There are a few different ways for people to save taxes based on the medical expenses they incur. Sadly, the Patient Protection and Affordable Care Act, signed into law on March 23, 2010, reduces many of these tax breaks.
The first changes took effect on January 1, 2011. As of New Year’s Day, you can no longer use money set aside in your flexible spending account to pay for over the counter medications. According to the IRS:
Under the new standard, the cost of an over-the-counter medicine or drug cannot be reimbursed from the account unless a prescription is obtained. The change does not affect insulin, even if purchased without a prescription, or other health care expenses such as medical devices, eye glasses, contact lenses, co-pays and deductibles. The new standard applies only to purchases made on or after Jan. 1, 2011, so claims for medicines or drugs purchased without a prescription in 2010 can still be reimbursed in 2011, if allowed by the employer’s plan.
A second revenue raiser deals with the penalty for withdrawing money from a Health Savings Account that is not used to pay for your family’s health care costs. Prior to this year, this penalty was equal of 10% of each dollar withdrawn. Beginning in 2011, the penalty doubles to 20% for non-healthcare withdrawals from an HSA.
The next wave of tax increases takes effect in 2013. For starters, the annual max you can set aside through your employer sponsored Flexible Spending Account for medical expenses is cut in half to $2,500. Remember, with an FSA, you pay for medical expenses with pre-tax dollars. Married couples where both spouses work, therefore, stand to lose out on up to $5k of pre-tax medical spending each year.
The second change impacts the medical deduction you can claim as an itemized deduction on your tax return. Starting in 2013, you can only deduct medical expenses paid on behalf of you and your family to the extent the amount spent during the year exceeds 10% of your Adjusted Gross Income. Under the current rules, the threshold is 7.5% of AGI. For every $100k of income, therefore, expect to lose out on as much as $2.5k of your medical deduction. Please note that this increase will not affect taxpayers over the age of 65 until 2017.
There is some good news, however. The rules do not impact the medical expenses allowed when calculating the dreaded AMT. Since the current threshold for deducting medical expenses under the AMT is already 10% of AGI, many people who are hit by this tax every year might not see any tax increase due to this change.
Like the universal health insurance rules we have here in Massachusetts, the Patient Protection Act adds a penalty for individuals who don’t have health insurance that meets a “minimum essential coverage” threshold. This new non-coverage penalty starts at $95 per person in 2014, jumps to $325 per person in 2015, and then jumps again to $695 per person the next year. After 2016, this penalty is indexed for inflation. Expect to report and remit this penalty as part of your federal income tax return.
There will also be an excise tax on “High Cost Employer-Sponsored Health Coverage” starting in 2018. This excise tax will be equal to 40% of the amount that the annual health insurance premium paid exceeds $10,200 for single individuals and $27,500 from families. The Act did include a higher threshold for the first three years for taxpayers who live in the17 states with the highest health insurance costs.
HSAs Look Even Better:
Besides increasing the penalty for money withdrawn from a Health Savings Account (HSA) not used for your family’s health care expenses, the Act did not affect HSAs. As we wrote in our February 2009 Newsletter, HSAs are a great tool to help you minimize your healthcare costs and save taxes.
Here are four tax breaks available to you if you contribute to an HSA:
- Money contributed into an HSA is tax-deductible. Either you contribute into an HSA on your own, or your employer contributes on your behalf.
- Money invested within the HSA is your money and grows tax-deferred. Unlike Flexible Spending Accounts (FSA) offered to you as part of your employee benefit package where you set aside a set amount of money to pay for your family’s healthcare costs with pre-tax dollars, there is no “use it or lose it” pitfall with HSAs.
- Money can be withdrawn tax-free from your HSA at any time to pay for your family’s healthcare expenses.
- Any money remaining in your HSA upon your reaching the age of 65 is available to subsidize your retirement.
For 2011, you qualify to set up an HSA if your health insurance plan has a deductible of at least $1,200 for an individual plan or $2,400 for a family plan. Single taxpayers can then contribute up to $3,050 (in 2010) into an HSA while Married Couples can contribute up to $6,150 (in 2010) annually. Please note that the amount you can contribute into an HSA exceeds your annual deductible, which is one reason that HSAs are so attractive.
To find out more about HSAs, check out IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans. You can also read through the instructions to the Form 8889, Health Savings Accounts.