The Challenge of Deducting Medical Expenses

Some married couples could boost their tax break by filing separate returns.

Rising medical costs seem to be on everyone's mind these days as the battle over health-care-reform legislation moves from Congress to the courts. Although the tax code provides a deduction for some medical costs, only a fraction of taxpayers are able to overcome the steep hurdle to claim it.

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That's because you must itemize your deductions, and you can write off only those out-of-pocket medical and dental expenses that exceed 7.5% of your adjusted gross income. So if your AGI is $50,000, for example, and you have $4,000 in unreimbursed health-care costs, you would be able to claim a skimpy $250 as an itemized deduction on Schedule A.

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However, it makes sense to itemize your deductions only if they exceed the amount of the standard deduction for your filing status. For 2010, the standard deduction is $5,700 if single or married filing separately; $8,400 if a head of household with dependents; or $11,400 if married filing jointly. In addition, you can claim an extra $1,100 deduction for each married taxpayer or spouse who is 65 or older or for taxpayers of any age who are blind. The extra standard deduction is $1,400 for individuals and heads of household.

Medical expenses include payments for doctors and dentists, hospital fees, insurance premiums (including Medicare, medigap and a limited amount of long-term-care insurance premiums), prescription medications, medical equipment, and supplies that are not reimbursed by health insurance or a flexible spending account. You cannot deduct expenses for your general health, such as vitamins. But you can deduct expenses for a doctor-prescribed weight-loss program. For details on other deductible expenses, from acupuncture to x-rays, see IRS Publication 502, Medical and Dental Expenses.

If it looks as though your medical expenses are approaching the tax-deductible threshold, make sure you add up all related costs for you, your spouse and your dependents. (And for future planning, try to bunch elective medical procedures into years that you'll qualify for a medical deduction.) You may even be able to deduct medical expenses that you paid for a family member who doesn't qualify as your dependent, such as an elderly parent or an adult child. New for 2010 returns: Parents can deduct the medical expenses they pay for their children under age 27, even if they are not dependents or are not covered under their parents' health-insurance plan.

Don't forget to include miles driven for medical purposes. For 2010, you can deduct actual out-of-pocket transportation costs, such as gas and oil, or 14 cents per mile, plus parking fees and tolls.

Special cases

If your income took a hit last year due to temporary unemployment or reduced hours, your lower income may be the ticket to deducting some medical expenses, even if you haven't been able to deduct them in the past. The lower your AGI, the more of your medical expenses you'll be able to deduct.

And while in most cases filing jointly offers married couples the biggest tax saving, you may want to file separately if one spouse has significant medical costs. Be aware that some tax credits, such as child, dependent-care and higher-education credits, aren’t available if you file separately. But if those special situations don't apply to you and one spouse has lower income and high medical costs, you may be able to deduct significantly more by filing separately than you could by filing a joint return. If you are subject to the alternative minimum tax, a parallel tax system that does not permit many of the usual exemptions and deductions allowed under normal tax rules, you have to meet an even tougher test: Deductible medical expenses must exceed 10% of your AGI.

If you are self-employed and pay health-insurance premiums, you can deduct 100% of the cost from your income when calculating your federal income taxes. (That means this deduction is not subject to the 7.5% AGI limitation that other medical expenses are.) And for 2010 only, self-employed individuals can also deduct the cost of health insurance when they calculate how much of their net earnings are subject to self-employment taxes, which are made up of both the employer and employee share of Social Security and Medicare taxes.

Flex your savings

Considering how difficult it is to deduct medical costs on a tax return, most workers are better off contributing to their employer's flexible spending account to pay for their out-of-pocket health-care bills. Because the money that goes through the flex account is not taxed, the effect is the same as allowing you to deduct medical costs -- without worrying about the 7.5% limit.

But starting in 2011, you can no longer use FSA funds to purchase over-the-counter medicines. You must have a prescription to qualify for reimbursement. The new rule also applies to funds leftover from 2010 flex account set-asides that you spend during the January 1 through March 15, 2011, grace period that most employers allow so that employees don’t have to forfeit unused funds.

Mary Beth Franklin
Senior Editor, Kiplinger's Personal Finance