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We’re in one of the busiest times of the year: tax season.
Except for those who love number-crunching, few clients look forward to tax preparation. It is one of the most stressful times, especially if clients don’t fully understand how tax planning fits into their comprehensive financial plan.
An important part of tax planning is medical expenses, which add up quickly. Your clients (including spouses and dependents) will have medical expenses throughout the year, and hanging onto those receipts could save them money this year.
Tax-planning knowledge benefits your clients financially through better money management. You can help them learn how and when to claim medical expenses for their household. All clients have different healthcare expenses throughout the year, and this is especially true if a household has incurred or paid large out-of-pocket medical expenses, or if their itemized deductions are greater than the standard deduction for the year.
Medical and dental expenses are tax-deductible Schedule A itemized deductions (Form 1040 or 1040-SR), but it’s not always obvious which expenses can be claimed or how to go about collecting this information.
The standard versus itemized tax deductions
The standard deduction in 2021 for single filers is $12,550 and $25,100 for joint filers. Additionally, for those aged 65+ or legally blind, the standard deduction is $1,350 higher, or $1,700 higher if unmarried and not a surviving spouse.
You’re likely thinking your clients don’t have a shot at beating the standard deduction and coming out ahead. Although it’s true that the Tax Cuts and Jobs Act has made it less likely for some individuals to benefit from itemizing deductions, the only way to find out if your clients will benefit is to help them with itemized deductions and compare those to the standard deduction to determine which results in a lower tax bill.
Medical tax deductions: Which healthcare expenses are deductible?
Let’s start with what qualifies as a deductible expense. The IRS Publication 502 provides a list of medical expenses that help. Typically, if the healthcare expense prevented or alleviated a specific mental or physical medical problem, then it most likely qualifies as a medical tax deduction.
Unfortunately, things like gym memberships, daily vitamins, or cosmetic surgery (unless reconstructive or preventative) are not appropriate for medical tax deductions.
Regardless, clients can consider other wellness-like expenses when receiving care from any of these types of medical practitioners, including acupuncturists, chiropractors, optometrists, occupational therapists, osteopathic doctors, physical therapists, and psychologists.
What’s less known is that your client can also deduct expenses for travel to and from medical care, which includes parking and hotel stays if required. Additionally, prescription medications, long-term care services, and certain insurance premiums can be deducted. They can also deduct expenses made for medical-related home improvements (such as installing an elevator or accessibility ramp).
Taxpayers can deduct these qualified expenses (if unreimbursed) that are more than 7.5% of their adjusted gross income (AGI). For example, if a clients’ household AGI was $200,000 in 2021, they would be able to deduct expenses in excess of the first $15,000.
Information to collect to itemize medical tax deductions
If you and your clients have chosen to take medical tax deductions, together you can collect the following information to provide with their annual tax return:
- Gross income and adjusted gross income (AGI)
- Medical insurance premiums
- Medical and dental expenses
Gross income and adjusted gross income (AGI)
AGI (adjusted gross income) is defined as gross income minus adjustments from things like educational expenses, student loan interest, alimony payments, and retirement account contributions. It’s this number, not gross adjusted income, that matters for deduction purposes. As a simple calculation, you and your clients can determine whether their estimated medical and dental expenses exceeded 7.5% of their AGI for the tax year.
Medical insurance premiums
If your clients skew younger, you likely serve a lot of working professionals. Any client with employer-sponsored health insurance pays their premiums pre-tax, and the premiums are automatically deducted from each paycheck. Because of this, most employer-sponsored plans aren’t deductible since they’re already tax-advantaged.
However, if your client is self-employed and isn't eligible for subsidized coverage elsewhere (e.g., their spouse’s employer), then they may be eligible for the self-employed health insurance deduction. But this is treated as an adjustment to income, rather than an itemized deduction.
Medicare premiums may also be tax-deductible if the cost of premiums for Part B, Part C (Medicare Advantage), Part D, and/or Medigap coverage, plus other eligible medical expenses for the year, exceed 7.5% of your client’s AGI.
Medical and dental expenses
Keep track of unreimbursed expenses in the family to make itemized deductions, as clients can only deduct expenses that were not paid by their health insurance plan, health savings account (HSA), or an Archer medical savings account.
Once your client has collected receipts or other proof of healthcare expenses, they can organize the information to make it easier to prepare their tax return or obtain professional advice. Below are categories to include in an unreimbursed medical expenses spreadsheet:
- The name and address of each person or organization paid;
- The date and amount of the payment;
- Who paid the expenses;
- Who received the medical care;
- The type of medical care that was received (see the IRS Publication 502); and
- A description of the medical care and its purpose.
Prescription drug costs can be added to other medical or dental expenses to claim a greater deduction. Clients can list any unreimbursed expenses for drugs in the “medicines” category on their organizational spreadsheet.
Although itemizing tax deductions doesn’t make sense in some cases, it can pay off in others, especially if your clients know they’ll be spending a lot on their healthcare or on medication costs during the year. Also, once in retirement, incomes become fixed at typically lower amounts, and healthcare utilization increases. Therefore doing this exercise annually is incredibly important.
As a comprehensive financial advisor, you’re dedicated to clients’ best interests year-round, which includes helping them get the highest tax refund possible. Beyond this year’s refund, expanding clients’ tax-planning knowledge can reduce their stress levels. This exercise will contribute to improved money management throughout the year and to your clients’ financial wellbeing for the rest of their lives.
Christine Simone is a co-founder of Caribou, a healthcare cost prediction and optimization solution for financial advisors. She often writes on the topics of healthcare and women in tech. Caribou is a proud sponsor of the upcoming Market Outlook Summit on April 5, 2022.
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