Medical Expense Tax Deductions

Medical expense deductions are subject to a confusing array of restrictions and exclusions.

The total cost of living in a nursing home is usually deductible as a medical expense by the taxpayer. The cost of an assisted living facility may be partly or wholly deductible depending on the medical necessity for such care. The cost of a retirement home is rarely deductible. 

The best known restriction on deducting medical expenses is that only those medical expenses that exceed 7.5% of your adjusted gross income are deductible as an itemized deduction. For example, a taxpayer with an adjusted gross income of $50,000 would not be able to deduct the first $3,750 of medical expenses.

Another restriction is that medical expenses are only deductible for the taxpayer, a spouse (on a joint return) and any dependents. (The tax rules for status of a dependent are also complicated and are described in a separate article.)

When children or other relatives are paying for some or all of the medical costs of an elderly or disabled person, the deductibility will hinge on whether the family member needing the care is a dependent of the one paying for the medical costs.

The self employed are allowed an above-the-line deduction (before adjusted gross income) for up to 100% (for 2003 and future years) of their health insurance premiums, including long-term care insurance. Medical expenses other than health insurance are deductible as itemized deductions if they exceed the 7.5% exclusion.  This deduction for health insurance premiums also applies to partners and to owner-employees of S corporations. The law therefore encourages self employed individuals to get comprehensive medical insurance - which is usually more costly than major medical plus the cost of routine medical care.

Employees can get up to 100% their medical expenses paid free of tax if their employer provides a generous form of group medical policy or if the employer has arranged for employees to participate in a cafeteria plan or medical reimbursement plan. A retired employee may be able to enjoy similar benefits from a former employer, but in most cases, the retired employee will be required to pay the former employer for the cost of the medical insurance premiums.

There are two ways that a self employed person can establish a medical expense reimbursement plan that will make all of their family medical costs deductible. And, this type of plan is more economical because it will permit the purchase of economical major medical insurance combined with the direct payment of routine medical costs and checkups. 

But there is a catch that must be overcome.

This type of plan is only available to employees. The owner of an unincorporated business is not an employee and isn’t eligible for this kind of employee benefit. To become an employee of your own business, you have to incorporate the business. Another alternative is available to those who have a spouse who is working in the family business.  

First, for those who have a spouse who is actively involved in their business, a medical reimbursement plan can be established for all employees - including the spouse. The plan can exclude (1) part time employees, (2) seasonal employees, (3) employees who have worked for the company for less than three years and (4) employees under 25 years of age. Otherwise, benefits must be available to 80% of eligible employees. Even so, if a business only has one employee (the spouse of the owner),  that employee can be covered. And ... the covered benefits can include benefits for members of the employees’ family - a spouse or children. A formal written plan is strongly recommended even though it’s not an absolute requirement. 

If the spouse of the owner is not actively involved in the family business, then it will be necessary to operate the business as a taxable (C) corporation. The same eligibility rules will apply to the corporation employees as described above. 

Where a business has a number of employees who would be eligible for the benefits, it doesn’t make sense to establish the plan just for the benefit of the owners - but it does make sense to establish some kind of medical reimbursement or insurance plan for the employees because it’s hard to get employees to work for you without such a plan.  

Additional Information

Medical Deduction for Retirement Home Expenses

Copyright, 2003, Vernon K. Jacobs

Vernon Jacobs is the Editor/Publisher of The International Wealth Protection Reports, which are a collection of research reports on legal methods of asset protection and tax avoidance. Further information on this subject is available at http://www.offshorepress.com/  Jacobs is a CPA who has worked as a free lance tax and financial author/editor since 1977. Details about his credentials and experience are online at http://www.offshorepress.com/vkjcpa/  

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