Medical Expenses Can Be a Valuable Income-Tax Deduction - Brief Article

Healthcare Financial Management, April, 2001 by William G. Kistner

No one wants to pay more income tax than the law requires. When preparing their returns, many taxpayers itemize their tax deductions to reduce their Federal income-tax liability. Maximizing deductions is a good way to reduce the taxes owed to the government. When tracking expenses that can be deducted, taxpayers should consider their medical and dental expenses.

Taxpayers may claim as itemized deductions certain medical and dental expenses for themselves, a spouse, and dependents when filing their Federal income-tax return. They also may deduct medical expenses that they pay for any person whom they could have claimed as a dependent on their return if that person did not receive $2,800 or more of gross income or did not file a joint return. A child of divorced parents is treated as a dependent of both parents when computing medical expenses. However, each parent may deduct only the portion of medical and dental expenses that exceeds 7.5 percent of their adjusted gross income. Medical expenses are not subject to the reduction in itemized deductions for taxpayers with adjusted gross incomes over $128,950 ($64,475 for married persons filing separately).

What to Include

Medical expenses include the costs of related transportation, hospitalization insurance, Medicare supplemental insurance, certain capital expenditures that exceed any increase in property value, and certain expenses incurred by a physically handicapped person for removing structural barriers to accommodate the disability When a medically related capital improvement is made to a home, such as installing an elevator, the person should obtain a written recommendation for the improvement from a physician and a written appraisal from a reliable real estate appraiser or valuation expert. The taxpayer should be prepared to prove to what extent the value of the property was not increased by the cost of the improvement, because only the amount that exceeds the increase in property value is deductible.

A person also may deduct the cost of hearing aids, dentures, eyeglasses, and wages paid for nursing services. The cost of elective cosmetic surgery is not deductible, but cosmetic or plastic surgery to correct a deformity or personal injury or to treat an illness or disease is deductible. Prescription drugs and insulin are the only medications that are considered medical expenses.

Certain medical expenses may qualify for dependent care credit, but may not be used for both benefits. Taxpayers should analyze each benefit on the basis of their marginal tax rate and medical-expense deduction limitation (7.5 percent of adjusted gross income) to determine how best to classify the expense.

When medical care is received far away from home, a person can deduct lodging expenses of up to $50 per night per individual as a medical expense. Lodging can include the expenses for the person seeking treatment and other qualified individuals, such as a parent traveling with a sick child.

Filing

A person may deduct medical expenses only in the year in which they are paid. If medical expenses are charged to a credit card, the person should deduct the expenses in the year the charge is incurred even if the charge is paid in a later year.

A married couple filing separate returns and not living in a community property state each may claim only the medical expenses they actually paid. Any medical expenses paid out of a joint checking account in which the spouses have the same interest are considered to have been paid equally by each spouse unless one can show otherwise.

Because a person may deduct only the portion of medical and dental expenses that exceeds 7.5 percent of adjusted gross income, a married couple should consider filing separate returns whenever the medical expenses of one spouse substantially exceed those of the other spouse. They should figure their taxes jointly and separately before deciding which way to file.

Reimbursements

A person must reduce total medical expenses for the year by the total reimbursements received from insurance, including Medicare, or other sources for medical expenses during the year before applying the 7.5 percent adjusted gross-income limit. If a person deducts medical expenses in one year and then is reimbursed for them in a later year, the person must report the reimbursement as income in the later year. However, the taxpayer should not report more than the amount previously deducted as medical expenses.

In making the calculation, the taxpayer also may exclude the amount of expenses in the previous year that did not reduce the amount of income taxes paid. For example, a person who had a taxable loss in the year of the deduction would not have had a tax benefit from the medical deductions, and any subsequent reimbursement is not considered income. This same rule would apply if the expenses did not produce any benefit in the earlier year because the expenses did not exceed 7.5 percent of one's adjusted gross income in that year.

Medical Savings Accounts

Beginning in 1997 and continuing for four years, self-employed persons and persons employed by small employers who are covered under a high-deductible health plan can deduct contributions to a medical savings account (MSA). Income earned in an MSA is tax-free, as are distributions from an MSA to pay for medical expenses incurred by the account holder.