Filed: Feb. 19, 2004
Latest Update: Nov. 14, 2018
Summary: 122 T.C. No. 8 UNITED STATES TAX COURT DELBERT L. AND MARGARET J. BAKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 448-02. Filed February 19, 2004. Ps and AFVW executed a residence agreement entitling Ps to lifetime residence at VW. VW provides four different levels of accommodations. During the years in issue, Ps resided in an independent living accommodation which provides the lowest level of care and resembles a regular residence that can be found in any nonretire
Summary: 122 T.C. No. 8 UNITED STATES TAX COURT DELBERT L. AND MARGARET J. BAKER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 448-02. Filed February 19, 2004. Ps and AFVW executed a residence agreement entitling Ps to lifetime residence at VW. VW provides four different levels of accommodations. During the years in issue, Ps resided in an independent living accommodation which provides the lowest level of care and resembles a regular residence that can be found in any nonretirem..
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122 T.C. No. 8
UNITED STATES TAX COURT
DELBERT L. AND MARGARET J. BAKER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 448-02. Filed February 19, 2004.
Ps and AFVW executed a residence agreement
entitling Ps to lifetime residence at VW. VW provides
four different levels of accommodations. During the
years in issue, Ps resided in an independent living
accommodation which provides the lowest level of care
and resembles a regular residence that can be found in
any nonretirement living community. Ps paid monthly
service fees of $2,170 and $2,254 for 1997 and 1998,
respectively. Several amenities were available to Ps,
including medical services and the use of pool, spa,
and exercise facilities.
D, the vice president of finance for AFVW, the
operator of VW, calculated the portions of the monthly
service fees paid by independent living residents that
were allocable to medical care. C, an ad hoc
committee, of which P-H was a member, reviewed D’s
calculations. On the basis of certified financial
information provided by AFVW, C calculated a higher
amount allocable to medical care. Both D and C used
the percentage method to calculate the portions
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allocable to medical care. Ps claimed medical
deductions based on C’s calculations, and also claimed
additional deductions as a result of P-H’s use of the
pool, spa, and exercise facilities.
R audited Ps and issued a notice of deficiency
determining deficiencies on the basis of D’s
calculations, and also disallowing the deductions for
use of the pool, spa, and exercise facilities. R
subsequently sought the advice of an actuary and, on
the basis of the actuary’s report, now claims that the
actuarial method must be used to determine the portion
allocable to medical care. The actuary provided
calculations using both the actuarial method and the
percentage method. Ps rely on C’s calculations and a
supplemental report prepared by P-H.
Held: Ps are not required to use the actuarial
method and may use the percentage method to determine
the portions of the monthly service fees that are
allocable to medical care.
Held, further: Sec. 7491(a), I.R.C., places the
burden of proof on R in certain situations. R concedes
that Ps have satisfied the requirements of sec.
7491(a)(2), I.R.C. Ps submitted credible evidence
under sec. 7491(a)(1), I.R.C., with regard to the
factual issue of the portions of monthly service fees
allocable to medical care. Ps did not submit credible
evidence regarding claimed deductions for use of the
pool, spa, and exercise facilities. Therefore, R bears
the burden of proof on the monthly fees issue but not
on the facilities issue.
Held, further: Sec. 213(a), I.R.C., allows
deductions for expenditures for medical care, subject
to certain limitations. Using the percentage method,
the annual amounts of monthly service fees paid by Ps
that are allocable to medical care are $7,766 and
$8,476 for 1997 and 1998, respectively. Ps are not
entitled to additional deductions for use of the pool,
spa, and exercise facilities.
Delbert L. Baker and Margaret J. Baker, pro sese.
Guy H. Glaser and Vicken Abajian, for respondent.
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GOEKE, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes of $983 and $1,252 for the
taxable years 1997 and 1998, respectively. After a concession,1
the issues for decision are: (1) What portions of monthly
services fees paid by petitioners for lifetime residence at a
continuing care retirement community are allocable to medical
care under section 213;2 and (2) whether petitioners are entitled
to deduct additional amounts under section 213 for medical use of
pool, spa, and exercise facilities at the retirement community.
We hold that the portions of the monthly service fees paid by
petitioners for medical care were $7,766 and $8,476 for 1997 and
1998, respectively. We further hold that petitioners are not
entitled to any deductions for 1997 and 1998, respectively, for
the use of the pool, spa, and exercise facilities.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
1
Petitioners concede that they are not entitled to claim as
a depreciation expense $595 of the $775 reported on their 1997
return. Respondent’s determination with respect to 1997 includes
a computational adjustment to petitioners’ Social Security
benefits and/or Tier I Railroad Retirement benefits based on
other changes to adjusted gross income. This adjustment will be
taken into account by the parties in the Rule 155 computation.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure. Dollar amounts are generally rounded to the nearest
dollar.
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incorporated herein by this reference. Petitioners, Mr. Baker
and Mrs. Baker, resided in Riverside, California, at the time
they filed their petition.
I. Background
On December 22, 1989, petitioners and Air Force Village
West, Inc. (AFVW) executed a residence agreement entitling
petitioners to a lifetime residence at Air Force Village West
(Village West). AFVW is a nonprofit organization that was
incorporated in the State of California on September 21, 1984.
AFVW was organized to establish, maintain, endow, and operate
continuing care retirement communities (CCRCs) for officers (and
their spouses and qualified dependents) of the U.S. uniformed
services who are more than 60 years old and have been retired or
honorably separated from active duty. Village West is one of the
CCRCs owned and operated by AFVW. Village West is a gated,
guarded, perimeter-fenced, resortlike retirement community
located on 153 acres of land in Riverside, California.
A. Construction of Village West
The construction of Village West occurred in three phases.
The first phase involved the construction of the following living
units and health care facilities: (1) Independent Living Unit
(ILU) apartments, duplexes, and cottages; (2) an Assisted Living
Unit (ALU) facility with 20 rooms; (3) a Skilled Nursing Facility
(SNF) with 59 beds; (4) a Commons building with a suite of rooms
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set aside, in part, for an outpatient medical services clinic;
(5) an F-Wing of apartment units; (6) a G-Wing of apartment
units; (7) a pool area with Jacuzzi; (8) a maintenance and
housekeeping building; (9) a mechanical building; and (10) an
outside courtyard. The first phase was substantially completed
in December 1989, and initial operation began, and the first
residents moved in, at that time.
The second phase of the construction of Village West
involved the construction of the following additional housing,
administration, and maintenance buildings: (1) A landscape
building; (2) administrative offices located at the Commons
building; and (3) additional ILU cottages. The second phase was
completed in October 1993 and started operation at that time.
The final phase of the construction of Village West involved
the expansion of the existing ALU facility and the construction
of a new Special Care Unit (SCU) facility. The final phase was
completed in June 1997 and started operation at that time.
B. Living Accommodations at Village West
Village West provides the following four different levels of
living accommodations: (1) Independent living, or ILU; (2)
assisted living, or personal care (previously referred to as
ALU); (3) special care, or SCU (Alzheimer’s/Dementia unit); and
(4) skilled nursing, or SNF. The ALU, SCU, SNF, and outpatient
medical services clinic are located in one building which also
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houses the administrative offices of AFVW, the dining room, and
apartment units. This building is known as the Village West
Health Center and is also called the Commons building. During
the years in issue, the Village West Health Center was available
for patient use by both residents of Village West (hereinafter
sometimes referred to as AFVW residents) and nonresidents of
Village West who lived in the surrounding community (hereinafter
referred to as noncontract patients). Noncontract patients were
charged higher rates for use of the Village West Health Center
and certain services were billed to them on a fee-for-service
basis.
1. Independent Living Units
The ILU apartments, duplexes, and cottages are designed for
normal, everyday independent living of AFVW residents, and
resemble regular residences that can be found in any
nonretirement living community. All ILUs are initially equipped
with miniblinds, wall-to-wall carpeting, and standard kitchen
appliances. These are paid for by AFVW.
During 1997 and 1998, several amenities were available to
AFVW residents living in the ILUs, including: (1) An emergency-
pull-cord system installed in each ILU; (2) complete building and
grounds maintenance; (3) weekly housekeeping services; (4) a 24-
hour front desk service; (5) access to a fitness center,
available for medical therapy, with spa and exercise areas; (6)
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an indoor/outdoor swimming pool and Jacuzzi; and (7) complete
patient access to all on-campus health services provided in the
Village West Health Center. Beginning in June 1997, AFVW
residents living in ILUs gained access as patients to the newly
opened SCU also located in the Village West Health Center.
The front desk is staffed 24 hours a day and is the focal
point for information, service, and assistance to residents. One
of the duties of the front desk was monitoring and responding to
the emergency-pull-cord system installed in the ILUs and other
areas of AFVW where the system is in place. The emergency-pull-
cord system was connected directly to the front desk and a crisis
nurse, an assistant, and a security guard would be dispatched to
the ILU if necessary.
During the years in issue, Mr. Baker used the pool, spa, and
exercise facilities at Village West. Petitioners, like other
AFVW residents, were not charged a separate fee to use these
facilities.
2. Assisted Living Units
The ALU facilities represent an intermediate step between
independent living and the need for a higher level of care; i.e.,
skilled nursing care. The ALUs are designed for two types of
individuals. They are designed for individuals who are unable to
leave a building unassisted under emergency conditions, including
but not limited to, individuals who depend on mechanical aids
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such as crutches, walkers, and wheelchairs and who are unable or
likely to be unable to respond physically or mentally to an
emergency situation such as a fire. The ALUs are also designed
for individuals who need care and supervision with the activities
of daily living, such as eating, bathing, and dressing. The ALUs
are designed to provide occupants with a comfortable, homelike
atmosphere where they are encouraged to provide their own
furniture, bedding, and linens.
During the years in issue, both AFVW residents and
noncontract patients occupied rooms as patients in the ALU
facilities. AFVW residents who became patients in the ALUs
received a 60-percent discount off the regular rate charged to
noncontract patients who occupied similar units as patients.
3. Special Care Units
The SCU at Village West is a special unit designed to
provide living accommodations to individuals with diagnosed
Alzheimer’s disease and/or similar forms of irreversible
dementia. Admission is based strictly on doctor’s orders. The
SCU is fully enclosed, can only be accessed through a security-
locked door, and is manned 24 hours per day by nursing staff
members. Patients in the SCU are provided the same services as
the individuals occupying the ALUs. Additionally, other programs
are provided which are specially geared to enhancing the dignity
and lifestyle of patients during the remainder of their lives.
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During the years in issue, both AFVW residents and
noncontract patients occupied rooms as patients in the SCU. AFVW
residents who became patients in the SCU received a 60-percent
discount off the regular rate charged to noncontract patients who
occupied similar units as patients.
4. Skilled Nursing Care
The SNF at Village West provides the highest level of care
of all the health care facilities located at Village West.
Admission to this facility is based strictly on doctor’s orders.
The accommodations provided in the SNF include a skilled nursing
facility bed, 24-hour nursing care, and three meals per day. In
addition, occupants of the SNF receive services such as long-term
maintenance care, necessary diagnostic care, preventative care,
therapeutic care, and rehabilitative care required by the
chronically ill.
During the years in issue, both AFVW residents and
noncontract patients occupied rooms as patients in the SNF. AFVW
residents who became patients in the SNFs received an
approximately 50-percent discount off the regular rate charged to
noncontract patients who occupied similar units as patients.
C. The Residence Agreement
Petitioners chose a 1,427-square foot, two bedroom, two
bathroom, duplex unit for their ILU accommodations. Under the
residence agreement executed on December 22, 1989, they were
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required to pay certain fees in exchange for a lifetime residence
at Village West. Petitioners were required to pay: (1) A
nonrefundable processing fee of $500; (2) an entrance fee of
$130,015; and (3) an initial monthly service fee of $1,418, which
was subject to annual increases by AFVW.3 The residence
agreement states that in the case of two individual AFVW
residents, the entrance fee is considered paid one-half by each.
Petitioners deducted $34,541 of the entrance fee as a medical
expense on their jointly filed 1989 tax return.4 Petitioners
paid monthly service fees to AFVW of $2,170 and $2,254 for 1997
and 1998, respectively.
Under the terms of the residence agreement, petitioners were
guaranteed several amenities in exchange for their payment of
monthly service fees, including: (1) The emergency-pull-cord
system; (2) 24-hour availability of a licensed nurse from the SNF
to respond to medical emergencies; (3) outpatient and other non-
life-threatening nursing services provided at the Village West
Health Center outpatient medical services clinic by their nursing
3
The residence agreement does not indicate how the entrance
fee would be used by Village West. An independent auditor’s
report of AFVW provides that the entrance fees, net of the
portion that is refundable to the residents, are recorded as
deferred revenue and amortized into income. The portion of the
entrance fees that is estimated to be refundable is reflected as
a liability on the statements of financial position.
4
The record does not indicate how this figure was
calculated.
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staff; and (4) a guaranty from AFVW of a bed in the Village West
units or SNF and that the fees charged for use of the unit or the
facility would be at a reduced rate from the standard fees
charged to noncontract patients occupying such facilities. The
residence agreement is silent as to the amount of the fee
reduction for use of the units or the facility.
Under the terms of the residence agreement, AFVW could
require that petitioners be transferred to a different level of
living accommodation if certain medical conditions existed.
Additionally, the terms of the agreement provided that
petitioners were entitled to lifetime care.
II. AFVW’s Financial Information and Calculation of Deductible
Medical Expenditures
A. AFVW’s Financial Information for 1997 and 1998
In a report entitled “Air Force Village West - Health
Facility Information” (hereinafter referred to as the report or
the Health Facility Information report), Charles L. Dalton (Mr.
Dalton), vice president of finance for AFVW, certified that
financial information, allocation tables, and supplemental
accounting data contained in the report had been compiled from
the accounting records of AFVW. The report included information
for the years ended December 31, 1997, and December 31, 1998.
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The following chart represents various revenue and expense
items for 1997 listed in the report:
REVENUES
Description Amount
Monthly fees $7,979,906
Entrance fee revenue 2,978,303
Entrance fee terminations 551,616
Resident ALU fees 301,321
Noncontract patient ALU fees 80,156
Resident SCU fees 55,445
Noncontract patient SCU fees 3,640
Resident SNF fees 470,787
Noncontract patient SNF fees 1,207,747
Investment income 2,890,228
Gain from sale of securities 107,335
Net, direct billings 355,185
EXPENSES
Description Amount
Total operating expenses $16,069,104
Total interest expense 4,797,339
Total depreciation and amortization 2,161,331
Total issue cost 98,395
Total environmental services 1,028,776
SNF expenses 3,044,041
ALU and SCU expenses 929,275
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Various SNF revenue and expenses for 1997 were listed as follows:
REVENUES
Description Amount
SNF room and board, private/Medicare/ $795,567
HMO fees for residents
SNF room and board, private/Medicare/ 1,207,747
HMO fees for noncontract patients
SNF ancillary services, Medicare/HMO 365,444
billings for residents
SNF ancillary services, Medicare/HMO 448,462
billings for noncontract patients
EXPENSES
Description Amount
Direct Expenses:
Food service $163,348
Payroll and benefits 1,342,771
Departmental costs 214,727
Patient charges 726,229
Purchased Services:
Housekeeping and laundry 99,092
Food service (benefits) 22,106
Maintenance 39,316
Landscape 29,833
Administration 123,011
Insurance 21,970
Linens 8,403
Depreciation and amortization 211,343
Contracts 8,206
Utilities 33,686
Total expenses 3,044,041
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The following chart represents various revenue and expense
items for 1998 listed in the report:
REVENUES
Description Amount
SNF room and board, private/Medicare/ $585,802
HMO fees for residents
SNF room and board, private/Medicare/ 1,315,694
HMO fees for noncontract patients
SNF ancillary services, Medicare/HMO 315,969
billings for residents
SNF ancillary services, Medicare/HMO 378,905
billings for noncontract patients
EXPENSES
Description Amount
Total operating expenses $17,759,058
Interest expense 4,669,121
Depreciation and amortization 2,321,300
Issue costs 107,134
Total environmental services 1,030,677
SNF expenses 3,330,031
ALU expenses 984,333
SCU expenses 796,306
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In a separate document (hereinafter referred to as the 1998
financial document) that should have been included in the Health
Facility Information report because it represents the most
accurate data, the following relevant revenue and expense items
were listed for 1998:
REVENUES
Description Amount
Monthly fees $8,329,241
SNF noncontract patient fees 1,301,382
ALU noncontract patient fees 104,083
SCU noncontract patient fees 110,202
EXPENSES
Description Amount
Total operating expenses $16,986,770
Interest expense 4,704,320
Depreciation and amortization 2,338,558
Issue costs 107,134
Total environmental services 1,020,109
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Various SNF expenses for 1998 were listed in the Health
Facility Information report as follows:
REVENUES
Description Amount
SNF resident fees $585,802
SNF noncontract patient fees 1,315,694
SNF Medicare/HMO billings for residents 315,969
SNF Medicare/HMO billings for 378,905
noncontract patients
SNF other 15,696
Home care 49,578
EXPENSES
Description Amount
Direct Expenses:
Health services - payroll and benefits $374,008
SNF - payroll and benefits 964,802
Clinic - payroll and benefits 120,955
SNF - departmental expenses 197,028
Clinic - departmental expenses 40,446
Patient chargeables 677,894
Depreciation 166,303
Insurance 32,531
Utilities 26,073
Contract 3,055
Purchased Services:
Corporate administration 125,684
Environmental services 144,295
Food services 381,040
Maintenance 36,111
Landscaping 30,306
Linens 9,500
Total expenses 3,330,031
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Similar charts were included detailing an allocation of expenses
to the ALU and SCU. The report states that the SNF, ALU, and SCU
expense information listed above does not include an allocation
of amortization of debt issue cost, amortization of preopening
cost, or an allocation of interest expense. Specific expenses
associated with the pool, spa, and exercise facilities at Village
West are not identified in the financial information in the
report.
In allocating expenses to the SNF, the following explanation
was provided:
Line Item Description
Food service Percent of total contract
Payroll and benefit Direct labor costs plus benefits
Departmental costs All expenses in specific dept.,
except payroll and benefits
Housekeeping and laundry Percent of total contract
Food service Benefits of employees directly
allocated to cost center
Maintenance A specific employee dedicated to
the health care facility
Landscape Based on previous time study
Administration Based on previous time study
Insurance Policies directly related to
facility plus 10 percent of other
policies
Linens Linens purchased directly for the
SNF
Depreciation and Directly from the fixed asset
amortization program
Contracts Alarm system, copiers, fire drill,
Medical Director, etc. (No
ancillary contractors)
Utilities 10 percent of the total utilities
for AFVW
Interest expense 10 percent of total interest
expense for AFVW
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The explanation notes that allocations for ALUs and SCUs are the
same except for maintenance, landscaping, administration,
insurance, contracts, utilities, and interest, which were
allocated on the basis of two-thirds of the SNF costs.
The report contains an allocation of costs to the emergency-
pull-cord system for ILUs for 1998.5 The cost was determined by
developing an average hourly rate for front desk staff monitoring
the system, multiplying this by the number of hours in a year
(because the system was monitored 24 hours a day), and then
adding an overhead cost factor of 30 percent of the staff cost.
On the basis of an average hourly rate of $7.75, the total cost
to monitor the emergency-pull-cord system for ILUs was determined
to be $88,257.6 Mr. Dalton calculated this allocation.
The report contains revenue totals for 1997 and 1998 for
monthly services fees from ILU residents. For 1997, the total
monthly service fees from ILU residents are listed as $7,979,906.
For 1998, the report lists total monthly service fee revenue of
5
The report does not contain a cost allocation to monitor
the system for ILUs for 1997.
6
The following represents the calculations contained in the
report:
Hours required (365 days x 24 hours) 8,760
Average hourly rate 7.75
Total staff cost $67,890
Overhead of 30 percent 20,367
Total cost to monitor $88,257
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$8,327,083. The report also shows average census figures for the
ILUs for 1997 and 1998. The schedule reflects that for 1997
there were 372 occupied ILUs containing 574 residents. For 1998,
there were 386 occupied ILUs containing 591 residents.
B. Mr. Dalton’s Calculations
On behalf of AFVW, Mr. Dalton calculated the deductible
portion of the monthly service fees paid in 1997 and 1998 for
AFVW residents living in ILUs. Mr. Dalton informed ILU residents
of his calculations and advised them to consult their tax adviser
for possible application on their tax returns. The general
approach utilized by Mr. Dalton was to use costs associated with
the SNF in determining the medical expense attributable to ILU
residents. Some of the figures used by Mr. Dalton to calculate
the allocation percentage are different from those outlined in
the Health Facility Information report.
1. Calculation of 1997 Medical Expenses
For 1997, Mr. Dalton used a percentage method to determine
the proper allocation of monthly service fees to medical care.
Mr. Dalton calculated the allocation percentage by determining
the total expenses associated with the SNF and subtracting from
this figure depreciation, interest expense, and Medicare and HMO
insurance reimbursements allocable to the SNF.7 He then divided
7
Mr. Dalton did not allocate any medical costs for the
emergency-pull-cord system for 1997 or 1998.
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this amount by the total costs, excluding total depreciation and
interest expense, of Village West. Mr. Dalton calculated that
17.78 percent of the total monthly service fees paid by residents
living in ILUs were allocable to medical care. Applying slightly
different residency and monthly service fee figures than those
contained in the Health Facility Information report, Mr. Dalton
concluded that the portion of monthly service fees for ILU
residents that was allocable to medical care was $374 per
residence per month.
2. Calculation of 1998 Medical Expenses
In 1998, AFVW switched to an actuarial method to determine
the deductible portion of monthly service fees.8 However, Mr.
Dalton still prepared a calculation for that year using the
percentage method so that AFVW residents joining the community
prior to January 1, 1998, would have information comparable to
prior years for tax return preparation. Using the same
methodology as in 1997, Mr. Dalton calculated that 19.01 percent
of the total monthly service fees paid by residents living in
ILUs were allocable to medical care. Applying slightly different
residency and monthly service fee figures than those contained in
the Health Facility Information report, Mr. Dalton concluded that
8
The evidence in the record does not contain calculations by
AFVW or Mr. Dalton using the actuarial method to determine the
deductible portion of monthly service fees paid in 1998.
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the portion of monthly service fee for ILU residents that was
allocable to medical care was $416 per residence per month.
C. Ad Hoc Committee’s Calculation of Medical Expenses
In 1997, the resident council of Village West established an
ad hoc committee (hereinafter sometimes referred to as the
committee) to recalculate what portion of the monthly service
fees paid by residents living in ILUs should be allocated to
medical care. The ad hoc committee reported to the resident
council. Petitioner was a participant of the ad hoc committee.
In February 1998, Mr. Dalton supplied the resident council with
information for purposes of determining the appropriate medical
deductions for ILU residents for 1997 and 1998.9
In a letter dated March 13, 2000, the ad hoc committee
reported to the resident council its findings regarding income
tax deductions for ILU residents for health care expenses. Using
the percentage method, the committee calculated that the portions
of monthly services fees allocable to medical care were 40.3
percent and 41.6 percent for the years 1997 and 1998,
respectively. In calculating total operating expenses, the
committee subtracted interest expense, depreciation and
amortization, issue cost, and noncontract patient expenses from
total AFVW expenses. In calculating medical expenses, the
9
The information supplied included the 1998 financial
document that should have been included in the Health Facility
Information report.
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committee included SNF, ALU, and SCU operating expenses, and
subtracted out noncontract patient fees and depreciation and
amortization allocable to the three facilities. The committee
then made certain upward adjustments to account for the
emergency-pull-cord system, food service, environmental service,
utilities, and insurance. The adjustments for food service and
environmental expenses were based on formulas provided by the
food service contractor and the environmental service contractor.
The adjustment for utilities was based on a square-footage method
and the adjustment for the insurance was based on a ratio- and
square-footage methodology.
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The following chart prepared by the ad hoc committee
represents its calculations for 1997:
Operating Expenses Amount
Total expenses $16,069,104
Interest expense (4,797,339)
Depreciation and amortization (2,161,331)
Issue cost (98,395)
Noncontract patient expense (1,291,543)
Total operating expenses 7,720,496
Medical Expenses Amount
SNF operating expenses $3,044,041
ALU and SCU operating expenses 929,275
Emergency pull-cord system 87,374
Food service adjustment 482,769
Environmental service adjustment 112,617
Utilities adjustment 81,146
Insurance adjustment 18,234
SNF noncontract patient fees (1,207,747)
SNF depreciation and amortization (211,343)
ALU noncontract patient fees (80,156)
SCU noncontract patient fees (3,640)
ALU and SCU depreciation and amortization (140,895)
Allocable medical expenses 3,111,675
Dividing medical expenses by total operating expenses, the
committee calculated that the allocation percentage for 1997 was
40.3 percent.10
10
3,111,675 ÷ 7,720,496 = .403 or 40.3 percent.
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The following chart prepared by the ad hoc committee
represents its calculations for 1998:
Operating Expenses Amount
Total expenses $16,986,770
Interest expense (4,704,320)
Depreciation and amortization (2,338,558)
Issue cost (107,134)
Noncontract patient expense (1,515,667)
Total operating expenses 8,321,091
Allocable Medical Expenses Amount
SNF operating expenses $3,330,031
ALU and SCU operating expenses 1,780,639
Emergency pull-cord system 88,257
Utilities adjustment 103,641
SNF noncontract patient fees (1,301,382)
SNF depreciation and amortization (166,303)
ALU noncontract patient fees (104,083)
SCU noncontract patient fees (110,202)
ALU and SCU depreciation and amortization (161,071)
Allocable medical expenses 3,459,527
The operating expenses figures used by the committee were taken
from the 1998 financial document that should have been included
in the Health Facility Information report, not from the figures
actually contained in the report. Dividing medical expenses by
total operating expenses, the committee calculated that the
allocation percentage for 1998 was 41.6 percent.11
In a memorandum dated March 15, 2000, the resident council
reported to AFVW residents a summary of the ad hoc committee’s
findings. Attached to the memorandum was a chart showing that
11
3,459,527 ÷ 8,321,091 = .416 or 41.6 percent.
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the annual deduction could be calculated by dividing total
monthly service fees for the year by 12 months to arrive at the
total average monthly service fees paid by ILU residents per
month. This amount is then divided by the number of ILU
residents shown in the census chart, resulting in the average
monthly service fee per resident. Multiplying the average
monthly service fee by the allocation percentage provides the
medical deduction per resident per month. The chart contained
the following information relevant to monthly service fees for
ILU residents for 1997 and 1998:
Independent Living Units
Year Number Occupied Residents Total Yearly Service Fee
1997 372 574 $7,979,906
1998 386 591 8,329,241
In a memorandum to AFVW residents dated February 1, 2002,
the resident council, in conjunction with AFVW management,
provided information to residents regarding income tax deductions
for health care expenses. The memorandum states that management
changed from the percentage method to the actuarial method in
1998 to determine the allowable deduction, and that management
planned to continue to use the actuarial method for new
residents. It is noted that the actuarial method will produce a
different deduction than the percentage method, and individual
residents are advised to analyze each method and select the one
most beneficial for his or her tax situation.
- 26 -
The memorandum further states that for the years 1997, 1998,
and 1999, the ad hoc committee had coordinated and worked with
AFVW management to review and make recommendations regarding the
portion of monthly service fees allocable to medical care. In
addition, the memorandum states that certified data from the
financial records of AFVW for these years was provided to the ad
hoc committee and that data was used to determine the appropriate
allocation percentage. The allocation percentage is listed as
40.3 percent and 41.6 percent for the years 1997 and 1998,
respectively. The memorandum then states that the portion of the
monthly service fees allocable to medical care is determined per
resident. AFVW residents were advised to consult their tax
adviser for possible application of the information contained in
the memorandum, and it is stated that neither AFVW nor the
resident council is a tax adviser. The memorandum is signed by
the chairman of the resident council and the president/CEO of
AFVW.
III. Petitioners’ Tax Returns
On their jointly filed 1997 and 1998 Forms 1040, U.S.
Individual Income Tax Return, petitioners reported medical and
dental expenses of $12,743 and $16,828, respectively.12 Of these
amounts, $6,557 and $9,891 for the years 1997 and 1998,
12
The amounts stated in this paragraph are before
application of the 7.5-percent floor contained in sec. 213(a).
- 27 -
respectively, related to the portion of the monthly services fees
paid allocable to medical care. These amounts are primarily
derived from the ad hoc committee’s calculations. The amounts of
$3,461 and $3,596 for the years 1997 and 1998, respectively,
related to Mr. Baker’s use of the pool, spa, and exercise
facilities at Village West. The remainder of the reported
amounts was for various other items.
Petitioners’ claimed entitlement to deductions for Mr.
Baker’s use of the pool, spa, and exercise facilities is based in
part on a letter dated July 29, 1991, from Elaine K. Jones, M.D.,
which states that her evaluation confirms Mr. Baker’s previous
diagnoses of hypertension, valvular heart disease,
hyperlipidemia, and degenerative arthritis. The letter states
that to treat the above medical conditions it is imperative that
Mr. Baker continue his exercise program, including the exercise
room, swimming pool, and whirlpool at least three times a week.
The letter also states that the exercise program will help
alleviate the symptoms of Mr. Baker’s chronic illnesses.
IV. Respondent’s Determination
The examination in this case commenced after July 22, 1998.
On September 28, 2001, respondent issued a notice of deficiency
to petitioners for their 1997 and 1998 taxable years. In the
notice, respondent determined that the portion of the monthly
service fees attributable to medical care was limited to $4,488
- 28 -
and $5,142 for the years 1997 and 1998, respectively.13
Respondent’s determination for 1997 was based on Mr. Dalton’s
determination that $374 of the monthly service fees per residence
in an ILU was allocable to medical care.14 The determination for
1998 was calculated by multiplying the 19.01-percent allocation
figure determined by Mr. Dalton by petitioners’ total monthly
service fees paid to AFVW.15 These determinations are based on
the percentage method, not the actuarial method.16 Respondent
completely disallowed petitioners’ claimed deductions for both
years relating to Mr. Baker’s use of the pool, spa, and exercise
facilities at Village West. The remaining claimed medical
deductions were allowed.
Respondent subsequently sought the advice of Alwyn V. Powell
(Mr. Powell), an actuary, for the purpose of determining the
portion of the monthly services fees allocable to medical care.
On the basis of Mr. Powell’s expert report, respondent now
asserts that $4,584 and $5,304 are the correct amounts allocable
13
The amounts stated in this paragraph are before
application of the 7.5-percent floor contained in sec. 213(a).
14
$374 x 12 months = $4,488.
15
($2,254 x 12 months) x 19.01 percent = $5,142.
16
Respondent’s determinations based on the percentage method
are inconsistent because for 1997 he determined the amount
allocable to medical care based on the weighted average of
monthly service fees paid by ILU residents but for 1998 he
determined the amount allocable based on the actual monthly
service fees paid by petitioners.
- 29 -
to medical care for petitioners for the years 1997 and 1998,
respectively. In his report, Mr. Powell calculated the amounts
allocable to medical care for petitioners using the actuarial
method, an alternative actuarial method,17 and the percentage
method. Mr. Powell relied on the financial information contained
in the Health Facility Information report for purposes of
applying the above three methods.
Respondent’s current position is that the actuarial method
is the correct way to calculate the deductible portion of
petitioners’ monthly service fees. In the event that the
percentage method must be used, respondent generally argues that
the percentage method calculations performed by Mr. Powell are
the correct calculations to use.18
OPINION
During the years in issue, petitioners lived in an ILU,
which, as stated above, is a residential unit designed for
normal, everyday independent living of AFVW residents, and
resembles a regular residential accommodation that can be found
in any nonretirement living community. The primary issue in this
case is the amount of the monthly service fees paid while
17
On brief, respondent expressly states that use of the
alternative actuarial method is not being advocated in this case.
18
Respondent does not argue that we should use any of the
figures used by Mr. Dalton in his calculations under the
percentage method, which figures were the basis of the
determination in the notice of deficiency.
- 30 -
petitioners resided in an ILU that is allocable to medical
care.19 Resolution of this issue depends in part on whether we
apply the percentage method or the actuarial method.
Additionally, we must decide whether petitioners are entitled to
medical deductions for amounts they claim are attributable to Mr.
Baker’s use of the pool, spa, and exercise facilities at AFVW.
Section 213(a) allows as a deduction any expenses that are
paid during the taxable year for the medical care of the
taxpayer, his spouse, and dependents and that are not compensated
for by insurance or otherwise. Estate of Smith v. Commissioner,
79 T.C. 313, 318 (1982). The deduction is allowed only to the
extent the amount exceeds 7.5 percent of adjusted gross income.
Sec. 213(a); sec. 1.213-1(a)(3), Income Tax Regs. The term
“medical care” includes amounts paid “for the diagnosis, cure,
mitigation, treatment or prevention of disease, or for the
purpose of affecting any structure or function of the body”.
Sec. 213(d)(1)(A); Estate of Smith v. Commissioner, supra at 318-
319.
19
The portion of fees paid by residents in higher levels of
care, such as ALUs, SCUs, or the SNF, that is allocable to
medical care is not at issue in this case. For further
discussion of the treatment of costs incurred while residing in a
retirement home, see Levine v. Commissioner, 695 F.2d 57, 59-60
(2d Cir. 1982), affg. T.C. Memo. 1981-437, Estate of Smith v.
Commissioner,
79 T.C. 313, 319 (1982), and sec. 1.213-1(e)(1)(v),
Income Tax Regs.
- 31 -
Petitioners claim that they are entitled to a medical
deduction related to the monthly service fees paid using the
percentage method and applying an allocation percentage of
approximately 41 percent. Petitioners also claim that they are
entitled to additional medical deductions as a result of Mr.
Baker’s use of the pool and spa facilities at AFVW.
Respondent agrees that petitioners are entitled to deduct
under section 213 a portion of the monthly service fees paid to
AFVW. However, respondent argues that the actuarial method
should be used to calculate the amount allocable to medical care.
Respondent contends that petitioners are not entitled to any
deductions for Mr. Baker’s use of the pool, spa, and exercise
facilities at Village West because petitioners have not
substantiated how the claimed amounts were calculated or that the
expenditures were paid for the primary purpose of and are
directly related to the medical care of the taxpayers.
I. The Allocation Methods
The primary disagreement between the parties with respect to
the monthly service fees issue is the appropriate method to use
to calculate the portion of the fees allocable to medical care.
Petitioners, relying on published guidance by the Commissioner,
argue that they are entitled to use the percentage method.
Respondent, relying on the expert report of Mr. Powell, argues
that the actuarial method should be used.
- 32 -
A. The Percentage Method
The percentage method assumes that the medical care portion
of entrance fees and monthly service fees is the same portion or
percentage as the CCRC’s medical expenses to total costs because
the sum of the fees over the resident’s lifetime is expected to
cover the costs of care for residents in a CCRC. Thus, the
percentage method generally involves analyzing each expense
category to determine what portion of each category’s total costs
is for medical purposes. In his report, Mr. Powell explained
that this allocation process is fairly straightforward for CCRCs
that provide medical care through stand alone detached units with
budgets separate from the nonmedical center or that purchase
medical services from a third party. However, most CCRCs that
Mr. Powell was familiar with (including Village West) do not make
this distinction in their budgets and operate on a blended basis
for the entire facility.
Under the percentage method, once total medical expenses are
determined, this amount is divided by the CCRC’s costs to
determine the medical expense allocation percentage. This
percentage is then multiplied by the total monthly fees collected
from ILU residents for the year to find the total medical costs
allocable to monthly fees revenue. This total is then divided by
the number of ILU residents to determine the portion of the fees
that is allocable to medical care.
- 33 -
B. The Actuarial Method
According to respondent’s expert, Mr. Powell,20 the
actuarial method is a procedure based on actuarial projections of
longevity and health care utilization for estimating the
deductible portion of fees paid by a taxpayer to a CCRC. Like
the percentage method, the actuarial method initially requires
that expenses be allocated between medical care and nonmedical
care. The following is a simplified description of the actuarial
method used by Mr. Powell and relied on by respondent. On brief,
respondent acknowledges that this description does not detail
much of the complexity in actually applying the method.
The first step in applying the actuarial method is to
determine operating expenses and capital expenses for the use of
fixed assets. The second step is to estimate the length of time
a resident will spend in each level of care. Although this is
normally accomplished using actuarial tables, CCRCs present a
complicating factor because survivorship possibilities and the
corresponding life expectancies need to be refined by the level
of care (e.g., independent living versus assisted living versus
skilled nursing care). The third step is to combine the
20
Mr. Powell is the chairman and CEO of A.V. Powell &
Associates, LLC, a firm of consulting actuaries and accountants.
Mr. Powell has an undergraduate degree in major statistics from
Harvard and a master’s degree in actuarial science from Georgia
State University. Mr. Powell was recognized by the Court as an
expert in actuarial science.
- 34 -
assumptions about costs of services with the longevity projection
to determine the lifetime total costs of care and the lifetime
total medical care costs. By applying the lifetime medical care
costs, the fourth step uses the contract provision about monthly
service fees paid to determine the prepaid medical care costs.
The amount of medical care that is funded before transfer to
assisted living or nursing care is the difference between
lifetime medical care costs and the sum of monthly service fees
paid. This difference is referred to as the prepaid medical care
costs and should be considered deductible under section 213(a).
The calculation of the portion of the prepaid medical care costs
that can be claimed for the entrance fee and the portion that can
be claimed for the total monthly service fees for the year is at
the discretion of the taxpayer with the limitation that the
actuarial present value sum of all deductions does not exceed the
prepaid medical care costs.
C. Appropriate Allocation Method
The threshold dispute is over which method to use to
determine the portion of the monthly service fees that is
allocable to medical care. As explained in detail below, the
percentage method preferred by petitioners has been accepted by
respondent and generally relied upon since at least 1967.
Properly applied, the percentage method provides a reasonable and
straightforward approach for determining the portion of monthly
- 35 -
service fees that is allocable to medical care. The method
provides a direct link between the actual fees paid by the
residents and the medical costs incurred by the CCRC during the
taxable year. Despite this, respondent asserts that the
actuarial method is more precise and accurate. Respondent freely
admits that the actuarial method is more complex, indeed, so
complex as to defy full explanation in testimony and on brief.
Both methods involve subjective judgments, so neither is immune
from differences of opinion. We hold under these circumstances
that petitioners are not compelled to adopt a new method, and we
decline respondent’s suggestion that the percentage method be
usurped by the actuarial method.
As noted above, use of the percentage method has been
sanctioned by respondent for over 35 years. In Rev. Rul. 67-185,
1967-1 C.B. 70, Rev. Rul. 75-302, 1975-2 C.B. 86, and Rev. Rul.
76-481, 1976-2 C.B. 82,21 the Commissioner addressed similar
situations involving the issue of whether the portion of a
monthly fee paid by individuals in connection with their
21
We are aware that revenue rulings are not binding on this
Court or other Federal courts. Rauenhorst v. Commissioner, 119
T.C. 157, 171 (2002); Frazier v. Commissioner,
111 T.C. 243, 248
(1998). However, the public has a right to rely on positions
taken by the Commissioner in published guidance. Alumax, Inc. v.
Commissioner,
109 T.C. 133, 163 n.12 (1997), affd.
165 F.3d 822
(11th Cir. 1999); Am. Campaign Acad. v. Commissioner,
92 T.C.
1053, 1070 (1989); Nissho Iwai Am. Corp. v. Commissioner,
89 T.C.
765, 778 (1987); see also Rev. Proc. 89-14, sec. 7.01(5), 1989-1
C.B. 814 (taxpayers may rely on published revenue rulings in
determining the tax treatment of their own transactions).
- 36 -
residence at a retirement home under a lifetime care contract was
deductible by the individuals as an expense for medical care
under section 213, subject to the limitations of the statute. In
the rulings, the taxpayers had entered into agreements with a
retirement home under which they became entitled to live in the
home and to receive lifetime care that included specified
residential accommodations, meals, and medical care. In exchange
for the promise of the lifetime care, the taxpayers paid a
monthly fee to the homes.
In Rev. Rul. 67-185, supra at 70, the taxpayers proved that
on the basis of the retirement home’s experience, a portion of
the monthly fee was for costs of providing medical care,
medicine, and hospitalization. The ruling cited the holding in
Rev. Rul. 54-457, 1954-2 C.B. 100, that where a university
charges a student a lump-sum fee which includes his education,
board, medical care, etc., the portion of the charge which was
allocable to medical care is considered a proper medical expenses
deduction if there is a breakdown showing the amount of the fee
allocable to medical care, or such information was readily
available to the university. Id. at 71. Rev. Rul. 67-185,
supra, then stated that the principle in Rev. Rev. 54-457, supra,
relating to allocation of the fee, was equally applicable to its
situation. Rev. Rul. 67-185, supra at 71, concluded:
- 37 -
Accordingly, where the taxpayers, a husband and
his wife, pay a monthly life-care fee to a retirement
home, and prove that a specific portion of the fee
covers the costs of providing medical care for them,
that portion of the fee is deductible by the taxpayers
as an expense for medical care in the year paid,
subject to the limitations prescribed in section 213 of
the Code.[22]
In Rev. Rul. 75-302, supra, the taxpayer, pursuant to a
lifetime care contract with a retirement home, was required to
pay a lump-sum fee. The Commissioner ruled that the portion of
the lump-sum fee that was properly allocable to the taxpayer’s
medical care was deductible as an expense for medical care in the
year paid, subject to the limitations in section 213.
The facts involved in Rev. Rul. 76-481, supra, are similar
to those in Rev. Rul. 67-185, supra. Rev. Rul. 76-481, supra at
82, noted that the fees were calculated without reference to any
similar contract with other patients at the institution and was
not medical insurance. Additionally, because the home had not
been in operation for a sufficient length of time to demonstrate
from its own financial experience what portion of the fees was
allocable to medical care of the residents, the home used long-
term financial information from a comparable retirement home.
Id. at 83. The home determined that 15 percent of the monthly
fee would be used to discharge the home’s obligations to provide
medical care to its residents. Id.
22
See also Rev. Rul. 68-525, 1968-2 C.B. 112 (relying on the
statement in Rev. Rul. 67-185, 1967-1 C.B. 70).
- 38 -
The ruling first examined previous rulings discussing the
deductible portion of fees paid by taxpayers for lifetime care
from retirement homes. Id. The ruling cited the statement in
Rev. Rul. 67-185, supra, quoted above. The ruling then addressed
the monthly fee issue and stated:
In addition, the portion of the monthly fee (15
percent * * *) paid by the taxpayers that is properly
allocable to medical care is also deductible as an
expense for medical care in the year paid, subject to
the limitations prescribed in section 213 of the Code.
[Id.]
The ruling also discussed the deductibility of portions of an
entrance fee paid by the taxpayers.23 Id.
23
In other rulings, taxpayers have been allowed to deduct
specific portions of entrance fees paid to retirement homes,
subject to the limitations of sec. 213. See Rev. Rul. 76-481,
1976-2 C.B. 82 (10 percent of entrance fee allocable to medical
care); Rev. Rul. 75-302, 1975-2 C.B. 86 (30 percent of entrance
fee allocable to medical care). In Estate of Smith v.
Commissioner, 79 T.C. 313, 321-322 (1982), we held that 7 percent
of an entrance fee paid to a retirement home was allocable to
medical care because this percentage was determined to be the
cost of providing free days of standard care in a convalescent
center for the residents’ lifetimes. The Commissioner acquiesced
in our decision in Estate of Smith at 1984-2 C.B. 1.
- 39 -
None of the above rulings have been revoked or modified,24
and the Commissioner has relied on these rulings in issuing
private letter rulings regarding the deductible portion of
monthly service fees.25 Indeed, the Commissioner in private
letter rulings has cited the above revenue rulings and sanctioned
use of the percentage method. See, e.g., Priv. Ltr. Rul. 86-30-
005 (Apr. 4, 1986), which states in relevant part:
The proper allocation of medical to total fees may
be determined by dividing all directly related medical
expenses by total expenses. To the extent that they
can be substantiated and are allocable to medical care
facilities, medically related expenses may include,
24
Although Rev. Rul. 76-481, supra, was clarified by Rev.
Rul. 93-72, 1993-2 C.B. 77, the clarification does not affect the
issue in the instant case. It is unclear whether the
Commissioner has considered the issue of the deductibility of
monthly service fees since 1993. See Rev. Proc. 93-43, 1993-2
C.B. 544 (stating that no further rulings will be issued on the
issue of whether amounts paid for medical care extending
substantially beyond the taxable year may be deducted under
section 213); see also Rev. Proc. 99-3, 1999-1 C.B. 103
(designating the issue stated in Rev. Proc. 93-43, supra as an
area under extensive study in which rulings or determination
letters will not be issued until the Service resolves the issue
through publication of a revenue ruling, revenue procedure,
regulations, or otherwise). We note that the monthly service
fees in this case relate to current medical care.
25
See, e.g., Priv. Ltr. Rul. 86-51-028 (Sept. 19, 1986);
Priv. Ltr. Rul. 86-41-037 (July 11, 1986); Priv. Ltr. Rul. 86-30-
005 (Apr. 4, 1986); Priv. Ltr. Rul. 82-13-102 (Dec. 30, 1981).
Private letter rulings are not regarded as precedent in this
Court and may not be relied on by the public. Sec. 6110(j)(3);
Alumax, Inc. v. Commissioner, 109 T.C. at 163 n.12. However,
private letter rulings may be cited to show the practice of the
Commissioner. Rowan Cos., Inc. v. United States, 452 U.S. 247,
261 n.17 (1981); Hanover Bank v. Commissioner,
369 U.S. 672, 686-
687 (1962); Rauenhorst v. Commissioner, 119 T.C. at 170 n.8;
Estate of Cristofani v. Commissioner,
97 T.C. 74, 84 n.5 (1991).
- 40 -
among other items, salaries of nurses, nurses’ aides,
orderlies and incidental medication and supplies, as
well as expenses allocable to the facility, such as,
housekeeping, maintenance and utilities, a
proportionate share of interest on indebtedness, real
estate taxes, insurance, and depreciation.
* * * * * * *
(5) Medical expenses for purposes of the
computation of the ratio of medical to total expenses
include, but are not limited to, salaries of the
Medical Center staff, incidental medication and
supplies, the proportionate amount attributable to the
provision of medical care of housekeeping, maintenance,
utilities, administrative and marketing costs, interest
on indebtedness, real estate taxes and depreciation of
the nursing facility.
There is no requirement in the revenue rulings that
taxpayers engage in an actuarial analysis to factor in life
expectancy and health care level expectancy on the basis of the
residency population of a CCRC to determine estimated lifetime
medical care costs and total costs. The rulings focus on the
amount of fees paid by residents to the CCRC during the taxable
year that are properly allocable to medical care in the year
paid, and imply that the percentage method is an appropriate
method for taxpayers to use. The actuarial method used by
respondent’s expert requires estimating total lifetime costs of
services and lifetime medical care costs, steps that are not
anticipated or required by the revenue rulings. Additionally,
the longstanding practice of the Commissioner has been to allow
use of the percentage method. The Commissioner’s guidance
- 41 -
provides further justification for our holding that petitioners
are not required to use the actuarial method.
II. Burden of Proof
We must now determine which party bears the burden of proof
as to the factual issues in this case. Generally, the taxpayer
bears the burden of establishing the entitlement to any deduction
claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);
New Colonial Ice Co. v. Helvering,
292 U.S. 435, 440 (1934).
However, in certain circumstances, if the taxpayer introduces
credible evidence with respect to any factual issue relevant to
ascertaining the proper tax liability, section 7491 places the
burden of proof on the Commissioner. Sec. 7491(a)(1). Credible
evidence is “‘the quality of evidence which, after critical
analysis, the court would find sufficient upon which to base a
decision on the issue if no contrary evidence were submitted’”.
Higbee v. Commissioner,
116 T.C. 438, 442 (2001) (quoting H.
Conf. Rept. 105-599, at 240 (1998), 1998-3 C.B. 755, 994).
Section 7491(a)(1) applies only if an individual taxpayer
complies with substantiation requirements, maintains all required
records, and cooperates with reasonable requests by the
Commissioner for witnesses, information, documents, meetings, and
interviews. Sec. 7491(a)(2).26
26
Sec. 7491 is effective with respect to court proceedings
arising in connection with examinations commencing after July 22,
(continued...)
- 42 -
Whether an expense is for medical care is primarily a
question of fact. Levine v. Commissioner, 695 F.2d 57, 59 (2d
Cir. 1982), affg. T.C. Memo. 1981-437; Counts v. Commissioner,
42
T.C. 755, 764 (1964); Estate of Smith v. Commissioner, 79 T.C. at
319; sec. 1.213-1(e)(1)(v), Income Tax Regs. For purposes of
this case, the factual issues involved are: (1) The portions of
the monthly service fees allocable to medical care under the
percentage method; and (2) the amounts, if any, that petitioners
are entitled to deduct for Mr. Baker’s use of the pool, spa, and
exercise facilities.
On brief, respondent argues that petitioners have failed to
present credible evidence that they are entitled to the amounts
of the medical deductions claimed on their returns for the years
in issue and that they did not comply with the substantiation,
recordkeeping, and cooperation requirements of section
7491(a)(2). However, at trial, respondent specifically stated
that petitioners had cooperated and maintained records.
Respondent represented to the Court that the only issue under
section 7491(a) was whether petitioners had presented credible
evidence. We treat respondent’s representation at trial as a
26
(...continued)
1998. Internal Revenue Service Restructuring and Reform Act of
1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727. Respondent
has conceded that the examination in this case commenced after
July 22, 1998.
- 43 -
concession that petitioners have satisfied the requirements of
section 7491(a)(2).
The stipulated joint exhibits and petitioners’ exhibits
contain detailed financial information, including total revenue
and expenses figures for Village West for the years in issue.
Petitioners rely primarily on the findings of the ad hoc
committee, of which Mr. Baker was a member, with certain
adjustments. AFVW management informed its AFVW residents that
certified data from the financial records of AFVW for the years
in issue was provided to the ad hoc committee and that the
committee coordinated and worked with management to review and
make recommendations regarding the allowable deductions for
medical expense. This financial information and the ad hoc
committee’s report are detailed and contain the revenue and
expense figures necessary to calculate petitioners’ medical
deductions for the years in issue. After discussing this issue
with the parties at trial and examining their briefs, we
interpret petitioners’ position to be that both the ad hoc
committee’s findings and the findings resulting from petitioners’
subsequent adjustments are appropriate methods of calculating the
appropriate allocation percentage and determining petitioners’
medical deductions.
After thorough review and critical analysis of the
stipulated joint exhibits and petitioners’ exhibits, we find that
- 44 -
petitioners have submitted credible evidence; i.e., evidence
which, after critical analysis, is sufficient on which to base a
decision sustaining the ad hoc committee’s calculations regarding
the portion of the monthly service fees that is allocable to
medical care under the percentage method.27 Accordingly, we hold
that respondent bears the burden of proof regarding the portions
of the monthly service fees paid by petitioners in 1997 and 1998
that are allocable to medical care under the percentage method.28
However, with respect to the claimed deductions for medical
use of the pool, spa, and exercise facilities, we find that
petitioners have not submitted credible evidence. The financial
information discussed above, as further explained below, does not
contain specific figures or calculations by Mr. Dalton or AFVW
relating to expenditures for the facilities that are sufficient
27
See Forste v. Commissioner, T.C. Memo. 2003-103 (holding
that taxpayers produced credible evidence in the form of draft
proposal offers and final settlement agreement that was
sufficient to show that a payment was made in settlement of tort
or tort-type claim for personal injury).
28
On brief, petitioners argue that respondent’s reliance on
Mr. Powell’s report and use of the actuarial method constitutes a
new matter. Petitioners may be correct, especially in light of
the fact that any appeal in this case would normally lie to the
Court of Appeals for the Ninth Circuit. See, e.g., Estate of
Harper v. Commissioner, T.C. Memo. 2002-121 (discussing recent
decisions by the Court of Appeals for the Ninth Circuit regarding
burden of proof). However, because we have already held that
respondent has the burden of proof, we need not reach this issue.
- 45 -
for us to base our decision. Therefore, we conclude that the
burden of proof does not shift to respondent on this issue.29
III. Portion of Monthly Services Fees Allocable to Medical Care
Under the Percentage Method
The parties’ positions regarding the application of the
percentage method are based primarily on the ad hoc committee’s
report and the portion of Mr. Powell’s report discussing this
method. Respondent argues that Mr. Powell’s application of the
method and the resulting conclusion should be followed if the
percentage method is applied. Petitioners rely primarily on the
ad hoc committee’s findings with certain adjustments contained in
a supplemental calculation. After discussing this issue with the
parties at trial and examining their briefs, we interpret
petitioners’ position to be that both the ad hoc committee’s
findings and the findings resulting from petitioners’ subsequent
adjustments are appropriate methods of determining the
appropriate allocation percentage. Petitioners ultimately argue
that, based on either calculation, the appropriate allocation is
approximately 41 percent.
A. Petitioners’ Calculations
Petitioners generally agree with the approach and financial
figures used by the ad hoc committee, of which Mr. Baker was a
29
Petitioners do not argue that respondent raised a new
matter with respect to the disallowance of the claimed deductions
for Mr. Baker’s use of the pool, spa, and exercise facilities.
- 46 -
member. They also presented a supplemental report prepared by
Mr. Baker as another means of establishing the appropriate
allocation percentage. As previously mentioned, we interpret
their position to be that the allocation percentage is
approximately 41 percent under either the ad hoc committee’s
calculations or Mr. Baker’s supplemental report.
In order to complete its calculations regarding the
appropriate allocation percentage, the ad hoc committee relied on
certified data from the financial records of AFVW. The committee
coordinated and worked with AFVW’s management in reaching its
calculations. Petitioners have adequately demonstrated to the
Court how the ad hoc committee used the information provided by
AFVW management to arrive at its conclusions regarding the
appropriate allocation percentage.
The ad hoc committee calculated an allocation percentage by
dividing medical expenses by total operating costs, with specific
item adjustments to both figures. In calculating total operating
costs, the committee subtracted interest expense, depreciation
and amortization, issue cost, and noncontract patient expenses
from total costs. In calculating medical expenses, the committee
included SNF, ALU, and SCU operating expenses, and subtracted out
noncontract patient fees and depreciation and amortization
allocable to the three facilities. The committee then made
certain upward adjustments to account for the emergency-pull-cord
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system, food service, environmental service, utilities, and
insurance. The adjustments for food service and environmental
expenses were based on formulas provided by the food service
contractor and the environmental service contractor. The
adjustment for utilities was based on a square-footage method and
the adjustment for insurance was based on a ratio- and square-
footage methodology.
The committee ultimately concluded that the allocation
percentages were 40.3 percent and 41.6 percent for the years 1997
and 1998, respectively. The resident council reported to AFVW
residents a summary of the ad hoc committee’s findings. The
resident council explained how the allocation percentage was to
be applied, provided the same census figures used in the Health
Facility Information report, and stated what the medical
deduction was per resident.
Mr. Baker testified that the calculations in the
supplemental report he prepared were similar to the ad hoc
committee’s calculations. He testified that his calculations
assumed that the fee charged for a medical service approximated
the cost of Village West’s providing that service. Mr. Baker did
not explain in detail the adjustments contained in his
supplemental report, and we are unable to satisfactorily connect
his figures to the financial information contained in the record.
As a result, we find the supplemental report to not be helpful,
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and we choose not to rely on it in our analysis. Accordingly, we
will examine respondent’s position to determine whether he has
shown that the allocation percentages and portions of the monthly
service fees allocable to medical care are different from those
calculated by the ad hoc committee.
B. Mr. Powell’s Calculations
Respondent relies on the percentage method as applied by Mr.
Powell. Although Mr. Powell did not believe that the percentage
method should be used, he developed a procedure for generating a
percentage for use with the percentage method. Mr. Powell stated
that the basic formula would examine the relationship between
total costs and amounts allocated to medical care, with
adjustments for specific items. In his report, Mr. Powell stated
that because the sum of entrance fees and monthly service fees
over the resident’s lifetime is expected to cover the costs of
care for residents in a CCRC, it is reasonable to assume that the
costs of medical care in the fee structure represent the same
proportion or percentage in the total costs. Mr. Powell relied
on the financial figures in AFVW’s Health Facility Information
report. He did not rely on the 1998 financial document.
Mr. Powell stated that total costs would include
departmental cash expenses plus depreciation and interest
expense. Subtractions would be made for issuance costs
associated with debt financing, room and board revenues and
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Medicare and HMO billings for noncontract patients in the SNF,
and ancillary services associated with the SNF. He stated that
it is reasonable to subtract medical expenses not associated with
the residents from both the numerator and denominator of the
formula. Additionally, the ancillary fees that are paid on a
fee-for-service basis and expected reimbursements from Medicare
and HMO insurance should also be subtracted from both the
numerator and denominator because these expenses are not expected
to be covered by entrance fees or monthly service fees.
Similar to the ad hoc committee, Mr. Powell believed that
the expenses for medical care would include expenses allocated to
the ALU, SCU,30 and SNF, plus a portion of the interest expense
allocable to these facilities. The same debt finance costs, SNF
room and board revenues, and ancillary services and Medicare and
HMO billings subtracted from the total costs would also be
subtracted from the medical expense. In addition, ancillary
services, Medicare, and HMO billings for residents should be
subtracted; however, Mr. Powell stated that he could not obtain
an accurate amount due to a difference between the accrual and
cash bases for those revenues.
30
The SCU was completed in June 1997 and began operation at
that time. Mr. Powell did not allocate any medical expenses to
the SCU for 1997.
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The following chart prepared by Mr. Powell reflects his
calculations for 1997:
Operating Expenses Source for Amount
$16,069,104 Total operating expenses for AFVW,
including depreciation and interest
expense
(93,395) Issuance costs associated with debt
financing
(1,207,747) SNF room and board revenues for
noncontract patients
(448,462) SNF ancillary services, Medicare, and
HMO billings for noncontract patients
14,319,500 Total for denominator
Medical Expenses Source for Amount
$3,044,014 Operating expenses allocated to SNF
929,275 Operating expenses allocated to ALU
479,734 10 percent of interest expenses to SNF
319,823 6.67 percent of interest expenses to ALU
(1,207,747) SNF room and board revenues for
noncontract patients
(448,462) SNF ancillary services, Medicare, and
HMO billings for noncontract patients
(0) Ancillary services, Medicare, and HMO
billings for residents; not included
1
3,116,664 Total for numerator
For 1997, the percentage is 21.8 percent ($3,116,664 ÷
$14,319,500).2
1
We note that the total of the medical expenses is $3,116,637,
not $3,116,664 as listed in Mr. Powell’s report.
2
We note that application of the corrected medical expense
figure still produces a percentage of 21.8 percent.
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The following chart prepared by Mr. Powell reflects his
calculations for 1998:
Operating Expenses Source for Amount
$17,759,058 Total operating expenses for AFVW,
including depreciation and interest
expense
(107,134) Issuance costs associated with debt
financing
(1,315,694) SNF room and board revenues for
noncontract patients
(378,905) SNF ancillary services, Medicare, and
HMO billings for noncontract patients
15,957,325 Total for denominator
Medical Expenses Source for Amount
$3,330,031 Operating expenses allocated to SNF
984,333 Operating expenses allocated to ALU
796,306 Operating expenses allocated to SCU
466,912 10 percent of interest expenses to SNF
311,275 6.67 percent of interest expenses to ALU
311,275 6.67 percent of interest expenses to SCU
(1,315,694) SNF room and board revenues for
noncontract patients
(378,905) SNF ancillary services, Medicare, and
HMO billings for noncontract patients
(0) Ancillary services, Medicare, and HMO
billings for residents; not included
4,505,533 Total for numerator
For 1998, the percentage is 28.2 percent ($4,505,533 ÷
$15,957,325).
To complete his procedure, Mr. Powell chose to apply the
percentages to the total monthly service fees that petitioners
paid to Village West. As previously mentioned, petitioners’
monthly service fees were $2,170 and $2,254 for 1997 and 1998,
respectively. Thus, Mr. Powell calculated that petitioners were
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entitled to deductions (before application of the 7.5-percent
floor) of $5,67731 and $7,628.32
C. Analysis of Parties’ Positions
Our approach in this case is to examine the ad hoc
committee’s calculations regarding the appropriate allocation
percentage in light of respondent’s allegations of error, which
are primarily based on Mr. Powell’s calculations, his testimony,
and the testimony of Mr. Dalton.33 In order to accomplish this
task, we will address the portions of the committee’s
calculations that respondent claims are inaccurate. Because
respondent relies on Mr. Powell’s application of the percentage
method, we generally compare this approach with that used by the
ad hoc committee.
The ad hoc committee computed the denominator by starting
with total costs and subtracting total interest expense, total
depreciation and amortization, total issue cost, and total
noncontract patient expense. Mr. Powell did not subtract total
interest expense and total depreciation and amortization.
31
Calculated as 21.8 percent of 12 x $2,170.
32
Calculated as 28.2 percent of 12 x $2,254.
33
We note that to the extent respondent has not challenged
certain assumptions by the ad hoc committee, we treat these as
concessions by respondent and express no opinion as to the
validity or accuracy of the assumptions.
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However, Mr. Powell did subtract SNF ancillary services,
Medicare, and HMO billings for noncontract patients.
The ad hoc committee calculated medical expenses by first
calculating the sum of SNF, ALU, and SCU operating expenses,
expenses related to the emergency-pull-cord system, and certain
adjustments related to food service, environmental service,
utilities, and insurance. It then subtracted noncontract patient
fees for the SNF, ALU, and SCU, and depreciation and amortization
allocable to the SNF, ALU, and SCU.34 In addition to including
operating expenses of the SNF, ALU, and SCU, Mr. Powell included
interest expense allocable to the SNF and ALU. He did not
include an expense for the emergency-pull-cord system or
adjustments for food service, environmental service, utilities,
or insurance. Mr. Powell did not subtract either noncontract
patient fees for the ALU and SCU or depreciation and amortization
of the SNF, ALU, and SCU. However, he did subtract SNF ancillary
services, Medicare, and HMO billings for noncontract patients.
The ad hoc committee and Mr. Powell used slightly different
financial figures in their reports.
34
In the Health Facility Information report, expenses
related to depreciation are included in the medical expenses
allocable to the SNF, ALU, and SCU. Allocations for amortization
of debt issue cost, amortization of preopening cost, and interest
expense are not included.
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1. Appropriate Financial Information To Use
The ad hoc committee and Mr. Powell both relied primarily on
the financial information for 1997 and 1998 that was contained in
the Health Facility Information report. For 1998 revenues and
expenses, the committee relied on the 1998 financial document
that should have been included in the report. There are minor
differences between the figures presented in the 1998 financial
document and the report. Respondent has not argued that the
financial information used by the ad hoc committee is inaccurate
or unreliable, and Mr. Powell acknowledges in his report that the
1998 financial document was based on actual results for that
year. With respect to the explanation of expense allocation
assumptions by AFVW, Mr. Powell stated that he reviewed the
assumptions and relied on AFVW’s management’s judgment because he
believed the final results were reasonable. Accordingly, we
proceed under the assumption that the financial figures and
expense allocation assumptions contained in the Health Facility
Information report are appropriate, with the exception that
revenue and expense figures for 1998 should be based on the 1998
financial document.
2. Interest Expense and Depreciation and Amortization
In calculating total costs, the ad hoc committee subtracted
interest expenses and depreciation and amortization. In
calculating allocable medical costs, the committee also
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subtracted interest expense and depreciation and amortization
allocable to the SNF, ALU, and SCU. Mr. Powell included both
interest expense and depreciation and amortization in his
calculations.
Mr. Powell testified that it was not technically accurate to
subtract depreciation and interest expense from total costs and
medical expenses. He explained that entrance fees and monthly
service fees are used to cover the total costs of AFVW, which
includes capital costs. Therefore, he felt that excluding these
two items from total costs would distort the allocation
percentages. Petitioners argue that under the percentage method
only operating expenses are included in the denominator of the
equation. They claim that interest should not be included
because it is simply the cost of borrowing capital to fund the
investment in Village West and does not represent an operating
expense. Petitioners claim that depreciation and amortization
are not operating expenses because they represent the initial
capital costs of investing in plant and equipment.
Under the percentage method, the medical expenses of the
CCRC are calculated and then compared to all the expenses of the
community to determine the appropriate percentage of expenses
allocable to medical care. In applying the percentage method in
this case, both the numerator and denominator in the equation
should include interest expenses and depreciation and
- 56 -
amortization because the evidence in the record indicates that
Village West offered a nursing care arrangement where the monthly
service fees for the years in issue were intended to cover all
expenses related to AFVW residents. Neither the residence
agreement nor the financial information submitted by the parties
indicates whether the entrance fees or monthly service fees are
allocated to specific costs or what that allocation is. Thus,
the denominator in this case should be based on the total costs
of the CCRC, which necessarily includes costs for these two
items. It is also logical to include interest expense and
depreciation and amortization costs related to medical facilities
when other expenditures relating to the operation of those
facilities (e.g., utilities, food services, health services) are
included. Therefore, we assume for purposes of this case that
the monthly service fees are applied equally to all expenses,
including interest expense and depreciation and amortization.
Accordingly, we agree with respondent and Mr. Powell that, in
this case, interest expense and depreciation and amortization
should be included in both the numerator and denominator.35
35
The SCU was placed in service in June 1997 and started
operation at that time. Accordingly, in calculating the interest
expense allocable to the SCU for 1997 we include half the amount
that would have been allocable had the facility been in operation
for the entire year.
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3. Emergency-Pull-Cord System and Other Adjustments
The ad hoc committee made upward adjustments to the medical
expense figures to account for the emergency-pull-cord system and
food service, environmental service, utilities, and insurance
figures that it felt were not adequately reflected in AFVW’s
financial records. The committee’s calculations for the
emergency-pull-cord system are based on Mr. Dalton’s calculation
contained in the Health Facility Information report.
Respondent’s general argument on this issue is that Mr.
Powell’s calculations should be followed. However, Mr. Powell
did not specifically discuss the emergency-pull-cord system or
other adjustments either in his report or during trial.
Respondent’s only specific argument is contained in his reply
brief wherein he states that “Although it is petitioners’
contention that the pull cord was not included as a medical
expense, * * * Mr. Dalton testified the pull cord system became
an indirect cost.”
Mr. Dalton prepared the allocation worksheet for the
emergency-pull-cord system. He testified that there is a pull-
cord system in all ILUs so that in case of an emergency a
resident can pull the cord connected to the front desk and
Village West can provide a crisis nurse within a number of
minutes. Mr. Dalton testified that there were seven or eight
persons who worked at the front desk and that although other
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services were provided by front desk staff one of the main
functions was to address the emergency-pull-cord system. In
making the allocation, Mr. Dalton assumed that the allocable cost
of front desk staff to monitor the system would be an average
hourly rate for one person for 24 hours a day for 365 days a
year. Mr. Dalton explained that the expenditures for the system
are not set out in a specific account but are charged to a
general ledger account. Specifically, he testified that the
payroll and benefits for a person monitoring the system would be
found under the resident services expense category, which
includes certain expenses related to the staffing of the front
desk.
After reviewing the financial information and the ad hoc
committee’s report, we find that no amount from the resident
services expense account (other than the committee’s allocation
for the pull-cord system) was included by either Mr. Powell or
the committee in their medical expense calculations. Respondent
does not challenge the amount of the allocation by Mr. Dalton for
medical expenses associated with the emergency-pull-cord system,
and we find the calculation to be reasonable based on the
evidence in the record. Because respondent has not raised any
other arguments on this issue or specifically argued or presented
adequate evidence that the other upward adjustments are
- 59 -
inappropriate, we accept the allocations to the pull-cord system
and the other adjustments made by the ad hoc committee.
4. SNF Ancillary Services, Medicare, and HMO
Billings, and ALU and SCU Noncontract Patient Fees
In his calculations, Mr. Powell excluded from both total
costs and medical costs expenses for SNF ancillary services,
Medicare, and HMO billings for AFVW residents and noncontract
patients, and ALU and SCU noncontract patient fees. However, Mr.
Powell stated that he could not obtain an accurate amount of SNF
ancillary services, Medicare, and HMO billings for AFVW
residents, and therefore he did not exclude any amount in his
calculations. Respondent has not specifically argued or provided
any amount that we should exclude for SNF ancillary service,
Medicare, and HMO billings for AFVW residents. Accordingly, we
need only address the remaining items as they relate to whether
expenses related to noncontract patients should be excluded from
total costs and medical expenses.
Both the ad hoc committee and Mr. Powell subtracted
noncontract patient fees related to the SNF from total costs and
medical costs. The committee also subtracted noncontract patient
fees related to the ALU and SCU. After reviewing Mr. Powell’s
reasoning and respondent’s arguments (discussed in further detail
below) with respect to expenses and reimbursements related to
noncontract patients, we infer that this was an oversight on the
part of Mr. Powell, and the committee’s position on this issue is
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not being challenged. Accordingly, the noncontract patient fees
related to the SNF, ALU, and SCU should all be excluded from
total costs and medical expenses.
In his report, Mr. Powell states that it is reasonable to
subtract SNF ancillary service, Medicare, and HMO billings from
total costs and medical expenses. Respondent argues that the
entrance fees and monthly service fees are expected to cover the
costs of care for residents of a CCRC, and therefore it is
reasonable to subtract expenses not expected to be covered by the
fees. Respondent contends that ancillary services that are paid
on a fee-for-service basis, and expected reimbursements from
Medicare and HMO insurance are expenses not covered by the
entrance fees and monthly service fees.
At trial, Mr. Dalton testified that if medical care was
covered by insurance, then the fees were charged directly to the
insurance company and charged to an expense account. If payment
was received from Medicare or an HMO insurance company, the
payments were credited to a revenue account.
We agree with respondent on this issue. Our understanding
of the facts of this case is that the monthly service fees are
paid to cover costs related to AFVW residents. The ad hoc
committee allocated SNF, ALU, and SCU expenses to medical care;
however, these facilities are also used by noncontract patients.
The noncontract patients are charged fees for use of the
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facilities, and petitioner has not disputed that noncontract
patients also pay for certain services on a fee-for-service
basis. Additionally, AFVW can receive reimbursement from
Medicare and HMO insurance for care given to noncontract
patients. These fee-for-service and reimbursement proceeds are
included as revenue in AFVW’s books. Although these proceeds are
not used specifically to offset expenses in the noncontract
patient expense accounts, the revenue relates to care given to
noncontract patients in the SNF, ALU, and SCU, and we believe
that the expenses of these facilities should be reduced to
accurately reflect the portion of the monthly service fees paid
for care of AFVW residents. In substance, this treatment is
consistent with the subtraction of SNF, ALU, and SCU noncontract
patient fees from total costs and medical expenses. We have
reviewed the figures used by Mr. Powell and find them consistent
with AFVW’s financial information and acceptable for purposes of
this calculation.36
D. The Court’s Application of the Percentage Method
Mr. Dalton and the ad hoc committee applied the allocation
percentage to a weighted average of monthly service fees paid by
36
We are unable to derive the amount for 1998 for SNF
ancillary services, Medicare, and HMO billings for noncontract
patients from the 1998 financial document that should have been
included in the Health Facility Information report. Therefore,
like Mr. Powell, we rely on the 1998 information contained in the
report.
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occupants of ILUs. Mr. Dalton’s calculations provide a deduction
per residence while the ad hoc committee’s calculations are per
resident. Mr. Powell applied the percentage based on the actual
monthly service fees paid by petitioners and calculated an
allocable amount per residence.37 Although respondent states
that Mr. Powell’s application of the percentage methodology is
correct, respondent argues that a weighted average should be used
because it provides some consistency among ILU residents and is
fair and objective. Petitioners argue that the allocation
percentages should be applied to the actual fees they paid.
We believe that the more appropriate application of the
percentage method is to allocate to each resident the same amount
for purposes of determining the appropriate medical deduction
related to the payment of monthly service fees. If we accepted
petitioners’ approach, single residents and residents of double-
occupancy ILUs that are larger than the average ILU (and thus pay
higher monthly service fees) would get a larger medical expense
deduction based solely on the number of occupants of the ILU or
the square footage of the unit. We fail to see the relationship
between the health care expenses of residents and the size and
37
This application of the percentage method appears at odds
with a statement in the section of Mr. Powell’s report providing
an overview and criteria for the evaluation of the different
methods. In his report, Mr. Powell states that similar residents
have the same expected health care usage and thus should receive
the same deduction regardless of the size of their accommodations
or the fees they pay.
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cost of their ILUs. Accordingly, we hold that the allocation
percentage must be applied based on the number of residents and
the average weighted monthly service fees (or weighted annual
service fees in the case of residents living in ILUs for the
entire year).
On the basis of the undisputed assumptions by AFVW and our
findings above, we have calculated the amounts allocable to ILU
residents of Village West for medical care related to their
monthly service fees. Our calculations show that the amounts of
$7,766 and $8,476 paid by petitioners as service fees for 1997
and 1998, respectively, were for medical care. The details of
our calculations are contained in the attached appendix.
IV. Deductions for Use of Pool, Spa, and Exercise Facilities
Petitioners claim that they are entitled to deductions for
Mr. Baker’s use of the pool, spa, and exercise facilities
because: (1) The use of the facilities was necessary to
alleviate his chronic illnesses; and (2) a portion of the monthly
service fees is properly allocable to the operation and
maintenance of these facilities. Respondent argues that no
deductions are allowable because Mr. Baker’s use of the
facilities was personal in nature, any expense related to use of
the facilities would otherwise have been incurred by AFVW
residents, and the methodology used by petitioners to allocate a
portion of the monthly service fees to the operation and
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maintenance of the facilities is flawed and should be
disregarded.
Deductions for expenditures for medical care are confined
strictly to expenses incurred primarily for the prevention or
alleviation of a physical or mental defect or illness. Haines v.
Commissioner, 71 T.C. 644, 647 (1979); sec. 1.213-1(e)(1)(ii),
Income Tax Regs. An expenditure which is merely beneficial to
the general health of an individual, such as an expenditure for a
vacation, is not an expenditure for medical care. Sec. 1.213-
1(e)(3)(ii), Income Tax Regs. An important condition that must
be satisfied for the claim to succeed is whether the expenditure
would have been made even if there had been no illness. Jacobs
v. Commissioner,
62 T.C. 813, 819 (1974); Lepson v. Commissioner,
T.C. Memo. 1982-304.
Petitioners introduced a calculation by Mr. Baker for
allocating a portion of the monthly service fees to the cost of
providing the facilities. Mr. Baker applied varying allocation
percentages to gross expense figures from eight different expense
categories to arrive at a total allocation amount. He then
divided this amount by the number of occupied ILUs in 1997 and
1998 to arrive at an allocation amount per residence.
Petitioners did not explain or introduce credible evidence how
Mr. Baker arrived at the specific allocation percentages for each
expense category or the relevance of those specific categories.
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Although we are permitted in certain circumstances to
estimate a deductible amount, Cohan v. Commissioner, 39 F.2d 540,
543-544 (2d Cir. 1930), we can only do so when the taxpayer
provides evidence sufficient to establish a rational basis upon
which an estimate can be made, Vanicek v. Commissioner,
85 T.C.
731, 743 (1985). In this case, even assuming that all other
requirements for deductibility under section 213 have been
established, petitioners have failed to provide evidence upon
which we can make a rational estimate. Additionally, we note
that the facilities were available for recreational use by
petitioners and their family, and petitioners have failed to
establish what portion of Mr. Baker’s use was for medical
purposes. Accordingly, we hold that petitioners are not entitled
to deductions for Mr. Baker’s use of the pool, spa, and exercise
facilities.
Contentions we have not addressed are moot, irrelevant, or
meritless. To reflect the foregoing,
Decision will be entered
under Rule 155.
- 66 -
APPENDIX
I. 1997
Total Costs Amount
Total expenses $16,069,104
Issue cost (98,395)
SNF noncontract patient fees (1,207,747)
ALU noncontract patient fees (80,156)
SCU noncontract patient fees (3,640)
SNF ancillary services, Medicare, and (448,462)
HMO billings for noncontract patients
Total costs 14,230,704
Medical Expenses Amount
SNF operating expenses $3,044,041
ALU and SCU operating expenses 929,275
Emergency pull-cord system 87,374
Food service adjustment 482,769
Environmental service adjustment 112,617
Utilities adjustment 81,146
Insurance adjustment 18,234
Interest expense for SNF 479,734
Interest expense for ALU 319,823
Interest expense for SCU 159,991
SNF noncontract patient fees (1,207,747)
ALU noncontract patient fees (80,156)
SCU noncontract patient fees (3,640)
SNF ancillary services, Medicare, and (448,462)
HMO billings for noncontract patients
Medical expenses 3,974,999
Medical expenses divided by total costs equals an allocation
percentage of 27.93 percent.
The number of ILU residents was 574 and they paid a total annual
service fee of $7,979,906, or an average of $13,902.
Applying the allocation percentage of 27.93 percent to the
weighted average annual service fee of $13,902 results in a
medical care allocation of $3,883 per resident.
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II. 1998
Total Costs Amount
Total expenses $16,986,770
Issue cost (107,134)
SNF noncontract patient fees (1,301,382)
ALU noncontract patient fees (104,083)
SCU noncontract patient fees (110,202)
SNF ancillary services, Medicare, and (378,905)
HMO billings for noncontract patients
Total costs 14,985,064
Medical Expenses Amount
SNF operating expenses $3,330,031
ALU and SCU operating expenses 1,780,639
Emergency pull-cord system 88,257
Utilities adjustment 103,641
Interest expense for SNF 470,432
Interest expense for ALU 313,778
Interest expense for SCU 313,778
SNF noncontract patient fees (1,301,382)
ALU noncontract patient fees (104,083)
SCU noncontract patient fees (110,202)
SNF ancillary services, Medicare, and (378,905)
HMO billings for noncontract patients
Medical expenses 4,505,984
Medical expenses divided by total costs equals an allocation
percentage of 30.07 percent.
The number of ILU residents was 591 and they paid a total annual
service fee of $8,329,241, or an average of $14,093.
Applying the allocation percentage of 30.07 percent to the
weighted average annual service fee of $14,093 results in a
medical care allocation of $4,238 per resident.
