Medical Expenses – Plan Now to Get Maximum Tax Benefit

Medical Expenses – Plan Now to Get Maximum Tax Benefit

By: Martin M. Shenkman, CPA, MBA, JD

Get Your Tax Benefits: Even if you're lucky enough to have great medical insurance coverage, you're still likely to have considerable out-of-pocket costs that insurance won't cover. If you're not so lucky, your unreimbursed medical costs will be even greater. Being able to deduct those unreimbursed expenses will help you financially. This article will guide you to do just that. To get these benefits you need to understand the basic tax rules, some planning steps, and the records you need to keep to be sure you get every deduction you can, and assure you that if you get audited you'll breeze through.

Deducting Medical Expenses Generally: In order to get a tax deduction, your payments for medical or dental bills have to be, according to the IRS, "primarily to alleviate physical or mental defects or illnesses". Payments for your general health, such as vitamins or a vacation are not deductible. Tip: If you're taking supplements to address a specific health condition, have your doctor prescribe them. Then save the prescription in your tax file so you can demonstrate to the IRS that they are not just for general health. This will help support your deduction. You must actually pay the bill in 2007 to deduct it. If you pay by check, it's the date when you mail or deliver the check that determines the year of deduction. For credit cards, it's the date your charge appears on the bill, even if paid in 2008. Tip: Save your cancelled checks and credit card receipts to prove your 2007 deductions.

Insurance Reimbursements: If your insurance company pays for an expense, or reimburses you, in 2007, you cannot deduct the amount paid or reimbursed. You can only deduct the amount you actually paid over the reimbursement.

Home Improvements: You can deduct the cost of special equipment and home improvements if the main purpose is your medical care. These can include: adding an accessible entrance ramp, installing a lift, widening doorways, building handrails, modifying cabinets, etc. Your deduction is limited if the improvements increase the value of your home, or were for personal motives such as aesthetic reasons. Specifically, you cannot deduct your expenditures to the extent of any increase in the value of your home. Example: You spend $10,000 to add a wheel chair ramp to your front porch, and an elevator to your home. Your home was worth $350,000 before and $353,000 after. Your $10,000 expenditure is reduced by $3,000 the increase in your home's value, providing a $7,000 tax deduction. Tip: If you've spent a lot, have your house appraised before and after the improvements. Since improvements to your home to accommodate a disability generally don't increase the value of your home the least costly and safest approach may be to have a local realtor give you a before and after valuation. The cost will be modest compared to a formal appraisal, but far more persuasive than ignoring the issue until you been audited.

Conference Expenses: The cost to attend a medical conference that addresses the concerns of a chronic illness you, a spouse or dependent (e.g., child) has can be deducted. You can deduct the costs of admission and travel, but not meals and lodging.

Medical Expenses - 7.5% Rule: You can only deduct expenses to the extent that they exceed 7.5% of your adjusted gross income (AGI). This is all your taxable income (wages, dividends, interest) less certain adjustments (e.g., alimony). Tip: Estimate what 7.5% of your income is likely to be. If you're likely to be close this year, try to defer medical expenses until 2008 to bunch them up in that year, or accelerate medical expenses you'd otherwise pay in 2008 into 2007. The goal is to bunch medical expenses in years when you can exceed the 7.5% threshold to get the most tax benefit. Example: You earn $45,000 and $5,000 of investment income, for a total of $50,000. You spend $16,000 on medical costs, of which $9,000 is reimbursed by insurance. Your deductible medical expenses are $7,000 [$16,000 - $9,000], but this must be reduced by $3,750 [7.5% x $50,000] to $3,250. If you're in a 30% state and federal tax bracket your tax benefit would be worth about $1,000.

Special Work Related Expenses: There is a valuable exception to the 7.5% limitation (described above) that can provide considerable benefit if you're working. If you have a chronic illness that has progressed to the point that you need to incur extra business expenses ("impairment related expenses" in IRS terminology) to do your work satisfactorily, those costs are deducted as business expenses instead of as medical expenses. This can avoid the 7.5% limitation above that might otherwise prevent you from getting any deduction. If you're self employed these are written-off on Schedule C. If you're an employee you have to fill out a special schedule, Form 2106 "Unreimbursed Employee Business Expenses". While most employee business expenses are reduced by 2% of your adjusted gross income (similar to the reduction for 7.5% of AGI for medical expenses described above), impairment related expenses are not. Example: In order to continue working, you purchase a scooter and hire a part time assistant to move equipment for you because of the progression of your chronic illness (Multiple Sclerosis, Crohn's Disease, Parkinson's, etc.). These costs should be fully deductible under this special rule. Your deduction will not be subject to the 7.5% medical limitation because it would be treated as business expenses. It is not subject to the 2% general limitation on business expenses because it is an "impairment related expense".

Record Keeping: The key to maximizing your tax deductions, making an audit easy, minimizing your time and effort, is proper record keeping. The best approach is to use a computerized checkbook and bookkeeping program, like Quicken. You can easily memorize all your payments, set automatic reminders to pay regular bills, and more. Once the set up is done (and you can have someone help you if you're not familiar with it), a few key strokes will make everything you do routine and easy. Be sure to modify the standard Quicken (or other program) categories to reflect the various medical deduction categories you need (most are discussed in this article). Not only will this eliminate most of the paperwork, it will make it really easy to print out schedules of deductions for your tax return. If you still use a manual check register, use two lines per check entry so you can write a detailed description for each check. You could use a special symbol or color of ink for each tax category to make the year end work easier. Then at year end you'll have to manually write up a summary for each tax deduction category, or have your tax preparer do it. The final step in the process is to coordinate the back up for these schedules. The easiest way to do that is to set up a filing system that matches your computerized (or manual) checkbook. Two approaches: 1) Check number order: Set up a file folder or loose leaf binder and put all your receipts in check number order. Example: You pay a credit card bill that includes a medical deduction. Number the credit card and medical receipts with the check number and put them in the file or binder in check number order. 2) Categories: Set up file folders or a loose leaf binder with tabs for each tax deduction category and put all your receipts in date order (as they come in) in the appropriate folder or behind the appropriate tab.

Filing Your Return: Once you have all your planning done, and your records in place, you'll be ready before April 15, 2008 to file your income tax return. You have to file Form 1040 including Schedule A "Itemized Deductions". The simpler Form 1040A and 1040EZ cannot be used.

Conclusion: Follow these simple steps and you'll maximize your tax deductions. Be cautious, however, there are a myriad of additional rules and complexities. This article has explained some of the general rules and a few of the benefits most likely to be relevant to those living with a health issue, a chronic illness, or other condition. Tip: Hire a tax pro to help, but minimize their time and hence cost by getting all your records in pristine order. Bottom Line: The unfortunate reality is that the tax laws are extraordinarily complex, costly to implement, and once all the limitations and tax rates are considered, unfortunately the tax benefits just don't provide enough help for anyone with a chronic illness or other serious health condition.

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