The money you spend on health insurance premiums can be a deductible medical expense, but few taxpayers actually get to deduct the cost. That's not a bad thing, though. It only means that most taxpayers are better off taking the standard deduction because their medical expenses -- including medical insurance premiums -- don't exceed 7.5 percent of their adjusted gross income.
What Amount is Deductible?
All the money you spend on health insurance premiums is deductible as part of an itemized deduction for medical expenses that includes the dollars you spend out-of-pocket for such things as doctor and dentist bills, prescriptions, glasses or contact lenses and hospital bills. But you can deduct only the amount that exceeds 7.5 percent of your adjusted gross income. Quick math: If your AGI is $65,000, your medical expenses cutoff (7.5 percent) is $4,875. Your medical-expense payments, including out-of-pocket insurance premiums, are $5,103. The amount you can subtract as part of an itemized deduction is $228.
If you’re part of a company’s group plan and your premiums are paid under a cafeteria-style arrangement, these are pretax dollars and cannot be counted in reaching the 7.5 percent. Only the after-tax dollars deducted from your paycheck to pay your portion of an employer's plan can be counted.
If you are not part of an employer’s plan, all the dollars you spend on medical insurance premiums are eligible as part of an itemized deduction. Internal Revenue Service (IRS) Publication 502 covers medical and dental expenses, and it generally defines “medical insurance” as policies that cover physician, hospitalization, surgical fees, X-rays and laboratory tests, prescription drugs, vision and dental care and long-term care insurance contracts.
For a self-employed individual to deduct health insurance, you first must show a net profit for the year. To calculate the allowable deduction, take your self-employment income, subtract the 50 percent deduction for self-employment taxes and subtract any tax-deductible contributions you make to a qualified retirement plan. What’s left is your maximum allowable deduction for a self-employed health insurance deduction. A self-employed person can't deduct premiums on a personal health insurance policy if he is eligible to participate in his spouse's employer-subsidized group plan. This is true even if neither he nor his spouse participates in the employer's plan
Premiums paid for disability insurance, income-replacement insurance, that part of your car insurance that provides medical insurance for persons injured in an accident and policies for loss of life and limb cannot be included in the itemized medical deduction.
Tax Benefit Alternatives
In addition to cafeteria plans, which allow employees to make pretax contributions to an account from which they can buy group health insurance, there are a couple of other common ways to gain tax benefits even if you can’t deduct your health insurance premiums. A Flexible Spending Account is part of another employer-sponsored plan that will allow you to designate pretax dollars to be used for allowable medical expenses, including some non-prescription drugs. Health Savings Accounts allow both individually-insured persons and employees whose company offers the plan a chance to buy high deductible insurance policies and contribute pretax dollars to an HSA, which is essentially an IRA for medical expenses. Both kinds of accounts are explained fully in IRS Publication 969. For additional information on Flexible Spending Accounts and Health Savings Accounts, see the References section.
Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.