Thanks to the Affordable Care Act legislation, it's harder than ever to write off medical expenses, which is unfortunate because they keep going up for most folks.
However, if you will be age 65 or older at year-end, a lower deduction threshold applies to you for this year (but not next year). Regardless of your age, loading up on medical expenditures before year-end could be a tax-smart move that increases your 2016 write-off. Here's what you need to know.
Higher threshold for itemized medical write-offs
Best and worst states for taxes
Back in the good old days (before 2013), you could claim an itemized deduction for medical expenses paid for you, your spouse, and your dependents--to the extent those expenses exceeded 7.5% of your adjusted gross income, or AGI. AGI is the number at the bottom of page 1 of your Form 1040. It includes all taxable income items and is reduced by certain write-offs, such as those for deductible IRA contributions and alimony payments.
The 7.5%-of-AGI hurdle was hard enough to clear. Now, an even higher deduction threshold of 10% of AGI applies to most folks. However if either you or your spouse will be 65 or older as of Dec. 31, 2016, the unfavorable 10%-of-AGI deduction threshold will not impact you until next year. For 2016, the familiar 7.5%-of-AGI deduction threshold still applies in your case. (Next year, however, the unfavorable 10%-of-AGI threshold will apply to everybody, regardless of age.)
Tax-smart reaction: Concentrate medical expenditures in alternating years
If you have flexibility about when medical expenses are incurred, you may be able to concentrate them in alternating years. That way, you can claim an itemized medical expense deduction every other year, or every third year.
Example 1: Your annual AGI is $65,000. In 2016, you pay $9,000 of medical expenses because you have elective surgery, buy new glasses and contact lenses, and have some dental work done. Next year you expect to pay only about $2,000.
On your 2016 Form 1040, you can claim an itemized deduction of $2,500 ($9,000 minus the $6,500 10%-of-AGI deduction threshold). Next year, you won't have any deduction. But if you simply spread the two-year total of $11,000 of medical costs evenly over this year and next year, you would be completely out of luck in both years.
Bottom Line: Deductions in some years are better than no deductions ever.
Example 2: Same as Example 1, but this time either you or your spouse (or both) will be age 65 or older as of Dec. 31, 2016. So the 2016 deduction threshold in your case is only $4,875 (7.5% of $65,000).
On your 2016 Form 1040, you can claim an itemized medical expense deduction of $4,125 ($9,000 minus the $4,875 threshold). Next year, the 10%-of-AGI deduction threshold will apply to you, and you won't get any deduction. But if you simply spread the two-year total of $11,000 of medical costs evenly over this year and next year, you would get a much smaller deduction this year and no deduction next year.
Bottom Line: Loading up on medical expenses this year will cut your tax bill over the two-year period.
Another tax-smart move: Take advantage of your company's health care FSA
Understanding estate and gift tax rules
Amounts you contribute to your employer's health care FSA plan are subtracted from your taxable salary. Then you can use the funds to reimburse yourself tax-free to cover qualified medical expenses. For 2016, the maximum FSA contribution for each employee is $2,550. Next year, the cap may be slightly higher due to an inflation adjustment. If your company has a health care FSA plan, failing to participate is like leaving money on the table.
If you are self-employed
Self-employed folks who pay their own medical and dental insurance premiums are generally allowed to deduct those costs "above the line" on page 1 of Form 1040. This rule is helpful, because you need not itemize to benefit from an above-the-line deduction. Unfortunately, that's the end of the good news. In general, your only recourse for other out-of-pocket medical expenses (other than health premiums) is claiming an itemized deduction when those costs exceed 10% of AGI, or 7.5% of AGI if you qualify for the lower threshold due to your age or your spouse's age.
The bottom line
Your tax results can be improved if you plan ahead for medical expenditures (to the extent possible) and take advantage of your employer's health care FSA (if one is offered). If you have questions or want more information, contact your tax adviser.