Direct Gifts Part 2 – Medical Expenses

Take-Away: The direct payment of another individual’s medical expenses is not treated as a taxable gift. Unlike the direct payment of tuition, the direct payment of medical expenses is much more broadly defined.

Background: As previously reported, the direct payment of another individual’s tuition obligation is not treated as a gift, and thus not subject to gift taxation. That same Tax Code section also applies to the direct payment of another’s medical expenses and excepts that direct payment as a taxable gift. [IRC 2503(e)(2)(B).]

Direct Payment: Just like the tuition exception to being classified as a gift, the exception for medical expenses also requires a direct payment to the service provider in order to not be treated as a gift. The recipient can deliver to the medical provider a check made payable to the provider.

Example: Gretchen pays her granddaughter’s orthodontia treatments that cost $17,500. Gretchen gives a check to her granddaughter payable to the orthodontist, which the granddaughter delivers when she next visits the orthodontist. Note that Gretchen may also give her granddaughter $15,000 a year as an annual exclusion gift. No gift tax will be incurred by Gretchen for that year.

GST: Since the direct payment of medical expense is not treated under IRC 2503(e) as a gift, the direct payment of those expenses on behalf of a grandchild will not be subject to the generation skipping transfer tax (GST.)

Medical Expenses: Medical expense is broadly defined in the Tax Code. [IRC 213(d).] It covers: (i) the diagnosis; cure; mitigation; treatment or prevention of disease; (ii) the purpose of affecting any structure or function of the body; or (iii) transportation primarily for and essential to medical care that are deductible for income tax reporting purposes. [Regulation 25.2503-6(b)(3).]

Deductible Medical Expense: Only if the medical expenses incurred would be income tax deductible will those same expenses qualify for direct payment and thus not be treated as a gift. Accordingly,  the payment of medical insurance premiums, prescription drugs, or to a provider for medical care would all qualify as a medical expense. Not covered, for example, would be a gym membership used for a weight reduction program or for health adjacent needs, e.g. a dietary program like Weight Watchers.

Reimbursement: If medical expenses directly paid by the payer are later reimbursed by a health insurer, then the payer’s payment will not qualify for the IRC 2503(e) exclusion as a gift. [Regulation 25.2503-6(b)(3).] In such a situation, the insurer’s reimbursement must be turned over to the payer who directly paid the medical expense. If the reimbursement amount is retained by the recipient of the medical services, then the payer of those expenses will be treated as having made a taxable gift (which might then be covered by the payer’s federal gift tax annual exclusion.)

Transportation and Lodging: Also covered under medical expense is the cost of transportation (and possibly lodging) that is associated with the recipient receiving medical care. However, specific rules apply, so caution is needed as this is not a blanket exception.

Example: Pat travels to the Mayo Clinic in Rochester, Minnesota for a second opinion prior to medically required surgery. Pat’s travel expenses to Mayo and her stay at a hotel adjacent to Mayo could be directly paid by her parents and not be treated as a gift. Pat is accompanied by her husband to Mayo. The meal expenses that Pat and her husband incur while in Rochester may, or may not, be fully covered as a direct expense. Lodging expenses may qualify if Pat’s evaluation at Mayo requires more than one day.

Long-term Care: Medical expenses also covers long-term care services like the cost of nursing homes and assisted living facilities if those services are provided by licensed health care providers.

Not Cosmetic Surgery: Not falling under medical expenses is the cost of cosmetic surgery, unless such surgery is needed to correct a birth defect or disfigurement from an injury or disease. [IRC 213(d)(9)(A).]

Reporting: Since the direct payment of medical expenses is not treated under the Tax Code as a gift, there is no need to file a Federal Gift Tax Return Form 709 to report the direct payment. The direct payment of medical expenses are not technically part of the definition of ‘gifts.’ [See Instructions to Form 709.]

 Practical Observation: Some medical expenses might be relatively easy to pay directly, or through the delivery of a check payable to the medical service provider, such as a flat-fee orthodontia payment. Other expenses, like an extended hospitalization or nursing home expense may not be amenable to a flat or fixed-fee for those medical services. As such, the constant writing of checks on behalf of another could become irritating to the payer.

One  way to address this need for the payer to constantly write checks is to open a checking account dedicated to the recipient’s medical expenses. The recipient could then be designated as the payer’s agent, who has authority to write checks from the checking account solely for the payment of their medical expenses. Alternatively, the payer could give to the recipient a charge card with authorization to make medical expenditures for their own benefit using the payer’s charge card. Either approach eliminates the payer having to constantly write checks, but in each case, it is the payer’s funds that are being directly used to pay the recipient’s medical bills.

Conclusion: Like the direct payment of tuition, the direct payment of another’s medical expenses  is a great way to reduce the payer’s taxable estate without making a taxable gift, or having to comply with the annual exclusion gift rules and limitations. The direct payment of medical expenses that would otherwise be an income tax deduction is not a gift that must be reported on a Federal Gift Tax Return and the amount paid is not subject to any dollar limitation.