Real World/Road Rules Challenge Contestant Learns – and Shares – a Tax Lesson

Last night, I was browsing through my email and a message caught my eye. A reader passed along a link to this piece written by Diem Brown, with a note that said, more or less, “Can you believe she didn’t know about the medical deduction?”

By way of background, Brown, age 30, is a recurring cast member on MTV’s Real World/Road Rules Challenge – a show that’s been around for about 15 years (I used to be quite the fan). In September 2005, Brown was diagnosed with stage 2 ovarian cancer. According to Glamour, only 30% of women survive advanced stages of the disease. As part of her treatment, Brown has had one of her ovaries, several lymph nodes and part of one of her fallopian tubes removed. She now blogs about her odyssey – including her wish to have a baby – at People.com.

The bit that caught the eye of my reader was this:

Throughout all this, I found two more really cool things.
1. This is a tax deduction no one ever told me about!
You can write off medical bills that exceed 7.5% of your income (doctor visits, dentist visits, medications, and even health insurance premiums – if you are out of pocket). EX: If you make $50,000 in 2012 and your medical bills are $30,000 you can write off $26,250 from your taxes, since 7.5% of $50,000 is $3,750.

2. If you help pay someone’s hospital bill who is not your dependent, then you can deduct that amount from your taxes!
TurboTax has all the information, but sounds pretty dang amazing if you ask me!

Brown did a decent job of explaining the deduction (even though some not so nice folks commented otherwise). And I’m not a bit surprised that she didn’t know the details until now. Even though taxpayers talk quite a bit about the medical expense deduction, most don’t actually qualify to use it.

To qualify for the medical expense deduction, you first have to itemize. Statistically, only about 1/3 of taxpayers itemize. Specifically, in 2009 (the last tax year for which complete data is available from IRS), only 32.5% (45,695,736) of the 140,494,127 returns filed claimed itemized deductions. Of those, just about 10 million taxpayers, or 7% of all taxpayers, claimed the medical expenses deduction.

Why so few? Statistically, taxpayers who itemize tend to be middle to upper income taxpayers; the biggest chunk of itemizers are those taxpayers who report between $100,000 and $200,000 in adjusted gross income (AGI) (report downloads in Excel) followed by those who report between $200,000 and $500,000. That already shrinks the pool.

Next, keep in mind that the medical expense deduction is limited to those qualifying medical expenses over 7.5% of your AGI. Think back to those statistics I just noted: that means that a majority of itemizers will have to spend, at the low end, at least $7,500 in medical expenses before they can claim a single dollar of medical expenses deduction and, at the high end, at least $37,500 in medical expenses before they can claim a single dollar of medical expenses deduction. That represents a lot of expenses. That might explain why, of those who itemized their deductions in 2009, neither of those income groups topped the list of those claiming the medical expenses deduction.

Taxpayers who claimed the medical expenses deduction were found most commonly in the $60,000 to $75,000 of AGI and $75,000 to $100,000 of AGI categories, strictly by the numbers. It’s even more fun to look at the percentages (as compared to the numbers): nearly 21% of those taxpayers in the $60,000 to $75,000 AGI range claimed the medical expenses deduction while only 8% of those taxpayers in the $100,000 to $200,000 AGI range claimed the medical expenses deduction.

Also figuring into those statistics? The cost of health insurance: that’s generally the expense that puts taxpayers over the magical threshold to claim the medical deduction. Traditionally, high income wage earners tend to have their medical insurance provided by an employer while those in lower income tax brackets don’t receive as much of a perk when it comes to benefits. That means that those at the lower end of the itemizers (mostly middle class) are likely to pay more as a percentage of income – and thus, qualify for the deduction.

Will that change with the new health care act? I think so. For one, there will be added pressure on employers to provide health care insurance for employees at all income tax levels. Those who don’t receive coverage from their employers will be forced to pay on their own: expect that number to go up as employers increasingly decide that employees aren’t really employees but rather independent contractors (related note: expect increased audits from IRS on this issue). Finally, the floor for itemizing medical expenses is slated to increase from 7.5% of AGI to 10% of AGI meaning that taxpayers must claim more in expenses to qualify for the deduction. Those changes will definitely affect filing statistics in the next few years.

But for now, the numbers of taxpayers deducting medical expenses on their tax returns are pretty statistically insignificant. I don’t find it odd that many taxpayers don’t know about the deduction or how to claim it. It’s not a particularly strongly drafted piece of the Code. I’ll go even further and say that I think the medical expenses deduction is one of the most flawed pieces of the Tax Code (together with the charitable deduction) because I don’t think it tends to benefit those who need it the most. Those who spend the most dollars as a percentage of income are generally barred by the dollar limitations for itemizing and those who spend the most dollars on a pure total basis are often limited by the alternative minimum tax (AMT) or barred by the deduction floor (that 7.5% of AGI). It is, quite frankly, a hot mess.

So, I think it’s great that Brown called attention to the specifics of the deduction. Some promotion might go a long way towards educating taxpayers (and maybe even Congress) to the opportunities and limitations of the deduction as written. And, of course, let’s hope that more and more taxpayers won’t need it in the first place… stay well, Diem!

This summer has been a whirlwind of activity and I’ll admit that I haven’t had as much time for fun reading as usual. I am always grateful for tips (you can email, tweet or Facebook me). Let me know if you want me to mention you in the piece.

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