Deducting Medical Expenses

By Jennifer M. Gangloff

When you have health problems, medical expenses can quickly add up, even with insurance.

For some people, though, federal tax law offers a way to recoup some of your costs through deductions that will reduce your taxes. As with any tax issue, figuring out if you’re eligible and what expenses you can deduct is often tricky. For medical expenses, what and how much you can deduct hinges on such things as your employment situation, the type of insurance you have, your filing status, whose expenses you’re deducting, what the expenses are for, and the ages of you and your dependents, to name a few.

In any case, there are two basic criteria you must meet in order to deduct your medical expenses:

• You must itemize your deductions on your tax return (on Schedule A, Form 1040).
• Your unreimbursed medical expenses must exceed 7.5 percent of your adjusted gross income (AGI).

AGI, in general, is your taxable income from all sources, such as wages, alimony and capital gains, minus adjustments – specific deductions, such as student loan interest, some self-employment taxes and moving expenses. Unreimbursed medical expenses are those that aren’t paid for by an insurance company or other sources or through a flexible spending account.

Let’s say your AGI is $50,000 and you had $5,000 in unreimbursed medical expenses in 2003. How much could you deduct on your taxes? Multiply your AGI by 7.5 percent ($50,000 x 0.075), and you get $3,750. Remember, only expenses above that floor are deductible. So, you must further subtract $3,750 from $5,000, for a total of $1,250. And since this is a deduction and not a dollar-for-dollar tax credit, you must further multiply the deduction by your highest marginal tax rate to figure the value of your deduction. If you were in the 25 percent tax bracket, for instance, your tax bill would be reduced by about $313 ($1,250 x 0.25).

Even if your expenses are more than 7.5 percent of your AGI, itemizing may not be appropriate. Itemizing only pays off if all of your qualifying expenses total more than what you would get with the standard deduction.

Figuring out if you can deduct your medical expenses and if doing so will pay off can be a daunting process, notes Jackie Perlman, senior tax research coordinator for H&R Block in Kansas City. Today’s tax software can do much of the work for you, she says, but bear in mind that it can’t necessarily determine if a particular medical expense is allowable under the law. Reading tax form instructions can help you understand definitions and various legal criteria, as can filling out practice IRS worksheets or running scenarios through online tax calculators.

But if you don’t have the energy or inclination to sift through the nuances of tax law yourself, consult a qualified tax professional, Perlman suggests.

Just what medical expenses can you deduct? In general, tax law defines qualified medical expenses as any costs you pay for the “diagnosis, cure, mitigation, treatment or prevention of disease, or treatment affecting any structure or function of the body.” Examples include payments to doctors and hospitals, your portion of health insurance premiums, dental expenses, travel for treatment and prescription medications, among numerous others.

You can deduct such medical expenses for yourself, your spouse and your dependents, and certain other people. Again, you may need to consult the IRS or a tax professional for individual advice.

If you haven’t given much thought yet this year to your potential medical deductions, it’s not too late. One strategy some people find helpful is what’s informally known as bunching. With bunching, you bunch together medical expenses in a single tax year. This is especially helpful if you’re just shy of meeting the 7.5 percent threshold.

For instance, if you anticipate that you or family members will need new eyeglasses or dental work early next year, or if you’ve been putting off buying a wig or prosthesis, or having reconstructive breast surgery after a mastectomy, consider getting it done and paid for this year if it puts you enough over the 7.5 percent minimum to make itemization worthwhile. If you have outstanding medical bills from previous years, you could also pay them off this year. In general, though, you can’t include medical expenses that you’ve prepaid for services to be provided mainly in the next tax year.

Note that if you bunch your expenses this year, you may miss out next year on qualifying deductions. But the year after that, bunching may again pay off, creating an every-other-year itemization cycle. And certainly, if paying all these expenses now will put you in a financial bind or add to your debt load, don’t risk it.

Also, if you didn’t claim an expense that would have been deductible in a previous tax year, you can, within certain time limits, file Form 1040X, which is an amended tax return. Don’t claim the expense in the current year.

“There are a lot of twists and turns in taxes,” Perlman says. “So much of what you can do depends on individual circumstances. If you ’re not sure, ask for help.”