Squaring up with the IRS

contributed by Jim Palazzolo, CPA, PLC

As is always the case with making choices in applying tax rules and regulations, specific facts and circumstances must be considered. This article is not intended to provide tax advice, planning or guidance. Competent professional advice should be obtained before completing your return.

What are deductible federal medical expenses?

Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.

Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They don't include expenses that are merely beneficial to general health, such as vitamins or a vacation.

Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract. (Your Federal Income Tax Guide (PDF) Part 5: Medical and Dental Expenses). The IRS also provides a checklist of what can be included versus not included.

The state of Michigan gives no consideration in preparing individual income tax returns to medical expenses.

The small print and the planning opportunities

Two things to keep in mind:

Only those taxpayers who itemize deductions on Schedule A of their return can take medical deductions
Only the annual costs exceeding a certain floor are allowed to be deducted

If you take the standard deduction, you are not allowed the medical deduction. Beginning in 2013, the floor is 10% of the Adjusted Gross Income (AGI) of taxpayers who were born after January 2, 1951. Taxpayers or their spouses born before January 2, 1951 may take 7.5% of their AGI.

AGI is the sum of all taxable income less allowed adjustments. It’s the last number appearing on page 1 of your tax return.

The deduction is allowed for the medical expense of taxpayer, the spouse, if filing jointly, and qualifying dependents.

The medical expense deduction is based on when the payment was made, not when the service was provided if cash/debit card, a check or an on-line/phone payment method is used. Credit card payments are deductible on the date the charge is made without regard to when the card is paid. Expenses incurred before the taxpayer’s death can either be deducted on the decedent’s final income tax return or on the estate tax return provided the expense is paid within one year after the date of death and a statement is included with the decedent’s final return (or amended return) attesting to the fact that these expenses were not nor will they be claimed on the estate’s return.

Bunching of expenses into one year or deferring them into another may be advisable to take advantage of the deductible floor in one or the other. Careful consideration of the rules regarding the deductibility of expenses you paid for persons who qualify as medical dependents but not claimed as dependents on page 2 of your return can result in allowable medical deductions. The source of your payments of the expenses of medical dependents can include gifts, subject to gift tax rules, from the medical dependent.

Also, since the floor is dependent upon the AGI as shown on the return as filed, married taxpayers might do well to consider filing separately to split the joint AGI when one spouse has significant expenses that may be lost when the AGI of both are used in the calculation of the floor. Specific rules apply to payments from joint accounts and in community property state filers which are detailed on page 142. Of course, significant other considerations must be taken into account before deciding on your optimal filing status.

Single persons may claim Head of Household status with its lower tax rates for a dependent parent even if the parent does not live with you but meets the requirements of this filing status. See pages 24 of Publication 17, "Who Is a Qualifying Person Qualifying You To File as Head of Household."

The IRS devotes an entire publication -- Pub 502 (PDF) -- to Medical and Dental expenses. It and the current issue of Publication 17 (PDF), Your Federal Income Tax For Individuals, are available for more information.

I recommend you discuss the deductibility of medical expenses and the tax planning opportunities available with a competent tax advisor before completing your return.

Jim Palazzolo is the managing member of james thomas palazzolo, cpa, plc based in Ann Arbor Michigan. He has happily provided tax planning, preparation and IRS related services as well as accounting services since 1987 for local and global customers.

Continue reading the Winter, 2008 issue of Thrive