Whether or not you can deduct the cost of health insurance on your income tax returns depends on several factors. If you're a full-time employee, self-employed individual, or you paid for your insurance using pre-tax or after-tax dollars all have an impact on what you can claim. It can also depend on whether you take the standard deduction or itemize. Learn more about who can take a deduction for health insurance premiums and how the process works.
The Medical Expense Deduction
Health insurance costs are included among expenses that are eligible for the medical expense deduction. You must itemize to claim this deduction, and it’s limited to the total amount of your overall costs that exceed 7.5% of your adjusted gross income (AGI) in tax year 2020, the return you'll file in 2021.
This threshold was historically 7.5% until 2013 when it increased to 10%, although it remained at 7.5% for taxpayers who were age 65 or older, at least for a little while. Then, as of December 31, 2016, all taxpayers were supposed to meet the 10% threshold to be able to claim this deduction, regardless of their age.
The Tax Cuts and Jobs Act (TCJA) restored the threshold to 7.5% retroactively for 2017 and going forward through 2018. It was slated to hike back up to 10% in 2019, then the Further Consolidated Appropriations Act extended the 7.5% threshold indefinitely.
How to Apply the Percentage Threshold
This 7.5% rule is typically disadvantageous mathematically, unless you have significant other medical expenses in addition to your insurance premiums. You can include these in the deduction to help you get over the 7.5% threshold.
As an example, you could not deduct your premiums in 2020 if your AGI was $60,000 and you paid $4,500 in health insurance premiums over the course of the tax year because 7.5% of your AGI works out to $4,500. You didn’t pay anything in excess of that figure.
But you’ve spent a cumulative total of $7,500 if you additionally paid $3,000 in additional uninsured medical expenses. This is $3,000 more than your 7.5% threshold so you can claim that the entire $3,000 as an itemized tax deduction.
The Threshold Doesn't Apply to All Your Income
The good news here is that this percentage doesn't apply to your total income, but only to your AGI. This is the number that's arrived at after you've taken certain above-the-line deductions on Schedule 1 of your Form 1040 tax return, reducing your total, gross income to your taxable income.
Above-the-line deductions include things like certain retirement plan contributions, tuition, and student loan interest. Your AGI will typically be less than your overall income if you can claim any of these deductions. For example, you might have earned $60,000, but your AGI is just $54,000 if you contributed $6,000 to your IRA in that year. Your 7.5% threshold drops from to $4,500 to $4,050.
Your AGI appears on line 11 of your 2020 Form 1040 before you claim itemized deductions or the standard deduction for your filing status on line 12.
Tax Deduction vs. Pre-Tax Salary Deduction
Employees who pay for health insurance with pre-tax dollars through payroll deductions aren’t eligible to take a further deduction for these same expenses. Check your pay stubs if you’re unsure how you’re paying for insurance that's available through your employer. You're using pre-tax dollars if the deductions are made before your employer calculates your tax withholding on the balance.
Paying for health insurance as a pre-tax salary deduction is actually more advantageous and will probably save you more money than taking the itemized deduction for medical expenses.
Pre-tax health benefits reduce your taxable salary, and the income tax, Social Security tax, and Medicare tax that you must pay are all a percentage of that taxable salary.
If You’re Self-Employed
Self-employed persons can take a deduction for health insurance premiums they pay for themselves and their dependents directly on line 16 of the 2020 Schedule 1. This is another above-the-line adjustment to income. You can then transfer the total of Part 2 of Schedule 1 to line 10a on your 2020 tax return.
This is one of those deductions that can reduce your AGI from the total of your gross income, and you don't have to itemize your deductions to take it. It's not limited by the 7.5%-of-AGI rule. You can claim up to 100% of what you spent on premiums if you're self-employed, but the deduction is limited to your net self-employment income. Any premiums beyond your net self-employment income can be claimed as an itemized deduction, along with any other out-of-pocket medical expenses.
- Employees benefit when health insurance premiums are deducted tax-free from their salaries without any of the limitations associated with the itemized deduction.
- Self-employed persons can deduct health insurance "above the line" on their 2020 Schedule 1, which also eliminates the hassle and limitations of itemizing.
- Other taxpayers can deduct the cost of health insurance as an itemized deduction only if their overall medical and dental expenses exceed 7.5% of their adjusted gross incomes in 2020.
Tax laws change periodically, and you should consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and is not a substitute for tax advice.