For the past few years I have been gifting each of my children $15,000. I did this in 2019. My middle son had surgery in 2019 and his health insurance carrier disputed a surgeon’s bill for $7,700. The claim was that the procedure was not emergency and the doctor was out of network. My son contested this and in 2019 I paid the $7,700 bill so the bill would not be sent to collections.
In 2020, this was resolved in his favor and he was reimbursed the $7,700. Because this was his policy, the check was sent to him but he then reimbursed me.
My tax preparer is fairly confident that no one has any income because he says no one received a tax deduction so a tax benefit rule says no income. But since there never was a payment to a medical care provider he says that the special gift exception for medical costs may not apply and maybe I made a $22,700 gift to my son in 2019 and he made a $7,700 gift to me in 2020.
My preparer says I will owe no gift tax but may need to file a return to report the gift. Your thoughts?
A: I think no reporting at all, but my conclusion is an extension of a judicial doctrine other than the tax benefit rule. Looking at 2019 in isolation, you transferred $22,700 to or for the benefit of your son. The gift tax allows a $15,000 exclusion each year, which means no gift has to be reported within that threshold.
Transfers made directly to a medical care provider on behalf of another are also excluded from the gift tax base. So in 2019 all is fine. Gifts are not income so there is no gift or income tax from the transfers.
Then in 2020 the medical care expenses are reimbursed. This can be viewed as correcting an error. No one claimed a tax deduction in 2019 so the 2020 reimbursement is not income. This is called the tax benefit rule (no tax benefit for the initial payment means no income for the reimbursement).
The 2019 medical payment that you made was excluded from the gift tax base so that there were not reportable gifts in excess of $15,000. Your preparer seems concerned that the reimbursement could be taken to mean there was no medical provider exclusion available in 2019.
There is another doctrine in tax law called the “relation back doctrine.” It was developed in a Supreme Court case called Arrowsmith (like the Sinclair Lewis novel or the rock band).
The doctrine arises because we file tax returns on an annual basis. Annual filing requires us to determine the tax effect based on what we know for that year. If we filed a single tax return for our entire life we could instead report based on the facts that we know for that lifetime.
The reason your son gave you $7,700 in 2020 was because of the payment that you made on his behalf in 2019. Then we can say that the 2020 payment relates back to the 2019 transaction. The Arrowsmith doctrine says we should determine the 2020 treatment by relating it back to the earlier transaction with which it is paired.
Tax advisers may argue whether the doctrine applies here. I believe that it does. If so, then there was no $7,700 transfer made in 2019. The 2020 “fix” that relates back allows us to couple the two transactions.
For this reason I would not say that your son made a gift to you in 2020. There is also no need to invoke the tax benefit rule if we essentially ignore the 2019 payment by application of relation back.
Others may disagree. I apply Arrowsmith most often when someone gets a lawsuit payment that relates to a claim from a prior year sale of one or more capital assets. The later payment can be treated as a capital gain, with no sale in the later year, by relating it back to the earlier transaction.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.