With the ever-increasing cost of health insurance and medical care, you should be vigilant in looking for chances to claim any possible healthcare-related tax breaks. Unfortunately, changes taking effect this year make that harder than ever. Here's the story, along with some potential solutions.

IRS-Approved Medical Expenses

Here's an alphabetical list of some costs that count as medical expenses for itemized deduction purposes:

  • Acupuncture;
  • Ambulance;
  • Artificial limb and artificial teeth;
  • Bandages;
  • Braille books and magazines;
  • Car (cost of special equipment so disabled person can drive);
  • Chiropractor;
  • Christian Science practitioner;
  • Crutches;
  • Dental care;
  • Diagnostic devices;
  • Drugs (prescription only except for insulin);
  • Eyeglasses and contact lenses (plus wetting and cleaning solutions);
  • Eye surgery;
  • Guide dog;
  • Hearing aid;
  • Home improvements for medical purposes (to the extent they don't add to the value of your home);
  • Hospitalization;
  • Insurance premiums for health coverage (including age-based);
  • Premiums for qualified long-term care insurance;
  • Laboratory fees;
  • Lifetime care fees (percentage of fees paid under lifetime contract with a continuing care retirement community);
  • Meals (while staying in hospital or similar facility);
  • Medicare insurance premiums;
  • Nursing home and long-term care services;
  • Nursing services;
  • Optometrist services;
  • Osteopath services;
  • Oxygen;
  • Psychiatric care;
  • Psychoanalysis;
  • Stop smoking program;
  • Surgery;
  • Telephone (cost of special equipment for hearing impaired);
  • Television (cost of special equipment to display subtitles for hearing impaired);
  • Therapy;
  • Transplant;
  • Transportation to receive medical care (24 cents per mile for 2013, which is up from 23 cents per mile for 2012);
  • Weight loss program (if part of treatment for specific disease or condition, such as obesity);
  • Wheelchair;
  • Wig (if hair is lost due to medical issue);
  • X-rays.

Source: IRS Publication 502, Medical and Dental Expenses

Itemized Medical Deduction Threshold is Now Higher

Before this year, you could claim an itemized deduction for medical expenses paid for you, your spouse, and your dependents, to the extent those expenses exceeded 7.5 percent of your adjusted gross income (AGI).

Your AGI is the number at the bottom of page 1 of your Form 1040. It includes all your taxable income items and is reduced by certain write-offs -- such as those for moving expenses, deductible IRA contributions, alimony payments, and student loan interest.

The 7.5 percent-of-AGI hurdle was hard enough to clear. Now, thanks to the 2010 healthcare legislation, an even higher threshold of 10 percent of AGI applies to most taxpayers --beginning this year. However if either you or your spouse will be 65 or older as of December 31, 2013, the unfavorable new 10 percent-of-AGI threshold will not affect you until 2017. Until then, the longstanding 7.5 percent-of-AGI threshold will continue to apply for those 65 and older.

Potential Tax-Smart Idea: Pay Medical Expenses Every Other Year

Many types of medical expenses do qualify for the deduction (see right-hand box). However, there are also many expenses that are not eligible, such as cosmetic surgery that improves a person's appearance but doesn't treat illness or disease or help the body function better.

If you have flexibility about when medical expenses are incurred, you may be able to concentrate them in alternating years. That way, you can claim an itemized medical expense deduction every other year, or every third year -- instead of never getting a tax benefit.

Example: Let's say your AGI is $65,000. You pay $11,000 of medical expenses in 2013 because you have elective surgery, buy new contact lenses, and have a dentist put sealants on your children's teeth. Next year, you pay only $2,000 in medical expenses.

On your 2013 Form 1040, you can claim an itemized deduction of $4,500 ($11,000 minus the $6,500 10 percent-of-AGI threshold). Next year, you won't have any deduction. But if you simply spread the two-year total of $13,000 of medical costs evenly over this year and next year, you'll be completely out of luck in both years.

Bottom Line: Deductions in some years are better than not getting any deductions.

Another Tax-Smart Solution: Take Advantage of Your Company's Healthcare FSA

Until this year, there was no tax-law limit on contributions to your employer's healthcare flexible spending account (FSA) plan (although many plans impose their own limits). But the FSA situation has also changed.

Background: Amounts you contribute to the FSA plan are subtracted from your taxable salary. Then, you can use the funds to reimburse yourself tax-free to cover qualified medical expenses that are not reimbursed by insurance.

Starting this year, however, the maximum annual FSA contribution for each employee is capped at $2,500 by law. That doesn't change the fact that you should take full advantage of your company's FSA plan if one is offered. Failing to do so is like leaving money on the table. But you may be able to get less taxable benefit from an FSA.

What If You Are Self-Employed?

Self-employed taxpayers who pay their own medical and dental insurance premiums are generally allowed to deduct these costs "above the line" on page 1 of Form 1040. This rule is helpful, because you do not need to itemize to benefit from an above-the-line deduction.

Unfortunately, that's about the end of the good news. In general, your only recourse for other out-of-pocket medical expenses (other than health premiums) is claiming an itemized deduction when those costs exceed 10 percent of AGI (or 7.5 percent if you qualify for the lower threshold due to your age or your spouse's age).

Conclusion

The federal income tax treatment of out-of-pocket medical expenses has taken a turn for the worse. However, your tax results might be able to be improved if you plan ahead for medical expenditures (to the extent possible) and take advantage of your employer's healthcare FSA (if one is offered). If you have questions or want more information about your situation, contact your tax adviser.

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