Can An ERISA Lien Be Tax Deductable?

Question
Can a client claim ERISA lien payment (reimbursement for medical expenses) for medical deduction?

Answer
That is a great question, but the answer is likely "no". The answer can be found by looking at both the income taxation of settlement rules under IRC §104(a)(2), and the medical expense deduction rules under IRC §213. Typically, a medical expense when paid can be deducted if the taxpayer itemizes on Schedule A. Those expenses are still subject to a 7% cap against adjusted gross income. But, where funds are received for a settlement, those funds are excluded from taxation. However, where a taxpayer claims a deduction for medical expenses, and later settles, the amount of the medical expenses deducted becomes taxable in the year of settlement. For example, if a taxpayer settles a case in 2010 and receives a lump sum of $100,000 as part of a personal injury settlement, but paid out of pocket $3,000 in medical expenses, which were deducted in 2008, the taxpayer would recognize $3,000 in gross income from the settlement. This is to ensure that a medical expense deduction against income is not taken when funds are received as part of a settlement and the taxpayer did not have to pay for his/her medical expenses out-of-pocket, or the taxpayer was reimbursed (such as from settlement proceeds).

The technical question that remains is whether the adjustment under IRC §104(a)(2), referencing IRC §213(d) is intended to only work retrospectively. There may be an argument, for example, that funds set aside for a Medicare set aside are deductible, as they represent payments actually made for medicals post-settlement. But there are equal arguments against that treatment.

So if an ERISA plan pays for medical expenses that would not be deductible in the first place, because the taxpayer did not make those payments. When a taxpayer reimburses the plan with dollars from a settlement, those dollars would remain tax-exempt through operation of the Tax Code. But I do not believe the reimbursement of those expenses would permit the taxpayer to take an income tax deduction (as an itemized deduction) because the source of funds is from a third party (and not the taxpayer).

Sylvius von Saucken, Esq.