With the ever-increasing cost of health insurance and medical care, you should be vigilant in finding ways to claim tax breaks related to health care. Unfortunately, that's now harder than before because a change included in the Affordable Care Act (ACA) increased the income-based threshold for deducting itemized medical expenses.
However, some seniors have been given a one-year reprieve: A lower deduction threshold will apply for 2016 to people who are at least 65 years old as of year end. But the lower threshold is scheduled to expire after 2016. So, it could make sense for seniors to load up on medical expenditures before the end of this year to take advantage of the lower threshold.
Here are the details and some tax-planning guidance to help you make the most of itemized medical expense deductions over the next two years.
Higher Threshold for Medical Expense Deductions
Before 2013, you could claim an itemized deduction for medical expenses paid for you, your spouse and your dependents, to the extent those expenses exceeded 7.5% of your adjusted gross income (AGI). AGI includes all of your taxable income items, and it's reduced by certain write-offs, including those for deductible IRA contributions, alimony payments and student loan interest.
Now, thanks to the ACA, a higher deduction threshold of 10% of AGI applies to most taxpayers. However, if either you or your spouse will be at least 65 as of December 31, 2016, the unfavorable 10%-of-AGI deduction threshold won't affect you until 2017. (For 2016, the longstanding 7.5%-of-AGI deduction threshold still applies for qualifying seniors.)
Consider "Bunching" Medical Expense Deductions in Alternating Years
If you have flexibility about when medical expenses are incurred, try to concentrate them in alternating years. That way, you can claim an itemized medical expense deduction every other year or so — instead of losing the opportunity to claim any deduction for your health care costs.
Suppose you're a 40-year-old single person with an AGI of $65,000 for 2016 and 2017. Your threshold for deducting medical expenses is $6,500 (10% of $65,000) in 2016 and 2017. This year, you pay $9,000 of medical expenses, including an elective surgery, new glasses and contact lenses, and some dental work. Next year you expect to pay only about $2,000.
On your 2016 personal tax return, you can claim an itemized deduction of $2,500 ($9,000 – $6,500). For 2017, you can't claim any itemized deduction for medical expenses.
However, if you had spread the two-year total ($11,000) equally between 2016 and 2017, you couldn't have deducted any medical expenses in either year. The lesson: Deductions for concentrated (or "bunched") expenses in some years are better than no deductions ever.
Alternatively, let's suppose you're a 70-year-old single person with AGI of $65,000 in 2016 and 2017. Your threshold for deducting medical expenses is only $4,875 (7.5% of $65,000) for 2016. In 2017, your threshold increases to 10% of AGI (or $6,500).
As in the previous example, you pay $9,000 of medical expenses in 2016, including an elective surgery, new glasses and contact lenses, and some dental work. Next year you expect to pay only about $2,000.
On your 2016 personal tax return, you can claim an itemized medical expense deduction of $4,125 ($9,000 – $4,875). Next year, the 10%-of-AGI deduction threshold will apply to you, and you won't get any deduction.
If you had spread the two-year total of $11,000 of medical costs evenly over this year and next year, you could deduct $625 this year ($5,500 – $4,875) and nothing next year.
Take Advantage of Your Company's Health Care FSA
Here's another tax-savvy move to consider: Contribute to an employer-provided health care FSA plan. These contributions can be subtracted from your taxable salary, and then you can use the funds to reimburse yourself tax-free to cover qualified medical expenses.
For 2016, the maximum FSA contribution for each employee is capped at $2,550. Next year, the cap may be slightly higher due to an inflation adjustment. If your company has a health care FSA plan, failing to participate is like leaving money on the table. The sign-up period to participate in 2017 is rapidly approaching. (It may be as early as sometime in October for some employers.)
Instead of making contributions to an employer-provided health care FSA, self-employed taxpayers who pay their own medical and dental insurance premiums are generally allowed to deduct those costs "above the line." (In other words, these costs are a deduction for AGI, not from AGI.) This rule is helpful, because you aren't required to itemize to benefit from an above-the-line deduction.
Your tax results can be improved if you plan ahead for medical expenditures (to the extent possible) and take advantage of your employer's health care FSA (if one is offered). But that's where the year-end planning ends for itemized medical expense deductions.
Unfortunately, your only recourse for other out-of-pocket medical expenses (other than health premiums) is to claim an itemized deduction when those costs exceed 10% of AGI — or 7.5% of AGI for 2016 if you qualify for the lower threshold due to your age or your spouse's age. If you have questions or want more information, contact your tax advisor.
IRS-Approved Medical Expenses
Here's an alphabetical list of some commonly encountered costs that count as medical expenses for itemized deduction purposes: