How to handle upfront payments for ongoing year-straddling services?

Question

[Note to mods: sorry if this is a repeat, but I can't find any evidence this post ever made it out to the world.]

How does a cash-basis taxpayer handle an upfront payment for ongoing services that straddle the year-end boundary?

I can give two actual, non-hypothetical examples.

First example is ours. The after-school program my child is enrolled in required a non-refundable upfront payment in full. Having made the payment, my child gets to go to the after-school program for the designated days for the entire school year, which runs from September

2015 to June 2016. If we withdraw him we do *not* get any money back.

So how do I fill out the child dependent tax credit stuff? Do I claim the full amount (subject to the limits) in 2015? Am I supposed to prorate and claim only the part attributable to 2015 services rendered? (And if so, what happens the remainder? Claimed in 2016 or lost?) Would the answer change if the "unused" part of the payment is refundable on withdrawal? Similar questions for submitting this for reimbursement to a dependent care FSA.

Second example is a pregnant acquaintance. She does not have health insurance and so signed a contract in 2015 with an obstetrician where she paid $X in full up front in return for ongoing prenatal care and handling the birth (which will be in 2016). So what can she claim as a

2015 Sched A medical deduction? And does the refundability (or lack thereof) of the payment make any difference to the answer?

Thanks.

Alan · Accepted Answer

When you made the payment you created an asset..... the right to send your child to an after-school program. This is governed by the Section

263 regulations that deal with prepaying expenses that extend substantially beyond the current tax year. The rule uses the earlier of 12 months from the date you obtained the right or benefit or the end of the tax year after the tax year where the money was paid. So... in your case, in looks like the time period is such that you are not required to capitalize the amount paid and you can treat the whole payment as being made in 2015 for purposes of Form 2441.

As to the FSA.... you need to read the plan document and see what it says about prepayments. I'm guessing that the payment would be allowed for 2015. Don't forget you can not double dip..... i.e., use any amount reimbursed by the plan to obtain a tax credit.

Assuming the doctor has not registered with the State Insurance Commissioner to sell health insurance... we do not have a deductible health insurance premium. Therefore, I give you the same answer as above. As it does not take 12 months to have a child, the time period of the benefit will not extend beyond 12 months from the time the right to care was received. The amount is deductible in the year paid.

Both answers above assume that the taxpayer makes use of the benefit. I.e., in case 1 you actually send your child to the after-school program and in case 2, the taxpayer actually receives medical care from the doctor.

Arthur Rubin · Answer

Publication 502, for medical expenses, states:

There is an exception for deposits for lifetime care for a disabled child. I don't think this clarifies the situation, though. I'd say it should be a current expense.

Alan's comment about the section 263 regulations doesn't seem to be on point. Child care expenses are in section 21, and medical expenses are in section 213. Section 263 regulations do not necessarily apply.

Alan · Answer

Don't know why my brain said 263... it's section 461.  There have been  rulings interpreting the words substantially beyond the current tax year  to mean no more than a 12 month period after payment.

How to handle upfront payments for ongoing year-straddling services?

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