)) and tax benefits for employers and employees (provisions (5) through (8)):
- Medical Expense Deduction -- 26 USC §213
- Long-term Care Insurance Payments (Exclusion) -- 26 USC §7702B
- Household and Dependent Care Credit -- 26 USC §21
- Waiver of Retirement Fund Premature Withdrawal Penalties -- 26 USC §72
- Disabled Access Credit -- 26 USC §44
- Impairment Related Work Expense deduction -- 26 USC §67 [d]
- Flexible Spending Account (Employee Fringe Benefit) -- 26 USC §106 and 26 USC §125
- Dependent Care Assistance Plan (Employee Fringe Benefit) -- 26 USC §129
Tax Benefits For Individuals - Medical Expenses
Q 3a. What PAS expenses qualify for the medical expenses deduction?
26 USC §213 defines deductible medical expenses as: "amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body" or "for qualified long-term care services" or "for any qualified long-term care." As interpreted by regulations and Tax Court decisions, a service provided to an individual must be of a medical or quasi-medical nature in order to be deductible. If the services involve assistance in performing any of the activities of daily living (ADL's), it is likely that they will qualify as medical care expenses. If the services clearly compensate for the functional limitations of a disability, they should qualify as well.
To qualify for deductibility, the services do not need to be performed by a medically trained or licensed professional. It is the nature of the services that determines their eligibility. For people who need comprehensive PAS services that include both deductible and nondeductible elements, it may be useful to maintain careful time and task records showing the amount of PAS worker time devoted to each type of personal assistance service.
When the services of a PAS worker are eligible for the medical expense deduction, costs associated with those services, such as an apportionment of employment taxes paid on behalf of the worker, would ordinarily qualify for deductibility too.
Q 3b. What PAS expenses do not qualify for the medical expenses deduction?
If a service involves assistance in performing an activity of daily living or compensates for the functional limitations of a disability, they will likely qualify for the deduction. However, there must be a direct connection between the expense and either the limitation or the activity of daily living. While a sign-language interpreter for a person who is deaf should qualify for the deduction, housecleaning services would not because even if an illness or impairment constitutes the reason why one cannot do one's own housework, the connection with the illness or impairment is not direct enough. A deaf person may require a sign language interpreter to communicate with others directly because of his deafness. In contrast, people are less likely to hire a housekeeper directly because they have disabilities that prevent them from doing housework.
Q 3c. Is the benefit for PAS available to a spouse or dependent child?
The law provides that the deduction of medical expenses may be applied to the costs of medical care for a payor's spouse or dependent. Therefore the cost of any PAS which could be considered medical care qualifies for deduction whether the care is received by the taxpayer, the taxpayer's spouse or the taxpayer's dependent.
Q 3d. Are any benefits uniquely available to self-employed taxpayers?
The medical expense deduction is a personal deduction. It doesn't matter whether you earn your income from paid- or from self-employment.
Q 3e. Are there any other special terms or conditions?
In order to obtain a deduction for medical expenses of any kind, two conditions have to be met. First, you must have enough deductions to be able to itemize. The vast majority of taxpayers claim the standard deduction, and, unless your itemization would result in a larger number than your standard deduction, you cannot, and would not want to, itemize.
That applies to all deductions, but with the medical expense deduction there is another condition. Not all your qualifying medical expenses are deductible. Only those that exceed 7.5% of your adjusted gross income (AGI) are. That means if you had an AGI of $10,000 and medical expenses of $800, only $50 of your costs would actually be deductible. Since 7.5% of $10,000 is $750, that first $750 would be lost to you.
Sometimes, a PAS expense might qualify for both the medical expense deduction and the household credit discussed below. In that case, you have to decide on which approach yields a better result, but you can never claim the same expense under both.
Long-term Care (LTC) Insurance Payments Exclusion
Q 4a. What is the nature of this tax benefit?
Generally speaking, PAS received and paid for pursuant to a long-term care insurance policy are not taxable to the recipient. The same is generally true if the insurance provides cash payments with which the recipient purchases and pays for LTC.
Q 4b. Are the LTC insurance premiums that people pay eligible for any tax benefit?
Premiums paid for qualifying LTC insurance are deductible as medical expenses.
Q 4c. Is the benefit available to a spouse or dependent?
This is not so much a tax law question as a question about the insurance policy. The benefit is available to whoever is covered under the policy. If the policy covers a taxpayer and the taxpayer's spouse, then the benefit is available to the spouse. If the policy covers the taxpayer only, then there would be no payments for the spouse to receive and no way for the spouse to be covered.
Q 4d. Are there any other special terms or conditions?
Sec. 7702B contains some technical requirements but they focus mainly upon the individual's eligibility to receive services. As a practical matter though, these requirements are not likely to become an issue, because the LTC insurance provider will typically require documentation of need and eligibility at least as stringent as the law requires. Need for assistance in the performance of two or more ADL's is the most common standard used, and it is also basically the standard used by the tax code.
Household and Dependent Care Credit
Q 5a. What is the nature of this benefit?
This is a credit, which differs from a deduction. With a deduction you subtract the amount of the deduction from your income to arrive at the reduced amount of income on which you owe tax. With a credit you subtract the value of the credit directly from the tax you owe.
Q 5b. Is the benefit for PAS available to a spouse or dependent?
Yes, in fact it is only available for care provided to a spouse or dependent. The credit is available to offset the costs of care provided to a child under the age of 13, or to a spouse or dependent who is substantially unable to care for himself or herself. The care that is covered is the care required so that the taxpayer can go out to work, and it includes household services.
Q 5c. What degree of incapacity or disability does the law require?
The law does not focus on the degree of disability or the nature of the services. Mostly it is concerned with the eligibility of the taxpayer. It approaches this eligibility with a number of requirements designed to ensure that the expenses in question are work-related and were incurred so that the taxpayer could earn income outside the home. There are also certain limitations as to where the services are provided, and there are requirements that the care recipient reside in the home of the taxpayer for the majority of time.
Q 5d. How much is the credit?
Computation of the credit is complex. The credit is aimed at lower-income taxpayers and is calculated on a sliding scale. First you must determine your "applicable percentage." For taxpayers with AGI of $15,000 or less per year, the credit is 30% of the taxpayer's work-related care expenses. This percentage falls as income rises, by one percent for each additional $2,000 of AGI, until it reaches 20% for people with AGI's of $35,000.
Once you know your applicable percentage you have to apply that to your work-related care expenses, but there is a dollar limit. If you are claiming the credit on behalf of one qualifying care recipient, you can claim up to $3,000 in work-related care expenses, up to $6,000 if you have two or more qualifying care recipients. For a taxpayer with a $15,000 AGI, whose applicable percentage is 30%, the maximum amount of the credit would therefore be $900 (30% of $3,000). For a taxpayer with an AGI of $35,000 claiming the credit on behalf of two care recipients, the maximum amount of the credit would be $1,200 (20% of $6,000).
Waiver of Retirement Fund Premature Withdrawal Penalties
Q 6a. What are premature withdrawal penalties?
Under the rules governing all types of retirement accounts, withdrawals can ordinarily not begin until specified ages have been reached (usually 59 and a half). If withdrawals are made before that date, or in other ways that violate the rules, the taxpayer incurs not only ordinary income tax on the amount withdrawn but also a 10% excise tax penalty.
Q 6b. How can early withdrawal penalties be avoided?
Depending on the type of retirement account--IRA, 401 (k), 403 (b)--certain approved uses of the money, certain specified reasons for withdrawing it, will allow waiver of the penalty. These usually include medical expenses and other disability-related costs.
Q 6c. What degree or definition of disability is required?
The law uses a definition of disability which focuses on illness or injury that makes a person unable to work, and that has lasted or is expected to last for at least one year or to result in death. This is the definition used in the Social Security Act for eligibility for disability benefits as well. Medical evidence is not literally required but will often be decisive in establishing that one has a disability in this context.
Q 6d. What PAS services can this waiver be used to support?
Any PAS that qualified for the medical expense deduction should ordinarily qualify for the penalty waiver. With respect to other PAS, the law is not so clear as to whether the penalty will be forgiven. It appears that the IRS has considerable discretion in this area, and people filling out the tax form that requests the waiver should be certain to get competent professional help in explaining the connection between the PAS and their disability.
Q 6e. What is the form of the tax benefit that results from obtaining the waiver?
The benefit takes the form of a reduction by 10% in the amount due on the withdrawal. Ordinary income tax will still be due, but that may also be reduced through the usual means that exist for claiming deductions, credits, other exclusions and the like.
Q 6f. Is the benefit for PAS available to a spouse or dependent?
The waiver of retirement fund premature withdrawal penalties is not generally available to the spouse or dependent. An account owner could not ordinarily claim the waiver for funds withdrawn to pay medical or disability-related expenses incurred by a spouse or dependent. On the other hand, many of the expenses in question will probably qualify for the medical expense deduction, so can be used to reduce the regular income tax, if any, due on the withdrawal.
Q 6g. Are any benefits uniquely available to self-employed taxpayers?
There are no benefits that are uniquely available to self-employed taxpayers that are associated with the waiver of retirement fund premature withdrawal penalties.
Q 6h. Are there any other special terms or conditions?
Generally, under §72(t)(1), a taxpayer will have his tax rate raised by 10% if he prematurely withdraws funds from a qualified retirement plan. However, under §72(t)(2)(A)(iii), this penalty could be waived if the withdrawal is due to the disability of the taxpayer. Under §72(m)(7), an individual is considered disabled if he "is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration." §72(m)(7) further requires the individual at issue to present appropriate proof of the claimed disability.
Q 6i. Are there any limits or caps on the size of the tax benefit?
There is no cap or limit to the waiver of the penalty; likewise, there is no cap or limit on the way that the withdrawn funds can be used, so long as they are related in some way to the taxpayer's disability.
Q 6j. What is the form of the tax benefit?
The benefit to PAS takes the form of a tax deduction in the sense that by waiving the penalty for premature withdrawal, the taxpayer's tax rate does not incur a 10% increase.
Q 6k. Are there any income limitations applicable to the ability of taxpayers to claim the benefit?
There are no income limitations applicable to the ability to claim the benefit.
Tax Benefits For Employers And Employees - Disabled Access Credit
Q 7a. How does the Disabled Access Credit support PAS?
The disabled access credit is not taken by individuals. It is a credit available to small businesses which incur "eligible access expenses" in order to accommodate individuals with disabilities. Ordinarily, these accommodations would be for customers but they can be for employees as well.
Q 7b. What kinds of expenses qualify for the credit?
Among the expenses that are considered eligible for the credit are costs for readers for people who are blind or sign-language interpreters for people who are deaf. Although not included among the examples listed in the statute, other PAS expenses including job coaches and those providing other assistance services would likely qualify.
Q 7c. What definition of disability must the service recipient meet?
Beyond using the ADA definition, the statute does not focus on the definition or degree of disability of the person receiving the service. Rather, it is the eligibility of the business in terms of its size and in terms of the relationship between the service or accommodation and the requirements of the ADA that are of primary importance.
Q 7d. Does the service have to be provided at the business location?
The purpose of the service must be to facilitate access. This must be direct, so in most cases it will be provided at the small business's place of operation. But one could foresee exceptions. If, for example, an employee who needed a reader were sent on an assignment in the field, the reader's services would not be disqualified if provided at the remote location.
Q 7e. How does the service recipient benefit from this credit?
The tax benefit takes the form of goods or services that the recipient does not pay for and on the receipt of which no tax is owed. As such, it is similar to a tax-exempt fringe benefit of employment for workers, or a free accommodation for customers or clients. While the literal tax benefit goes to the business, it enables the business to incur accommodation expenses which may be crucial to enabling the service recipient to work.
Q 7f. Are any benefits uniquely available to self-employed taxpayers?
If a qualifying small business, including one owned by a person with a disability, incurs expenses that are eligible for the credit, it can claim the credit on its business return or a corporate or partnership return.
Impairment-Related Work Expenses
Q 8a. How does this provision work?
The Impairment-Related Work Expenses (IRWE) is an itemized deduction. The person on whose behalf the deduction is taken and who received the services must be earning income in order to claim the deduction, because its purpose is work-related.
Q 8b. What PAS expenses qualify for the IRWE deduction?
The statute does not focus on any definition or degree of disability or any particular type of goods and services. The only example cited in the statute is "attendant" services but "other" expenses of a "handicapped" person are also covered. It is the nature and purpose of the expenses, including services, that determines its eligibility for the deduction.
Q 8c. Must the services be utilized at the place of employment?
Because the statute includes the words "at or in connection with" the place of employment, much confusion has surrounded this question. While the IRS and courts have not seen fit to answer the question, the likely answer, based on the "in connection" language, is that the purpose of the expenditure and its direct relationship to the job would be the key issue.
Q 8d. Are any benefits uniquely available to self-employed taxpayers?
This deduction is available only to working people. A self-employed person can deduct all the business' expenses from income in determining the net profit of the business, but the IRWE provision would not be used for the expenses of conducting a business or the expenses of self-employment.
Flexible Spending Account
Q 9a. What is a Flexible Spending Account?
A Flexible Spending Account (FSA) is a fringe benefit of employment. Under it, employees can designate certain amounts out of their salary for meeting certain, usually health-related expenses that are not covered by the firm's health insurance. The employee thus still pays for the services, but does so on a tax-favored basis because the amounts that are run through the FSA are pretax dollars. Thus the employee does not pay tax on the income used to purchase the services, and does not have to go through the trouble of claiming any deductions.
Q 9b. What PAS expenses can be met through a FSA?
The FSA is of limited but potentially some value in subsidizing PAS. The only expenses that can be covered by an FSA are expenses for PAS services which qualify for the medical expense itemized deduction discussed under Question 3 above. There is one exception to this. Certain over-the-counter versions of prescription drugs that would not be eligible for the itemized deduction are permitted to be reimbursed through an FSA. Nothing that would remotely amount to PAS has been granted such an exception, however.
Q 9c. Does the employer have any role in determining the scope of what expenses can be covered?
The employer plays a key role. This happens in two ways. First, the employer has undoubtedly had a large role in determining the scope of the employer-sponsored health insurance available to the worker. The best insurance plans might cover some PAS expenses, but less expansive plans would not.
The employer also plays a role in designing the plan itself. Many plans are not as broad as the medical expense deduction, meaning that in some cases items that would legally qualify for itemized deductibility are not available through the plan.
Q 9d. Are any benefits uniquely available to self-employed taxpayers?
Self-employed individuals are not eligible for flexible spending accounts.
Dependent Care Assistance Plan
Q 10a. What is a Dependent Care Assistance Plan?
A Dependent Care Assistance Plan (DCAP) is a fringe benefit of employment. Under it, the sponsoring employer provides various forms of daycare or other care, up to a maximum dollar limit of $5,000 or total earned income from the employment, whichever is less, to employees as a fringe benefit. This means again that the employee neither pays for the service nor has to worry about deducting it. It is tax-free because it is excluded from the recipient's income.
Q 10b. Can the spouse or dependent of the employee receive the services?
By definition, the DCAP is designed to provide services to dependents or spouse (or, depending on the plan, sometimes parents or other family members) of the employee. It could not be used to provide services to the employee directly.
Q 10c. What PAS services are available through the DCAP?
The law does not focus on the degree of disability or the precise nature of services. Its concern is rather with the eligibility of the employee and with the amount of service provided.
Q 11. Must one itemize in order to receive favorable tax treatment for PAS expenses?
In the case of the medical expense deduction, the IRWE deduction and the retirement early withdrawal penalty exception, the taxpayer must itemize. In the case of the household and dependant credit, long-term care insurance, the flexible spending account, and the dependant care assistance plan, PAS expenses need not be itemized.
Q 12. Are the tax benefits employment linked?
Only in the case of the IRWE, the Household and Dependant Care Credit, the Flexible Spending Account, and the Disabled Access Credit, the tax benefit must be employment linked.
Q 13. Does it matter where the PAS is provided?
It does matter for the Medical Expense Deduction, Household and Dependant Care Credit, IRWE and the Disabled Access Credit.
Q 14. How could tax policy be improved to better handle PAS expenses?
While there are no simple ways to improve the Tax Code, two areas for future focus to consider include a more expansive definition of medical care that embraces social and rehabilitative goals and services and second is a more enlightened understanding of the gateway costs (including PAS) for an individual with a disability to live a more productive and independent life that deserve unequivocal, favorable tax treatment.