How does the gift tax medical exclusion work?
A client pays medical expenses for a non-relative. Can they take a deduction for medical expenses? Are they subject to gift tax?
Q. When someone pays medical bills on behalf of another person directly to a medical provider, is the payment subject to gift tax?
Our clients Nadia and Dominik paid medical bills for their neighbors’ 28-year old son Mark, who was injured in an accident. He fractured his leg in a fall and ended up needing surgery and a hospital stay of several days. He is currently recuperating at his parents’ house. He is “between jobs,” has no health insurance, and is not covered by his parents’ insurance. Nadia and Dominik decided to help the family by paying a part of Mark’s expenses. In all, they paid about $25,000 to the hospital, including the surgical bill. They are close friends with these neighbors, but they are not related to them. Are the medical expenses deductible on Nadia’s and Dominik’s joint tax return? Do they have to report the payments on a gift tax return?
A. Payments that qualify for the gift tax medical exclusion are not subject to gift tax.
The medical expenses that Nadia and Dominik paid are not deductible. They are not reportable gifts because they are eligible for the medical exclusion.
A taxpayer may deduct only those medical expense paid for the taxpayer, the taxpayer’s spouse, and dependents claimed on the taxpayer’s return. There are exceptions for dependents not claimed because of the rules for divorced parents, for dependents who earn more than the gross income limitation ($4,300 in 2021), and for taxpayers who are themselves dependents. Because Mark is not Nadia’s and Dominik’s dependent, the medical expenses they paid for him are not deductible on their tax return.
The gift tax medical exclusion
In general, the federal gift tax applies to any transfer to someone of a gift of money or property over the annual gift tax exclusion ($15,000 in 2021), whether made directly or indirectly. There are four types of transfers that are not subject to the gift tax:
- Transfers to political organizations
- Transfers to certain tax-exempt organizations
- Payments that qualify for the educational exclusion
- Payments that qualify for the medical exclusion
To qualify for the medical exclusion, payment must be made on behalf of an individual to a care provider such as a doctor, hospital, therapist, or other institution or medical professional. Payment must be made directly to the care provider. There is no limitation on the money amount spent on medical care.
The care provided must meet the requirements of medical care for the medical expense deduction, including diagnosis and treatment for illness or injury. Medical care also includes amounts paid for medical insurance on another person’s behalf. However, unlike the medical expense deduction, for the medical exclusion the donee does not have to be a dependent or related to the taxpayer in any way.
Medical expenses that are reimbursed or reimbursable by the donee’s health insurance are not eligible for the exclusion. If expenses are subsequently reimbursed by insurance the payments are considered gifts to the donee.
Applying these requirements to your clients’ situation, Nadia and Dominik paid $25,000 to the hospital for Mark’s medical treatment. Because they made the payments directly to the hospital for expenses that meet the definition of medical care, the payments they made qualify for the gift tax medical exclusion.
If instead Nadia and Dominik had given money to Mark or to his parents, or had paid for something other than medical care, payments over the exclusion amount would likely be subject to the gift tax. In that case Nadia, or Dominik, or both (depending on the amount, who made the gift, whether they were gift-splitting, etc.) would have to complete Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return, to report the payments.