If large uninsured medical expenses were accrued, but not paid, before death, the executor must make a potentially important choice about how they’re treated for federal tax purposes.
The executor can choose to deduct accrued (as-yet-unpaid) medical expenses, along with any medical expenses paid before death, on the decedent’s final Form 1040. These medical expenses are deductible to the extent they exceed 10% of AGI for 2019 (up from 7.5% of AGI for 2018), assuming the decedent’s final Form 1040 claims itemized deductions.
To take advantage of this special rule, the accrued medical expenses must be paid out of the decedent’s estate during the one-year period beginning with the day after the date of the decedent’s death.
This special rule is an exception to the general rule that expenses of a cash-basis taxpayer must be paid in cash before they can be deducted. Final medical expenses can easily exceed the percent-of-AGI threshold, especially when death occurs early in the year before much income has been earned.
There’s another option for wealthy individuals with estates above the unified federal estate and gift tax exemption amount: The executor can choose to deduct accrued medical expenses on the decedent’s federal estate tax return, rather than on the decedent’s final 1040.
When federal estate tax is owed, deducting accrued medical expenses on the estate tax return is usually the better option. That’s because the estate tax rate is 40%, while the decedent’s final federal income tax rate could be as low as 10%. Moreover, the full amount of accrued medical expenses can be deducted on the estate tax return (not just the amount that’s over the percent-of-AGI threshold).
Important note: Under the Tax Cuts and Jobs Act (TCJA), the unified federal estate and gift tax exemption is $11.4 million per person for 2019 (up from $11.18 million for 2018). For married couples, the exemption is effectively doubled to $22.8 million for 2019 (up from $22.36 million for 2018). The exemption amounts will be adjusted annually for inflation from 2020 through 2025. In 2026, the exemption is set to return to an inflation-adjusted $5 million, unless Congress extends the more generous exemption.
