You May Be Able to Deduct Medical Expenses, But There’s a Catch

Jacqueline N. Janczewski, CPA, MBT, PFS

As you likely know, health insurance does not cover everything. In fact, multiple studies have found that out-of-pocket medical expenses are rising rapidly — even for the insured. If there is good news, it is that some unreimbursed health care costs can be tax-deductible in certain circumstances. Let’s take a look.

7.5% rule

If you itemize deductions on your income tax return, you are permitted to deduct a variety of medical and dental expenses for yourself, your spouse and your dependents. However, there is a catch: You can take the deduction only if these expenses exceed 7.5% of your adjusted gross income (AGI) — and then you can deduct only the amount over the 7.5% threshold. For example, if your AGI is $200,000, the floor above which the deduction begins is $15,000 ($200,000 x 7.5%). So if you have $20,000 in eligible health care expenses, you may claim a $5,000 deduction ($20,000 – $15,000).

Remember that this deduction is limited to unreimbursed expenses. You must reduce your total deductible expenses by any reimbursements from insurance or other sources, regardless of whether you receive the reimbursement directly or it is paid on your behalf to a medical provider.

What qualifies?

Another potential stumbling block is the fact that not all medical and dental expenses qualify for the deduction. For example, expenses for cosmetic surgery, health-club dues, medical marijuana, vitamins and over-the-counter drugs (except insulin) generally are not eligible. Fortunately, in addition to most office visits, hospital stays and prescription drugs, these costs typically are deductible:

• Health insurance and qualified long-term care insurance premiums (subject to limits);
• Inpatient alcohol and drug addiction treatment;
• Acupuncture sessions;
• Weight-loss programs for physician-diagnosed diseases;
• Smoking-cessation programs;
• In vitro fertilization (IVF) programs;
• LASIK vision correction surgery;
• Adaptive equipment, such as eyeglasses, contact lenses, hearing aids, dentures, crutches and wheelchairs;
• Nursing home care, including meals and lodging, if the availability of medical care is the principal reason for residence; and
• Transportation expenses essential to obtaining eligible medical care, such as the cost of taxis, buses, trains or ambulances, as well as personal vehicle mileage.

Note that although transportation expenses related to obtaining care can be deductible, lodging and meal costs typically are not.

Tax tips for the self-employed

The self-employed can deduct 100% of the health insurance premiums they pay for themselves and their spouses, dependents and nondependent children under age 27, regardless of whether they itemize. (The deductible amount may be limited depending on the taxable income of the business.) You can even deduct premiums you pay for Medicare Part B, Medicare Part D or a medigap policy, if you continue to run your business after you qualify for Medicare. Be careful: You cannot claim the self-employed health insurance deduction if you are eligible to participate in a subsidized health plan offered by an employer of yours or a family member.

If you are self-employed and eligible for the 20% qualified business income (QBI) deduction, also weigh potential benefits of the self-employed health insurance deduction against any resulting reduction in the QBI deduction. Depending on your circumstances, it may be more advantageous to claim insurance premiums as an itemized deduction so you can preserve a larger QBI deduction.

Planning opportunity

The IRS provides a list of all qualified medical expenses on its website. If it looks like you might reach the 7.5% of AGI threshold in 2024, review the list and think about scheduling appointments or deductible services or making purchases that qualify before the end of the year.

For more information, contact your ORBA advisor or Jacqueline Janczewski at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.

Closely Held Business Owners: Make an Exit Plan Before You Need It

Colin O’Neill, JD, CPA

If you own a closely held business, it probably accounts for a significant portion of your net worth, so a sound exit strategy may be critical to the health of your retirement and estate plans. Here are some tips for getting started before you decide to retire, move on to a new venture or otherwise make your exit.

What is it worth?

The first step in exit planning is to obtain a professional valuation of your business. This will help you understand how prospective buyers or investors view it and gauge its value. It may be tempting to rely on a rule of thumb, such as earnings multiples commonly used in your industry. However, rules of thumb typically are based on industry averages and are not a good substitute for professional appraisals that, among other things, consider your company’s underlying fundamentals, unique attributes, risk profile and future earning potential.

A valuation professional will examine the factors that drive your business’s value and highlight weaknesses that may reduce it. Analyzing these factors can help you identify changes that will likely boost your company’s value and can increase its selling price. For example, if your management team lacks depth and relies too heavily on your talents, prospective buyers may be concerned about the company’s ability to perform without you. Bringing in executives with the skills needed to take over after you have left can enhance your business’s value.

What are your options?

There are many options for exiting a business, and the right ones depend on your goals. For example, if your goal is to diversify your assets for financial and estate planning purposes, selling the business outright to a third party might be appropriate. However, if you are not ready to give up working in the business, a better option may be to sell a minority stake in the company to a private equity firm or other investor group.

It is also important to consider your family circumstances. Do your children or other family members work in the business or plan to? If so, you may wish to transfer ownership interests to them as part of your estate plan. However, if your liquid assets outside the business are insufficient to fund your retirement, it may make sense to sell the business to family members, perhaps in installments over time.

What if your family is not interested in taking over the business, but you are reluctant to sell to a third party or dilute your ownership by bringing in outside investors? There are other options that allow you to tap your equity without giving up control (at least not right away). Examples include management buyouts and employee stock ownership plans (ESOPs). See “Is an ESOP right for you?” below.

What are the tax implications?

Taxes can have a major impact when you exit a business, especially if you are selling it. For example, if your company is a corporation, selling stock rather than assets is usually preferable because your profits will generally qualify for more favorable capital gains treatment. Plus, if your business is organized as a C corporation, you will avoid the double taxation associated with asset sales.

In such cases, proceeds are taxed once at the corporate level and again when they are distributed to shareholders. Buyers, on the other hand, usually prefer to acquire assets because they obtain a higher basis in fixed assets for depreciation purposes.

If you sell assets, it is important to consider how the purchase price will be allocated. There may be opportunities to reduce your tax bill by allocating a portion of the purchase price to assets that generate capital gains, such as goodwill and certain other intangibles. If your company is a C corporation and you are able to allocate some of the purchase price to your personal goodwill, that amount will be paid directly to you, avoiding double taxation.

Start early

Identifying the right exit strategy and laying the groundwork for leaving your business can take time. So the earlier you start planning and discussing goals with your advisors, the better.

Sidebar: Is an ESOP right for you?

If your business is a corporation, one exit strategy to consider is an (ESOP). An ESOP is a qualified retirement plan, similar to a 401(k), that invests primarily in your company’s stock. Not only is an ESOP an attractive financial benefit for employees, but it can also be a powerful tool for exiting the business on your own terms.

For example, an ESOP typically allows you to:

• Create a market for some or all of your shares (by selling them to the ESOP).
• Tap your equity in the company without immediately giving up control. You can continue to manage the company, plus, if you serve as trustee of the ESOP trust, you will be able to vote the trust’s shares on most corporate decisions.
• Defer or eliminate capital gains taxes on the sale of C corporation stock by reinvesting the proceeds in qualified replacement securities, assuming you meet certain requirements.
• Generate substantial tax benefits for the company, including tax deductions for ESOP contributions and, if your company is an S corporation, eliminating tax on income passed through to shares held by the ESOP.

For more information, contact Colin O’Neill at [email protected] 312.670.7444. Visit ORBA.com to learn more about our Wealth Management Services.