The high cost of medical services makes having health insurance a necessity. Medical insurance premiums can be paid with either pre-tax or after-tax dollars, depending on how you get your insurance. The way you pay for your insurance also determines whether you can take a deduction for the costs.
Employer-sponsored health insurance premiums and those bought by the self-employed are made with pre-tax dollars.
Medical Insurance Premiums Pre Tax
Some employers offer to pay for health insurance premiums through a salary reduction agreement as part of your employee benefits. You agree to get paid a certain amount less in cash and your employer agrees to use that money to pay for your health insurance. For example, you might agree to take $5,000 off your annual salary in exchange for health insurance premiums. You then pay for your health insurance in pre tax dollars, because when your employer fills out your W-2 at the end of the year, your federal taxable income doesn't include the premiums. For example, if you were going to be paid $85,000, but $5,000 went to premiums, your W-2 only shows $80,000. So, you're not allowed to claim a deduction for these costs because they're not counted as income to begin with.
If, on the other hand, you pay your medical premiums out of your own pocket, you're allowed to deduct those costs as part of the medical expenses deduction. However, the medical expenses deduction is limited to only the expenses that exceed a certain percentage of your adjusted gross income – 7.5 percent for the 2017 and 2018 tax years. So, if you're not itemizing or expenses don't add up to the threshold percentage of your AGI, you won't get any deduction.
If you're paying out of pocket because you're self-employed, you might be in for a bigger tax break. As long as you're not eligible for coverage under an employer plan, or a spouse or dependent's employer plan, you can deduct your premiums as an adjustment to income rather then use the medical expenses deduction. Not only do you not have to itemize, but there's no AGI threshold you have to surpass to get a benefit. However, your deduction can't exceed your net self-employment income for the year.
Unfortunately for taxpayers without employer paid health insurance or an employer-sponsored plan, your insurance premiums still get hit by payroll taxes or self-employment taxes. If your premiums are paid through a salary reduction agreement, your employer doesn't withhold payroll taxes from the value of the premiums. But, if you pay them out of pocket and deduct them as part of the medical expenses deduction, you still pay the payroll taxes or self-employment taxes on the income.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."