Although Congress continues to debate healthcare reform, current tax rules still apply. This means that taxpayers who itemize their personal deductions can claim a medical expense deduction for costs not reimbursed by insurance that exceed 7.5% of adjusted gross income. Sometimes it is not easy to determine whether an expense qualifies as a deductible medical expense. Here are some recent developments that affect medical deductions:
To be a deductible medical expense, a cost must be paid for the diagnosis, cure, mitigation, treatment or prevention of a disease; or for the purpose of affecting any structure or function of the body (Code Sec. 213(d)). In other words, two tests must be met: There must be a condition, and there must be a treatment.
Despite the 7.5% floor for deducting medical expenses and that only expenses in excess of insurance reimbursements qualify, taxpayers are claiming significant write-offs for medical expenses, according to the Spring 2009 Statistics of Income Bulletin — which details itemized deductions claimed on 2007 returns (www.irs.gov/taxstats/article/0,,id=208577,00.html). Here are the average deductions claimed for those within an adjusted gross income range:
- $15,000 to under $30,000: $6,849
- $30,000 to under $50,000: $6,040
- $50,000 to under $100,000: $6,690
- $100,000 to under $200,000: $9,922
- $200,000 to under $250,000: $22,810
- $250,000 and over: $32,813
For purposes of the alternative minimum tax, only medical expenses that exceed 10% of adjusted gross income are allowed (Code Sec. 56(b)(1)(B)).
Sex Reassignment Surgery
The tax law bars deductions for cosmetic surgery unless it is incurred for treatment of a disfiguring condition that arises from a congenital abnormality, personal injury, trauma or disease — such as reconstructive surgery following the removal of a malignancy (Code Sec. 213(d)(9)). In a case of first impression, the Tax Court tackled the question of whether sex reassignment surgery meets the exception to the ban on deductible cosmetic surgery.
In the case, the taxpayer was born a genetic male but was diagnosed with gender identity disorder, or GID. This is a recognized condition in the medical field. He took female hormones and had sex reassignment surgery and breast augmentation surgery. The taxpayer, now a female, claimed a medical expense deduction for costs totaling $21,741 for the hormone therapy and sex reassignment surgery, and $19,195 for the breast augmentation surgery. None of these costs were covered by insurance.
The IRS disallowed all of these expenses. It has previously issued advice to this effect (Chief Counsel Memorandum 200603025). The IRS believed that congressional action was needed to clarify whether this type of surgery should be treated as necessary cosmetic surgery, which would be deductible; or cosmetic surgery to improve appearance, which would not be deductible. Until such time, it viewed sex reassignment surgery as a nondeductible cosmetic procedure.
The Tax Court held that all of the expenses were deductible medical costs except for those related to the breast augmentation surgery (O'Donnabhain, 134 TC No. 4 (2010)). In the court's view, both tests for a deductible medical expense are met in this case: The person suffered from a medical condition and received appropriate treatment. More specifically, it recognized that a person suffering from GID experiences persistent psychological discomfort because of gender, which is a condition. The treatment for this condition is hormone therapy, living in public as the opposite sex and ultimately, undergoing sex reassignment surgery.
The Tax Court, however, did not allow a deduction for the cost of breast augmentation. In this case, the taxpayer had normal breasts before the surgery and had the surgery to improve appearance — not to ameliorate a deformity. Previously, the Tax Court allowed an exotic dancer known as Chesty Love to take a business deduction for the cost of cosmetic surgery to become a size 56N (Hess, TC Summary Opinion 1994-79). In this case, the deduction was an ordinary and necessary business expense — her breasts became her stage props.
Cost of Baby Formula
A number of prior cases and rulings have addressed when and to what extent the cost of special foods or beverages can be deductible. More than 50 years ago, the IRS ruled that doctor-prescribed foods and beverages are deductible only if they are in addition to normal dietary needs (Rev. Rul. 1955-261, 1995-1 CB 307). On the basis of this ruling, the IRS disallowed the cost of a reduced-calorie diet prescribed by a doctor for an obese person because the food was a substitute for normal foods with nutritional requirements (Rev. Rul. 2002-19, 2002-1 CB 849).
In a recent case, a mother wanted to deduct the cost of infant formula. The mother had had a double mastectomy and was unable to breast-feed. The IRS ruled that the cost of the baby formula was not a deductible medical expense (Letter Ruling 200941003). It was used to satisfy nutritional needs of the baby — not to supplement the baby's nutritional needs.
In Vitro Fertilization
In vitro fertilization (IV) is a process by which egg cells are fertilized by sperm outside the womb. The cost of the procedure runs about $12,000 per cycle. Although many medical insurance policies cover some fertility treatments, IV usually is not covered.
The cost of IV and other fertility treatments can be deductible by a mother who cannot become pregnant in the usual way. In this case, IV can be viewed as treating the condition of infertility. The IRS allows deductions for temporary storage of eggs or sperm as well as surgery to reverse tubal ligations and vasectomies undertaken to prevent a person from having children (see IRS Publication 502).
However, IV costs are not always deductible. Take the recent case of a healthy father who used IV with two different women to father two children. The Tax Court denied the deduction and an appellate court agreed (Magdalin, CA-1 USTC 2010-1 ¶50,150, aff'g TC Memo 2008-293).
The expenses did not meet the first criteria of a deductible medical expense because they were not incurred to treat a condition. The father was perfectly healthy. Thus, the costs were nondeductible personal expenses.
New Rules for 2010
Some numbers have changed for purposes of the medical expense deduction.
- Health savings accounts (HSAs): A health savings account is an IRA-like account to which deductible contributions can be made (Code Sec. 223). Earnings in the account grow on a tax-deferred basis, though withdrawals to pay medical expenses can be taken tax-free. Each year, the IRS sets limits on contributions to HSAs; the limits for 2010 are higher than they were for 2009 (Rev. Proc. 2009-29, IRB 2009-22, 1050).
For 2010, the contribution limit for an individual with self-only coverage under a high-deductible health plan (defined below) is $3,050. The contribution limit for an individual with family coverage is $6,150. Anyone who is at least 55 years old by the end of the year can add another $1,000 to the deductible contribution limit.
A high-deductible health plan is defined as one with an annual deductible of not less than $1,200 for self-only coverage, or $2,400 for family coverage (Code Sec. 223(c)(2)(A)). The annual out-of-pocket expenses for deductibles, copayments and other amounts (other than premiums) cannot be more than $5,950 for self-only coverage, or $11,900 for family coverage.
- COBRA coverage for the unemployed: The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act )(P.L. 111-5) introduced a new benefit: Individuals involuntarily terminated from a job on or after Sept. 1, 2008, and before Jan. 1, 2010, and whose employers were subject to COBRA could opt for this coverage in which the federal government pays 65% of their premiums for up to nine months. The Department of Defense Appropriations Act, 2010, (P.L. 111-118) extended this benefit. More specifically, the federal government will continue to pay 65% of insurance premiums for eligible individuals for up to 15 months instead of the former nine-month period. Eligible individuals include those involuntarily terminated in January and February 2010 (instead of through the end of 2009).
Individuals using COBRA who become ineligible for coverage (e.g., they join another group plan or become eligible for Medicare) must notify the plan providing the COBRA coverage. An individual who fails to make this notification and continues to receive the COBRA premium subsidy after becoming eligible for other group health coverage or Medicare may be subject to a penalty of 110% of the subsidy (Code Sec. 6720C).
The federal subsidy is tax-free for individuals with modified adjusted gross income (MAGI) below $125,000 for singles, and $250,000 for joint filers (Act Sec. 3001(b)(1) of the 2009 Recovery Act). There is a phase-out for tax-free treatment for singles with MAGI between $125,000 and $145,000, and for joint filers with MAGI between $250,000 and $290,000. For those with MAGI over this ceiling, the subsidy is included in gross income.
The IRS provides information on the COBRA subsidy for employers as well as employees and former employees at www.irs.gov/newsroom/article/0,,id=204505,00.html.
- Driving for medical purposes: Those who use a car to drive to a doctor, pharmacy, therapy session or for other medical purposes can deduct the cost of driving based on an IRS-set mileage rate. For 2010, the rate for medical driving is 16.5 cents per mile (Rev. Proc. 2009-54, IRB 2009-51, 930). The 2010 rate is down significantly from the 2009 rate of 24 cents per mile.
In order to claim this deduction, it is important to keep good, contemporaneous records to substantiate medical-related driving.
Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.