Tax Deductibility

If you have a child with a severe learning disability (LD), you may qualify for valuable tax benefits. If your child has AD/HD or other physical, mental or emotional impairments, you may also qualify for tax benefits. Because tax laws are complex and many tax preparers often do not have occasion to use these unique tax benefits, families are at risk of losing refunds worth thousands of dollars. It's likely that 15% to 30% of families with a disabled child have one or more unclaimed tax benefits.

This guide provides a summary of the most significant federal income tax benefits and should not be considered legal advice. Tax decisions should not be made simply on the basis of the information provided here. You are advised to print out this guide and give a copy to your tax advisor. You should also explore potential state income tax benefits, which are too numerous to review in this guide.

The following summarizes the principal tax benefits that may be available to families caring for children with severe learning disabilities.

(See IRS Publication 502, "Medical and Dental Expenses.") What Expenses Qualify for a Tax Deduction?

The following expenses may qualify for the deduction if a medical professional recommends the service or treatment for the child and there is a medical diagnosis of a neurological disorder, such as a severe learning disability:

• Tuition for a private school
• Tutoring
• Specialized materials (e.g., books, software and instructional materials)
• Diagnostic evaluations (by a private practitioner)
• Therapy
• Transportation expenses for a private school or tutor

Retroactive Claims for Refunds

The IRS allows taxpayers to file amended returns and collect refunds for unclaimed tax benefits retroactively up to three years. This means a taxpayer can file an amended return for the 2005 tax year (and also for the 2006 and 2007 tax years) and claim a refund if the return is filed not later than April 15, 2009. (See IRS Publication 17, "Your Federal Income Tax," 2008, pages 18-20.) Besides Parents, Who Can Claim a Child as a Dependent? A relative caretaker (e.g., a grandparent or aunt) or a non relative caretaker (e.g., a foster parent or legal guardian) may be able to claim a child as a dependent and qualify for related tax benefits. A relative caretaker and the child are not required to live in the same household. More information is available in IRS Publication 501; "Exemptions, Standard Deduction and Filing Information"; pages 9-19: http://www.irs.gov/pub/irs-pdf/p501.pdf.

Eligibility is determined by a five-part test

The most critical requirement is that the caretaker must provide more than half of overall financial support for the child. For example, there may be cases where the caretaker is making a substantial financial contribution toward LD-related expenses (e.g., private school tuition) that represents more than half of the overall cost of support for the child. In those situations, the caretaker could list the child as a dependent and claim the tuition as a medical expense deduction on Schedule A. Medical Expense Deductions A taxpayer may claim a deduction for medical expenses of the taxpayer or the taxpayer's dependents (see box for more information on dependents). Section 1.213-1(e)(1)(v)(a) of the Department of the Treasury regulations provides, in part, that while ordinary education is not medical care, the cost of medical care includes the cost of attending a special school for a mentally or physically handicapped individual, if his condition is such that the resources of the institution for alleviating such mental or physical handicap are a principal reason for his presence there.

As such, the IRS has ruled that tuition and transportation costs for a special school that has a program designed to educate children with learning disabilities and amounts paid for a child's tutoring by a teacher specially trained and qualified to deal with severe learning disabilities may also be deducted. (Revenue Ruling 78-340, 1978-2 C.B. 124.) Special instruction, training or therapy, such as Braille, lip reading, sign language instruction, speech therapy and remedial reading instruction, would also be deductible. Related books and materials can qualify for the medical expense deduction.

IRS Private Letter Ruling 8616069 (1985 PLR L 41) discusses what types of conditions and instruction may not qualify. Generally, for families to qualify for the deduction, the child's doctor must recommend the special school, therapy or tutoring, and there must be a medical diagnosis of a neurological disorder, such as a severe learning disability, made by a medical professional. Transportation expenses for the special school or the tutor also qualify for a medical expense deduction. If transportation is by car, the allowable expense in 2008 is 19 cents per mile (for miles driven from January 1 to June 30) and 27 cents per mile (from July 1 to December 31), or the actual cost of operating the vehicle.

Furthermore, deductible medical expenses include expenses for the diagnosis and treatment of physical disorders, and travel and lodging costs related to such diagnosis and treatment expenses. This can include testing by a speech-language pathologist, psychologist, neurologist or other person with professional qualifications.

Note: Expenses claimed as a medical expense deduction and later reimbursed by an insurance company or school district (e.g., the service is adopted as part of the child's Individualized Education Program, or IEP) must be reported as taxable income for the year in which the reimbursements are received. If parents have paid for the services but haven't claimed them as a medical expense, they should ask that the school district not issue a 1099 form in connection with the reimbursement. If the school district does issue a 1099, consult with a tax advisor about how to proceed. Not everyone who has medical expenses can use them on their tax return. Medical expenses must be claimed on Schedule A, Itemized Deductions, and are subject to certain limitations. First, the family must have itemized deductions that exceed their standard deduction in order to use Schedule A (about 65% of taxpayers do not itemize for this reason). Second, medical expenses are allowed as a deduction only to the extent that they exceed 7.5% of adjusted gross income, a significant threshold for many families.

Health Savings Accounts and Flexible Savings Arrangements

Alternative approaches to obtaining tax benefits in connection with medical expenses may involve use of a health savings account (HSA) or a flexible savings arrangement (FSA). All the LD-related medical expenses reviewed above can be paid through an HSA or FSA with pretax dollars. An HSA allows a worker to use up to $5,800 in 2008 for family coverage, in pretax income for medical expenses. An HSA may only be opened when the employee has a "high deductible" health insurance plan. Amounts placed in an HSA may be carried over to following years if not used. An FSA can be part of a "cafeteria plan" of alternative fringe benefits offered by an employer. An employee can allocate pretax income to the account and then withdraw it during the year to pay for medical expenses. Employers may also make contributions to the FSA, and the maximum amount is set by the terms of the employer plan. Two important conditions are:

1. The amount to be placed in the account must be determined by the employee at the beginning of the year.
2. Funds in the FSA that are not used by the end of the year are lost. However, a recent amendment allows a onetime transfer of FSA funds to an HSA.