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How Health Costs Can Lower Tax Bills

With Unemployment Surging, More May Qualify for Medical Expense Deduction; Writing Off the Swimming Pool

This may be the year to take a tax deduction for medical expenses.

This write-off has long been one of the least useful for most taxpayers because medical costs have to be a significant percentage of income to be deductible. But this year the economy's convulsions have left an estimated 16% of the U.S. work force—25 million people—unemployed or underemployed. And many are digging into their own pockets to cover medical bills, insurance premiums or Cobra payments. Meanwhile health costs have surged, even for those with coverage. The upshot is that more people are likely to qualify to take it than in the past.

Accountants are paying attention. "With health-care costs rising, the medical deduction is worth looking at, especially if a taxpayer's income has gone down," says Danny Snow, an accountant with Thompson Dunavant in Memphis.

In the past, relatively few people have been eligible to take the deduction because it allows no write-off for expenses equal to the first 7.5% of adjusted gross income. (The Senate Finance Committee has voted to raise this hurdle to 10% next year.) So a taxpayer with $80,000 of AGI and $10,000 of medical expenses would have to disallow the first $6,000 before getting a deduction for the remaining $4,000. Unlike a tax credit that counts dollar-for-dollar against the amount you owe, a deduction simply reduces income. And you need to keep records.

Within these constraints there is good news, however. The medical deduction covers a wide range of expenses—everything from contact lens solution, physical therapy and acupuncture to home health care, medical travel and even part of the cost of some swimming pools.

Most important in this difficult year: Insurance premiums are deductible if they are paid with after-tax dollars. This may prove a boon to those like Stevan Currier, of Harriman, Tenn., who lost his job with a trucking company last February. He had been paying Cobra insurance premiums out of pocket at a reduced rate of $430 per month, but the cost recently rose to $1,290. These charges plus others, and his reduced earnings, may make him eligible for the deduction, however small.

"This year I'm going to need all the help I can get," he says.

Because the hurdle to taking this deduction is high, it pays to strategize. Experts often advise "bunching" expenses—say for several children having orthodontic treatment—so that as many as possible fall into one year rather than being spread over several.

For complete details see Internal Revenue Service Publication 502 at But here's a summary of the ins and outs:

Basics: To be deductible, a medical expense must be paid with after-tax, out-of-pocket dollars. The expense must also be for treatment of a medical issue, not just for maintaining good health. (There are a few exceptions, such as an annual physical or dental exam.) Costs are normally deductible in the year paid or applied to a credit card. Medical care does not have to be provided in the U.S., but drugs from outside the U.S. must be legally approved for import. Dental expenses qualify.

Insurance: Insurance premiums paid with pretax dollars aren't deductible, and neither are medical expenses that are reimbursed by insurance, flexible spending plans or health savings accounts. But insurance premiums paid with after-tax dollars, including Cobra and Medicare Parts B and D, do qualify. So do out-of-pocket co-payments for lab fees, doctor's visits, drugs, tests and the like. A portion of long-term-care premiums is deductible: The amount grows as the taxpayer ages, but for a 55-year-old it is $1,190 for 2009.

Covered treatments: In general, the IRS allows deductions for the sorts of things that insurance covers, and more. Allowable expenses include acupuncture, physical therapy, fertility treatments, psychiatric care and psychotherapy. Eligible devices and equipment include hearing aids, eyeglasses and contact lenses (plus solution), dentures, and wigs for hair loss due to disease or treatment. The cost of programs to treat alcoholism, stop smoking and lose weight can also be deductible.

What can't you deduct? Expenses for cosmetic surgery, baby formula or diapers (although pregnancy tests qualify), hair transplants, gym memberships and spa treatments, among others. The IRS also disallows costs for most over-the-counter drugs, which some Flexible Spending Plans reimburse. So a Stop Smoking program may be deductible, but nicotine chewing gum isn't. See IRS Publication 502 for a full list.

Home modifications: In the past, deductions have been allowed for a swimming pool prescribed for physical therapy and an air-conditioning system for someone with severe allergies. More common are deductions for lead abatement or modifications for disability. But if the modification leads to an increase in the value of the property, that increase isn't deductible. So if someone puts $30,000 into remodeling a home to make it wheelchair-accessible and those changes increase the value of the property by $10,000, then $20,000 would be deductible. Given the current housing market, this disallowance may be smaller than in the past. Get appraisals if you go this route.

Care for the elderly and disabled: Skilled nursing-home care is fully deductible. So is a portion of assisted-living expenses. Home-health-care services are often deductible if they involve care with so-called activities of daily living, such as helping with a shower. (Help with housekeeping isn't deductible.) The cost of respite care for an Alzheimer's patient should count as well. But all payments must be to qualified providers who are working legally.

The cost of buying and keeping a guide dog or other service animal is deductible, as is tuition for some programs for a child with special needs, such as autism. Tutoring for learning disabilities may also qualify.

Dependent strategies: Do you pay medical costs or insurance premiums for someone else? The IRS has a special rule that may help. If you provide over half the support for a person, then you may be able to deduct his or her medical costs if these exceed 7.5 % of your AGI. If this hurdle is too high, consider giving the person the money, then having him pay the bill and taking the deduction himself. Such gifts are currently tax-free up to $13,000 for individuals or $26,000 for couples, annually. Amounts above that limit are tax-free up to a lifetime limit of $1 million, but you must file a gift tax return.

Medical Travel: This is an often overlooked area that applies to many people. It can include expenses incurred to travel to everything from a doctor's office to an Alcoholics Anonymous meeting. The rate for 2009 is 24 cents per mile if you drive. The full cost of other forms of travel such as airplanes, subways or taxis, is deductible, as are parking fees and highway tolls. If a relative or nurse needs to go with the patient, the travel costs of that person are eligible as well. Lodging counts if it is necessary and not extravagant. (A stay at a five-star hotel probably would not qualify.) Most meals are deductible only if they are part of inpatient care.

Recordkeeping: Although audit rates are low, be prepared to prove this deduction if you take it. Says Robert Meighan, an accountant and vice president of TurboTax, "That does not mean keeping every parking receipt. But you need to keep paperwork on large expenses, such as insurance premiums, and reasonable proof of estimates for smaller ones."

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