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William Perez

Deducting Health Insurance

By March 16, 2011

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People can deduct the cost of health insurance on their income tax return. Who's eligible to deduct expenses for medical and dental insurance depends partly on whether you are an employee or self-employed, and partly on whether your health insurance was paid for using pre-tax dollars or post-tax dollars.

Health insurance costs as part of the medical expense deduction. This deduction is among the itemized deductions, and total medical expenses are deductible only to the extent they exceed 7.5% of your adjusted gross income. Mathematically, this is very disadvantageous. Still, if you have significant medical expenses, adding in health insurance may help you to get over the 7.5% threshold.

Be aware, however, that employees who paid health insurance using pre-tax dollars through payroll deductions won't be able to take a further deduction for these same expenses. Or to phrase this differently, paying for health insurance as a pre-tax salary deduction is more advantageous than the itemized deduction. That's because pre-tax health benefits reduce your taxable salary, so the deduction comes "off the top," so to speak, and isn't clawed back by the 7.5% threshold. Further, health insurance premiums are deducted pre-tax for income tax, Social Security tax and Medicare tax on an employee's paycheck, making this employee benefit triple-tax free. (Quadruple tax-free if your state allows for pre-tax health insurance benefits.)

Self-employed persons take a deduction for health insurance for themselves and their family directly on their Form 1040 as an adjustment to income. This is much more beneficial than the itemized deduction, because the expense isn't limited by the 7.5% of income threshold. And for 2010 only, the self-employed health insurance deduction will reduce the Self-Employment Tax. In previous years, and starting again in 2011 and going forward, the health insurance deduction for self-employed persons will only reduce the income tax, and not reduce in any way the Self-Employment Tax.

Thus for 2010 only, self-employed persons will enjoy parity with their employee counterparts in benefiting from the triple tax-free nature of the health insurance deduction.

Alas, this particular 2010 tax break for self-employed persons has generated uncertainty. IRS Publication 535, which deals with business expenses commonly encountered by self-employed persons, has not yet been updated to reflect this one-time change in the tax laws. In fact, I recently heard from Ms. Jenny, who emailed me with the following question:

"I was reading from the IRS website that one cannot use the health insurance premium to reduce the self-employment [tax].... It is contrasting to what your article states. Do you have a link to the official documentation for this 'special rule for 2010' only to verify this?"

Jenny went on to quote from Publication 535, which informs taxpayers, "Do not subtract the health insurance deduction when figuring net earnings for your self-employment tax."

I continue to be amazed at how diligent the readers of About.com are about getting their taxes right. Taxpayers should compare multiple sources of information to make sure that their taxes are calculated correctly, and not just rely on software to make the decisions and calculations for them. So, Jenny, here's what's going on.

This change was part of the Small Business Jobs Act of 2010, which was signed into law on September 27, 2010. Section 2042 of the Small Business Jobs Act revised Internal Revenue Code section 162(l)(4) by permitting health insurance expenses to reduce net earnings for the purpose of calculating the self-employment tax for the year 2010 only. The current version of Publication 535 (as of the writing of this article) relates to the year 2009, and the PDF version of that publication states that the 2010 version will be posted soon. However, the IRS does reference this special rule for 2010 in their Instructions for Schedule SE (which is the tax form used for calculating Social Security and Medicare taxes for self-employed persons). You'll find it mentioned on page 1, column 1, under the heading What's New:

"Deduction for self-employed health insurance. For 2010, you may be able to reduce your net self-employment income by the amount of your self-employed health insurance deduction"

It's mentioned again on page 3. But very curiously, the IRS did not mention this 2010-only tax savings in their Tax Tips for March 14, 2011, which was entitled "Health Insurance Tax Breaks for the Self-Employed." That tax tip from the IRS mentioned that self-employed persons can deduct the cost of medical and dental insurance, but did not point out the additional benefit of reducing the self-employment tax.

So in summary, anyone can (potentially) deduct the cost of health insurance. Employees benefit most since health insurance premiums are deducted triple tax-free from their salary, without any of the limitations of the itemized deduction or the hassle of remembering to deduct the expense on their tax return. Self-employed types can deduct health insurance on page 1 of the 1040, which is also advantageous in avoiding the hassle and limitations of itemizing. Other taxpayers can deduct the cost of health insurance only as an itemized deduction. Being able to deduct medical and dental insurance costs is going to become an essential feature of our tax incentive system, especially since having health insurance coverage will become mandatory starting in 2014, thanks to the health care reform legislation passed back in March 2010.

Comments
October 7, 2012 at 9:24 pm
(1) Grammar King says:

Seriously, I stopped reading the article when in the very first paragraph you failed to use “your” vs “you’re” correctly. You said “whether you’re insurance”, when I am sure you meant to say “whether your insurance”. The contraction “you’re” is actually short for “you are” whereas “your” is indicative of ownership. If something is worth writing, it is worth writing correctly. I’m sure you’re going to look this up, then head to your keyboard and then you’re going to correct your mistake! Cheers.

October 7, 2012 at 9:36 pm
(2) William Perez says:

Thank you for bringing this to my attention. I have corrected the error.

November 8, 2012 at 4:04 pm
(3) Joe says:

All I have to say is:

Grammer King, your a jerk.

November 21, 2012 at 8:49 am
(4) D Right One says:

I had to have my taxes certified by an accountant last year after I filed myself using one of the software packages. The accountant found more refunds than the software due to comparing different scenarios. The accountant was twice as much as the software but the refund amount just from what she found more than offset the fee. Bottom-line, use a good accountant. The IRS tax structure and yearly revisions are usually too much to keep up for anyone who can’t use 1040EZ. You don’t do your own dentistry or defend yourself in court. Use an accountant to keep yourself out of the IRS crosshairs and get more money back.

January 19, 2013 at 7:09 pm
(5) Dude says:

Grammer King, what a royal fail on your part. You forgot about your own proper comma usage, and I quote, in part:

“…when in the very first paragraph you…”

You should have used commas or parenthesis, like this:

“…when, in the very first paragraph, you…”

or like this:

“…when (in the very first paragraph) you…”

Whenever it’s worth the time to correct someone, you should be very careful in making sure you don’t appear as a fool, yourself.

February 8, 2013 at 8:09 am
(6) Taxed says:

everyone keeps saying that employer pre-tax premiums are tax free. it appears to me they are only tax free when spending them. the amount of the premiums still show up on my W2 as part of my yearly income and i am taxed on the amount that was previously tax free. all it really does is reduce my tax burden per paycheck but then hits me at the end of the year!

i would love to hear your take on this.

March 2, 2013 at 8:01 am
(7) Race says:

What is with this grammar crap?! It was a typo get over it. grammar king (with a small g); you”re a loser. get a job and a sideshow.

March 3, 2013 at 3:35 pm
(8) MT_Ron says:

I have rental income and an HSA. I can only deduct the HDHP premiums if I am on unemployment. If I create a corp and have it operate as a property management company, pay me a wage for the 1 hour a month it takes to manage the properties and have it provide me the HSA as an employee benefit, would I be breaking any rules? The corp would charge me a management fee of enough to cover the wages and the HSA. The 1 hour per month is because the leases are triple net commercial leases and it actually takes less than an hour per month of work.

I know this question may sound specific to my situation but your answer could help any landlord. Thank you.

April 22, 2013 at 5:47 pm
(9) Eric says:

Hi Taxed –

Depending on how much the premiums are, you “could” be taxed on them. They started showing up on W2′s as part of the ACA requirements. If the total of what you + your employer pays in premiums exceeds the limit of the “Cadillac Plan” threshold set by the ACA, you pay a tax on that portion. Below this limit, you avoid all the federal taxes, including the FICA taxes.

January 2, 2014 at 8:50 pm
(10) dood says:

Dude can’t spell

January 12, 2014 at 4:07 pm
(11) Michelle Caudill says:

I am like the others here, It was a typo. It doesnt take away from the meaning for the article. It was still informative and though it may have irritated you. You lacked the tact to correct.

January 30, 2014 at 9:30 am
(12) Bob says:

This is a tax law thread. Please respect the rest of us and limit your comments to tax issues, which are frustrating enough without reminders from high school. Grammatical corrections are distracting and are best made on Facebook!

February 3, 2014 at 9:11 pm
(13) jz says:

If I have my own private health ins, can I still have my premiums pre-taxed through payroll? Does my employer have to send pymt of premiums through the company?

February 7, 2014 at 2:11 pm
(14) tc says:

jz- if you purchase Health Ins on your own you pay taxes on the premiums and don’t get the benefit of a pre-tax deduction. As stated in the article you can include Health Ins premiums as an itemized deduction to the extent that the bring all your Medical related costs about 7.5% of your AGI. Even then you’re still paying FICA (SS and Med) taxes on them, whereas if you are an employee and your employer’s Health Plan is setup as a Section125 deduction (most employer’s plans are) you will not pay Fed, State or FICA taxes on the Health Ins Deduction that is withheld from your paycheck.

This unfair, of course, to employee’s like you that have their own private insurance as well as self-employed persons. Congress needs to fix this and just make Health Ins non-taxable for everyone for Fed and FICA taxes! With the roll-out of ACA we’ll be seeing fewer employees getting their insurance from their employers. This tax disparity needs to be addressed.

PS I agree with GrammarKing who commented earlier on the author’s grammar. While I don’t normally expect or care about proper grammar usage in comments, I think it is reasonable to expect the author of an article to proofread it before publishing.

So Dude (comment 5): If you’re going to lecture another commenter on proper grammar usage, you may want to spell the word “grammar” properly: without the “e”.

February 11, 2014 at 1:20 pm
(15) David says:

Any word on how a self employed person should calculate the deduction if they are eligible for the PPACA tax credit? I’m assuming similar to the Small Business Tax credit that tax credits would reduce deductible premium, but how would that then impact MAGI calculation for determining eligibility to the tax credits? Would it make a difference if the tax credit were taken in advance v. at tax time?

March 18, 2014 at 2:54 pm
(16) Marta says:

In case you care. Preparation not preparation.

April 14, 2014 at 6:12 pm
(17) Willie G says:

My child is 24 and not in school. I pay for part of his insurance. My employer picks up part under Obama Care. I don’t ask my child, who does not live with me, to pay me back because it is not a great amount. Can I deduct the amount I pay for my child’s insurance on my taxes?

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