Medical Expense Deductions and Tax Breaks for the 2021 Tax Year
Medical expenses you've paid during the year, including some health insurance premiums, can provide a bounty of possible deductions and breaks at tax time. You might be eligible for an itemized deduction for medical expenses if you meet certain requirements, or you might consider a tax-free reimbursement from a flexible spending, health reimbursement, or health savings account.
Here are some of your options when it comes to using medical expenses to reduce your tax liability.
The Itemized Deduction for Medical Expenses
Many of your medical expenses are tax-deductible if you itemize your deductions rather than claim the standard deduction. In tax year 2020, you can claim a deduction for the balance of your expenses, including many insurance premiums, over 7.5% of your adjusted gross income (AGI).
As an example, let's say you have an AGI of $75,000 and you spent $7,500 on medical expenses throughout the year. You first multiply 7.5% by $75,000 to find out where your threshold for deductions begins. This gives you $5,625 (7,500 x 0.075 = 5,625). Your costs beyond $5,625 are deductible. That means you could claim a deduction for $1,375 of your medical expenses for that year.
It used to be that you could only deduct the portion of your expenses that exceeded 10% of your AGI. The Tax Cuts and Jobs Act (TCJA) temporarily dropped the threshold to 7.5% and the Further Consolidated Appropriations Act of 2020 extended that 7.5% threshold through the 2020 tax year. Barring further legislation, it's set to return to 10% for the 2021 tax year.
Qualifying Medical Expenses
The IRS defines qualifying medical expenses as those related to the "diagnosis, cure, mitigation, treatment, or prevention of a disease or condition affecting any part or function of the body."
Qualifying expenses include:
- Costs for medical services from physicians, surgeons, dentists, and other medical professionals
- Costs for medications prescribed by a medical professional
- Costs for medical devices, equipment, and supplies prescribed by a medical professional such as eyeglasses
- Costs for health and dental insurance premiums, as long as they're not reimbursed by your employer
- Costs for long-term care and long-term care insurance
- Transportation and lodging costs for traveling to a health care facility, including a standard mileage rate of $0.17 per mile in 2020.
Over-the-counter treatments, nutritional supplements, vitamins, and first aid supplies don't qualify unless they're prescribed by a medical professional.
Itemizing vs. the Standard Deduction
It might be more beneficial to use a pre-tax savings plan to pay for out-of-pocket medical expenses rather than claiming an itemized deduction for them. The TCJA nearly doubled the standard deduction for all filing statuses.
You can itemize your deductions or you can claim the standard deduction, but you can't do both.
The standard deductions in tax year 2020 are $12,400 for single taxpayers, $24,800 for married couples filing jointly, and $18,650 for head of household filers. In tax year 2021, those figures increase to $12,550, $25,100, and $18,800, respectively.
Since you can't claim the standard deduction if you itemize, it might not be worth it to claim medical expenses, even with the lower 7.5% AGI threshold in 2020. Your overall itemized deductions should surpass your standard deduction—otherwise, itemizing your deductions would actually increase your tax burden.
Pre-Tax Savings Plans
The itemized deduction is, at best, only partially tax-deductible because you can only deduct the portion that's more than 7.5% of your AGI (or 10% in 2021—again, this assumes there is no further legislation on the issue). Anyone whose total medical expenses for the year are less than 7.5% of their AGI wouldn't be able to claim the deduction at all.
However, whether you itemize or take the standard deduction, you can take advantage of tax-favored accounts like flexible spending accounts (FSAs), health savings accounts (HSAs), and health reimbursement accounts (HRAs). They're considered 100% deductible, even if you don't itemize.
Flexible Spending Accounts
Some employees might be eligible to set up medical flexible spending accounts through their employers. FSA plans let employees save pre-tax money through payroll deductions, then they can submit various medical expenses to the account for reimbursement.
You can contribute up to $2,750 a year per employer in the 2020 and 2021 tax years. Your spouse can contribute an equal amount to your FSA, as well, if you're married. Eligible medical expenses include co-pays, deductibles, prescriptions, and some over-the-counter medications.
The drawback to this type of account is that you must use the money within the year—you can't save your contributions toward a future health calamity. Some plans allow for up to $500 to carry over into the next year, but that's the maximum carryover amount allowed.
Health Reimbursement Accounts
Some employers offer their workers health reimbursement accounts. The employer will reimburse an employee for certain qualified medical expenses, and these reimbursements are also tax-free.
Your employer contributes to a plan to which you can submit your requests for reimbursement. There's no limit to the amount of money that your employer can contribute, unlike with an FSA, and the money can roll over into subsequent years if you don't use it all in the same calendar year.
Health Savings Accounts
Taxpayers can set up health savings accounts either on their own or through a group plan with their employer. Like FSAs, these are pre-tax savings accounts. Unlike FSAs, health savings accounts don't have a "use-it-or-lose-it" feature for accumulated savings. They can carry forward to cover expenses in future years.
Health savings account holders can use their savings funds to pay for medical expenses on a tax-free basis, but they must have a high-deductible health insurance plan (HDHP) to qualify. The HSA helps to defray the out-of-pocket costs of these policies.
HDHP minimum deductibles are $1,400 for self-only plans in 2021 and $2,800 for family coverage (these amounts remain the same from what they were in 2020).
Contribution limits in the 2021 tax year are $3,600 for individuals and $7,200 for families. You're entitled to an extra $1,000 "catch-up" contribution if you're 55 or older. These limits represent a small increase from 2020 limits ($3,550 for individuals and $7,100 for families). The catch-up contribution remains unchanged.
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