Module 17 Health Federal Tax Considerations

Tax Treatment of Benefits

When you have a health insurance policy, the premiums will either be paid by you or your employer. In general, if your employer pays the premiums, you can exclude the amount from your income for tax purposes. If your employer reimburses you for those premiums, the amount of the reimbursement is also not considered to be taxable income. Self-paid premiums are typically not deductible. The tax rules for this are the same as deducting medical expenses. However, some exceptions exist. If any unreimbursed medical expenses exceed 7.5% of a persons adjusted gross income, the amount over the 7.5% threshold can be deducted. Unreimbursed medical expenses include any premiums paid or any out of pocket expenses not covered by the insurance. (Note: medical expenses that are reimbursed by the insurance CANNOT be deducted.) Disability Income Policies When an individual buys a disability income policy, the premiums are not deductible from his/her income tax liability. However, the benefits received while disabled are considered tax-free. Self-Employed Persons Under certain circumstances, a self-employed person can deduct up to 100% of his/her health insurance premiums from income taxes. Tax Treatment of Health Premiums and Benefits The tax treatment of health insurance premiums and benefits depends, to a large degree, on the type of insurance in question. Tax of Disability Income Insurance Premiums paid for personal disability income insurance are not deductible by the individual insured, but the disability benefits are tax free to the recipient. When a group disability insurance plan is paid entirely by the employer for the employees, and benefits are paid directly to the individual employees who qualify, the premiums are deductible by the employer. The benefits, in turn, are taxable to the recipient. On the other hand, if an employee contributes to any portion of the premium, his or her benefit will be received tax free in proportion to the premium contributed. For example, if an employee pays 40 percent of the premium and the employer pays 60 percent, 40 percent of the benefit is tax free to the employee and 60 percent is taxable.

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Also, a self-employed individual may deduct 25 percent of amounts paid for health insurance covering the individual, spouse and dependents through 1991. The deduction cannot exceed self-employment net earnings and is not available where the individual or spouse is eligible to participate on a subsidized basis in an employer-sponsored health plan. Persons under age 65 who are retired on permanent and total disability may be eligible for a tax credit on their disability income. The credit is equal to 15 percent of an initial base amount ($5,000 if married with one spouse eligible or unmarried), less: 1. amounts received under pension, annuities or Social Security disability benefits; and 2. one-half the excess of the individuals adjusted gross income over specified amounts (e.g. $10,000 if married and filing a joint return or $7,500 if single). Taxation of Medical Expense Insurance Incurred medical expenses that are reimbursed by insurance may not be deducted from an individuals federal income tax. Furthermore, incurred medical expenses that are not reimbursed by insurance may only be deducted to the extent they exceed 7.5 percent of the insureds adjusted gross income. For example, an individual who has an adjusted gross income of $35,000 would be able to deduct only the amount of unreimbursed medical expenses of $2,625. For purposes of figuring any deductible medical expenses, prescription drugs, insulin, hospital expenses, physical and surgeon fees, nursing care, dental care, rehabilitative treatments and medical insurance premiums can all be considered. Benefits received by an insured under a medical expense policy are not included in his or her gross income, since they are paid to offset losses he or she incurred. However, medical expense insurance benefits must be included in gross income to the extent that reimbursement is received for medical expenses deducted in a prior year. Tax Treatment of Group Health Plans As an incentive for employers to provide health insurance benefits to their employees, the federal government grants favorable tax treatment to group plans. Lets briefly review this treatment. Taxation of Group Health Premiums Employers are entitled to take a tax deduction for premium contributions they make to a group health plan, as long as the contributions represent an ordinary and necessary business expense. By the same token, individual participants do not include an employer contributions made on their behalf as part of their taxable income. As a general rule, individual premium contributions to a group health plan are not tax deductible. Only when unreimbursed medical expenses expenses that can include any individual contributions to a group medical plan exceed 7.5 percent of an
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individuals adjusted gross income can a tax deduction be taken. The deduction is limited to the amount exceeding 7.5 percent of adjusted gross income. Any premiums the individual contributes for group disability or group AD&D coverage are not considered qualifying medical expenses when determining this excess. Taxations of Group Health Benefits Any benefits an individual receives under a medical expense plan are not considered taxable income, since they are provided to cover losses the individual incurred. It is a somewhat different story with disability income plans, however. Disability benefit payments that are attributed to employee contributions are not taxable, but benefit payments that are attributed to employer contributions are taxable. Lets look at an example. Anne is a participant in a contributory group disability income plan in which her employer pays two-thirds of the premium and Anne pays one-third. Her employer qualifies for a tax deduction for its share of the premiums and, as is true with employer contributions to all group health plans, Anne is not taxed on those contributions. The premium portion that Anne pays does not qualify for a tax deduction for her. Now assume Anne becomes disabled and receives disability income benefits of $900 a month. One-third of the monthly benefits - $300 would be tax-free, since it is attributed to the premium she paid; the remaining two-thirds of the payment - $600 would be taxable income, since it is attributed to the premium her employer paid.

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