As with any area of risk management, the taxation of benefits and premiums must be considered. Typically, the benefits received under an individually owned medical insurance policy are not considered taxable income.

One of the benefits of owning medical insurance is found on Schedule A of the IRS 1040. If an individual or family's total medical expenses exceed 10% of their Adjusted Gross Income (AGI) – or 7.5% of their AGI if they or their spouse is 65 or older (but only as a temporary exemption through December 31, 2016) – they may deduct only the amount of those total medical expenses that exceed the 10% (or 7.5%) threshold as an itemized deduction. The deductible expenses include premiums for medical, dental and long-term care insurance. Also deductible are the total out-of-pocket expenses associated with the insurance types mentioned above, but only under certain circumstances, which differ for individual policies and policies from employers. Click here to read the IRS rules.

Practice Question:
Jack's and his wife were both younger than 65 in 2014. Their AGI for 2014 was $75,000. They were able to itemize their tax deductions on Schedule A of their 1040. In 2014 they paid $4,200 in medical insurance premiums and $1,350 in dental insurance premiums for individual policies they own. That year Jack and his wife incurred $9,540 in medical expenses and $2,250 in dental expenses. They had a $2,500 deductible on their medical insurance policy and a $1,500 deductible on their dental insurance policy. Both policies paid 100% of the participant's expenses once deductibles are met. How much can Jack and his wife deduct for medical expenses on their 2014 taxes?
A. $17,340
B. $9,550
C. $7,550
D. $2,000
E. $0

Answer: D
In computing what they can deduct, they can add the total amount they paid in premiums ($4,200+$1,350). They can also include the deductibles they paid ($2,500+$1,500). The total of their 2014 expenses is $9,550. The total of these expenses exceeds 10% of their AGI ($75,000 x 10%=$7,500) by $2,000 ($9,500 - $7,500 = $2,000). Thus, $2,000 is the amount they can deduct on their 2014 taxes.

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