554 F. 2d 564 - Turecamo v. Commissioner of Internal Revenue

Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Leonard J. Henzke, Jr., William S. Estabrook III, Tax Div., Dept. of Justice, Washington, D. C., for appellant.

Michael H. Simonson, New York City, for appellees.

Before VAN GRAAFEILAND, Circuit Judge, KELLEHER* and GAGLIARDI,** District Judges.

GAGLIARDI, District Judge:

The Commissioner of Internal Revenue ("the Commissioner") here appeals the decision of the Tax Court permitting Alfred and Frances Turecamo ("the taxpayers") to claim Mrs. Turecamo's mother, Mrs. Kavanaugh, as a dependent pursuant to Section 152(a) of the Internal Revenue Code ("the Code"), 26 U.S.C. § 152(a), and to claim certain attendant tax deductions. The single issued raised on this appeal may be stated simply: Are Basic Medicare hospitalization benefits paid pursuant to Part A of Subchapter XVIII of the Social Security Act1 to be considered support provided by the Medicare beneficiary for the purposes of determining whether a related taxpayer may claim the beneficiary as a dependent under the dependency support test of § 152(a) of the Code? The Tax Court concluded that for these purposes Basic Medicare benefits are not to be considered support furnished by the recipient. For the reasons stated below, we agree and affirm.

The Facts

The material facts are undisputed. In 1970 Mrs. Kavanaugh was 81 years old and lived with the Turecamos, her son-in-law and daughter, in their home. On August 5, 1970 Mrs. Kavanaugh was admitted to the Long Island Jewish Hospital in New Hyde Park, New York, where she remained until her discharge on October 9, 1970. On that date she returned to the taxpayers' home and continued to reside there until her death in December, 1970.

The total hospital bills incurred by Mrs. Kavanaugh were $11,095.75, of which $10,434.75 was paid by Medicare allowances pursuant to the provisions of Part A of Subchapter XVIII of the Social Security Act, "Hospital Insurance Benefits for Aged and Disabled," 42 U.S.C. §§ 1395c to 1935i-2. The taxpayers paid the balance of the hospital charges not covered by Part A as well as all of the additional costs of nursing care required when Mrs. Kavanaugh was at their home. They thus paid a total of $3,531.00 in medical expenses on her behalf in 1970.

That year the taxpayers also provided Mrs. Kavanaugh with several rooms in their home for her use as an apartment. In sum, the taxpayers provided Mrs. Kavanaugh with food, lodging, clothing and entertainment worth approximately $4,000. Although Mrs. Kavanaugh received $1,140 in social security benefits which she applied toward her support, she did not reimburse the taxpayers for any of the expenditures made by them on her behalf.

Acting on the assumption that they had provided more than half of Mrs. Kavanaugh's support in 1970 and that consequently she qualified as their dependent, as provided in § 152(a) of the Code,2 the taxpayers claimed an additional dependency exemption on their 1970 joint federal income tax return and also listed $3,531 as deductible medical expenses paid on her behalf.3

The Commissioner disallowed the taxpayers' claims, ruling that the $10,434.75 in Part A Basic Medicare payments made on behalf of Mrs. Kavanaugh were to be considered as having been contributed by Mrs. Kavanaugh herself in determining whether she could be claimed as a dependent by the Turecamos. In so ruling the Commissioner relied on his previous decision in Rev.Rul. 70-341, 1970-2 C.B. 31, in which he characterized Part A Basic Medicare benefits as social security payments and thus, in accordance with the traditional tax treatment of governmental disbursements made in furtherance of social welfare objectives (discussed infra ), he ruled that Basic Medicare payments are includible as the recipient's own contribution to her support in determining who had provided more than one-half of her support under the § 152(a) dependency support test.4 As a result of the inclusion of the Basic Medicare payments in the computation of Mrs. Kavanaugh's support, it was held that the Turecamos did not meet the § 152(a) dependency support test because they had failed to establish that they had provided over half of Mrs. Kavanaugh's support.5 Consequently, they were not entitled to claim her as a dependent and the additional personal exemption and medical expenses deduction were denied. A resulting tax deficiency was assessed.

The Tax Court overruled the Commissioner and held that the Part A Basic Medicare benefits paid out on behalf of Mrs. Kavanaugh are not to be included in the computation of the support furnished by the recipient-dependent. 64 T.C. 720 (1975). With the amount constituting Part A benefits thus disregarded by the Tax Court, the Turecamos' expenditures on behalf of Mrs. Kavanaugh easily made up more than one-half of her total support, as required by § 152(a) of the Code. See footnote 5, supra. The dependency claims were therefore allowed and it was determined that no tax deficiency existed.

We affirm the Tax Court's holding that Part A Basic Medicare benefits are to be excluded from a calculation of the recipient's total support for purposes of the dependency support test of § 152(a) of the Code on two separate analytical grounds. A proper determination of the issue on each ground requires, as a general preliminary matter, a consideration of the dependency exemption provisions of the Internal Revenue Code of 1954 and a review of the kinds of financial benefits traditionally included or excluded from the support test of those provisions.

We have compared the characteristics of these financial benefits which determine their support test consequences with the relevant characteristics of Part A payments. As appears more fully below, based upon this comparison and upon an analysis of the provisions and legislative history of the entire Medicare statute, Subchapter XVIII of the Social Security Act, 42 U.S.C. §§ 1395-1395pp, we are unable to conclude that benefits paid pursuant to Part A, Basic Medicare, should be treated any differently from those paid out under private insurance policies or under Part B, Supplementary Medicare, which are disregarded when calculating the beneficiary's support, as the Commissioner concedes.

We are led to the same conclusion independent of this analysis of the statutory provisions of Part A and the comparison of it with other benefits. In the present case, a consideration of the absence of economic impact of the receipt of Part A benefits on the recipient's financial relationship with the Turecamos convinces us that Part A benefits should not be included as an element of the recipient's total support.

Section 152(a) Support Dependency Test

Section 152(a) of the Code permits a taxpayer to claim as his dependent any of certain qualified individuals, including his mother or mother-in-law, if he has provided more than half of that individual's support during the taxable year in question.6 For each individual determined to be his dependent under the § 152(a) support test, the taxpayer may claim an additional personal exemption pursuant to § 151(e) of the Code. In addition, § 213 of the Code allows the taxpayer to take medical expense deductions for certain expenditures made for the medical care of himself, his spouse, and "dependents (as defined in Section 152)."

In order to prove the dependency status claimed under § 152(a) and to take advantage of the consequent tax benefits under §§ 151(e) and 213 of the Code, the taxpayer must first establish the total support costs expended on behalf of the claimed dependent from all sources and then demonstrate that over half of this amount was provided by the taxpayer. See, e. g., Hogg v. U. S.,428 F.2d 274, 283 (6th Cir. 1970), cert. denied, 401 U.S. 910, 91 S.Ct. 871, 27 L.Ed.2d 808 (1971); Klofta v. U. S., 333 F.Supp. 781 (N.D.Ohio 1970); Hopkins v. Commissioner, 55 T.C. 538, 541 (1970). In this respect " support" is broadly defined to include "food, shelter, clothing, medical and dental care, education, and the like," Treas.Reg. § 1.152-1(a)(2)(i). For the purposes of determining whether the taxpayer who is claiming the individual as a dependent has provided more than half of that individual's support, "there shall be taken into account the amount of support received from the taxpayer as compared to the entire amount of support which the individual received from all sources, including support which the individual himself supplied." Id. Thus, as a general rule under the support test, the medical expenses of an individual, including extraordinary hospitalization expenses, are to be considered part of his support. Payment of these extraordinary expenses plainly constitutes support supplied by the individual himself if made by him, while if made on his behalf by a third party is to be considered support received from that third party. Thus it is conceded by both parties here that if the Turecamos had themselves paid the extraordinary hospitalization costs which were incurred by Mrs. Kavanaugh and actually covered by Part A benefits, that payment would have been included in her support calculation and would have been attributed to the Turecamos.

However, when the cost of medical care is covered by privately obtained health or hospitalization insurance there is an exception to the otherwise broadly inclusive definition of support of Treas.Reg. § 1.152-1(a)(2)(i), supra. In Rev.Rul. 64-223, 1964-2 C.B. 50, the Commissioner ruled that where an individual is covered by a renewable term policy providing insurance against medical costs, the proceeds paid by the insurance company are to be disregarded in computing the individual's support. The rule involved in determining the "support" components of such insurance coverage is that it is the cost of the premiums paid to obtain the insurance, not the medical expenses paid for by the proceeds of the policy, which represents the individual's support.7 Accord, Mawhinney v. C. I. R., 355 F.2d 462 (3d Cir. 1966), aff'g per curiam 43 T.C. 443 (1965); contra, Samples v. U. S., 226 F.Supp. 115 (D.Ga.1963). In conformity with this principle, the Commissioner has ruled that the supplementary medical insurance benefits of Part B of Subchapter XVIII are excludible from the recipient's support because they are "in the nature of medical insurance proceeds." Rev.Rul. 70-341, supra, 1970-2 C.B. at 32.

Thus, if the Basic Medicare payments made on behalf of Mrs. Kavanaugh were treated in the same manner as private insurance proceeds or as Part B benefits for purposes of the § 152(a) dependency test, they would not be included as an element of the total support expended on her behalf and, consequently, the taxpayers' dependency claim would be upheld.

The Commissioner, however, ruled below and argues on this appeal that the Part A Basic Medicare payments are not in the nature of individual medical insurance proceeds but are instead governmental disbursements made in the furtherance of social welfare objectives. The result of such a characterization, it is argued, is that the Part A benefits should be regarded as amounts paid by Mrs. Kavanaugh for her own support, for the Commissioner points to an established line of authority holding that state welfare benefits which pay for basic human necessities are attributable to the recipient on whose behalf the payments were made.

For example, in Lutter v. Commissioner, 61 T.C. 685 (1974), aff'd per curiam, 514 F.2d 1095 (7th Cir.), cert. denied, 423 U.S. 931, 96 S.Ct. 283, 46 L.Ed.2d 260 (1975), payments made to an indigent parent under the Federal-State "Aid to Families with Dependent Children" (AFDC) program, Subchapter IV of the Social Security Act, 42 U.S.C. §§ 601-644, were held to constitute support provided for the children by the State in assessing whether the parent had provided more than half the children's support. The Tax Court had previously ruled in Donner v. Commissioner, 25 T.C. 1043 (1956), that payments made by a state Department of Public Welfare for the benefit of the taxpayer's institutionalized invalid child were to be deemed elements of the child's support not provided by the parent. Accord, Rev.Rul. 71-468, 1971-2 C.B. 115, acquiescing in Carter v. Commissioner, 55 T.C. 109 (1970) (state old-age assistance payments actually expended on support costs by recipient held support furnished by state); Newman v. Commissioner, 28 T.C. 559 (1957).

Under this same principle of including governmental welfare benefits in the total "support" of the recipient, a principle which he now seeks to apply to Part A Basic Medicare payments, the Commissioner has routinely ruled that benefits received pursuant to Federal Old Age, Survivors, and Disability Insurance ("OASDI"), Subchapter II of the Social Security Act, 42 U.S.C. §§ 401-431, constitute support furnished by the recipient for purposes of the dependency test of § 152(a) of the Code. See, e. g., Rev.Rul. 58-419, 1958-2 C.B. 57, expanded by Rev.Rul. 64-222, 1964-2 C.B. 47 (OASDI benefits received by insured and spouse constitute support attributable to them for dependency test); Rev.Rul. 57-344, 1957-2 C.B. 112 (OASDI benefits received by child of retired or deceased individuals deemed support provided by that child rather than by parent or guardian in determining who furnished more than half of the child's support).

Part A Basic Medicare

The Commissioner's claim that Part A Basic Medicare hospital insurance benefits must be included in a computation of the beneficiary's support for purposes of the dependency support test of § 152(a) of the Code thus rests on his contention that Part A benefits are properly characterized as social insurance or welfare benefits, not individual insurance proceeds. However, as previously indicated, our examination of Part A convinces us on two separate grounds that the Tax Court was correct in excluding Basic Medicare hospitalization benefits from the calculation of Mrs. Kavanaugh's support. Upon an analysis of the Medicare statute in its entirety and in light of the relevant legislative history, we are not inclined to disturb the Tax Court's conclusion that, for purposes of the § 152(a) support test, no valid basis exists for distinguishing between hospitalization benefits received under Part A of Medicare and either private insurance proceeds or supplementary benefits received under Part B. In addition to this statutory analysis we believe that a practical consideration of the extraordinary nature of the receipt of Part A benefits from the perspective of their economic impact on the financial relationship which the recipient, Mrs. Kavanaugh, has maintained with the Turecamos, warrants the exclusion of Part A benefits from the recipient's support calculation.

Statutory Analysis

Federal Health Insurance for the Aged and Disabled was first enacted by Congress in 1965 as Subchapter XVIII of the Social Security Act, 42 U.S.C. §§ 1395-1395ll (1970), as amended, 42 U.S.C. §§ 1395-1395pp (Supp. V 1975). This subchapter was passed into law for the specific purpose of providing a coordinated and comprehensive approach to federal health insurance and medical care for the aged.8 Subchapter XVIII consists of one common definitional part, Part C, 42 U.S.C. §§ 1395x-1395pp, and two substantive parts, Part A, 42 U.S.C. §§ 1395c to 1395i-2, and Part B, 42 U.S.C. §§ 1395j-1395w, which together provide essentially the same health insurance protection as is furnished by comprehensive medical insurance plans underwritten by private insurers.

The Part A provisions for insurance against basic hospitalization costs are made available to all persons aged 65 and older who are entitled to monthly cash payments under Federal Old-Age Survivors, and Disability Insurance benefits (42 U.S.C. §§ 410-431) or to similar payments under the railroad retirement system. 42 U.S.C. § 1395c. This insurance covers in-patient hospital services, post-hospital extended care and home health services, and out-patient hospital diagnostic services. 42 U.S.C. §§ 1395d and 1395e. These services are paid for from a separate and self-supporting trust fund, the Federal Hospital Insurance Trust Fund, 42 U.S.C. § 1395i, which is financed by a separate compulsory payroll tax on the wages of employees, § 3101(b) and by an employer's excise tax § 3111(b) of the Code, and on earnings of self-employers, § 1401(b) of the Code. Individuals who have not become eligible for Part A benefits by qualifying for social security coverage and by paying the compulsory wage tax may choose to enroll in the program by paying voluntary monthly premiums. 42 U.S.C. § 1395i-2. The payroll taxes and voluntary contributions are calculated to insure the actuarial soundness and self-supporting character of the Trust Fund. 42 U.S.C. § 1395i(b).9 Payments for facilities and medical care pursuant to Part A are made directly by the government to the hospital or other institution which furnished the services. 42 U.S.C. § 1395f(a).

Daily administration of the Part A Basic Medicare disbursements program has been largely assigned to private organizations, termed "fiscal intermediaries", which are named by the provider or group of providers. 42 U.S.C. § 1395h. These intermediaries, which are frequently health and accident insurance companies (such as Blue Cross organizations), contract with the Department of Health, Education and Welfare to act as its disbursing agents. Id.

Part B of the Medicare system, which provides coverage for supplementary medical services, constitutes a voluntary insurance program for which persons aged 65 and older, 42 U.S.C. § 1395o, are eligible to enroll to obtain benefits in return for the payment of monthly premiums, as established by the Secretary of H. E. W., 42 U.S.C. §§ 1395p, 1395r(b) and (c). The premiums paid by enrollees, together with matching Government contributions, 42 U.S.C. § 1395w, are deposited into the Federal Supplementary Medical Insurance Trust Fund, 42 U.S.C. § 1395t, to pay for the benefits provided by Part B, 42 U.S.C. §§ 1395l (a) and 1395t(g), including physicians' and diagnostic services, outpatient physical therapy and home health services, 42 U.S.C. §§ 1395k and 1395x(s).

As under Part A, the day-to-day administration of Part B is undertaken through private intermediary entities acting as agents for HEW. These entities, entitled "carriers", 42 U.S.C. § 1395u, determine the amounts of compensation due, according to the "reasonable charges" for the services provided, and make the actual payments. 42 U.S.C. §§ 1395l (a)(1) and (a)(2)(A). Reimbursement payments are made only for services found to be medically necessary, 42 U.S.C. § 1395y(a)(1).

Part C establishes common definitions for the essential terms applicable to both Parts A and B. A "provider", for instance, whether a hospital facility or a home health agency, 42 U.S.C. § 1395x(u), and regardless of the Part under which it has provided services, is reimbursed on a "reasonable cost" basis as defined in 42 U.S.C. § 1395x(v). Numerous other provisions applicable to Parts A and B in common are set out in Part C.10

The Commissioner concedes that Part A and Part B constitute components of a single comprehensive health insurance system and are closely coordinated in design and administration. He contends, however, that the legislative history of the passage of Medicare demonstrates that Congress intended to establish two separate plans: Part A, a compulsory social insurance or welfare plan, and Part B, a government-sponsored voluntary individual insurance plan. The Commissioner concludes that this characterization of Part A must determine how benefits received under it are to be treated for purposes of the Tax Code's dependency support test, and that as social insurance or welfare receipts under the authority of Lutter v. Commissioner, supra, Donner v. Commissioner, supra, Carter v. Commissioner, supra, and Rev.Rul. 64-222, supra, the Part A medical benefits must be included in the amount of Mrs. Kavanaugh's total support as support she had contributed herself.

A consideration of the Congressional debates and of pertinent commentary does reveal a generally accepted characterization of Part A of Subchapter XVIII as a compulsory social insurance or welfare plan and of Part B as a voluntary individual insurance plan.11 However, this categorization of Part A for certain purposes does not itself conclusively determine the consequences of benefits paid and received under Part A for the specific purposes of the Tax Code's support test. It appears that the Part A and Part B programs were labelled "social welfare" and "individual insurance" primarily as a result of their respective provisions for compulsory and voluntary financing. These different funding methods in turn reflected the legislators' concern with such policy considerations as the desire to guarantee the participation of those citizens sought to be protected12 and to maintain their dignity and self-respect,13 concern for the fiscal integrity of the Social Security system,14 recognition of the relative ease of actuarially projecting hospital costs as compared to physicians' costs,15 doubts concerning the costs, burdens and fairness of compulsory social insurance-type financing,16 and concern over the possible intrusive effect of government financing on private physician-patient relationships.17 Although the foregoing legislative considerations may disclose a variety of reasons underlying the decision to fund Part A largely by means of payroll taxes and to finance Part B through voluntary premiums, they shed no light at all on the intent of Congress as it relates to the dependency support test consequences of benefits paid under Part A.18

Furthermore, to distinguish between Part A as social welfare and Part B as individual insurance on the ground that a fundamental element of the former is compulsory participation while the latter is characterized by voluntary enrollment is to ignore statutory provisions as well as pragmatic realities. In fact, participation is legally compulsory in neither but practically compelled in each, and each program is dependent at least in part on compulsory tax revenues.

An otherwise eligible individual may decline to accept hospitalization benefits under Part A, 42 U.S.C. § 1395f(a)(1), and may under both parts opt for alternative health insurance protection. 42 U.S.C. § 1395b. Of course, one who foregoes available Part A Basic Medicare benefits is not exempted from the required payment of the hospital insurance tax under §§ 3101(b) and 3111(b) of the Internal Revenue Code, and consequently Basic Medicare benefits are not readily refused.19

The situation is not conceptually different under Part B, where half of the program is funded by otherwise unappropriated federal revenues, 42 U.S.C. § 1395w, which are generated by individuals as general taxpayers whether or not they choose coverage under Part B Supplemental Benefits. It is also clear that the economic pressure on individuals eligible for Part B benefits to enroll in the supplemental program amounts to practical compulsion to do so. Because the Government underwrites half of the participant's costs of Part B, commercial plans providing benefits equivalent to Part B are unavailable at competitive premium costs.20 Consequently, the election of Part B coverage by nearly all eligible individuals was anticipated by Congress,21 is presumed by certain provisions of federal22 and state law,23 and is at present a statistically demonstrable fact.24

Additional aspects of Part A distinguish payments made under it from benefits under social welfare plans. As is the case with other insurance packages, Part A benefits become available as a matter of right only upon the occurrence of the specific medical contingencies set forth in the provisions of the program, 42 U.S.C. § 1395d.25 Unlike benefits paid under OASDI, supra, 42 U.S.C. §§ 401-431; AFDC, supra, 42 U.S.C. §§ 601-644; and various state welfare programs which the Commissioner claims to be analogous to Part A, Basic Medicare benefits are not made unconditionally available to the beneficiary, but must be applied exclusively against the cost of the specified contingencies.

Practical Effect of Part A Benefits on Recipient's Total Support

As indicated above, the provisions of Part A make up a hybrid form of medical insurance, for they contain elements similar to those distinguishing private, individual insurance regular and periodic payments for specified protection against risk of loss due to specified contingencies; the spreading of the payments against that risk over time and over a pool of participants; the actuarially calculated self-sufficiency of the disbursing fund as well as elements unlike private insurance compulsory financing through specially earmarked taxes; the non-deductibility of those payments; and Government sponsorship of the funding. Of all these component parts of Part A, the feature we find most significant in determining the § 152(a) support test consequences of the receipt of Part A benefits is the regular payment by a participant for financial protection against risk of loss, for this classic characteristic of insurance is the essential element of the Part A program which bears most directly on the existing economic relationship between the recipient of the benefits and other sources of support.

In any insurance system providing protection against unexpected medical expenses, the cost of that protection to a participant is plainly measured by the payments made to obtain it. These payments consist of the premiums paid by the policyholder in the case of private individual insurance, and the payroll taxes paid under Part A in the case of Medicare coverage. Although for any particular participant the risk of the events insured against occurring in a given year is generally unpredictable, the amount of the payments required to fund the insurance program is actuarially determined by spreading the risk of loss over a wide number of participants and, for each participant, over a number of years. Thus, while amounts paid out on behalf of any individual as insurance proceeds are likely to fluctuate widely from year to year, the annual payments made to obtain the insurance coverage are readily calculable and constitute the cost for any given year of the medical care thus insured against. In this respect Part A of Medicare is identical to private health insurance policies.

As a consequence, the economic relationship between an insurance beneficiary and one who regularly contributes to his support, if it is to be a planned and rational relationship, will reasonably include the routine cost of maintaining medical insurance coverage for the beneficiary as the budgeted "support" cost for his medical expenses, regardless of whether that cost takes the form of private insurance premiums, voluntary Part A premiums, or compulsory Part A taxes. Recognition of this condition appears to be the implicit rationale of the authorities holding private health insurance proceeds not to be includible as support for purposes of § 152(a) of the Code and permitting the deduction of health insurance premiums as medical expenses. See, e. g., Mawhinney v. Commissioner, supra.26 As observed by the Tax Court below, 64 T.C. at 730 n. 1 (concurring opinion of Wilbur, J.):