CRS STUDY EXAMINES EFFECT OF CODE CHANGES ON ELDERLY.

                          Louis Alan Talley

SUMMARY

Many tax code provisions have been modified in recent years. In general, these changes have been structured around a desire to reduce tax rates and simplify the Internal Revenue Code. These changes, such as the reduction of the number of tax brackets, and changes in the personal exemption amount, along with the reversion back to a standard deduction from the zero bracket amount, affect all taxpayers, including the elderly.

Under current law there are a number of special provisions in the tax code which have the effect of reducing the tax liability of the elderly or are of special significance to elderly taxpayers, including the following: (1) exclusion from taxation of certain Federal and other pension benefits during retirement; (2) a nonrefundable tax credit for the elderly and/or permanently and totally disabled; (3) an additional standard deduction amount for individuals aged 65 or older; a person who is both 65 years or older and blind is entitled to two additional standard deduction amounts; (4) the itemized deduction for unreimbursed medical expenses to the extent that the total amount of such expenditures exceed 7.5 percent of adjusted gross income; (5) a one-time exclusion of capital gains (up to $125,000 of the gain) on the proceeds from the sale of a principal residence by persons aged 55 or over; (6) the dependent care tax credit; (7) the Internal Revenue Service's program for tax counseling for elderly taxpayers. In addition, businesses have available a provision that a deduction may be taken for the removal of architectural and transportation barriers so that facilities or public transportation vehicles may be more accessible to and usable by the elderly.

TABLE OF CONTENTS

TAX TREATMENT OF SOCIAL SECURITY AND RAILROAD RETIREMENT BENEFITS

VETERANS' BENEFITS

ANNUITY INCOME

CREDIT FOR THE ELDERLY AND THE PERMANENTLY AND TOTALLY DISABLED

ADDITIONAL STANDARD DEDUCTION FOR THE ELDERLY OR BLIND

MEDICAL DEDUCTION RESIDENCE IN A SANITARIUM OR NURSING HOME

CAPITAL EXPENDITURES

DEPENDENT CARE CREDIT

$125,000 EXCLUSION OF GAIN FROM SALE OF RESIDENCE

TAX COUNSELING FOR THE ELDERLY

DECLARATION AND PAYMENT OF ESTIMATED TAXES

REMOVAL OF ARCHITECTURAL AND TRANSPORTATIONAL BARRIERS

* * * * *

During the 1980s, many tax code provisions had been modified. In general, these changes were brought about by the desire to reduce tax rates and simplify the Internal Revenue Code. Such changes as the reduction of the number of tax brackets, and changes in the personal exemption amount, along with the reversion back to a standard deduction from the zero bracket amount, affect all taxpayers, including the elderly. It is not the purpose of this report to detail all tax code provisions which in some way affect the tax liability of elderly Americans. Rather, this report details those provisions with specific applicability to older Americans.

Family members who support aged relatives are also provided special tax treatment in some cases. ¹ In addition, there are some provisions of general applicability which may be of particular benefit to the elderly such as the deductibility of medical expenses. A number of these types of provisions are also discussed in this report.

TAX TREATMENT OF SOCIAL SECURITY AND RAILROAD RETIREMENT BENEFITS

Current law provides that taxation of retirement benefits is not based upon occupation, but rather on the type of program under which the individual is retired. Two important types of retirement benefits, those paid under Federal social security and railroad retirement systems, are exempt if the retirees income falls below $25,000 for a single individual and $32,000 for married couples filing jointly. The tax is computed on the lesser of one-half of the benefit or one-half of the taxpayer's "combined income" in excess of $25,000 for single taxpayers (including heads-of-households) and $32,000 for married couples filing jointly. Combined income is defined as gross income, interest on tax-exempt obligations, and the social security or railroad retirement benefits.

VETERANS' BENEFITS

Pension payments or disability compensation received by veterans for service-connected and non-service connected disabilities are excludable from gross income.

ANNUITY INCOME

In computing tax liability, an individual must first ascertain the sum of funds the individual contributed to the cost of the annuity. Each payment of the annuity is then divided into two parts: (1) a return of cost (and thus, not taxable), and (2) reportable income. Generally, the individual determines the amounts to be considered a return of cost and the amounts to be considered taxable income, in the following way: (a) he ascertains his contributions to the annuity (b) he multiplies the annual pension by his life expectancy (as shown by life-expectancy tables issued by the Internal Revenue Service), (c) he divides the result of (a) by the result of (b) to find what percentage the one is of the other, and (d) he applies this percentage to each annuity payment to find what part is a return of cost and thus not taxable, and subtracts this amount from each annuity payment to find what part is taxable income.

CREDIT FOR THE ELDERLY AND THE PERMANENTLY AND TOTALLY DISABLED

During the early 1950s, when social security benefits were entirely tax-exempt, pressure for tax-free benefits for other forms of retirement income, such as civil servant pensions, was brought to bear on the Congress. As a result, the tax credit for the elderly and the permanently and totally disabled, formerly known as the retirement income credit and the tax credit for the elderly, was enacted with the codification of the Internal Revenue Code of 1954. Thus, the purpose of this tax credit is to provide parity between the retirement benefits received by public and private sector employees.

The 15 percent credit is computed on the lower of the amount of retirement income or "initial amount." The initial amount is determined by filing status. Those amounts are as follows:

      Single individual                                 $5,000

Finally, the initial amount is reduced by one-half the amount of adjusted gross income over the following levels:

      Single taxpayer                                   $7,500

Special rules apply in some cases where both taxpayers are eligible for this credit.

ADDITIONAL STANDARD DEDUCTION FOR THE ELDERLY OR BLIND

In addition to the personal/dependency exemption and the standard deduction, a taxpayer is allowed an additional standard deduction if he/she is elderly or blind on the last day of the taxable year. ² This additional amount is $650 for an elderly or blind married individual or surviving spouse and $800 for an elderly or blind unmarried individual for tax year 1990. These additional amounts are subject to adjustment for inflation. The increase, if not a multiple of $50, is rounded down to the next lowest multiple of $50.

MEDICAL DEDUCTION

Under present law, only those unreimbursed medical expenses in excess of 7.5 percent of the adjusted gross income of the taxpayer may be deducted. ³ Qualified medical expenses counted towards this 7.5 percent limitation include health insurance premiums, unreimbursed medical expenditures, and prescription drugs. The only nonprescription drug eligible for inclusion is insulin.

The determination of what constitutes medical care for purposes of the medical expense deduction is of special importance to the elderly. Two special categories are enumerated below.

RESIDENCE IN A SANITARIUM ON NURSING HOME

If an individual is in a sanitarium or nursing home because of physical or mental disability, and the availability of medical care is a principal reason for his being there, the entire cost of maintenance (including meals and lodging) may be included in medical expenses for purposes of the medical expense deduction. The Tax Court found in W. B. Counts and Mildred P. Counts, Petitioners, v. Commissioner of Internal Revenue, Respondent that:

In summary, the present regulations provide that the cost of inpatient hospital care, including the costs of meals and lodging at the hospital, is an expenditure for medical care as that term is defined in section 213(e)(1)(A). It is recognized that such costs of maintenance at an institution other than a hospital may constitute expenses for medical care; that whether such costs incurred at an institution other than a hospital are deductible as medical expenses is a factual question the answer to which depends not upon the nature of the institution but upon the condition of the person and the care which he receives; that the cost of nursing attention is an expense for medical care; that if A -- and we note that the regulations do not require THE principal reason for the person's presence in an institution is -- the availability of medical care for him, then the costs of meals and lodging, furnished as a necessary incident to such care, for as long as the person requires the care, are deductible; and that, if the availability of medical care is not a principal reason for the person's presence at the institution, the costs of meals and lodging are not deemed expenses for medical care, although, even in this event, the expenses for nursing attention are considered costs of medical care and are deductible. An example in subdivision (v)(b) of the regulations deals with the case of a person who resides at a home for the aged because of personal or family considerations and NOT BECAUSE HE REQUIRES MEDICAL OR NURSING ATTENTION; in this event, it is provided that the person's costs of meals and lodging are not embraced within the term "medical care" but that his costs of nursing attention are deductible. ⁴

CAPITAL EXPENDITURES

Capital expenditures incurred by an aged individual for structural changes to his personal residence (made to accommodate a handicapping condition) are fully deductible as a medical expense. The General Explanation of the Tax Reform Act of 1986 prepared by the Joint Committee on Taxation states that examples of qualifying expenditures are construction of entrance and exit ramps, enlarging doorways or hallways to accommodate wheelchairs, installment of railings and support bars, the modification of kitchen cabinets and bathroom fixtures, and the adjustments of electric switches or outlets.

DEPENDENT CARE CREDIT

The child and dependent care tax credit is available to taxpayers for employment-related expenses incurred to care for a dependent or spouse who is physically or mentally disabled. Employment-related expenses include expenses for household services, day care centers, and other similar types of noninstitutional care which are incurred in order to permit the taxpayer to be gainfully employed. With the passage of the Economic Recovery Tax Act of 1981 the tax credit for dependent care was increased and liberalized. Under current law, taxpayers may claim a nonrefundable credit of 30 percent of qualified expenses if their adjusted gross income is $10,000 or less. For taxpayers with incomes above $10,000 the credit is reduced by 1 percent for each additional $2,000 of adjusted gross income until an adjusted gross income of $28,000 is reached. Taxpayers with adjusted gross incomes in excess of $28,000 are provided a minimum 20 percent credit towards qualifying expenditures. The maximum amount of qualifying expenses is $2,400 for one dependent or $4,800 for two or more dependents. ⁵ Table 1 which follows on the next page gives the tax credit percentage and maximum allowable credits by adjusted gross income class.

Prior to the passage of the Economic Recovery Tax Act of 1981, these expenses, in the case of elderly dependents, were eligible only if incurred for services performed in the taxpayer's household. Under the new liberalized provision, if the dependent spends at least eight hours a day in the taxpayer's home, expenditures made for out of home, noninstitutional care are eligible for the credit. Dependent care centers must be in compliance with all State and local regulations for the taxpayer to count such expenditures toward qualified expenses. Married couples must file a joint return in order to be eligible for the credit.

                               TABLE 1.

Under present law, gain from the sale of a taxpayer's principal residence is taxable, but the tax may be deferred. If another residence is purchased or built within the prescribed time period, the taxpayer may qualify for the nonrecognition of all or part of the gain on the sale of the old residence, thus deferring tax on the nonrecognized gain. However, the basis of the new residence is reduced by the amount of the nonrecognized gain. ⁶ This provision is available to all taxpayers regardless of age or handicapping condition.

A taxpayer may also elect to exclude from gross income up to a $125,000 gain from the sale of a residence, provided (1) the taxpayer was at least 55 years of age before the date of the sale or exchange, and (2) he owned and occupied the property as his principal residence for a period totalling at least three years within the five year period ending on the date of the sale. Short periods of absence, such as for vacations, even if rented during those periods, are counted towards the three-year required period. Taxpayers meeting these two requirements can elect to exclude from gross income the entire capital gain from the sale or exchange if the capital gain is less than $125,000 or the first $125,000 profit if the gain is greater. The election may be made only once in a lifetime. If either spouse has previously made an election (individually, jointly, or from a previous marriage) then neither is eligible to elect the exclusion.

TAX COUNSELING FOR THE ELDERLY

The Internal Revenue Service has been empowered to provide training and technical assistance to prepare volunteers of private and public non-profit agencies and organizations to assist persons 60 years of age or older with their Federal income tax returns.

Reimbursements for transportation, meals, and other expenses incurred by volunteers during training and tax counseling assistance may be paid by the Internal Revenue Service.

DECLARATION AND PAYMENT OF ESTIMATED TAXES

Elderly individuals often must file and pay estimated tax payments. Payroll withholding during the working years can often be adjusted to cover income taxes owed on income not subject to withholding and thus avoiding the need to file estimated tax payments. The elderly often receive a large portion of their income from sources such as rental income, interest and dividend payments not subject to Federal tax withholding. Since most elderly individuals no longer receive salaries and wages from which withholding traditionally occurs, it often becomes necessary for them to make estimated tax payments.

REMOVAL OF ARCHITECTURAL AND TRANSPORTATIONAL BARRIERS

The removal of architectural and transportation barriers can be treated as a deductible expense (rather than as an expenditure which is capitalized over the useful life of the asset). Expenditures must be made to make facilities or public transportation vehicles (either owned or leased by the taxpayer and used in the taxpayer's trade or business) more accessible to and usable by the elderly and handicapped. There is no requirement that such expenditures be made only for the benefit of employees but rather the provision applies equally to all elderly and handicapped persons.

The maximum deduction permitted a business taxpayer (either individual, corporation, or a controlled group of corporations) for qualifying expenditures is limited to $35,000 a year. When first adopted, the qualifying expenditures were limited to $25,000 a year. The deduction has been made a permanent part of the Internal Revenue Code by the Tax Reform Act of 1986.

² Prior law provided as extra personal exemption for age and blindness. The Tax Reform Act of 1986 provided an additional standard deduction in lieu of this personal exemption.

³ Note that reimbursed expenses are not deductible.

⁴ W. B. Counts, 42 TC 755, 763-764 (July 23, 1964).

⁵ Before 1981 taxpayers could claim an annual credit of 20 percent of qualified expenses up to $2,000 (for a maximum credit of $400) for one qualifying individual and $4,000 (for a maximum credit of $800) for two or more qualifying individuals.

⁶ An explanation of nonrecognition of gain can be found in Internal Revenue Code Section 1034(a).