As we discussed previously, the TAX CUTS AND JOBS ACT OF 2017 increased the standard deduction. Because of that, it is estimated that 94 percent of taxpayers will now take the standard deduction. One of the areas where you could itemize before and still can was in the field of medical expenses. This is an area where taxpayers can still see benefits of paying medical expenses.
For the average taxpayer, medical expenses have been difficult to deduct since there has always been this 7 1/2 to 10 percent income threshold. This means that if you have income of $60,000, you would have needed to have $4,500 of medical expenses (not including pre-tax health insurance premiums that you pay) to get any kind of benefit.
Are there other ways that a taxpayer can deduct these expenses?
Absolutely. There are really two main ones. The first one has been around for a long time and that is called the Section 125. It is also sometimes referred to as a Cafeteria Plan or a Flex Spending Account. These are employer plans that an employee can contribute to up to $2,650 for 2018, and that is done on a pre-tax basis. Then, that employee can use that account to reimburse themselves for medical expenses, dental expenses, optical expenses, and even prescriptions. Over-the-counter medicines are not included, just prescriptions. One of the disadvantages of this the entire time has been that it’s a use-it or lose-it system. Therefore, if you decide to contribute $2,650 to it and you only have $1,000 worth of medical expenses, that extra money is lost.
Secondly, a number of years ago the IRS came up with an account called the “Health Savings Account” (HSA) and they kind of addressed a lot of these issues. A Health Savings Account is actually an employee-owned account. It is actually your own account and is not owned by your employer. You can contribute $6,900 for a family or $3,450 for a self-only plan into that account for 2018 (excess amounts roll over into future years). In addition, if you are over the age of 55 you can contribute an additional $1,000. However, you must have a high deductible plan in order to do this. Now with healthcare plans, a lot of the plans are considered to be high deductible plans, but you really want to double check with your employer to make sure that their plan is considered to be an “HSA Eligible Plan.”
Can you give me more details on the HSA?
Other than the benefit of being individually owned and you can take them from job to job, and the fact that it can be rolled over from year-to-year: It is not a use-it or lose-it system. The higher contribution limits are also a benefit. In addition, the contributions are deductible whether you incur any medical expenses or not. So in my example above, if you contribute $6,900 to your family plan and you only have $2,000 of expenses, that extra $4,900 can actually be carried over into the next year, and years going forward.
You can also pay for your medical expenses with your regular after-tax dollars and get reimbursed for those expenses at a later date. For example, what we have had clients do is they will pay their medical expenses over the years. They will put money into their HSA and maybe five years from now they’ll want to buy a car or something like that, so now they can reimburse themselves for all five years of those expenses and be able to use that money as a down payment on a car. There is a penalty if you take money out of an HSA and you don’t use it to reimburse medical expenses.
However, that penalty goes away at age 65, so some clients treat this as another IRA. They put money into it over the years and then at 65 they start to withdraw the money. Even if you don’t use it for medical expenses, yes you have to pay income taxes on it, but you don’t have to pay any penalties, so it’s very similar to an IRA treatment.