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Professional Judgment
 
Medical and Dental Expenses

Medical and dental expenses not covered by insurance are among the special circumstances explicitly mentioned in Section 479A of the Higher Education Act. Medical expenses, like job loss, are among the most clear-cut examples of special circumstances. If the expenses are clearly medical or dental in nature, and the expenses are clearly documented, then the use of professional judgment is justifiable.

The only circumstance in which a financial aid administrator might fret over the use of professional for medical expenses is when the expenses are not medically necessary, such as elective cosmetic surgery or elective cosmetic dentistry. But even cosmetic surgery and cosmetic dentistry can be medically necessary. Examples include reconstructive surgery (e.g., breast reconstruction after mastectomy, facial reconstruction after a motor vehicle accident, and a nose job to correct a broken nose), surgery required for the psychological well-being of the patient, and procedures that contribute to the health of the patient (e.g., gastric bypass procedures for a morbidly obese patient, vision correction surgery). Abdominoplasty, blepharoplasty and lipoplasty all can have significant health benefits. Composite bonding and labial veneers, although frequently associated with cosmetic dentistry, can also be required to repair chipped or fractured teeth or to compensate for unusual or severe dental wear patterns. As a general rule, cosmetic surgery should be included in an adjustment if it is to correct a deformity related to an injury, illness or congenital abnormality, prevent or treat illness or disease, or to meaningfully promote the proper functioning of the body. Procedures whose primary purpose is to make one look younger or improve one's appearance, such as teeth whitening, should not be included. On the other hand, nothing in the statute excludes elective procedures from "medical and dental expenses", so use of professional judgment is probably acceptable even in purely cosmetic surgery and cosmetic dentistry.

Although one should not use the IRS's threshold on deductability of medical and dental expenses, the IRS's determination of allowable medical and dental expenses represents a reasonable set of guidelines as to which expenses to include in the professional judgment adjustment. The IRS requires expenses to be medically necessary, and that the determination of medical necessity have been made by a qualified medical professional. (This is why the IRS does not allow a deduction for over-the-counter medications.) The IRS restricts medical expenses to "expenses paid for the prevention or alleviation of a physical or mental defect or illness", such as "payments for the diagnosis, cure, mitigation, treatment, or prevention of disease, or treatment affecting any structure or function of the body". Expenses may include expenses for medical, dental or vision care, physical therapy, and psychotherapy. Allowable expenses may include after-tax health insurance premiums, expenses not covered by insurance, including co-pays, deductibles and non-covered expenses, prescription medications, and expenses for durable medical equipment (e.g., eyeglasses, crutches, thermometers, blood pressure meters, glucometers). Herbal remedies, vitamins and over-the-counter medications and holistic health are generally not included.

Detailed IRS guidelines can be found in IRS Publication 502, Medical and Dental Expenses (online, pdf) and are summarized in IRS Tax Topic 502, Medical and Dental Expenses.

The calculation of the adjustment to adjusted gross income (AGI) is straightforward. The adjustment is equal to the total of unreimbursed medical and dental expenses (i.e., deductibles, co-pays, after-tax insurance premiums, and other amounts not covered by insurance) minus the amount of any medical and dental expenses already deducted from AGI (i.e., above the line deductions for health insurance, such as the self-employed health insurance deduction), minus 11% of the income protection allowance. Any reimbursement of the medical and dental expenses, whether by insurance or a below the line tax credit like the Health Coverage Tax Credit, should be subtracted from the adjustment. Note that medical/dental employee benefits are excluded from wages reported in box 1 of the IRS Form W-2 and so are already excluded from AGI. Financial aid administrators should ask the family for an explanation if it fails to account for an insurance reimbursement.

This yields the following formula:

   PJ Adjustment =
         medical/dental expenses 
       - insurance reimbursements
       - self-employed health insurance deduction
       - Health Coverage Tax Credit
       - 11% of the IPA

The justification for this treatment is as follows. The Federal need analysis methodology assesses a portion of the family's discretionary income. To calculate discretionary income, it subtracts various non-discretionary allowances from income, including the Income Protection Allowance (IPA). The IPA is intended to be an allowance for modest living expenses, such as food, clothing, shelter and medical care. As a result, the EFC formula already considers such expenses to a certain extent.

So when reviewing a special circumstance appeal for medical and dental expenses not covered by insurance, financial aid administrators should subtract the portion of IPA attributable to medical care from the medical and dental expenses total before making an adjustment to income in order to prevent "double-dipping". The threshold to subtract for medical and dental expenses is 11% of IPA.

For example, consider a family of 4 with 1 in college which is seeking a professional judgment review for $4,000 in medical and dental expenses not reimbursed by insurance. In 2004-2005 their IPA will be $21,070. The medical care portion of IPA is 11% of $21,070, or $2,317.70. Accordingly, the financial aid administrator should adjust their income by the difference, $4,000 - $2,318, or $1,682. The financial aid administrator does not adjust it by the full amount of medical/dental expenses, since $2,318 of the $4,000 is already addressed by the formula.

Alternately, if the family's medical expenses were only $2,000, no adjustment would be warranted, since their medical expenses fall below the threshold implicit in the IPA figure. The Federal Student Aid Handbook gives an example similar to this one in the discussion of the IPA.

Some of the medical expenses may already have been excluded from AGI. For example, the self-employed health insurance deduction is an above-the-line deduction that is the lower of 70% of the health insurance premiums paid or the self-employment net profit. This deduction reduces AGI by a portion of the family's health insurance premiums. To avoid double-counting the health insurance premiums, the professional judgment adjustment to AGI should be reduced by the amount of this deduction in addition to the reduction for 11% of IPA. Other examples of medical expenses already excluded from AGI include health insurance premiums and medical expenses paid with pre-tax dollars, such as health insurance premiums and pre-tax flexible spending accounts deducted by the employer from the employee's paycheck.

Any change to income for medical and dental expenses should not be accompanied by an adjustment to taxes paid, as the family's tax liability is unchanged. Only when the adjustment to income corresponds to an anticipated reduction in taxable income (i.e., job loss or pay cut) does one make an adjustment to taxes paid. Just because an adjustment has been made to the family's income for financial aid purposes doesn't mean that they get a tax refund from the IRS. (Moreover, many families with high medical expenses are subjected to the Alternative Minimum Tax (AMT). The AMT complicates the process of identifying how a change in taxable income will affect taxes paid. So even for adjustments that relate to changes in taxable income, there might not be any change in taxes paid.)

The professional judgment strategy outlined above is motivated by the way in which the need analysis formula works. A special circumstances review is intended to look at circumstances that were not considered by the formula to the extent that they were not considered by the formula. When a financial aid administrator uses professional judgment, the adjustments are made to the inputs to the formula. The amount of the adjustment should equal the actual financial impact of the unusual circumstance, but only to the extent that the financial impact is not already considered by the formula.

A few financial aid administrators, however, use a threshold based on income. The most common such threshold is the 7.5% of AGI threshold used by the IRS for itemizing medical expenses on Schedule A. This practice is completely arbitrary and has absolutely no relevance to the need analysis methodology or any philosophy of need analysis. Federal need analysis is based on ability to pay, not taxable income. Professional judgment adjustments should relate to the expenses associated with the special circumstance, not arbitrary thresholds. Using a percentage of AGI would define special circumstances as being relative to the family's income, while ignoring the nature of the special circumstances. Fundamentally, the legislative language concerning "special circumstances" does not require that the expense itself be exceptional, but rather that the circumstances be exceptional. Moreover, need analysis is based on available income, not AGI, with all thresholds in the formula being pegged to available income, not AGI. It also does a disservice to the family, since 7.5% of AGI is often much higher than 11% of IPA. (According to the IRS, about one-third of taxpayers itemize expenses, and only six percent of those claim the medical expense deduction. So overall, only 2% of taxpayers claim the medical expense deduction. Parents of college age children are much less likely to itemize, so the percentage of students who would qualify under a 7.5% of AGI threshold is even smaller. Using a 7.5% of AGI threshold would exclude many families faced with serious medical conditions.)

Other thresholds on AGI that have been used by financial aid administrators include 3%, 4%, 7%, and even 11%. The latter is probably a mistaken application of the IPA threshold to AGI. The 7% threshold may be based on the IRS's 7.5% threshold. The 4% threshold is based on the College Board's institutional methodology. The 3% threshold is based on the Uniform Methodology as specified in the Higher Education Amendments of 1986 (P.L. 99-498). This predecessor of the Federal Need Analysis Methodology provided an allowance for medical and dental expenses in excess of 3% of total income. DCL GEN-87-27 indicated that the "allowance is for those unusual, unforseen expenses the family itself would have to pay. Basic medical expenses (including insurance) are covered in a family's Standard Maintenance Allowance". (The Standard Maintenance Allowance is the predecessor of the Income Protection Allowance.)

A few financial aid administrators say that they do not do any medical and dental expense adjustments because the medical expenses are already considered on the income tax return. This treatment is based on an incorrect understanding of income tax returns, as any itemization of medical expenses occurs after the computation of AGI, not before. In other words, medical expenses (with the possible exception of the self-employed health insurance deduction) do not affect AGI, only taxes paid.

Some financial aid administrators argue that since a special circumstance must distinguish the student from among a class of students, the family having above average medical and dental expenses is not necessarily sufficient for an adjustment. They then use the 7.5% of AGI threshold as a way of identifying medical expenses that are unusually high. Although this is a cogent argument, the use of a 7.5% of AGI threshold is arbitrary and fails to consider the family's situation on a case by case basis. Moreover, even if one were to use a percent-of-income threshold to screen for unusual circumstances, reducing the adjustment by 7.5% of AGI shifts need analysis from an assessment of ability to pay into the realm of capricious authoritarianism. If a financial aid administrator feels that a family having merely above average medical and dental expenses is insufficient on its own to justify an adjustment, then perhaps he or she should consider the nature of the expenses, making a decision to allow an adjustment for specific conditions, such as cancer, heart failure and other serious conditions, surgery, life sustaining medications, critical care, and hospitalization. (A few financial aid administrators use reasoning like this to preclude adjustments merely for high health insurance costs. However, to the extent that a family has above-average health insurance costs because of a serious medical condition, the health insurance costs do represent a special circumstances. Additionally, families that do not have the option of participating in a group health insurance plan are faced with much higher premiums than those that do.)

Focusing on whether the medical conditions are unusual as opposed to merely special loses sight of the goal of need analysis, namely to evaluate the family's ability to pay. If a family is faced with above-average medical and dental expenses, it affects their ability to pay for a college education. Medical and dental expenses are usually non-discretionary in nature. Having above-average medical expenses is itself a special condition, regardless of whether the health issues that lead to those expenses are unusual or not. Sometimes the quantity of expenses is a special condition even if the quality is not.

It is likewise not appropriate to refuse to consider a family's special circumstances because the family is middle or upper class. In one case a financial aid administrator refused to consider a family's appeal because the family had an AGI of $90,000. The family had $50,000 in medical bills due to a medical stay after a lapse in health insurance. The financial aid administrator reconsidered after the family demonstrated that the medical bills plus other non-discretionary expenses had caused them to have negative cash flow for the year. Federal need analysis does not establish any fixed cutoffs for aid based on income, but rather considers available income and discretionary net worth when evaluating ability to pay. Individual financial aid programs, such as the Hope Scholarship and Lifetime Learning tax credit, may establish income phaseouts, but need analysis itself does not set any a priori limits.

Some financial aid administrators will only do a professional judgment adjustment if the difference in income is at least $400. The motivation for this is that the verification tolerate is $400 (see 34 CFR 668.59(a)(2)(ii) and 34 CFR 668.59(c)(2)(ii)), and what's good for the gander is good for the goose. But financial aid administrators are not obligated to use the verification tolerance, and there is no guidance indicating that one should use an adjustment tolerance for professional judgment. One should not use an adjustment tolerance for professional judgment, since any change, even a slight one, will help soothe the savage parent. Note that since the contribution from income represents 22% to 47% of adjusted available income, a $400 difference can represent as much as a $188 change in EFC.

A few financial aid administrators will not use the medical and dental expenses from the prior tax year as the basis for an adjustment, but instead will ask the family for an estimate of their expenses during the award year. However, to the extent that the medical conditions during the prior tax year are ongoing, the expenses during the previous year are predictive of the expenses during the award year. This is why health insurance policies have preexisting condition clauses. Moreover, it is common for a family that experienced a big medical expense one year to experience another big but not necessarily related medical expense during the next year. When it rains, it pours.

If the family went into debt to pay for the medical expenses, only the amounts paid by the family during the year (including any debt service payments of interest and principal) should be used as an adjustment to income. The remaining debt should be used as an offset to assets.

In addition to adjusting income to compensate for medical and dental expenses, the financial aid administrator should also consider reducing income to adjust for lower earnings caused by the illness, whether due to lost work or short-term or long-term disability.

Some colleges require all students to have health insurance and to pay a student health fee. It is a common practice for such colleges to include the mandatory health insurance and student health fees in the cost of attendance. If the school allows the student to waive out of the school's health insurance program (i.e., because the student is covered under a parent's health insurance plan), the health insurance fees should not be included in that student's cost of attendance. If such a school is conducting a professional judgment review for medical expenses for such a student, the amount of any health insurance and student health fees already included in cost of attendance should be excluded from the adjustment to AGI, in order to prevent double-dipping.

Documentation should include a summary of the expenses (breaking out the expenses associated with each condition if there is more than one major medical condition) and copies of any large bills. If the family itemized medical expenses on their income tax return, a copy of Schedule A can serve as documentation.

If the financial aid office receives medical information as part of a professional judgment review for medical expenses, they should probably get the family to sign a HIPAA release form.

 

 
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