Finzer v. United States
100 A.F.T.R.2d (RIA) 5340, 2007 U.S. Dist. LEXIS 54137, 496 F. Supp. 2d 954 (2007)
Rule of Law:
An entrance fee to a continuing care retirement facility is not deductible as a medical expense if the fee is structured as a refundable loan and the medical services are primarily funded by separate monthly fees, particularly when the fee amount varies based on the size of the residential unit rather than medical care needs.
Facts:
- In 2002, John and Elizabeth Finzer (the Finzers) entered into a residency agreement with CC-Lake, Inc. (Hyatt), a licensed continuing care facility providing residential accommodations, meals, and assisted living/skilled nursing services if needed.
- The Finzers selected a 2,021 square foot villa, paying an entrance fee of $723,800, which was significantly higher than fees for smaller units that offered the same access to medical care.
- The residency agreement and an appended promissory note characterized the entrance fee as a loan, stating it would be repaid to the Finzers (or their estate) upon termination, less a small monthly charge up to a maximum of 10%, guaranteeing at least 90% refund.
- The agreement also required the Finzers to make separate monthly payments, explicitly stating that all operating costs, including assisted living and skilled nursing care, were intended to be paid from these monthly fees, not from the entrance fees.
- Hyatt's chief financial officer testified that the entrance fees were used to repay the facility's construction loan and were distributed to its owners, not to cover medical expenses.
- In February 2003, Hyatt sent the Finzers a letter suggesting that 18.9% of the entrance fee might qualify as a medical expense deduction, which the Finzers claimed on their original 2002 tax return.
- Sometime later, Hyatt sent another letter suggesting 41% of the entrance fee could be attributable to medical expenses based on a new actuarial methodology, but advised the Finzers to contact their tax advisor and took no position on deductibility.
- The Finzers' accountant, Marshall Weller, prepared an amended 2002 return relying solely on Hyatt's 41% figure.
Procedural Posture:
- John and Elizabeth Finzer filed their 2002 tax return, claiming a medical deduction based on 18.9% of their entrance fee to Hyatt.
- Sometime later, the Finzers filed an amended 2002 tax return, claiming an increased medical expense deduction of $159,960 based on 41% of their entrance fee, and sought a $43,178 refund.
- The Internal Revenue Service (IRS) denied the Finzers' requested refund.
- The Finzers brought an action in the United States District Court for the Northern District of Illinois to obtain the disallowed refund.
- The government filed a motion for summary judgment, which the District Court denied in Finzer v. United States, No. 06 C 2176, 2007 WL 781731 (N.D.Ill. March 7, 2007).
- The District Court held a bench trial on July 16, 2007.
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Issue:
Does an entrance fee paid to a lifetime care facility, which is characterized by a promissory note as a loan, is largely refundable, varies based on residential unit size rather than medical services, and whose proceeds are not used to cover medical expenses, qualify as a deductible medical expense under the Internal Revenue Code?
Opinions:
Majority - Kennelly, District Judge
No, an entrance fee paid to a lifetime care facility does not qualify as a deductible medical expense if it is characterized as a refundable loan, its amount varies by residential unit size rather than medical necessity, and medical care costs are covered by separate monthly fees. The court found that the Finzers failed to meet their burden of proving that the IRS's assessment was erroneous. First, the entrance fee amount varied significantly based on the size of the residential unit, not on the access to medical care, meaning the portion above the lowest unit fee was not attributable to medical costs. Second, the testimony and residency agreement clearly stated that monthly fees, not entrance fees, covered medical expenses, and the entrance fees were used for construction loans and distribution to owners. Third, the 41% deduction figure provided by Hyatt was not justified because it failed to account for significant operating costs like depreciation, sales, general, and administrative expenses. Finally, and most crucially, the court determined that the entrance fee was, in substance, a loan from the Finzers to Hyatt, evidenced by the promissory note and the guarantee of a 90% refund. Under tax law, a loan is not a taxable event and therefore cannot serve as the basis for a deduction, as established in Comm'r v. Tufts. The court distinguished this case from prior IRS Revenue Rulings (75-302, 76-481) because, in those rulings, the payments were either non-refundable or only partially refundable under specific circumstances, unlike the Finzers' virtually guaranteed 90% refund structured as a loan.
Analysis:
This case clarifies the stringent requirements for deducting entrance fees to continuing care facilities as medical expenses. It emphasizes that the substance of the transaction, particularly whether a payment constitutes a loan, will determine its deductibility, even if it has some connection to medical services. The ruling highlights the importance of the taxpayer's burden to prove a direct allocation of the fee to medical care, separate from housing or other amenities, and to justify any percentage claimed. It also provides a cautionary tale against relying solely on a facility's 'suggested' deductibility percentages without independent verification and justification. Future cases will likely scrutinize refundable fees and their characterization as loans more closely, making it harder for taxpayers to deduct such fees unless they can clearly demonstrate the fee is not a loan and directly funds medical care.
