Health insurance premiums and medical expenses are tax deductible only if you pay for them out-of-pocket. Furthermore, your financial situation, along with where you receive health insurance from, will play a large part in determining if the costs will be eligible for tax deductions.
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For example, if you are self-employed, your allowable tax deductions would differ from someone who receives medical coverage through a group employer-sponsored plan. When submitting a filing for tax deductions, the IRS allows you to select a standard deduction or itemize your medical expenses. The option you choose will depend on how many medical expenses you have incurred during the past year.
Are Health Insurance Premiums Deductible on Federal Taxes?
Health insurance premiums are deductible on federal taxes, as these monthly payments for coverage are classified as a medical expense. The general rule is that if you pay for medical insurance with out-of-pocket money, then you would be allowed to deduct the amount from your taxes.
For example, you would be able to take a tax deduction if you bought a federal marketplace health insurance plan and did not receive premium subsidies. Since the premiums for this Obamacare policy would be paid out-of-pocket, you could deduct the expenses while filing your taxes. If you did receive premium subsidies, then only the portion that you pay yourself would be allowed to be deducted. Below, we have identified some of the typical sources where you may get your health insurance from and if there are tax deductions available.
Health Insurance Source
Would Health Insurance Be Deductible?
|Employer-Sponsored||Premiums for company health insurance are not tax deductible. Employers take out premium payments from your payroll on a pre-tax basis. Therefore, your employee contributions are already taking advantage of the tax-savings and would not be allowed to further deduct these costs. Similarly, health savings account (HSA) contributions are paid on a pre-tax basis and would not be tax deductible.|
|COBRA Insurance||COBRA insurance is a health plan that allows you to continue employer-sponsored insurance coverage even if you no longer work for that company. Premiums for COBRA insurance are tax deductible, as they are paid entirely by you on an after-tax basis.|
|Marketplace||If you buy medical coverage through an insurance marketplace, then premiums would be tax deductible as a medical expense. It is important to note that if you are eligible to enroll in a spouse's employer's plan and opt out of that coverage, then you would not be able to take the tax deduction.|
|Medicare||Premiums for Medicare Part B, C or D along with Medigap coverage are tax deductible. Medicare part A would not be tax deductible if Social Security pays for the premiums.|
Standard Deduction vs. Itemized
Tax deductions are claimed and filed through your yearly tax return that is sent to the IRS for review. The IRS offers two options for declaring deductions, which include either taking the standard deduction or itemizing your medical expenses. Both will ultimately reduce your adjusted gross income (AGI) and therefore mitigate the amount of taxes that you would pay. AGI is the amount you earn in a given year minus any payments for alimony, student-loan interest and other costs. Recently, the Tax Cuts and Jobs Act has increased the standard deduction amounts along with suspending some of the itemized deductions available to you. For 2020, the standard deduction amounts are:
Standard Deduction Amount
|Head of household||$18,650|
|Married filing jointly||$24,800|
|Married filing separately||$12,400|
As shown above, depending on your situation, the standard deduction is a flat-dollar reduction of your AGI. When you take this deduction, you are essentially opting out of itemizing deductions. The biggest benefit to the standard deduction is that it makes the tax-prep process much simpler. For example, if you are single, have an AGI of $70,000 and decide to take the standard deduction, then your taxable income would be $57,600.
For 2020, taxpayers who decide to itemize can only deduct allowable medical expenses that exceed 7.5% of their AGI. For example, if you had an AGI of $100,000 and health insurance premiums of $7,000, you would not be able to deduct because the premiums did not exceed 7.5% of your net AGI ($100,000 x 7.5% = $7,500 threshold). But suppose you had another $2,000 in medical expenses along with your $7,000 in health insurance premiums. This would be a total of $9,000, which would exceed the $7,500 IRS threshold based off of your AGI. Therefore, you would be able to claim a $1,500 deduction on your tax return.
Self-Employed Health Insurance Deduction
If you are self-employed, then your allowable medical expense threshold decreases to 7.5%. In this case, if your AGI was $100,000, then you would be able to deduct any medical expenses that exceeded $7,500.
Independent contractors also are able to receive the self-employed health insurance deduction. This allows any health insurance premiums to directly reduce a self-employed person's AGI. For example, if you are self-employed, have an AGI of $100,000 and pay premiums of $5,000, then those premiums would immediately reduce your AGI to $95,000. This is different from the allowable medical expense threshold, because your premiums would instead directly affect your AGI and not need to be added with other expenses that you incurred.
Do I Take the Standard Deduction or Itemize My Expenses?
The decision to take the standard deduction or to itemize will ultimately be decided upon your own financial situation. Furthermore, choosing one or the other is not permanent, and you are able to change every year when you file your taxes. To determine what would work best for you, we suggest looking at the Schedule A 1040 Form. Here you can add up your itemized expenses and then compare that number with the standard deduction that would apply to you. If your itemized expenses are larger than your standard deduction amount, then you would be able to save money by taking the time to itemize your expenses.
For instance, suppose this year you paid your health insurance premiums and had several costly medical expenses like prescription glasses and medical tests. If your total health care costs pushed you to exceed the normal standard deduction you qualify for, then it would make sense to itemize so that you can get the greatest tax savings.
Other Medical Expenses That Are Tax Deductible
The IRS will let you take a deduction on any medical expenses paid out of your own pocket that were ordered by a doctor or health care professional. For a complete list of acceptable medical expenses, you can visit the IRS.gov website. But, some common expenses include:
- Long-term care
- Dental insurance
- Medical appointments
- Prescription drugs
- Medical tests
- Hearing aids
- Prescription glasses
- Contact lenses
- Birth control
Along with these direct medical expenses, the IRS will also allow you to deduct any travel costs that you may have incurred when going to get medical care. For example, if you have a physical therapy appointment that is one hour from your residence, you could deduct the cost of gas as a medical expense.
What Can I Not Deduct from My Taxes?
Any medical expenses that you are reimbursed for, like copays, would not be allowed to be deducted. As mentioned above, premium tax credits also fall under this category, as these credits allow you to reduce the health insurance costs that you would pay.
In addition, cosmetic expenses or procedures that are not related to your health would not count toward tax deductions. This can include hair transplants or other cosmetic surgeries that are not for the purpose of improving some underlying medical condition. Finally, you would not be able to deduct expenses for non-prescription drugs or general health purchases like toothpaste, vitamins or diet foods.
Expert Insights to Help You Make Smarter Financial Decisions
ValuePenguin has curated an exclusive panel of professionals, spanning various areas of expertise, to help dissect difficult subjects and empower you to make smarter financial decisions. Read on for more auto insurance insights.
- In your opinion, which has more perceived value: a partial reimbursement after making a large payment or paying the correct amount upon time of service? Why?
- At what point does itemizing tax deductions become more worthwhile than taking the standard deduction? What tips do you have to make itemizing deductions less intimidating?
- Therapy and travel costs associated with medical care are examples of purchases that are eligible for tax deductions. What advice would you give for consumers to better track tax-deductible purchases throughout the year?
- What major life event(s) should warrant Americans using a tax professional as opposed to a DIY tax preparation service?
- What is one piece of advice that Americans should take regarding yearly financial and tax planning when it comes to health care?
The commentary provided by these industry experts represent their viewpoints and opinions alone.
CPA and Accounting Lecturer at the Robert H. Smith School of Business, University of Maryland
In your opinion, which has more perceived value: a partial reimbursement after making a large payment or paying the correct amount upon time of service? Why?
Another way of asking this question is: When do you see a CPA sweat bullets? Answer: When they have to tell a client they owe taxes as opposed to getting a refund.
In my career as a CPA, I have tried many times to explain to clients the concept that overpaying your taxes during the year through withholding taxes or estimated tax payments is not a smart idea economically. After all, and we have all heard this, it is giving the government an interest-free loan. Yet roughly 80% of all tax returns filed every year in the USA are requests for refunds. Even if you argue that the overpayments are due to errors in withholding directions given by employees to their employers, with a couple of extra seconds of effort this could be rectified. Clearly, Americans would rather see a refund rather than having to write a check.
Behavioral economic practitioners will explain this phenomenon as a clear illustration of prospect theory. Humans, by and large, are loss averse when compared to "winning" by a factor of about two to three. To have to owe taxes, even if fairly insignificant, feels multiple times more hurtful when compared to even a small refund.
Refunds are perceived as "winning" at the tax game. To the average taxpayer, the refund says: "See, I won the tax game. I don’t owe as much as the government thinks!" CPAs also get caught up with this "winning" oriented attitude when they proudly tell the client that they are due a refund, as if the CPA’s prowess at preparing returns is the only reason.
However, prospect theory has shown that it is not difficult to educate people to undo the normal tendency to shun losses, i.e., not getting a refund, so vociferously. If that is true, why have I had such a hard time doing similarly with my clients with regards to owing taxes?
Here I believe we have the added hurdle of overcoming not just the "winning" or "losing" money perception, but the perceived foe — in this case, the government. Seems like no one is impervious when it comes to paying the government. Withholding taxes doesn't feel as if one is "paying" the government, as it is money not even seen. It’s deducted before it goes to your pocket, so it doesn't even seem like it belonged to you to begin with. Paying at tax time from the money that you did put in your pocket, that’s a different story.
Withholding taxes first started as a temporary measure during World War II in order to help the government pay for the costly effort. It came with a highly patriotic pitch and was easily endorsed by Americans. Check out Gene Autry’s song "I Paid My Income Tax Today." The government recognized that what was good for the goose was also good for the gander, and withholding taxes easily became permanent. Prospect theory was understood, at least intuitively, even then.
At what point does itemizing tax deductions become more worthwhile than taking the standard deduction? What tips do you have to make itemizing deductions less intimidating?
This is simple mathematics. If your itemized deductions are greater than your standard deduction, you itemize since your taxable income will be lower, and hence, lower taxes. For example, in 2021 the standard deduction for joint tax return filers will be $25,100. How many people will have itemized deductions higher than that amount? Well, not too many. In 2018 only a little more than 10% of all tax returns filed were taking the itemized deduction. This was down from 30% in 2017, reflecting the outgrowth of the Tax Cuts and Jobs Act, which significantly raised the standard deduction.
So, you could simply bet with the odds and take the standard deduction without thinking about it, or you could do a little math exercise, particularly wise to do if you own a home with a mortgage.
Here’s what to do. Take your mortgage interest paid for the year, add your charitable contributions, and then add on $10,000, the highest amount allowed for the state income and real estate tax deduction. If that amount is getting you close to the standard deduction — then it pays to go through the motions of completing Schedule A to see if indeed your itemized deductions will dwarf the standard deduction and help you lower your taxes.
As far as fighting the intimidation of going through the motions of itemizing, you can mentally calculate that for every dollar above the standard deduction your itemized deductions take you, you will save around 20 cents for each of those dollars, as based on the national average effective rate in 2019.
Therapy and travel costs associated with medical care are examples of purchases that are eligible for tax deductions. What advice would you give for consumers to better track tax-deductible purchases throughout the year?
Medical expenses are another category of itemized deductions, but they are not for everybody. No, I am not tax profiling, I am simply alerting you to the fact that the medical expense deduction is limited to only the amount of your out-of-pocket medical costs that exceeds 7.5% of your adjusted gross income. To see the benefit of this deduction, you will need to have either some relatively high medical expenses (not covered by insurance) or lower income to overcome the limitation hurdle.
To keep track of these is not an easy task, as you will have to resort to some degree of recordkeeping. I use one credit card specifically for costs that I think are deductible so that at the end of the year I can classify these by category. For example, I use this card only for charitable contributions, medical costs and fancy luxury items that I know are not deductible but where the dollars squandered feel better when charged to the credit card reserved for tax deductions. You can also download a medical deduction spreadsheet for free from squawkfox.com.
To keep track of the medical travel miles and costs, you can try TripLog, which is reasonably priced and is great for self-employed individuals. Just keep in mind that the deduction per mile for medical travel is 16 cents per mile. It is much better for entrepreneurs at 57.5 cents per mile.
What major life event(s) should warrant Americans using a tax professional as opposed to a DIY tax preparation service?
There are at least two major life events where the letters CPA become very valuable for the purpose of tax preparation: your first home purchase and the first child, whichever comes first. However, don’t expect the CPA’s tax software to outdo whatever your DIY online favorite can do.
Nope, the CPA’s value here at these milestones is long-term tax and financial planning advisory. You will want to hear what the CPA has to say about retirement planning, insurance and estate strategies, amongst others. The CPA is your best quarterback for these very important areas of your financial life.
Of course, opening your own business and entering a stock option plan at work are also immediate invitations to seek a CPA. Both are highly tax-complex transactions and should only be started with the advice of a CPA.
What is one piece of advice that Americans should take regarding yearly financial and tax planning when it comes to health care?
Wow, a loaded question. Trying to pin it down to just one piece of advice seemed daunting at first. But after a little reflection, it was easy — "buy" the risk.
That means buy insurance to have someone else bear the burden of the cost of the "what-if". Buy health insurance, both regular and long-term care, for "what if" you get ill or need long-term rehabilitation.
Buy disability insurance. Your odds of something interfering with your income-producing years are greater than a premature permanent trip to heaven.
Buy catastrophic coverage. I have seen too many families literally torn apart financially speaking when disaster strikes, and the financial burden falls on extended family members. Many of these policies can be had through employment, often in tax-favorable ways, so check with your HR department at work.