Tax Issues Complicate the Costs of Chronic Illness and Long-Term Care Insurance

Long-term care costs can be high enough to consume the estates of chronically ill individuals. It is only prudent, then, to consider insuring against those costs.

August 9, 2007
Sponsored by Thomson Tax & Accounting

by Vorris J. Blankenship

From the Journal of Taxation

An aging U.S. population is coming to terms with the realities and costs of 21st century healthcare, making plans to deal with the possibility of chronic illness and the need for long-term care. There are not surprisingly tax consequences at almost every turn: Are the costs of care deductible? Are insurance premiums deductible, and by whom? Are insurance reimbursements or other benefits taxable?

As a result of increased life span due to modern medical technology, the elderly and their families have good reason to be concerned about chronic illness and the cost of long-term care. Those costs can be very high — enough to consume the estates of many chronically ill individuals. It is only prudent, then, to consider insuring against those costs. The deductibility of long-term care costs and the taxation of long-term care insurance and life insurance available for chronic illness are examined below.

Long-Term Care Services

A taxpayer generally may deduct the un-reimbursed cost of certain long-term care services prescribed for a "chronically ill individual." For example, the cost of services provided in a nursing home for a chronically ill individual normally would be deductible as a long-term care service.


Deductible long-term care expenses for chronically ill individuals are, in large part, the same types of medical expenses as those deductible by taxpayers who are not chronically ill. Deductible long-term care services include "necessary diagnostic, preventive, therapeutic, curing, treating, mitigation and rehabilitative services."The general definition of medical care in Section 213 and the related Regulations includes essentially the same types of services.

There are, however, some significant differences. First, the long-term care deduction is limited to "services," whereas other deductible medical expenses are not so limited. Second and probably most important, long-term care services include "maintenance or personal care services," a type of service not deductible by taxpayers who are not chronically ill.

The “services” limitation. Limiting the deduction for long-term care to the cost of services is not quite as restrictive as it may at first sound. The Tax Court has held in other contexts that the term "services" includes the use or transfer of medical supplies as an integral part of the performance of medical services.

In Hospital Corporation of America, 107 TC 116 (1996), aff'd 92 AFTR 2d 2003-6705, 348 F3d 136 (CA-6, 2003), cert. den. (HCA), the issue involved a hospital's method of accounting for uncollectible receivables, a method that was available only for income derived from the performance of "services." The IRS contended that income attributable to medical supplies was not income from services.

The Tax Court held, however, that medical supplies furnished by the hospital were so "inseparably connected" to the performance of medical services that those services necessarily included income attributable to the supplies. The court noted that hospitals do not acquire medical supplies for sale to patients. Rather, a hospital's use of medical supplies is merely incidental to its main purpose of rendering medical services. Patients go to hospitals to receive a course of treatment (i.e., medical services), not to select and purchase medical supplies.

In Osteopathic Medical Oncology & Hematology, P.C., 113 TC 376 (1999), acq. in result, the issue was whether drugs administered by a chemotherapy clinic were "merchandise" that had to be inventoried. A divided Tax Court held that the chemotherapy drugs were so integral to the performance of medical services that income earned from the drugs was medical service income, and thus not income from the sale of merchandise. The court noted that the patient could not buy the drugs without accepting the medical services. The court did not find it significant that the cost of the drugs was large in relation to the amounts charged patients or that the clinic itemized the cost of the drugs on its bills. The Tax Court also distinguished a case holding that caskets sold by a funeral home were merchandise — primarily on grounds the magnificence of the caskets was as much a factor in drawing customers as the actual services provided by the funeral home.

The effect of these cases may be more expansive than at first appears. The list of medical supplies dealt with by the court in HCA was extensive. It included casts, crutches, canes, walkers, bandages, sutures, splints, skin staples, joint replacements, pacemakers, heart valves, orthopedic devices, drugs, intravenous solutions, blood, blood derivatives, surgical instruments, sponges, surgical drapes, surgical gowns, towels, syringes, alcohol preparations, drainage tubes, irrigating tubes, tourniquets, X-ray film, chemicals, dyes, nuclear materials, insulin, oxygen and other gases.

Although these cases characterized medical supplies from the standpoint of the service provider, the same characterization should apply from the standpoint of the patient. HCA analyzed the question from the perspectives of both the service provider and the patient, and Osteopathic Medical agreed with that analysis. Furthermore, the issue of characterization of medical supplies from the tax perspective of the patient is uncomplicated by the medical provider's need to do a proper tax accounting for receivables and inventories. Nevertheless, because the Tax Court decided these cases in different contexts, some caution is warranted in applying them to long-term care services.

Vorris J. Blankenship is a retired attorney and CPA, and has previously written for The Journal.

Copyright © 2007, Vorris J. Blankenship.