Federal and state tax laws often include specific provisions that can help taxpayers reduce their tax liability. However, the provisions are sometimes obscure or difficult to understand, thereby leaving taxpayers unaware of potential benefits. This article focuses on important tax considerations for families with special needs and describes ways they can save money on taxes.
Tools for Special Needs Tax Savings
American taxpayers have three primary mechanisms for reducing their tax liability and maximizing their tax refunds. These tools for important tax savings are exemptions, deductions and credits. Tax exemptions are basically reductions in the amount of income that is taxed based on circumstances. Exemptions lower taxable income by making a portion of individual or family income exempt from taxation. Prior to 2018, taxpayers could claim personal exemptions for themselves and their spouse on their tax return. They could also claim dependent exemptions for their qualifying children or other individuals for whom they paid a majority of (more than 50%) of living expenses.
Although personal and dependent exemptions are suspended through tax year 2025, there is a chance that they may be reinstated at some point. In addition, dependents could help taxpayers qualify for other important tax benefits, such as the child tax credit, additional child tax credit, credit for other dependents, earned income credit, child and dependent care credit and the head of household filing status, among others.
Tax deductions are expenses that can reduce taxable income. There are two basic types of deductions: above-the-line deductions and below-the-line deductions. Above-the-line deductions, which are also known as “adjustments to income,” are subtracted from your gross income to calculate your adjusted gross income (AGI). Contributions to a health savings account (HSA) and student loan interest are examples of above-the-line deductions.
Below-the line deductions are subtracted from your AGI to calculate your taxable income. In other words, above-the-line deductions are used to calculate your AGI and below-the-line deductions are used to determine how much your income will be taxable. The standard deduction and itemized deductions are examples of below-the-line deductions. Tax deductions are important tax tools for reducing the amount of a taxpayer’s taxable income.
Tax credits are amounts that can be subtracted from the tax you owe to reduce your tax liability. Some tax credits are refundable, while others are not. Nonrefundable tax credits credits can be used to reduce the amount of tax you owe to zero. Refundable tax credits can put money in your pocket, even if you owe no taxes. Rules regarding which credits are available and whether they are refundable or not can and do change from time to time. Tax credits are important tax tools for reducing a taxpayer’s tax liability and, in the case of refundable credits, helping them secure a larger refund.
Make sure you do your research prior planning your tax strategy and preparing your returns each year. Families with special needs dependents should seriously consider consulting a lawyer or accountant with expertise in special needs tax strategies. A professional advisor can offer important tax tips that can help families maximize their savings and refunds.
Special Needs Versus Disabilities
It should be noted that many people do not regard disabilities and special needs as interchangeable descriptions. What constitutes each condition is often subjective. There are those who regard an individual with special needs as disabled. Others believe any disability means that the person also has special needs.
Some people use the term disability in reference to a physical impairment, such as blindness. They use the term special needs to describe individuals with developmental disorders, emotional and behavioral problems, and learning difficulties. People who have some conditions, such as autism spectrum disorder, may be considered to either have special needs or disability, depending on who is doing the talking.
Regardless of whether a disabling condition is physical, mental, emotional or development, the Internal Revenue Service (IRS) uses the term disability. Tax deductions, exemptions, credits, and other important tax considerations for individuals who have special needs are found in their laws governing disabled people. State laws often differ from the IRS and other federal agencies. Any decisions made to take advantage of tax deductions and tax credits for dependents who have disabilities must take into account all applicable laws to obtain maximum tax savings.
Every Tax Exemption, Deduction, or Credit Must Be Fully Documented
The burden of proof is always on the taxpayer when claiming an exemption, tax deduction, or tax credit. Thorough documentation is especially crucial to tax strategies related to dependents with disabilities because of the unique benefits available to them. Taxpayers should plan on saving and organizing receipts and other important tax documentation for everything. Any recommendations made by healthcare professionals, schools, facilities, or any other source that results in extra costs should be substantiated with written documentation.
Important Exemptions for Dependents with Special Needs
A dependent is someone who is physically or mentally unable to care for themselves. For many taxpayers, their children must be younger than 19 years old or a full-time student under the age of 24 at the end of the year to claim them as dependents. Relatives the taxpayer supports, such as their siblings and children of their siblings, must also be younger than the taxpayer to qualify as a dependent.
Most dependents are members of the taxpayer’s household and are supported by the taxpayer. However, there are numerous conditions under which exemptions can be taken for dependents with income or who live in another residence. The important tax provisions governing such cases are complex, and taxpayers would be wise to consult a professional for important tax tips on claiming them.
Age limits are waived if the dependent is permanently and totally disabled at any time during the year. In such instances, the disability must prevent the individual from engaging in substantial gainful activity. A medical professional must also verify that the disability is permanent.
Many tax provisions regarding residency and support are also modified for disabled dependents. As those can provide significant tax benefits, taxpayers would likely find it beneficial to consult a professional to discuss tax strategies if they have a dependent that has income or who doesn’t live in the taxpayer’s household.
Important Tax Deductions for Dependents with Special Needs
Tax laws include several categories of expenditures that may be used to reduce taxable income. Known as itemized deductions, the expenses are subject to many limitations. These include medical costs, among others. Rather than facing the record-keeping burden of documenting and itemizing all their deductions, many taxpayers opt for the standard deduction, which is a fixed amount that doesn’t require verification.
That may not be the best choice for taxpayers with special needs family members. Many important tax deductions are available to them that can significantly reduce their taxable income. Deductions for medical expenses can be especially substantial for families that have dependents with special needs. Medical expenses generally include treatment for any part or function of the body. Learning disabilities are classified as a medical condition for tax purposes. Deductible medical expenses for individuals with disabilities may encompass many items, such as those described below, that are not available to others.
Assistive Devices
Tax deductions for assistive devices include the cost of acquiring, maintaining, and operating a wheelchair, speech generating device or other device needed for relief of the medical condition. The expenses are not deductible if the device is not used for the purpose of alleviating a medical condition. For example, a wheelchair would not be deductible if it is used only for transportation. It may seem unusual to consider a wheelchair a form of transportation, but some people that may not need a wheelchair to relieve a medical condition may actually use them for that purpose in places like airports and shopping malls.
Diet
Taxpayers may deduct the cost of special foods or diets that exceed the price of ordinary foods. Purchasing gluten-free foods for a child with autism who is also gluten intolerant would be one example. A medical professional must recommend the special foods in order for them to be deductible.
Education
Fees for tuition and supplies to attend specialized schools are deductible. Tutoring that’s required to meet special learning needs may be deducted. Costs incurred for attendance at a general education school for services that are provided by the school, such as an independent evaluation or assessment, for students with disabilities are deductible. Hiring someone to teach Braille or lip reading and the cost of materials printed in Braille are examples of allowable tax deductions.
Equipment
Deductible equipment is equipment that is needed to treat or alleviate a medical condition. It includes artificial limbs, eyeglasses and contact lenses, hearing aids, and specialized communication devices.
Home Modifications
A home modification is not deductible if it increases the home’s value unless the cost exceeds the increase in value. Installing entrance and exit ramps is an example of a deductible home improvement.
Impairment-Related Work Expenses
Some individuals with disabilities are active members of the workforce. However, they may need an attendant or other accommodations to enable them to perform their jobs. Those expenses may be deducted as an itemized deduction when they file their tax returns. They are not subject to the same limitation as ordinary miscellaneous deductions.
Long-Term Care Insurance
Taxpayers often want to provide for dependents with disabilities that will need lifelong care once they are no no longer able to care for them to to age or physical incapacity or upon their death. They may deduct portions of the premiums paid for long-term care insurance to provide continued care.
Professional Services
Professional services, including legal fees, are deductible if incurred to ensure that dependents with disabilities or special needs receive required care and treatment.
Supplies
Supplies are items, such as diapers, if they are needed because of a medical condition. If ordinary items, such as bedding, must be purchased in a different form in order to alleviate a disability, the additional cost may also be deductible.
Service Animals
The cost of purchasing training, maintaining and caring for a guide dog or other support animal are deductible if it is needed to assist a with visual impairment, hearing impairment, a mobility impairment or other physical disability. The costs of food, grooming and veterinary care for sch animals would be deductible.
Therapy
The cost of behavioral, physical, and speech therapy is deductible, as are exercise programs if recommended by a medical professional. So are costs related to equine therapy, and activities such as art, camps, dance, music, yoga, and play therapy if they are recommended by a medical professional.
Transportation
Transportation is deductible when it is needed in order to attend medical appointments, therapy sessions or special education programs. Taxpayers may deduct the costs of travel to and attending medical conferences to obtain information specific to the care and treatment of the special needs dependent. The conference must be recommended by a medical professional. Mileage or airfare is deductible if travel is necessary for testing or treatment.
Other
Other medical expenses include fees paid to healthcare providers, prescription medications, and costs associated with hospitalization or admission to a care facility if it is required for medical care. Medical expenses are deductible only if they are not reimbursed and if they exceed 7.5% of adjusted gross income.
Important Tax Credits for Dependents with Special Needs
Tax credits reduce the amount of tax due and, in some cases, may be refundable. There are four common types:
- Child and Dependent Care Credit—This important tax credit is for taxpayers who have a child under 13 or a disabled dependent of any age that they must pay someone to care for while they work or look for work.
- Credit for the Elderly and Disabled—This important tax credit is for taxpayers who are 65 or older or who are permanently and totally disabled. The credit currently ranges from $3,750 to $7,500.
- Earned Income Tax Credit (EITC)—This important refundable tax credit is for low to moderate income households that meet several qualifying rules. Those rules for this tax year include having earned income under $59,187 and investment income below $10,300.
- Saver’s Credit for qualified retirement savings contributions—Beneficiaries of A Better Life Experience (ABLE) accounts may qualify for the saver’s credit. Taxpayers who contribute to various types of retirement plans–including a traditional or Roth IRA, 401(k), 403(b), governmental 457(b), SARSEP, SIMPLE, 501 (c) (18) (D) and federal Thrift Savings plans. Depending on their AGI and filing status, a taxpayer may qualify for a saver’s credit of 10%, 20% or 50% of their contribution. This important tax credit could have a substantial impact on a taxpayer’s bottom line.
Tax-Deferred and Tax-Advantaged Accounts
Other programs and services are available that provide important tax benefits for families that have dependents with special needs. Tax-deferred and tax-advantaged accounts include 529 College Savings Plans, ABLE Accounts, Coverdell Education Savings Accounts, Flexible Spending Accounts (FSA) and Special Needs Trusts. Potential tax and other benefits are subject to numerous factors that vary according to individual circumstances. Therefore, consulting a qualified tax planner who can analyze all the relevant advantages and disadvantages that apply to a taxpayer’s unique circumstances could be a huge advantage when planning a tax strategy.
529 College Savings Plan
While 529 plans were initially established to save money tax-free for college tuition, they could be of benefit to families that have dependents with special needs who are enrolled in K-12 school programs. There isn’t a limit on how much may be deposited in the account, although contributions are subject to gift tax laws.
In some cases, the funds are also counted as assets when determining eligibility for some financial aid programs, including Supplemental Security Income (SSI). Most food stamp programs do not count 529 savings. Currently, the funds may be used for elementary and secondary education (K-12) and may be used for special needs services required for attendance, including books, equipment, supplies, and special schools fees. Most plans are state-sponsored, and restrictions vary. Rolling over 529 plans to an ABLE account may have a tax benefit for some individuals. Experienced accountants and tax attorneys could be crucial allies when determining whether 529 plans could provide you with important tax benefits.
Achieving A Better Life Experience (ABLE) Account
ABLE accounts are savings accounts for individuals who have disabilities or special needs. The accounts are state programs, and details may vary. The disability must have begun before age 26, and the tax-free funds must be used for disability-related expenses. These include expenditures to maintain health, independence, and quality of life.
The account is not counted as an asset when determining eligibility for means-tested government benefits, such as SSI or food stamps, subject to limitations of the amount in the account. However, a state Medicaid program may be entitled to the account balance to repay benefits when the beneficiary dies. The fact that funds are tax-free, are not counted as an asset could make these accounts and could result in a saver’s credit could make these accounts an important tax savings vehicle for families with special needs.
Coverdell Education Savings Accounts (ESA)
Coverdell accounts are trust or custodial accounts that are intended to pay for the qualifying educational expenses of a beneficiary. The beneficiary must be less than 18 years old or have special needs. No more than $2,000 may be added to the account each year, and the tax-free funds may only be used for qualifying education expenses. Expenses for K-12 education qualify, which can make this an especially important tax-advantaged account for families that have a dependent who has special needs that attends elementary or secondary school.
Unless the beneficiary has special needs, the account must be closed by age 30 to avoid penalties. A Coverdell education savings account may affect their eligibility for financial aid benefits. Depending on a family’s unique circumstances, tax professionals or financial planners may advise families to consider establishing both 529 and Coverdell accounts for family members with special needs.
Flexible Spending Accounts (FSA)
Flexible Spending Accounts are available only from employers. Employees authorize their employers to withhold pre-tax dollars, therefore FSAs reduce taxable income. Employees may have a Health Care Flexible Spending Account (HCFSA), a Dependent Care Flexible Spending Account (DCFSA), or both. Reimbursements are made from the withheld funds.
Health Care Flexible Spending Accounts reimburse qualifying health expenses. Dependent Care Flexible Spending Accounts reimburse qualifying dependent care expenses. There are no age restrictions on special needs dependents; other dependents must be less than 13 years old. Reimbursements for dependent care may affect the earned income credit. Both types of FSAs provide important tax benefits by reducing your taxable income while also putting money back in your pocket in the form of reimbursements.
Special Needs Trusts
Special needs trusts protect an individual’s eligibility for need-based benefits such as SSI and Medicaid. Trust funds are used to pay for unreimbursed medical expenses and services. The special needs trust must be established before the disabled person reaches 65, be irrevocable, and stipulate that Medicaid benefits will be repaid upon death.
A first-party trust must be funded from the individual’s assets but must be set up and administered by a trustee. In contrast, a third-party trust cannot be started with the assets of the disabled person. There is no age restriction on pooled trusts, which are established and managed by nonprofit associations. Special needs trusts can be a great vehicle for providing for a loved one’s lifelong care while offering important tax benefits.
Tax Implications of Early Withdrawals from Retirement Accounts
Taxpayers taking early withdrawals from retirement accounts, such as an IRA or 401(k), are subject to a 10% penalty. However, if the withdrawal is to pay for medical care for a dependent with special needs, the penalty is not applied, which can be a very important tax benefit, especially for taxpayers who make substantial early withdrawals. The taxpayer will still be subject to income tax on the withdrawal.
Know When to Consult an Expert in Disability Tax Laws
Tax laws are always subject to change. Family circumstances change. Health conditions change. Families that have dependents with special needs can count on changes in allowable exemptions, tax deductions, tax credits, and tax-advantaged accounts. Taxpayers that care for loved ones with disabilities will find the (deductible) fees paid to experts in disability tax laws to be a worthwhile investment.
Contributor Cali W., who wishes to keep her legal name private, is an experienced certified public accountant (CPA) who specializes in writing about finance topics.
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