- Form W-2? Check.
- Forms 1099-MISC? Check.
- Forms 1099-B? Check.
- Form 1098? Check.
- Receipts to support charitable deductions? Check.
- Receipts for medical expenses? Er, you might want to leave those at home.
Of all of the deductions in all of the tax world, medical expenses top the list of “tax breaks that you think you’re getting but you really aren’t.” And here’s why.
Statistically, the majority of taxpayers claim the standard deduction and do not file a Schedule A for itemized deductions. This is by design. For most taxpayers, the question of whether to itemize is purely financial: if your itemized deductions total more than the standard deduction, you would report those on Schedule A. For 2014, the standard deduction amounts are $6,200 for individual taxpayers or those taxpayers married filing separately; $12,400 for taxpayers married filing jointly or qualifying widow(er); and $9,100 for taxpayers filing as head of household.
Even if your itemized deductions are less than the standard deduction, you may choose to itemize. This isn’t very common but it may make sense because of your state tax return or because you are married filing separately and your spouse chooses to itemize. Whatever the reason, itemized deductions are still only claimed by about a third of all taxpayers. For 2012, the last year that data is available, just under a third of taxpayers itemized their deductions, or 46 million out of 145 million taxpayers who filed returns.
Of those 46 million taxpayers or so who choose to itemize, most do not claim medical expenses as deductions on their Schedule A. In fact, for 2012, medical expenses were not the most popular Schedule A deduction. They also were not the second, third or fourth most popular. According to the IRS, a mere 22% of taxpayers who itemized deductions in 2012 claimed the medical expense deduction. If you do the quick math, that works out to less than 7% of all taxpayers.
Those statistics don’t take into consideration a recent – and very significant – change: the raising of the medical expenses floor. In 2012 (and before), qualifying medical expenses were only deductible to the extent that they exceeded 7.5% of your adjusted gross income (AGI). So for example, if your medical expenses totaled $5,000 in 2012 and your AGI was $50,000, you could, assuming that you itemized, deduct $1,250 of medical expenses: $5,000 (total expenses) less $3,750 (7.5% of $50,000).
That all changed with Obamacare. The floor for itemizing medical expenses was raised beginning in the 2013 tax year from 7.5% of AGI to 10% of AGI (seniors are exempt from the increase through January 2017). Using our prior example, those same $5,000 in medical expenses that you claimed and deducted a portion of in 2012 aren’t deductible at all in 2013: $5,000 (total expenses) less $5,000 (10% of $50,000) is zero.
Hitting 10% of your AGI in medical expenses is a steep hill to climb. As AGI goes up, the chances of claiming the deduction go down. And, of course, as AGI goes down, the odds that you’re itemizing your deductions are reduced.
So who stands the best chance of benefiting from the medical expenses deduction? The upper middle class.
Statistically, those who have an AGI of between $75,000 and $100,000 claim the lion’s share of the medical expenses deduction. Those with AGI between $60,000 and $75,000 and $100,000 and $200,000 are next in line. All total, taxpayers with an AGI of between $60,000 and $200,000 claim nearly 40% of all medical expense deductions even though they comprise less than 20% of total taxpayers.
Who stands the least chance of claiming the deduction? The über wealthy. Not one taxpayer with an AGI over $10 million claimed the deduction in 2012. Those with an AGI of between $5 and $10 million were next least likely to claim the medical expenses deduction followed by those with an AGI of between $2 and $5 million. That trend of higher income taxpayers not qualifying for the medical expenses deduction will likely continue.
(Author’s note: While middle class is tough to define, the latest Census Bureau report (downloads as a pdf) places median household income at $52,250 for 2013. Expect AGI for those households to be a bit less since than that figure since it reflects only income subject to tax less certain adjustments.)
Of course, it’s not hard to understand why this happens when you look at the demographics and limits. Most itemizers tend to be middle to upper income taxpayers because exceeding the standard deduction limits usually requires – though not always – a certain level of income to support those expenses. Since the cost of medical insurance generally puts taxpayers over the magical threshold to claim the medical deduction, those that have their health insurance paid for by an employer (increasingly the case with Obamacare) will likely not have enough qualifying expenses to claim the medical expenses deduction. Those that pay for their own health care through the exchanges may not pay enough in premiums to get to the magic number.
So who is most likely to claim the medical expenses deduction for the 2014 tax year? The self-employed and small business owners. Those who continue to pay for their own health insurance are the most likely to hit the threshold for the deduction. Ditto for employees who contribute to their own plans through pay deductions. Seniors who pay extra for Medicare (especially Part D) may also reach the floor. And, of course, those with extraordinary health care expenses can also benefit from the deductions.
If those circumstances don’t apply to you, chances are you’re not going to hit the floor. Adding up those $10 and $20 co-pays likely won’t get you past 10% of your AGI unless you go to the doctor a great deal or have a high deductible plan.
If you think you’re near the floor (for a quick ballpark estimate, check your combined forms W-2 and calculate 10% of that number), then by all means, gather up proof of expenses. The rest of you can do yourselves and your tax professional a favor and leave the shoebox of medical receipts at home.