Paying Someone Else's Deductible Expense


A

Alan

A question pops up every so often (10 years or less) asking whether the
taxpayer can deduct the property taxes or mortgage interest that they
paid for someone else. Typically, this involves parent(s) and child.
The answer for property taxes is that you can't deduct property taxes
you paid on real property unless you are obligated to pay them.
The answer for mortgage interest, is that you can't deduct mortgage
interest unless you are liable for the loan and the interest is not
personal interest. I.e., the property is your main or vacation home and
the property secures the loan.

In reviewing some of the replies on these posts, there is usually a
comment that the person who had the obligation to pay (typically the
owner), may not take a deduction because that person did not make the
payment.

Now comes a tax court case from last December that says differently. The
court took the position that substance trumped form. The case involved
an adult child who was not a dependent who took a tax deduction on
Schedule A for medical expenses and property taxes paid for by her
mother. The medical expenses were paid directly to the providers and
the property taxes were paid to the city. No gift tax return was
prepared by the parent as the property taxes paid were less than the
annual exclusion ($12K at the time) and the medical expenses paid were
exempt from gift taxes because of the direct payment. The taxpayer
argued that the court "should consider them to have in substance passed
from Mrs. Field to petitioner and then to petitioner’s creditors;
therefore petitioner should be entitled to deduct the payments." The IRS
argued "that the form of the transaction should apply and that because
the money was paid directly from Mrs. Field to petitioner’s creditors,
petitioner may not claim the deductions."

The court ruled in favor of the petitioner on both deductions.

See Lang vs Comm'r, TC Memo 2010-286 for details.
http://www.ustaxcourt.gov/InOpHistoric/La5ng.TCM.WPD.pdf
 
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S

Stuart A. Bronstein

Alan said:
Now comes a tax court case from last December that says
differently. The court took the position that substance trumped
form. The case involved an adult child who was not a dependent
who took a tax deduction on Schedule A for medical expenses and
property taxes paid for by her mother. The medical expenses
were paid directly to the providers and the property taxes were
paid to the city. No gift tax return was prepared by the parent
as the property taxes paid were less than the annual exclusion
($12K at the time) and the medical expenses paid were exempt
from gift taxes because of the direct payment. The taxpayer
argued that the court "should consider them to have in substance
passed from Mrs. Field to petitioner and then to petitioner's
creditors; therefore petitioner should be entitled to deduct the
payments." The IRS argued "that the form of the transaction
should apply and that because the money was paid directly from
Mrs. Field to petitioner's creditors, petitioner may not claim
the deductions."
The issue in the past was whether the person paying the property tax
or mortgage interest for someone else could take the deduction.
That's not the issue in the case you are referring to.

In your case it's the opposite situation. Someone paid the
deductible bill for someone else, and the person whose bill it was
took the deduction. It was a legitimate gift. I don't see a problem
with it, since the person paying the bill would not be able to deduct
it.
 
M

Mark Bole

In reviewing some of the replies on these posts, there is usually a
comment that the person who had the obligation to pay (typically the
owner), may not take a deduction because that person did not make the
payment.
This is the main topic of your post, which Stu is further clarifying in
his initial reply.
 
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Alan <[email protected]> wrote:

The issue in the past was whether the person paying the property tax
or mortgage interest for someone else could take the deduction.
That's not the issue in the case you are referring to.

In your case it's the opposite situation. Someone paid the
deductible bill for someone else, and the person whose bill it was
took the deduction. It was a legitimate gift. I don't see a problem
with it, since the person paying the bill would not be able to deduct
it.
>>
Firstly, in the original post, it's crazy that the tax system/commissioner would waste money trying to argue this point...

The second point is more interesting. Ignoring gifting and interest on loans for a sec, there are two options. Either the payer is allowed to claim the payment as a deducible expense but the petitioner would also have to declare this as revenue. Or the payer is not allowed to claim the payment. Either option would result in the same amount of tax paid unless they are on a different marginal tax rate ;)
 
A

Alan

The issue in the past was whether the person paying the property tax
or mortgage interest for someone else could take the deduction.
That's not the issue in the case you are referring to.

In your case it's the opposite situation. Someone paid the
deductible bill for someone else, and the person whose bill it was
took the deduction. It was a legitimate gift. I don't see a problem
with it, since the person paying the bill would not be able to deduct
it.
As Mark pointed out, the main point of the post is the ability of a
taxpayer who is not making the payment to take the deduction. This is
the first court decision, that I am aware of, that says it is allowable
under the right set of circumstances. Most of the literature on this
issue always makes the point that to take a deduction, you have to be
the one who actually makes the payment. E.g., under tests to deduct a
tax, the IRS says:

"If you are a cash basis taxpayer, you can deduct only those taxes you
actually paid during your tax year. If you pay your taxes by check, the
day you mail or deliver the check is the date of payment, provided the
check is honored by the financial institution. If you use a pay-by-phone
account (such as a credit card or electronic funds withdrawal), the date
reported on the statement of the financial institution showing when
payment was made is the date of payment."

And under Medical deductions the IRS says:
"You can include only the medical and dental expenses you paid this
year, regardless of when the services were provided. If you pay medical
expenses by check, the day you mail or deliver the check generally is
the date of payment. If you use a “pay-by-phone” or “online” account to
pay your medical expenses, the date reported on the statement of the
financial institution showing when payment was made is the date of
payment. If you use a credit card, include medical expenses you charge
to your credit card in the year the charge is made, not when you
actually pay the amount charged."

Lastly, the decision reiterates that it is the substance of the
transaction and not the form that matters.
 
R

removeps-groups

A question pops up every so often (10 years or less) asking whether the
taxpayer can deduct the property taxes or mortgage interest that they
paid for someone else.  Typically, this involves parent(s) and child.
The answer for property taxes is that you can't deduct property taxes
you paid on real property unless you are obligated to pay them.
The answer for mortgage interest, is that you can't deduct mortgage
interest unless you are liable for the loan and the interest is not
personal interest. I.e., the property is your main or vacation home and
the property secures the loan.

In reviewing some of the replies on these posts, there is usually a
comment that the person who had the obligation to pay (typically the
owner), may not take a deduction because that person did not make the
payment.
Does this mean that no-one gets to take the deduction -- not the owner
because they didn't pay it, not the parent who actually paid the bill
because they were not legally obligated to pay it?
Now comes a tax court case from last December that says differently. The
court took the position that substance trumped form. The case involved
an adult child who was not a dependent who took a tax deduction on
Schedule A for medical expenses and property taxes paid for by her
mother.  The medical expenses were paid directly to the providers and
the property taxes were paid to the city. No gift tax return was
prepared by the parent as the property taxes paid were less than the
annual exclusion ($12K at the time) and the medical expenses paid were
exempt from gift taxes because of the direct payment. The taxpayer
argued that the court "should consider them to have in substance passed
from Mrs. Field to petitioner and then to petitioner’s creditors;
therefore petitioner should be entitled to deduct the payments." The IRS
argued "that the form of the transaction should apply and that because
the money was paid directly from Mrs. Field to petitioner’s creditors,
petitioner may not claim the deductions."

The court ruled in favor of the petitioner on both deductions.
If the court allows the medical deduction to be taken by the taxpayer,
it's as if the parent gave the taxpayer the gift and the taxpayer paid
it, in which case the parent must file a gift tax return if the
property tax + medical expenses were more than the 12k threshold.

But if the parent is not paying gift tax on the medical expenses, then
they only the parent can take the medical deduction. Their child can
be their dependent for the medical expense deduction, but not the
personal exemption. This is what seems logical to me.
 
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B

Bill Brown

If the court allows the medical deduction to be taken by the taxpayer,
it's as if the parent gave the taxpayer the gift and the taxpayer paid
it, in which case the parent must file a gift tax return if the
property tax + medical expenses were more than the 12k threshold.
Medical costs of another person paid by the taxpayer directly to the
provider are NOT gifts for federal gift tax purposes.
But if the parent is not paying gift tax on the medical expenses, then
they only the parent can take the medical deduction.  Their child can
be their dependent for the medical expense deduction, but not the
personal exemption.  This is what seems logical to me.
It may seem logical to you but the Tax Court did not rule that way.
 
A

Alan

If the court allows the medical deduction to be taken by the taxpayer,
it's as if the parent gave the taxpayer the gift and the taxpayer paid
it,
Exactly what the court said. Substance over form.


in which case the parent must file a gift tax return if the
property tax + medical expenses were more than the 12k threshold.
Repeating what Bill Brown said.... exempt from Gift tax rules as
payments were made directly to the medical providers.

But if the parent is not paying gift tax on the medical expenses, then
they only the parent can take the medical deduction. Their child can
be their dependent for the medical expense deduction, but not the
personal exemption. This is what seems logical to me.
In this instance the child is not a dependent for the exemption and no
mention was made as to whether the child was a dependent for medical
expense purposes as the parent was not going to take a deduction.
Lastly, from the decision:
"Although Mrs. Field and petitioner would not be subject to the gift
tax, the income tax treatment in this context is not controlled by the
gift tax consequence. See Pierre v. Commissioner, 133 T.C. 24, 35 (2009)."
 
D

D. Stussy

Bill Brown said:
Medical costs of another person paid by the taxpayer directly to the
provider are NOT gifts for federal gift tax purposes.


It may seem logical to you but the Tax Court did not rule that way.
I expect that the IRS will not acquiesce to this situation.
1) The donor gave a gift. No deduction.
2) The recipient was relieved of a liability. No deduction*, but also no
income as gifts are not taxable to the recipient.

No deduction per the income tax side of the law, except due to a quirk in
gift tax law, the amount of the gift reportable is actually under the
threshold for requiring a Form 709. Upon reading the decision, it appears
such had a bearing on the outcome. That quirk deemed the payment as
relayed through the recipient even though in form it was paid directly to
the third-party.

Had a form 709 been required, the outcome might have been diferent.
 
A

Alan

I expect that the IRS will not acquiesce to this situation.
1) The donor gave a gift. No deduction.
2) The recipient was relieved of a liability. No deduction*, but also no
income as gifts are not taxable to the recipient.

No deduction per the income tax side of the law, except due to a quirk in
gift tax law, the amount of the gift reportable is actually under the
threshold for requiring a Form 709. Upon reading the decision, it appears
such had a bearing on the outcome. That quirk deemed the payment as
relayed through the recipient even though in form it was paid directly to
the third-party.

Had a form 709 been required, the outcome might have been diferent.
That last statement is not that clear to me. Had the mother actually
gifted the amount to her child rather than paying the bills directly, a
Form 709 would have been required by the mother and the child could take
the deduction after spending the funds on medical expenses. The outcome
to the child, is the same.
 
N

NadCixelsyd

The answer for property taxes is that you can't deduct property taxes
you paid on real property unless you are obligated to pay them.
"the following taxes shall be allowed as a deduction for the taxable
year within which paid or accrued: (1) State and local, and foreign,
real property taxes."

I find nothing in the statute that requires the taxpayer to have the
obligation to pay the real property taxes.
 
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A

Alan

"the following taxes shall be allowed as a deduction for the taxable
year within which paid or accrued: (1) State and local, and foreign,
real property taxes."

I find nothing in the statute that requires the taxpayer to have the
obligation to pay the real property taxes.
I believe Reg 1.164-3(b) is where you can find the answer. The tax must
be imposed on someone who has an interest in the property.
 
R

removeps-groups

Medical costs of another person paid by the taxpayer directly to the
provider are NOT gifts for federal gift tax purposes.


It may seem logical to you but the Tax Court did not rule that way.
Maybe so, but it looks like double dipping. The medical expense paid
by a third person is both free from the gift tax as well as allowable
for a deduction.
 
B

Bill Brown

Maybe so, but it looks like double dipping.  The medical expense paid
by a third person is both free from the gift tax as well as allowable
for a deduction.
If the donor gave cash to the donee and the donee wrote a check to the
doctor would you call that double dipping? In substance there is no
difference between the two ways of having the donor pay the donee's
medical expenses.
 
R

removeps-groups

If the donor gave cash to the donee and the donee wrote a check to the
doctor would you call that double dipping? In substance there is no
difference between the two ways of having the donor pay the donee's
medical expenses.
In your example above, the donor would be liable for gift tax, but the
the donee who paid the bills would get the deduction. In the original
post, the donor gets to pay no gift tax, and the donee gets to take a
deduction. But I guess this is what the law says, so I'm fine with
that, was just saying it sounds illogical to me.
 
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S

Seth

If the donor gave cash to the donee
Then there would exist the issue of gift tax.
and the donee wrote a check to the doctor would you call that double
dipping? In substance there is no difference between the two ways of
having the donor pay the donee's medical expenses.
The gift tax is the difference.

Seth
 
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