Health Care Insurance and Cost Management - Taxation of Premiums and Benefits

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's total medical expenses exceed 7.5% of their Adjusted Gross Income (AGI) they are deductible as an itemized deduction. If they do not exceed 7.5% of AGI they are not deductible (a person can deduct all or nothing). 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.

Practice Question:
Jack's and his wife's AGI for 2006 was $75,000. They are able to itemize their tax deductions on Schedule A of their 1040. Last year they paid $2,200 in medical insurance premiums and $1,350 in dental insurance premiums. Last year Jack and his wife incurred $9,540 in medical expenses and $2,250 in dental expense. They have a $2,500 deductible on their medical insurance policy and a $1,500 deductible on their dental insurance policy. Both policies pay 100% of the participant's expenses once deductibles are met. How much can Jack and his wife deduct for medical expenses?

A. $15,340
B. $7,550
C. $3,550
D. $1,925
E. $0

Answer: B
They can deduct the total amount they paid in premiums ($2,200+$1,350). They can also deduct the deductibles they paid ($2,500+$1,500). The total of the expenses is $7,550. The total of these expenses exceed 7.5% of their AGI ($75,000*7.5%=$5,625). Since the total of their medical expenses exceeds 7.5% of their AGI they can deduct all of the expenses ($7,550).

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