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Medical Expense Deduction Legal Tax Angles: How to Save Taxes Without Going to Jail Employees can get a 100% "deduction" of all their medical and dental expenses if their employer provides a generous form of group medical policy or if the employer has arranged for employees to participate in a cafeteria plan or medical reimbursement plan. Technically, it's not really a "deduction" because it is never reported as income. In effect it's part of the employees' total compensation but is not taxable as income. This generous form of payment for medical costs, combined with the Medicare program has been one of the main reasons why medical costs have escalated so far. But that situation is changing. Medical and dental insurance rates have been increasing steadily and are expected to continue to increase faster than the rate of inflation. Employers are adopting a number of cost sharing arrangements with employees - such as making the employee pay for most or even all of the cost of coverage for a spouse and part of the cost for children. Many employers are using more temporary help and are out-sourcing work to India or the far east for cost savings. It's just harder to get a job that provides generous medical and dental expense coverage. Meanwhile, the government makes it difficult for low to middle income taxpayers to get any tax benefit from their medical and dental costs. The itemized deduction for medical costs is limited to the excess over 7.5% of a taxpayer's adjusted gross income. For an employee, that's basically the amount of gross salary. If a working couple makes $40,000 in wages (and has no other income and no deductions from gross income), the first $3,000 of medical costs or insurance are not deductible at all. The most cost-effective solution for those without employer paid medical insurance is to purchase major medical coverage -- which excludes reimbursements for routine and minor (meaning not catastrophic) expenses. As a practical matter, these expenses are not deductible -- unless the taxpayer is eligible for the Archer MSA program. The Archer Medical Savings Account (MSA) is a little known tax break somewhat like an Individual Retirement Plan but it's only available for medical costs. If a taxpayer has a major medical insurance policy with an exclusion of at least $1,700 (in 2003) for individuals and $3,350 for families, individuals can deduct 65% of the amount contributed to an MSA and families can deduct 75%. The money in the MSA can then be used for medical expenses that are not covered by the major medical policy. For more information about the MSA, see http://askmerrill.ml.com/product_details/1,2270,56,00.html Special Deductions for the Self Employed If you are self employed and are making a profit, the tax law allows you to deduct up to 70% (in 2002) of your health insurance premiums. (It is to increase to 100% in 2003.) That’s an above the line deduction and is not reduced by 7.5% of your adjusted gross income. However, it’s not a business expense that can be used to reduce your self employment income and S.E. taxes. It’s not necessary to provide health insurance to any employees in order to get this deduction. Any medical or dental expenses not covered by your insurance policy is treated as an itemized deduction and is first reduced by 7.5% of your adjusted gross income. The law therefore encourages self employed individuals to get comprehensive medical insurance - which is usually more costly than major medical plus the cost of routine medical care. There are two ways that a self employed person can establish a medical expense reimbursement plan that will make all of their family medical costs deductible. And, this type of plan is more economical because it will permit the purchase of economical major medical insurance combined with the direct payment of routine medical costs and checkups. But there is a catch that must be overcome. This type of plan is only available to employees. The owner of an unincorporated business is not an employee and isn’t eligible for this kind of employee benefit. To become an employee of your own business, you have to incorporate the business. Another alternative is available to those who have a spouse who is working in the family business. First, for those who own a corporation or have a spouse who is actively involved in their business, a medical reimbursement plan can be established for all employees - including the spouse. The plan can exclude (1) part time employees, (2) seasonal employees, (3) employees who have worked for the company for less than three years and (4) employees under 25 years of age. Otherwise, benefits must be available to 80% of eligible employees. Even so, if an unincorporated business only has one employee (the spouse of the owner), that employee can be covered. And ... the covered benefits can include benefits for members of the employees’ family - a spouse or children. A formal written plan is strongly recommended even though it’s not an absolute requirement. If the spouse of the owner is not actively involved in the family business, then it will be necessary to operate the business as a taxable (C) corporation. The same eligibility rules will apply to the corporation employees as described above. Where a business has a number of employees who would be eligible for the benefits, it doesn’t make sense to establish the plan just for the benefit of the owners - but it does make sense to establish some kind of medical reimbursement or insurance plan for the employees because it’s hard to get employees to work for you without such a plan. Vern Jacobs Copyright, 2003 |
Books and Services by Vern Jacobs
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