How Does the Medical Expense Deduction Work?

For anyone who lacks comprehensive medical insurance, a serious injury or illness can become a serious financial burden. For those who qualify, the federal income tax medical expense deduction can be an important source of savings during such challenging times. But the deduction has important limits.

The limits and qualifications of the medical expense deduction

For the 2020 tax year a taxpayer is permitted to claim all qualified and unreimbursed medical expenses that in the aggregate exceed 7.5% of their adjusted gross income, or AGI. In simplified terms, a taxpayer’s AGI is calculated by subtracting certain deductions and expenses from the taxpayer’s taxable income for the year. Among other things, a taxpayer’s AGI is used to determine how much income tax he or she owes.

For most taxpayers, 7.5% of AGI is a high enough threshold that in a year of good health, a typical taxpayer is relatively unlikely to qualify for the medical expense deduction even if a few otherwise qualifying expenses are incurred.

The scope of the medical expense deduction is quite broad, but it has important limitations:

  • Expenses that qualify for the deduction include:
    • Cost of treatment, including visits to doctors and surgeries.
    • Preventative care.
    • Specialist care, such as dental, vision, and psychiatry.
    • Prescription drugs and peripherals, such as hearing aids, glasses, or prosthetics.
    • Travel expenses related to medical care, including mileage, parking, and airline tickets.
  • Expenses that generally do not qualify for the deduction include:
    • Costs of elective procedures, like cosmetic surgery to enhance appearance.
    • Most over-the-counter medications and other health products.
    • Costs that are reimbursed by insurance or other means.

Reporting medical expenses to the IRS

To claim the medical expense deduction, a taxpayer must itemize deductions. Generally speaking, a taxpayer only itemizes deductions if their sum will be greater than the applicable standard deduction amount.

The Tax Cuts and Jobs Act of 2017 (TCJA) dramatically increased standard deduction amounts in part to reduce the number of deductions claimed in returns. In 2020 the standard deduction is $12,400 for individuals and $24,800 for married couples filing jointly.

The standard deduction essentially serves as a second threshold for determining whether claiming the medical expense deduction makes sense. If the taxpayer’s total deductions, including qualified medical expenses, will not exceed the standard deduction, simply taking the standard deduction is the better choice.

If claiming the medical expense deduction makes sense, the taxpayer will need to gather evidence of all the expenses that go into the aggregate figure. Receipts, invoices, mileage records, and other paperwork should be kept for at least three years. The evidence will be important in the event of an IRS audit.

Other health care tax strategies

The medical expense deduction is an important tax tool for individuals and families with high health care costs, but its thresholds limit its utility for many taxpayers. The tax code provides a few other ways to lower the financial impact of medical expenses, including health savings accounts and deductions for employer-provided insurance:

  • Health savings accounts. Contributions to a health savings account (HSA) are made on a pre-tax basis, which means they are not subject to income or employment taxes. Funds in an HAS can be used to pay for insurance premiums, deductibles, and qualified medical costs. To contribute to an HSA an individual must have a high deductible health insurance plan, which in 2020 must have a minimum deductible of $1,400 for individuals or $2,800 for a family.

In 2020, qualified individuals can contribute up to $3,550 for individual coverage or $7,100 for family coverage into an HSA.

  • Buying insurance through a family-owned business. Sole proprietors and other owners of small businesses can treat 100% of the premiums they pay to insure themselves, their spouses, and their dependents as business expenses.

Although premiums can be claimed as a business expense, individual expenses such as deductibles and medical bills cannot. Some business owners will benefit from insuring their family through their business while also setting up an individual HSA at the same time, ensuring that those individual expenses can be paid with pre-tax dollars.

Ferguson Timar is here to answer your questions

Families dealing with high medical costs need a partner to ensure their expenses are turned into an optimal tax deduction. At Ferguson Timar we are committed to providing every client with advice tailored to the client’s unique circumstances.

Are you contending with high medical bills and interested in knowing more about the medical expense deduction? Give Ferguson Timar a call today at (714) 204-0100 or send us an email to schedule an appointment with one of our tax professionals.