You can lighten your tax burden if you or a dependent faces a costly health issue. Thinkstock By the editors of Kiplinger's Personal Finance Updated January 2015 Fighting a major illness or injury can be enormously expensive, but you can find some help in the tax law.See Also: Tax Planning for Life's Major Events Although everyone knows medical expenses are deductible, in truth very few taxpayers actually get to deduct them. The catch? You must itemize deductions to write off medical expenses, and only about 25% of taxpayers itemize. And, such costs are deductible only to the extent they exceed 10% of your adjusted gross income (AGI). (The threshold is 7.5% of AGI for taxpayers age 65 or older; on a joint return, if either spouse is 65, the lower threshold applies.) With the 10% threshold, if your AGI is $100,000, the first $10,000 of unreimbursed medical expenses don't count. If you, your spouse or your dependent children are facing a major illness or injury, however, you may well surpass the threshold. If that’s a possibiity, be sure you tote up all your qualifying expenses. HSA and MSA Distributions If you have a health saving account or an Archer Medical Savings Account, withdrawals used to pay qualifying medical expenses are tax-free. Advertisement Flexible Spending Account Generally, employees are allowed to adjust the amount of salary earmarked for a medical reimbursement account only once a year. If during your open-enrollment season you anticipate higher medical bills in the year ahead, consider increasing the amount of money you set aside. Salary diverted into a reimbursement account and then used to pay medical bills escapes both income and Social Security taxes. You can put up to $2,550 a year into a medical flex plan. A $2,550 set-aside that avoids a 25% federal income tax rate and the 7.65% Social Security and Medicare tax would save you more than $800. Any state tax savings would make this an even better deal. In the past, flex plans came with a use-it-or-lose-it proviso. Any funds left unspent at the end of the calendar year (or March 15 of the following year in some cases), was forfeited. Now, companies can (but don’t have to) allow up to $500 of unspent funds to rollover into the next year. Make sure you understand how your company’s plan works. IRA and 401(k) Plan Payouts Although using retirement funds for anything other than retirement is generally discouraged, crushing medical bills could force you to tap your account. If you tap a traditional IRA before age 59½, the 10% penalty that normally applies to payouts before age 59½ is waived to the extent that you have qualifying medical expenses in excess of 10% of AGI (7.5% if you are age 65 or older). The same goes for early withdrawals from 401(k)s, although such withdrawals are difficult to make if you are still on the job. "In service" withdrawals are only allowed if you can meet hardship requirements. If you have left the job in a year in which you were age 55 or older, the 10% penalty doesn't apply regardless of the 10% rule. Even if you avoid the penalty, your IRA or 401(k) withdrawals will be taxed as income. Advertisement Disability Insurance Payments If your condition results in your receiving benefits under a disability insurance policy, the taxability of the income depends on who paid for the policy. If you paid, the benefits are tax-free. If your employer paid for the insurance, the benefits are fully taxable. Damages If you receive a settlement in a lawsuit that includes money for medical expenses you deducted in an earlier year, that amount is considered taxable in the year you receive it . . . but only to the extent that the deduction actually reduced your taxable income for the year you wrote off the expenses. If a settlement includes funds for future medical expenses, the amount is not taxable. Those future medical expenses aren't deductible either, until they exceed the amount of the award allocated to future medical care.