Can you Cancel your own debt?

Plus: The lowdown on IULs

Swimming Pool Deduction? 

Our favorite Fintech tax start-up is at it again - this time giving suss advice when it comes to the deductibility of swimming pools for medical purposes.

The first thing to point out is this IS a qualified medical expense that is deductible on your Schedule A - under the right conditions.

In Cherry v. Commissioner, Mr. Cherry was able to successfully defend his pool write-off for the following reasons:

  • The pool was prescribed by his doctor as the best form of exercise to aid with his bronchitis and emphysema.

  • Mr. Cherry actively tried to a community center to swim at that would fit with his work hours, but couldn’t.

  • Mr. Cherry utilized the pool 2x per day for exercise.

  • When Mr. Cherry traveled and was unable to swim, his breathing issues would return after 4-5 days.

  • The pool was rarely used by other family members.

In contrast, in the case of Le Beau v. Commissioner the medical deduction for Mr. Le Beau’s pool was denied since there was no documentation to support the medical necessity for the pool outside of Mr. Le Beau saying his doctor told him to lose weight. The interesting thing about this deduction is that the actual cost to build the pool is not what qualifies as the medical expense, it’s the cost to build the pool MINUS the increase in FMV of the home from the pool. So if you spend $80,000 to build a pool, and the pool adds $30,000 in FMV to your home, the actual deduction is ($80,000-$30,000) $50,000.

Cancel Your Own Debt? 

This is one of the more concerning pieces of advice I see on social media, but basically, people claim you can issue yourself a 1099-C and cancel your own debt.

As with most things - there is partial truth here. A 1099-C is a form you receive if your debt is canceled. However, there are two important things to remember:

  1. The 1099-C is issued by a 3rd party, you can’t self-issue and cancel debt you owe to an outside party.

  2. Any debt canceled on the 1099-C IS CONSIDERED TAXABLE INCOME TO YOU. Got $50,000 of debt canceled? Congrats, that’s now $50,000 of income to you that you’re paying taxes on.

As always - if something sounds too good to be true - it is, folks.

IUL’s are something I like to discuss once proponents often speak about the “tax-free benefits” of them.

In short, you’re able to take a loan against the cash-balance you accumulate in an IUL, and loans are no considered taxable-income. This is similar taking a loan on stocks owned or a HELOC on your home. The problem is for most taxpayers, IUL’s don't make sense even with that tax-advantage because the fees are so high, they’d be better off just investing in traditional accounts and pay tax upon sale or distribution.

In one of the scummiest things I’ve seen this week are life insurance agents claiming that this is a super-savvy tactic used by the wealthy, like UofM football coach Jim Harbaugh. There’s several stark differences that need to be pointed out. Functionally - Jim Harbaugh does not have an IUL, what he has is a setup that’s a type of executive deferred compensation.

For the policy - they loaned him $4M to start, then $2M a year for the following five years. This then allows him to take loans against the cash-value of his policy without incurring income tax. Then, as long as the policy is kept in-force, he won’t have to repay it while he’s alive, and the loan will be repaid to the policy from the death benefit upon his passing.

The key with these types of policies is that they only make sense from a tax-perspective if you can dump a huge amount of money into it early on. The types of policies the IUL scammers pitch are usually to lower-income individuals who can’t add enough cash early on in the policy to accumulate any meaningful cash-value balance they can draw from tax-free in the future.