Back to basics: Tax for families caring for aging parents
The tax effects of caring for family vary depending on the situation
As the U.S. population continues to age, more adult children are now caring for their parents due to their deteriorating health and mental acuity. A 2017 study from the Center for Retirement Research at Boston College estimates that 17 percent of the adult children in the U.S. will provide caregiving services for their parents with an average commitment of 77 hours per month at some point in their lives. Many of these hours are unpaid.
Additionally, many children pay unreimbursed out-of-pocket expenses to care for their parents. Tax benefits vary depending on whether parents pay their own expenses or whether the children provide support to care for their parents.
Regardless of how they support or care for their elderly loved ones, families should be aware of the potential tax deductions and credits that may be available and the household employee tax rules.
If parents qualify as dependents, then the children could claim several tax benefits
The most common scenario for families with aging parents occurs when parents can’t support themselves and the children pay for their parents’ living expenses. In that case, the following benefits may be available on the children’s return.
Claiming a parent on the caregiver’s return
While the Tax Cuts and Jobs Act (TCJA) eliminated all dependent exemptions for 2018 until 2026, in order for the caregivers to be able to claim other tax benefits for caring for their parents, the parents must still meet the tests to be a “dependent” of the caregiver. If the parents qualify, the taxpayer lists them on the lines for “Dependents” on the first page of Form 1040.
Child and dependent care credit could be available if parents live with their children
If the dependent parents’ annual gross income is less than $4,150, and their caregivers provide more than half of the person’s total support, the caregivers may claim the Dependent Care Credit on their return for the dependent’s care expenses. These expenses include medical expenses or work-related expenses incurred by the caregiver. The credit is limited available for up to 35% of qualifying expenses with a maximum credit of $3,000 (for one qualifying individual) or $6,000 (for two or more qualifying individuals).
Unlike the other benefits available, the credit requires the dependent parents to be disabled and to live with the caregiver in the home maintained by the caregiver. For more information see, IRS Pub. 503.
Utilizing a Flexible Spending Account (FSA) provides a benefit
A caregiver who has other employment may contribute to an FSA and exclude any contributions by the employer from the taxpayer’s income. No federal taxes are deducted from the contributions and withdrawing funds for paying medical expenses is tax-free. For more information, see IRS Pub. 969.
The children could claim the medical expenses deduction for the cost of caring for their dependent parent
If the parent qualifies as the taxpayer’s dependent, the taxpayer may qualify for a deduction for a portion of the expenses paid. Taxpayers can claim a medical deduction on their tax return for all the costs and expenses they pay to someone to provide care, including children and family members. The deductions for medical expenses still applies to payments made by the children for their parents’ care. The TCJA reduced the deduction threshold from 10 percent of AGI to 7.5 percent of AGI for 2017 and 2018. For tax years starting after 2018, the deduction floor returns to 10 percent.
This deduction can be particularly advantageous if the parents are in an assisted living facility because not only can medical expenses provided by the facility be deducted, but also included in medical expenses is the cost of medical care in a nursing home, home for the aged, or similar institution. This includes the cost of meals and lodging in the home if a principal reason for being there is to get medical care.
The new $500 family credit is available if parents are U.S. citizens or residents
Even when the parents do not qualify as dependents for the purposes of the credits listed above, if the parents receive more than half their financial support from a child over the course of the tax year, then the child can claim a $500 credit for each parent on their return. The only requirement for this credit is the parents must be U.S. citizens or U.S. residents (either green card holders or by meeting the substantial presence test).
The household employee rules apply to caregiving
When and where caregiving is provided determines the tax requirements. Some adult children may hire someone to provide care for the parents while the children continue to work, while others may stay with the parent to provide care. In either situation, the “Household Employee” rules apply to family and non-family caregivers. Generally, the IRS considers individuals to have a household employee if they hired someone to do household work and, the caregiver is under the control of the individual as to how the work is done and when the work is done.
When this is the case, the worker is considered an employee for tax purposes, regardless of whether they work full-time or part-time, were hired through an agency or were hired from a list provided by an agency or association. It also doesn't matter whether the worker is paid on an hourly, daily, or weekly basis, or by the job.
Household work is work done in or around an individual’s home and includes
- Health aides,
- Private nurses, and
Household work doesn't include services performed by these workers unless the services are performed in or around the taxpayer’s private home. Services not of a household nature, such as services performed as a private secretary, tutor, or librarian, even though performed in the home, are not considered household work.
Withholding required on household employee wages
If household workers are paid more than $2,100 in a year, then Social Security and Medicare must be withheld. For the dollar amounts and percentages, see the topic “Do You Need To Pay Employment Taxes?” in IRS Pub. 926.
Note: The taxes are 15.3 percent of wages. The employee's share is 7.65 percent. (The parents can choose to pay it themselves and not withhold it.) The parents’ share is 7.65 percent.
If the taxpayer parents pay cash wages of $1,000 or more in any calendar quarter of 2018 to any one household employee, they are required to also pay federal unemployment taxes.
Note: The federal unemployment tax is 6 percent of wages. Wages over $7,000 a year per employee aren't taxed. They also may owe state unemployment tax.
In addition to the federal unemployment tax that the parents would be required to pay, all states have unemployment benefit plans which comply with the federal unemployment regulations.
Payments to children for caregiving are wages
The IRS has consistently and continuously determined that if the children are paid wages to care for family members, they must report that income as wages on their tax return. These payments are reported to the caregiver on Form W-2.
Example: Dan and Mary, who are in their 70s, bought a house that is large enough and designed to allow their daughter Peggy and her husband Mike to live in the house with them. Peggy will stay home to take care of her parents as they age and become more in need of care and assistance with everyday living. Dan and Mary pay Peggy $1,000 every month for taking care of them in addition to amounts paid to Peggy for household expenses.
As Dan and Mary pay cash wages of $12,000 out of their retirement and investment income in 2018 to Peggy, they are required to withhold and pay Social Security and Medicare taxes.
Conclusion: Know the tax benefits and implications
Generally, children who care for their elderly parents take on additional out-of-pocket expenses to do so, and while many children feel the desire to give back to their parents when they need help the most, being aware of the tax benefits and implications of helping a loved one can help relieve the financial impact of doing so.
H&R Block Tax Professionals, click to login to the Tax Research Center:
- Is it better to use the flexible spending account (FSA) or claim the dependent care credit?
- What are the rules for dependent care flexible spending accounts (FSAs)?
- Who qualifies for the child and dependent care credit?
- Who is a qualifying person who was not physically or mentally able to care for himself or herself for dependent care credit purposes?
- What is the other dependent credit?
- What are the withholding and filing requirements on household employees?