You may know medical expense is tax deductible in schedule A (itemized deduction) of form 1040. However, you may overlook the fact you can’t deduct the medical expenses until such expenses exceed 10% of your adjusted gross income (AGI). That means if you have medical expenses of $20,000 during the year, assuming your AGI is $190,000, you can only deduct $1,000! ($20,000 – $190,000*10%). If your tax bracket is 30%, your tax saving from the medical expense of $20,000 is only $300 ($1,000 * 30%)!
You are right, your tax benefit will be even gone if the AGI is $200,000 in the above example.
That definitely is not helping you much. From the above example, if your tax bracket is 30%, your tax saving would have been $6,000 ($20,000 * 30%) without the 10% of AGI threshold.
How can we get away from the 10% of AGI threshold?
This is possible if you are running business in LLC, sole proprietorship or C-corporation.
By setting up section 105 Health Reimbursement Plan properly in your business, the eligible employee can get tax-free reimbursement from your company for medical expense.
Reimbursement means the Company pays you back the medical cost. This expense will be tax deductible by the Company, but you don’t need to report as income when you receive it!
Sounds too good to be true? You certainly need to be careful as such Section 105 plan has to be available for all eligible employees. You can perfectly structure this plan if your spouse is your only employee. In addition, you can define eligible employees who work full time, over 25 years old and over three years of service on the plan date.
Going back to the above example. If you have medical expense of $20,000, assuming you have a sole proprietorship business and your spouse is the only employee of your business, your spouse can reimburse $20,000 from the company for the medical expense before tax. Say your spouse’s salary is $60,000 from your business, the W-2 will show $40,000 as taxable wage instead because $20,000 is tax-free reimbursement for medical expense.The good part of it is the business can deduct the full $60,000 as payroll and employee benefit expenses!
If you have a business, this is definitely a better solution for medical expense deduction than Schedule A itemized deduction.