Cafeteria Benefit Programs and the IRS

QUESTION: I understand that my employer’s cafeteria plan can be used rather broadly to cover medical bills. I know that this includes doctors and dentists, premiums for medical insurance, prescriptions and so forth. But can it be used for medical items that do not qualify for itemized deductions on federal income taxes, such as health club dues, massage and non-prescription drugs? If not, what other unusual items might be covered? P. H.

ANSWER: First, let’s explain what we’re talking about. Cafeteria-style benefit plans allow workers to choose the exact coverage they want, not a pre-selected assortment. As a result, they are growing in popularity because workers can tailor their benefits to fit their personal needs. However, because employers deduct the cost of these plans as business expenses on their corporate tax returns, the menu selection is still very much controlled by what the Internal Revenue Service and the Congress consider qualified deductions.

In general, our experts say, cafeteria benefit programs will not cover costs that do not otherwise qualify as itemized medical expenses under IRS guidelines. This means that health club dues, massages and non-prescription drugs are out.

As you might suspect, there have been some attempts to pass off some extremely novel items as “medically related” expenses. A list of these compiled from IRS case rulings includes: toothpaste; bottled water; maternity clothes; Scientology fees; costs of divorces recommended by psychiatrists; costs of hotel rooms used for sex therapy recommended by a physician; costs of trips designed to boost morale, even if the vacation is recommended by a physician; dance lessons, even if they are recommended as physical or mental therapy, and veterinary fees for pets, which, of course, are not dependents.

What “unusual” items are allowed? One survey shows that the IRS in the past has allowed deductions for: Christian Science practitioners; abdominal supports; orthopedic shoes; acupuncture; cosmetic surgery; vasectomies; whirlpool baths; elastic hosiery; hair transplant operations, and remedial reading lessons for dyslexic children.

What ‘Ex-Dividend’ Means for Stock Buyers

Q: I understand that dividends are the amounts some companies pay their shareholders every quarter. But what does it mean when a company goes “ex-dividend”? --B. B.

A: Technically speaking, “ex-dividend” is a term that refers to a period of time during which the next dividend is not payable to those who buy the stock. Here’s how it works:

Let’s say that company ABC pays dividends for the quarter ending March 31 to shareholders of record on March 10. This means that for the period between March 10 and the payment date of March 31, the shares are “without a dividend” or “ex-dividend” for that one quarter to those investors who buy the shares in that time interval.

On the other hand, investors selling shares during the ex-dividend interval are still entitled to the March 31 quarter’s dividend because they were the owners of record on the date of reckoning. Practically speaking, shares actually turn ex-dividend a few days before the official shareholder of record date because of the time it takes for trades to clear by the official date. The number of days varies by stock exchange.

Stockbrokers and investors often like to buy just before an ex-dividend date to capture an additional payment. For example, if you buy shares the day before an ex-dividend day and hold them for a year and one day, you should qualify for five dividend payments, not the four that holding shares for a year usually permits.

However, you should know that shares typically increase in price as the ex-dividend date approaches, in part because investors are shopping for extra payments. Sometimes the increase in the share price is greater than the extra dividend is worth, so be careful. A stockbroker we know says he likes to start his ex-dividend shopping three weeks before the actual ex-dividend date just to avoid the run-up.

Shrinking Shares Not Necessarily a Loss

Q: In July, 1985, I invested in a real estate investment firm. Three years later, the firm was taken over by another company in an even stock swap. But one year later, the company was merged with yet another company in a deal that gave investors 0.9 of a share in the new company for every share they had of the old. Now, my original 500-share investment is 450 shares.

May I show this as a loss on my taxes by calculating the difference between the value of the new shares and the tax base of the old shares? May I report the loss and still keep my new shares? How should I report this on the tax form? --M. L. N.

A: Relax and put your pencil down. You have no loss to report because you haven’t lost anything. Yet.

You still own your stock. Although these shares in the newest company might not be worth as much as you paid for the shares of the original company and although you don’t have as many shares as you once had, there is no loss to report to the IRS until you actually sell your investment and tally up the results. Who knows, by the time you sell, your investment could be worth more than it originally was.

By the way, when you do sell the shares, you can figure your gain or loss by subtracting the cost of the original 500 shares from your net proceeds from the sale. Until then, you can only hope and pray that this real estate company starts improving its performance.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.