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Medical care is a popular tax write-off for most retirees.
Why?
Health care costs are a significant component of most household spending in retirement, roughly 15% of a retiree’s budget.
So why not get a tax break on them?
Let’s ensure you understand which medical expenses you can write off and discuss key issues to plan for if you intend to write off medical expenses in the 2022 tax year.
And, don't miss out on download our cheat sheet with relevant tax planning figures as we set the scene. It's the same tool we use with clients to help them reduce taxes.
Plan To Itemize
Many people overlook the fact that you can only claim most tax deductions for healthcare expenses if you itemize deductions. If you fail to plan accordingly, you may miss out on a tax reduction opportunity.
When you file your taxes, you have two options for deductions.
Itemize your deductions - that is, name them one by one
or
Take the standard deduction.
Schedule A of your tax return details what you can itemize, but common items include:
Mortgage interest
Medical expenses
Charitable gifts
State and local taxes
If your itemized deductions don’t add up to a larger amount than the standard deduction, it typically makes sense to claim the standard deduction instead.
So what is the standard deduction?
For 2022, the standard deduction is $25,900 for a married couple that files a joint return and $12,950 for single filers.
If you aren’t quite there, you may be able to get over the hump by shifting some deductible items from one year to the next. For example, if you regularly give to charity, you could consider making several years' worth of contributions at once so you can itemize and claim more of your medical expenses.
This strategy could make sense if you regularly have expenses that get you close to the limit or if you have one year with exceptionally high expenses that don’t push you over the standard deduction.
Know Your AGI
To plan for itemizing expenses effectively, you must know your taxable income, namely your adjusted gross income (AGI). Your AGI is the “master key” to understanding your eligibility for deductions.
To calculate your AGI, start with your gross income and subtract certain deductions like 401k and HSA contributions. You can find the complete list of deductions on Schedule 1. Line 11 of your 1040 tax return also shows your AGI for prior tax years, which you can use as a reference point to estimate your AGI for the current year.
For medical expenses, taxpayers can deduct their total medical expenses over 7.5% of your AGI. Note that you can only take the medical expense deduction on the portion of your expenses that exceed 7.5%—not the entire amount. This rule applies whether you’re a W-2 employee or are self-employed.
For example, suppose you have an AGI of $80,000 and medical expenses of $10,000. 7.5% of $80,000 is $6,000, so you can deduct qualified costs above $6,000. You have $10,000 in expenses, so $4,000 is the qualifying amount you can deduct.
Understand The IRS Definition of “Allowable” Expenses
While you don’t need to memorize any lists, you do need to be aware that the IRS doesn’t count everything as an allowable expense. Just because you have a medical and dental expense doesn’t mean you can deduct it from your taxes.
While that may not be great news, the list is more comprehensive than you might think. Some common examples of deductible expenses include:
Health insurance premiums, as long as you pay them with after-tax dollars. In other words, you can’t deduct expenses that you also use to justify a tax-free health savings account HSA distribution.
Long-term care insurance premiums and expenses
Home care expenses
Medical equipment like wheelchairs, walkers, eyeglasses, and hearing aids
Medical expenses you paid for dependents (should you meet the IRS Publication 502 requirements)
These things can add up. If you’re in a health insurance plan with higher premiums and you incur significant out-of-pocket costs, you could be close to or over the deduction limit.
What’s not allowable? Common examples include:
Late fees for otherwise deductible premium payments
Non-prescription drugs
Personal hygiene items
Cosmetic surgery
Funeral or burial expenses
Remember, you can’t deduct costs unless they are qualified medical expenses. Medical bills can strain your cash flow, so be sure you have a sufficient plan.
What Records Do You Need To Give To Your CPA?
When you itemize, you have the opportunity to save money, but it also tends to come with more paperwork. If you have deductible expenses that you plan to claim, make sure you keep receipts.
The more detail you can provide your CPA for tax preparation, the better off you are likely to be. If you aren’t sure if you need to keep a document, err on the side of caution. Your CPA will tell you if it turns out they don’t need it.
Create A Larger Strategy for Itemizing
You wouldn’t retire without a distribution plan, and you shouldn't end the tax year without a deliberate strategy, either. You might not itemize every year, but when you do, it should be intentional. Think ahead about ways you can be the most tax-efficient before the year is over, so you don’t miss any planning opportunities, like charitable contributions, home office deductions, interest deductions, and other elements that directly impact your income tax return.
Here's a powerful checklist of key issues to consider before year end just so you avoid missing anything.
Reach out to us for help! We can help you create a proactive tax plan that takes a holistic view of your money and help you plan for the “best” years to take advantage of itemizing.
If you are aged 50 plus with over $1 million in investments (excluding real estate), contact us for a free, no-obligation consultation.
Scott Hurt, CFP®, CPA
Scott is a fiduciary, fee-only financial advisor at Covenant Wealth Advisors serving clients across the United States. He specializes in helping individuals aged 50 plus create, implement, and protect a personalized financial plan for retirement.
Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.
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