Gifting Under the Medical Payment Exclusion

November 7, 2017

The payment of a beneficiary’s medical expenses is excluded from the gift tax, with no limitation on the amount excluded. To qualify for this exclusion, the payment must be made directly to the provider, and it must be for medical expenses that would qualify for an income tax deduction. You cannot claim an income tax deduction for the payment unless the payment is made for your spouse or dependent.

The exclusion for medical payments includes the payment of medical insurance. If you have a child or grandchild who is paying for his or her own insurance, payment of their insurance premiums is an efficient means of making a tax-free gift that does not consume the $14,000 annual exclusion.

Qualifying medical expenses are defined by reference to Code Section 213(d). See IRC § 2503(e)(2)(B). The exclusion applies to payments for (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 primary for and essential to medical care. Treas. Reg. § 25.2503-6(b)(3). Payments for medical insurance are also covered. The Section 213(d) definition of medical care is extremely broad. It also covers long-term care services, such as the costs of nursing homes or assisted living facilities, if provided by a licensed health care provider. The most notable area it does not cover is cosmetic surgery, unless to correct a birth defect or disfigurement from injury or disease. See IRC § 213(d)(9)(A).

Try to confirm that your donee’s medical expenses will not be reimbursed by medical insurance. If a donee’s medical expenses are subsequently reimbursed by insurance, your gift will be disqualified for the exclusion. Treas. Reg. § 25.2503-6(b)(3). In such case, the donee must either reimburse you or you will have to treat your gift as taxable for gift tax purposes, although the annual exclusion would apply to it to the extent available.

The requirement that you must make direct payments to medical provider(s) may prove to be administratively awkward or cumbersome. To simplify the arrangement, you can set up a separate Medical Checking Account in your own name for the medical donee’s benefit, and give the donee check writing authority over the account as your agent. You may also give the donee a credit card tied to that account. The child then can directly pay medical or educational expenses for the child and his or her descendants from the account using checks or the credit card. Since the account is in the donor’s name, and the donee is acting only as the donor’s agent, the direct payment requirement is satisfied and there will be sufficient records to withstand an audit.

Although the basic idea is simple, the implementation of gifting under the Medical Payment Exclusion can be complicated. There are traps for the unwary. Please call us if you would like to discuss your Medical Payment Exclusion gifting options.