Education-related medical expenses for special-needs individuals.

Previous Tax Clinic items have addressed the deductibility and potentially tax-favored funding mechanisms of tuition and fees as medical expenses for special-needs children (see Goldsberry, Tenney and Luke, "Deductibility of Tuition and Related Fees as Medical Expenses," TTA, November 2002, pp. 701-702; and Goldsberry, Luke, Pistorius and Tenney, "Funding Mechanisms for Medical Expenses," TTA, November 2003, pp. 664-666). These items addressed some of the issues faced by families with significant medical needs and expenses, particularly parents of special-needs children. Since the publication of these items, taxpayers have asked several specific questions as to the timing of the deductions and the deductibility of incremental expenses and specific activities.

This item addresses three specific areas:

1. Advance payment of tuition and fees;

2. Additional tuition and fee billings by nonspecial schools for additional "special school" types of service; and

3. Extracurricular activities (e.g., tutoring, music and dance lessons, and summer camps).

Advance Payments of Tuition and Fees

This issue is common in the case of tuition and fees for special schools. With the increase in schools designed to meet the needs of children with learning and other medically identified disabilities, fewer schools are residential in nature, and more follow the traditional academic year. Because the typical academic school year spans two calendar years, it is common for special schools to require contracts that include both the fall and spring semesters. Families may be required to pay for the entire year in advance or, more commonly, have options to pay on various terms (such as annually, or by semester or month).

Typically, prepaid medical expenses are not deductible in the year of payment; generally, they cannot be deducted until services have been rendered. The basis for this apparent exception to the general rules for cash-basis taxpayers is, in part, concern that the intended annual limit on medical expense deductions (i.e., based on adjusted gross income) could thereby be avoided; see Bassett, 26 TC 619 (1956).

Rulings: There are limited exceptions to this general rule. For example, taxpayers who make an advance payment under a contractual obligation may be eligible to deduct the entire expense in the year paid, even though some of the services are to be rendered in the following year. Rev. Ruls. 75302 and 75-303 may provide limited guidance in this regard, although the applicability of these rulings to the prepayment of special school tuition is not entirely clear (as they dealt with prepayments for future lifetime care).

Together, the two rulings indicate that the taxpayer must have a contractual obligation to pay a specified amount allocable to the medical provider's obligation to provide medical care in the future. In Rev. Rul. 75-302, the INS deemed it permissible that the contract contain a refund clause in the event of early termination, when the refunds were conditional and subject to penalties.

Bassett: On the other hand, in Bassett, the Tax Court ruled that a prepayment to a hospital was not currently deductible, because it was made without evidence of any specific arrangements or billings as to the payment made. Rev. Ruls. 75-302 and 75-303 were distinguished from Bassett, on the basis that contractual obligations did, in fact, exist.

Recommendation: Thus, taxpayers who wish to support a current deduction for advance tuition and fee payments to special schools must establish that the payments are made pursuant to a contractual obligation. Even when a contract does exist, however, it is not clear that advance payments may be deducted in the year of payment if, for example, monthly payment options are available.

Rev. Rul. 93-72 clarified Rev. Ruls. 75-302 and 75-303, stating that:

those rulings should not be interpreted to allow a current deduction of payments for future medical care (including medical insurance) extending substantially beyond the close of the tax year when the future care is not purchased in connection with obtaining lifetime care of the type described in those rulings.

Rev. Rul. 93-72 does not explain the term "substantially beyond," but does appear to acknowledge that the concepts behind the 1975 rulings are applicable to other types of medical expenses (such as tuition and fees paid to special schools). It is difficult to see how payment in one year for services to be provided over the first five to six months of the following year would be deemed to fail the "substantially beyond" test, but without further guidance, the answer is unclear.

Additional Services Provided by "Nonspecial Schools"

Taxpayers who send their special-needs children to "nonspecial" schools may still be able to deduct a portion of the tuition as medical expenses. The amount exceeding the normal tuition for regular students may qualify as a medical expense, to the extent that the additional program assistance provides therapeutic value to the student; see Rev. Rul. 69-607. The deductible portion of tuition need not be paid separately from the nondeductible portion.

If a school does not distinguish between normal tuition and medical care, the taxpayer may allocate part of the payment as normal tuition (based on comparable schools) and the remaining portion as qualifying medical expenses; see Fischer, 50 TC 164 (1968), and Fay, 76 TC 408 (1981). Incremental medical care can include a special program designed for a specific psychological-, physical- or mental-needs student, note-takers for deaf students or even psychotherapy services designed to help students adjust to normal school settings. The medical care determination does not depend on the title of the person rendering the service, the nature of the institution or whether it is considered medical care to others. However, the care must qualify as "medical care" under Sec. 213.

Tutoring and Other Extracurricular Activities

Numerous taxpayers have asked about the deductibility of the cost of tutoring and extracurricular activities under Sec. 213. Questions have arisen about activities such as summer camps, tutoring, and dance or music lessons.

Fees for summer camps may be deductible. For example, a YMCA day camp was designed to encourage interaction and physical growth among special-needs children through the use of different activities. In Emanuel, TC Suture. Op. 2002-127, the IRS allowed a deduction for the cost of recreation and leisure activities (normally not deductible), as the program was determined to be primarily therapeutic in nature.

The cost of special tutoring may also be deductible under Sec. 213. The Tax Court has held that the cost of tutoring provided to students with disabilities may be deductible as a medical expense, if it exceeds general tutoring or is provided by an educator trained to teach children with learning disabilities; see Sims, TC Memo 1979-499, and Rev. Rul. 78-340.

The cost of music lessons has also been held to be deductible if the lessons were of therapeutic value and prescribed for the sole purpose of alleviating a diagnosed condition; see Rev. Rul. 62-210. The applicability of this ruling may be limited, as the lessons were intended specifically to help alleviate a physical deformity. Obtaining similar results in less specific circumstances (or with other activities) has proven to be more difficult. Other activities, such as dance lessons, have been determined to be ineligible, on the basis that they were taken for general health purposes or prior to a condition being diagnosed; see, e.g., Thoene, 33 TC 62 (1959).

Conclusion

Taxpayers with special-needs children may be able to deduct various education and related costs as medical expenses. However, establishing deductibility can be difficult. Even if expenses are deductible, the issue of when may raise additional questions.

FROM EDWARD N. GOLDSBERRY, CPA, ANA JOHNSON, CPA, AND DANIEL TRAVIS, PKF TEXAS, HOUSTON, TX