In the US, the federal government and many states impose income taxes. Filing tax returns and paying income taxes are a reality that millions of Americans face. Such taxes are essential for the continued operation of many government programs like Social Security and Medicare.
Another essential is having health insurance, and these two systems share a common purpose. Just as taxes ensure certain community services keep running, your health insurance premiums ensure you have continued access to quality healthcare.
Because access to good medical care is so crucial, health insurance premiums can be tax deductible. If you are still determining how this tax deductibility affects you, read our easy-to-understand guide to tax deductibility in the US.
Tax Deductions For Health Insurance Premiums
When paid out of pocket for policies covering medical care, health insurance premiums typically qualify as deductible medical expenses on your federal taxes. This means you can often deduct these premiums from your taxable income.
But tax deductions for health insurance premiums depend on your employment status and how much you spent on medical care for the year.
If you’re self-employed and pay for medical insurance, you can deduct it from your taxes. However, if you are receiving employer-sponsored health insurance, your employer will likely pay a large portion of your premiums, which lessens the amount you can deduct (if any).
Employers who offer insurance report their compliance directly to the IRS. If you are filing your income tax returns as a self-employed person, you’ll have to report your insurance status yourself.
Premium Tax Credits As Part Of ACA Subsidies
Premium Tax Credits are a key component of the Affordable Care Act (ACA). Subsidies in the form of tax credits are designed to help eligible individuals and families afford health insurance coverage through the Health Insurance Marketplace.
To qualify for Premium Tax Credits, your household income must fall within a specific range, typically between 100% and 400% of the federal poverty level (FPL) for your household size. The Premium Tax Credits are usually paid directly to the health insurance company you choose. This reduces the amount you have to pay out of pocket for your monthly premiums.
Tax-Deductible Health Insurance Plans
Tax-deductible health insurance plans encompass a range of policies and circumstances that allow individuals to benefit from tax advantages.
ACA Marketplace Plans
ACA-approved plans are long-term major medical insurance policies that comply with the requirements and regulations established by the Affordable Care Act. These plans are available through the Health Insurance Marketplace or a licensed broker like Enhance Health.
ACA-approved plans are required to cover a prescribed set of essential health benefits. They are available at various price points and include different plans, from exclusive to preferred provider plans. The coverage you get will depend on the type of plan and the premium you pay.
You can sign up for an ACA plan during the Open Enrollment period from 1 November to 15 January (in most states). ACA plans are tax deductible and primarily revolve around the Premium Tax Credit (PTC) and the Health Savings Account (HSA) deductions.
Premium Tax Credit (PTC)
The Premium Tax Credit is a subsidy that helps eligible individuals and families afford health insurance purchased through the Health Insurance Marketplace. To qualify, your income should fall between 100% and 400% of the federal poverty level.
When you apply for health insurance, estimate your yearly net income. Based on this calculation, the government may provide advance premium tax credits, reducing your monthly premium costs.
At the end of the tax year, reconcile your estimated and actual net income on your tax return. If you received too much in advance premium tax credits, you’ll have to repay some. If you received too little, you might receive additional credits.
The Premium Tax Credit is refundable. If it exceeds the amount of tax you owe, you’ll receive the excess as a tax refund.
Health Savings Account (HSA)
If you have a high-deductible health plan (HDHP) that meets the ACA’s criteria, you may be eligible to open and contribute to an HSA. Contributions to an HSA are tax-deductible, reducing your taxable income by the amount you contribute and lowering your income tax liability.
There are annual contribution limits, and they can change from year to year. Additionally, if you are 55 or older, you may be eligible for catch-up contributions, allowing you to contribute more to your HSA.
The Consolidated Omnibus Budget Reconciliation Act, or COBRA, allows employees (and their families) who lose their health benefits (due to job loss, for example) to continue receiving their health plan benefits.
This is called continuation coverage, which only continues for a limited period. It’s applicable where coverage would have ended, like job loss, retrenchment, changing jobs, or a significant life event like a death or divorce.
COBRA requires employer-sponsored group health plans with 20 or more employees in the prior year to offer this option.
Be aware that you may be required to pay 100% of the premiums out-of-pocket. If you do, they’re tax deductible as a medical expense. But you must use the itemized deduction option, and your COBRA premiums and other medical expenses must exceed 7.5% of your Adjusted Gross Income (AGI.) ( For an explanation of what this means, see the section titled Maximizing Your Tax Benefits: Deducting Medical Costs, below).
COBRA premiums are typically not tax-deductible from federal income tax, as they are generally paid with after-tax dollars. However, there is an exception under the American Rescue Plan Act (ARPA).
This Act was enacted in March 2021 to provide financial relief to people affected by the COVID-19 pandemic, and funds are available for allocation until December 31, 2024. It allows eligible individuals (who face reduced work hours or involuntary termination of employment) to receive a tax credit.
This ARPA subsidy allows eligible individuals to receive a tax credit covering the total cost of their COBRA premiums for a specified period. It’s not a tax deduction but lessens the financial burden on qualifying COBRA members.
Short-Term Health Insurance
Short-term health plans are ideal for people waiting for the next ACA Open Enrollment period. They have a limited duration, typically several months to a year.
However, it does not have to comply with the ACA. That means you could be declined coverage based on a pre-existing medical condition and may not enjoy all the essential health benefits of ACA-compliant plans, like pregnancy and newborn care.
Short-term health insurance plan premiums are generally not eligible for the same tax deductions or tax advantages as those for ACA-regulated major medical plans. They are considered limited-duration insurance and don’t meet the requirements for health insurance tax benefits.
Short-term plans are not generally deductible as medical expenses on your federal income tax return because they typically don’t offer the comprehensive benefits of Qualified Health Plans (QHPs). They also don’t qualify for ACA premium tax credits and subsidies..
There is some good news: you can usually deduct short-term health insurance premiums as a medical expense when paid out-of-pocket using pre-tax dollars.
There are some conditions, though. You’ll have to use itemized deduction, and, as with COBRA, your total annual medical expenses (including short-term plan premiums) must exceed 7.5% of your AGI.
Employer-Sponsored Health Insurance – How Tax Deductions Work For Employees Vs. Employers
Failure to provide adequate ACA-compliant health insurance can result in tax penalties, which only apply to large companies with 50 or more employees.
If you receive employer-sponsored health insurance, your employer carries many of the costs. Employer-paid premiums for most health insurance coverage are exempt from federal income and payroll taxes. Still, they must report employees’ insurance status to the IRS.
That said, you may still be able to deduct health insurance premiums as an employee. But it works differently for employees and employers.
If you are employed and belong to a group health insurance plan, the premiums are primarily subsidized by your employer. The rest comes out of your paycheck, tax-free, which means that you are already receiving that tax benefit. Deducting these expenses again would be considered fraudulent.
You may not deduct the portion you pay as it has already been done, pre-tax, on your behalf. You can only deduct the out-of-pocket portion of your employer-sponsored health insurance premium.
Premiums Paid Pre-Tax
Many employers offer health insurance, and the premiums are deducted from your paycheck before income taxes are applied. Therefore, the amount you spend on health insurance premiums reduces your taxable income, resulting in lower overall taxes.
Your contributions are typically tax-deductible if your employer offers a Health Savings Account (HSA) or a Flexible Spending Account (FSA). Contributions to HSAs are tax-deductible up to certain limits, and contributions to FSAs are made with pre-tax dollars.
If your medical expenses (including health insurance premiums) exceed a certain percentage of your adjusted gross income (AGI), itemize your deductions when filing your federal income tax return. You may be able to deduct a portion of your premiums.
However, this is subject to specific rules and limits. (See the section titled Maximizing Your Tax Benefits: Deducting Medical Costs, below)
Tax Deductions For Premiums
Employers can typically deduct the employee’s health insurance costs as a business expense. It will be subtracted from the company’s gross income, reducing its taxable income.
Small businesses are eligible for the Small Business Health Care Tax Credit, which offsets the cost of providing health insurance. To qualify, the company must have fewer than 25 full-time employees and pay at least 50% of the premiums. (See the Health Insurance Tax Credits For Small Businesses section below for more information.)
Maximizing Your Tax Benefits: Deducting Medical Costs
There’s a definitive link between taxes and health insurance in the US, as the IRS oversees many aspects of ACA health insurance. And like in several other countries, US health insurance is tax deductible.
One of the ways to maximize your tax benefits is by deducting health insurance costs. However, the IRS allows you to deduct more than health insurance premiums. It also allows you to deduct unreimbursed payments for qualifying medical expenses.
Understanding Tax-Deductible Medical Expenses
For medical expenses to be tax-deductible, they must not have been reimbursed. Here are the specific rules and limitations the IRS sets for tax deductions of health insurance premiums:
- Eligible Medical Expenses: Medical expenses must be considered eligible by the IRS. These expenses include medical treatments, surgeries, COVID-19 medical expenses, preventive health care, dental and vision care, psychology and psychiatric services, and prescription medications. Spectacles, contact lenses, dentures, hearing aids, and travel to receive medical treatment also qualify.
- Not Reimbursed by Insurance or Other Sources: To be eligible for a tax deduction, these medical expenses must not have been fully reimbursed or paid for by insurance, employer-provided health plans, or any other source. You can only deduct medical expenses that you paid for out-of-pocket.
- Exceeding the Threshold: Medical expenses are subject to an “adjusted gross income (AGI) threshold.” AGI is your total taxable income minus adjustments like deductible contributions to a retirement plan. This means that you can only deduct medical expenses that exceed a certain percentage of your AGI, which is 10% of your AGI for most taxpayers.
- Itemization: To claim a deduction for medical expenses, you typically need to itemize your deductions on your federal income tax return. You should compare the total of your itemized deductions, including medical expenses, against the standard deduction to determine which option is more beneficial for your tax situation.
Non-Deductible Medical Expenses
You can’t deduct non-prescription drugs or vitamin supplements as medical expenses. The same goes for health club membership fees, toiletries, and diet foods.
If you pay for your medical expenses using a Health Savings Account, you can’t deduct those expenses. Those funds are already tax-advantaged.
Strategies To Reduce Income Tax Liability
For most Americans, paying taxes is inevitable, but there are ways to reduce income tax liability.
- Get an Individual Retirement Arrangement or IRA. This is a tax-advantaged savings account, so the funds aren’t taxed until distributed at retirement age. You can deduct your contributions or qualify for a tax credit equal to a percentage of your contributions.
- A Health Savings Account (HSA) lets you put money aside for everyday medical expenses. This tax-advantaged account is available to all US taxpayers on high-deductible health plans. These funds are not subject to federal income tax at the time of deposit, and contributions are 100% tax-deductible.
- Put your money into a 401(k) account. This is a pre-tax account, so the money you contribute comes before your income is taxed. Therefore, your overall taxable income will be lower, and you’ll pay less in taxes.
- If you’re self-employed and working from home, the IRS allows you to deduct expenses related to home-office set-up, mobile phone and internet bills (if used for work), retirement plan contributions, and health insurance premiums.
Self-Employed Health Insurance Deduction
Self-employed health insurance premiums are reported on the IRS Form 1040, a standard form for filing a personal income tax return. On this form, you declare your yearly income, calculate your taxes due on that income, and any eligible tax deductions.
Who Is Eligible For A Self-Employed Health Insurance Tax Deduction?
When you’re self-employed, you may be eligible to deduct medical, dental, and even long-term care insurance coverage. This coverage can be for yourself only or extended to your spouse and other dependents. It also applies if you were employed at a business and then left and are now self-employed.
You can only deduct the health insurance premiums for months when neither you nor your spouse qualified for any employer-subsidized health plan.
These deductions must be entered as an adjustment to income. You will benefit from this deduction regardless of whether or not you itemize your deductions.
Health Insurance Tax Credits For Small Businesses
If you run a small business, you may qualify for the Small Business Health Care Tax Credit, worth up to 50% of your expenses in employees’ premiums (up to 35% if you operate a non-profit).
A Small Business Health Options Program (SHOP) plan is generally the way to go. The Small Business Health Options Program is a program established under the ACA. It is designed to help small businesses provide health insurance options to their employees.
Still, you’ll have to meet some eligibility criteria:
- Fewer than 25 full-time employees
- The average employee’s annual salary is no more than about $56,000
- You offer this coverage to all your full-time employees.
- You pay at least half of your full-time employees’ premiums.
You don’t have to offer this coverage to your employee’s dependents. You also don’t have to provide it to employees who work less than 30 hours per week.
Your monthly health plan premiums relieve you of a huge burden – the costs of quality health care. But as you’ve seen in this guide to the tax deductibility of health insurance premiums, they can reduce your income tax burden, too.
Whether deducted pre-tax by an employer or as medical expenses if you’re self-employed, health insurance is good for your physical and financial well-being.
Are you looking for budget-friendly, tax-deductible, quality health insurance? Call Enhance Health today and find out more.