The Medical Expense Deduction After a Health Crisis: What Actually Counts

In a normal year, most people never come close to deducting medical expenses. Then comes the year with the surgery, the rehab, the oncologist three hours away, and the insurance plan that turned out to cover less than anyone thought. That is the year the medical expense deduction can matter.

It is also the year people get it wrong in both directions. Some never claim it because they assume it does not apply. Others claim things the law does not allow. Here is how the rule actually works.

The basic rule: Section 213 and the 7.5% floor

IRC Section 213 allows a deduction for medical care expenses paid during the year for you, your spouse and your dependents, to the extent they are not compensated by insurance or otherwise. The catch is the floor. IRS Tax Topic 502 explains that the expenses are deductible only "to the extent these expenses exceed 7.5% of your adjusted gross income for the year."

So if your adjusted gross income is $60,000, the first $4,500 of qualifying medical expenses does nothing for you. Only the amount above $4,500 counts.

And the deduction is an itemized deduction. Tax Topic 502 says you claim it on Schedule A (Form 1040). If your total itemized deductions, including the medical amount above the floor, do not beat your standard deduction, the medical expenses produce no tax benefit at all. Run both numbers before you decide.

What "medical care" means

Section 213(d)(1) defines medical care as amounts paid for four broad categories:

• Diagnosis and treatment. Amounts paid "for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body." Doctor visits, surgery, hospital stays, therapy and diagnostic tests live here.
• Transportation. Travel "primarily for and essential to" that medical care. Driving to chemotherapy counts. Driving to the pharmacy on the way home from work is a closer call.
• Qualified long-term care services, as defined in Section 7702B(c).
• Insurance. Premiums for insurance covering medical care, including Medicare Part B premiums, and eligible premiums for qualified long-term care insurance, subject to age-based limits that adjust annually.

Section 213(b) adds a limit on medicine: drugs count only if they are prescribed drugs or insulin. Section 213(d)(3) defines a prescribed drug as one that "requires a prescription of a physician for its use." Over-the-counter purchases generally do not count for this deduction, even if your doctor suggested them.

Lodging while you get treatment

Serious illness often means treatment away from home. Section 213(d)(2) treats lodging as medical care if the care is provided by a physician in a licensed hospital or an equivalent facility, there is no significant element of personal pleasure, recreation or vacation in the travel, and the lodging is not lavish or extravagant. The amount is capped at $50 per night for each individual. Publication 502 gives the example of a parent traveling with a sick child: up to $100 per night can be included. It also says plainly that meals are not included.

What does not count

• Anything reimbursed. If insurance, an employer plan or anyone else paid you back, it is not your expense.
• Anything paid from an HSA tax free. Section 223(f)(6) says an HSA distribution for qualified medical expenses "shall not be treated as an expense paid for medical care" for purposes of Section 213. You do not get to exclude the HSA money and deduct the same bill. See HSA withdrawals during a medical crisis.
• General health spending. Gym memberships, vitamins and similar items that benefit general health are not medical care unless they treat a specific condition. When in doubt, check IRS Publication 502, which lists many items by name.

Timing: the year you pay is the year you deduct

Section 213(a) refers to expenses "paid during the taxable year." That has two practical consequences.

First, bunching matters. Because of the 7.5% floor, a year with very large bills is the year the deduction works. If you have some control over when you pay a large balance, paying it in the same year as the surgery may produce a deduction where spreading it out would not.

Second, timing has to match across rules. If you are using the medical expense exception to the 10% early withdrawal tax on retirement money, that exception is also measured by medical expenses paid in the same year. Read retirement withdrawals for medical bills before you pull money from an IRA in December to pay bills in January.

The AGI problem in a crisis year

Here is a trap that catches people. The floor is 7.5% of adjusted gross income. In a crisis year, adjusted gross income can be strangely high. Retirement withdrawals to pay bills, a severance package, taxable disability payments and unemployment compensation all increase adjusted gross income, which raises the floor.

Look at an example. Your adjusted gross income is normally $50,000. In the year of the illness you also withdraw $30,000 from a traditional IRA. Adjusted gross income is now $80,000, and the floor moves from $3,750 to $6,000. Nothing about your medical bills changed, but $2,250 less of them is deductible.

You cannot always avoid this. But you should see it coming before you decide how to fund the bills.

Records that will hold up

If the IRS questions a medical deduction, the burden is on you to show what was paid, when, by whom, and for what. In a crisis year, records get lost because you are focused on getting better. Build the file as you go:

1. Explanation of benefits statements from the insurer, which show the charge, what insurance paid and what you owed.
2. Proof of payment for what you owed: bank statements, card statements, receipts.
3. A mileage log for medical trips with dates, destinations and purpose.
4. Lodging receipts with a note tying each stay to treatment dates.
5. Premium statements showing what you paid with after-tax dollars. Premiums paid through a pre-tax payroll plan are not deductible a second time.

Many patient portals let you download a year's worth of statements. Do it in January, before the portal purges the old ones or the account closes.

One more practical point. If a family member is paying some of your bills, decide early whose expense it is. Section 213 allows the deduction for expenses paid for yourself, your spouse and your dependents. Who actually wrote the check, and whether the patient is that person's dependent, can decide whether anyone gets the deduction at all. Sort that out before the money moves, not at tax time.

When the deduction does not fix the real problem

The deduction lowers taxable income. It does not pay the bills, and it does not cure a tax balance created by a withdrawal or a missed estimated payment. If the medical crisis also caused a missed filing deadline, read serious illness and IRS deadlines. If you are now looking at an IRS balance you cannot pay, the steps in owing the IRS after a job loss apply just as well to someone whose income stopped because of illness.

The bottom line

The medical expense deduction is real, but it is narrow. It applies only to unreimbursed medical care you paid during the year, only above 7.5% of adjusted gross income, and only if you itemize. In the year of a health crisis, it is worth running the numbers carefully, and worth keeping better records than you think you need.

You have enough to worry about this year. Do not let the paperwork be one of them.