The rising costs of health care in America and around the world have caused the Obama Administration to pass the Affordable Health Care Act, which requires all taxpayers to carry some form of health insurance in order to guard against high medical bills. Those who fail to do this will pay a penalty equal to one percent of their adjusted gross income (AGI). Fortunately, there is also a tax break for those who pay medical insurance premiums, especially if you are self-employed or have no access to group health coverage of any kind.

W-2 Employees

Employees who are paid a salary or earn hourly wages are allowed to deduct all unreimbursed medical expenses that they have paid out of pocket during the year for themselves, their spouses and their dependents. The range of medical expenses that can be deducted is very comprehensive and includes hospital visits, insurance copays and deductibles, cash payments to any type of medical professional for almost any type of treatment (including alternative and nontraditional treatments), prescriptions and many over-the-counter items such as vitamins and supplements. This list includes premiums paid for medical, dental, vision and long-term care insurance that are not paid by an employer or other party. However, you cannot deduct premiums paid for any type of short or long-term disability insurance. (For more, see: Cutting Your Cost for Marketplace Health Insurance.)

If you have qualifying medical expenses, add them up and put them on Line 1 of Schedule A of your 1040. If the sum total of all of your premiums paid and other unreimbursed expenses exceeds 10% of your adjusted gross income, then you can deduct the amount that exceeds that number as an itemized deduction. If you are age 65 or older, then the AGI threshold is only 7.5%.

But you have to be able to itemize deductions in order to take any type of deduction for medical expenses. In some cases, those who have enormous medical bills incur enough unreimbursed expenses to qualify for itemization from this category of expenses alone, but this is not common.

Example 1

Joe’s AGI for 2015 is $65,000 of W-2 wages. He crashes his car and incurs $4,000 of medical bills. He also pays $2,800 a year for his health insurance because his employer has no health plan. His total eligible expenses come to $6,800 a year. Joe can deduct a whopping total of $300 on his tax return for all of his unreimbursed expenses, because that’s the amount that exceeds 10% of his AGI (65,000 x 10% = $6,500). And Joe will not even be able to deduct that amount if he is unable to itemize deductions. (For more, see: An Overview of Itemized Deductions.)

Example 2

Frank and Betty are both 68 years old and retired. Betty becomes unable to perform three activities of daily living (ADLs) and is moved into a nursing home. The only health insurance that the couple is paying for is Medicare, and their premiums are deducted from their monthly Social Security check. Frank and Betty pay out $45,000 for nursing home expenses for the year. Their combined AGI from their Social Security, pension income, retirement plan distributions and Frank’s part-time job at a hobby store comes to $110,000.

In this case, the nursing home expenses combined with the Medicare premiums will not only far exceed the 7.5% threshold ($110,000 x 7.5% = $8,250) but will also exceed their standard deduction for 2015 for married taxpayers who file jointly. They will be able to itemize deductions as a result of this expense and can therefore also deduct any real estate tax, personal property tax, home mortgage interest and qualified charitable contributions that they paid during the year.

As you can see, it is rather difficult to accumulate enough expenses to incur an amount that can actually reduce your income tax. And those who are 65 and over only get the lower 7.5% AGI threshold through 2016, and then will have the same 10% threshold as everyone else in future years. Those who are struggling with this dilemma may be able to aggregate deductions by waiting until January to pay for certain expenses that would normally be incurred between Thanksgiving and the end of the year. The additional amount may be enough to clear the threshold in some cases.

Another idea is to simply pay to have a medical procedure done that you have been putting off if you incur other medical expenses that year. For example, Joe in example 1 could then pay to have Lasik eye surgery before the end of the year, and all out-of-pocket expenses he incurs for that would be deductible (assuming he is able to itemize). (For more, see: What Is the Difference Between Gross Income and Taxable Income?)

If You are Self-Employed

The tax rules are more forgiving for taxpayers who are self-employed when it comes to medical insurance deductions. Those who file Schedule C for income and expenses related to self-employment income can deduct the cost of premiums paid for medical, dental and long-term care insurance for themselves, their spouses and children or other dependents on Schedule C. These deductions are classified as deductions for AGI, or above-the-line deductions. This means that you do not have to itemize deductions for this expense. But as with W-2 income taxpayers, life and disability premiums are not deductible. These rules also apply to those who worked in partnerships and reported earned income on Form K-1. (For more, see: Overlooked Tax Deductions.)

The Bottom Line

The rules for deducting medical insurance premiums are rather unforgiving for those who earn W-2 income. Those in this category are only allowed to lump the cost of unreimbursed premiums that are paid in with all other unreimbursed medical expenses for the year. Those who are close to the threshold may want to consider the strategies mentioned here in order to obtain a deduction. Self-employed taxpayers can take an above-the line deduction for the cost of their medical premiums and do not need to itemize. For more information on how to deduct your medical insurance premiums, consult IRS Publication 502 at www.irs.gov or consult your financial or tax advisor. (For more, see: New Taxes Under the Affordable Care Act.)

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