When it comes to filing income tax returns, getting the lowest tax liability is not just about skill, it's about what you know. Unfortunately, many taxpayers lose deductions and credits just because they don't know about them. Many of the most overlooked deductions relate to medical and health costs, as well as insurance premiums.
The TCJA (tax cuts and jobs acts) eliminated many deductions but left most of those discussed in this article unchanged.
Summary
Contributions to the health savings account (HSA) are tax-exempt up to a predetermined limit.
Disability insurance is an extensive but complicated tax deduction.
Life insurance and commercial insurance premiums may also be eligible.
Several missed deductions are related to medical bills, insurance premiums, and other health care costs.
Disability insurance
Disability insurance is presumably the most common type of premium, ignored as a tax deduction. This type of insurance can provide additional income if you are disabled and unable to work. However, the deductibility of these premiums is complicated and limited.
The Internal Revenue Service (IRS) allows self-employed taxpayers to deduct "general insurance that covers business overhead expenses incurred during long periods of disability caused by injury or illness." But you can't deduct premium on a policy that pays for lost earnings due to illness or disability."
The only disability insurance eligible for deduction is that which covers overhead labor costs while on leave. This type of insurance would cover things like rent and utilities that are unavoidable during disability leave.
If you deduct your premium, all proceeds paid for the policy will be treated as taxable income. In contrast, policy benefits will not be taxable if you pay the premium yourself and do not deduct it. Some taxpayers use this arrangement to receive tax-exempt benefits to cover the company overhead costs—in the event of disability. Earnings are taxable even if your employer paid for disability insurance, not if you purchased it with your own after-tax dollars.
You must follow several rules if you are deducting health insurance costs, depending on your work situation, itemizing deductions, and whether you paid premiums in dollars before or after tax.
HAS (Health Savings Account)
Another insurance tax benefit that people who do not have access to traditional group health coverage should be aware of is a Health Savings Account (HSA), which combines a savings element with a tax benefit with a health insurance policy.
All HSA contributions, up to the maximum allowed by law, are tax-deductible, even those not listed in Schedule C. For fiscal 2020, you can contribute up to $3,550 ($3,600 in 2021) if you have only one coverage or $7,100 ($71,200 in 2021) if you have a family plan with an additional contribution of $1,000 allowed for taxpayers over 55.
Employers can also contribute to an HSA on behalf of employees, similar to a 401 (k). However, the combined amount of employer and employee contributions cannot exceed the annual contribution limit for each protection type.
Health savings accounts can generate a triple tax advantage in the form of tax-deductible contributions, tax-deferred increases, and tax-free withdrawals when the funds are used to pay qualifying medical bills.
Medical expenses
Medical expenses are deductible, but only for an amount that exceeds a certain percentage of the taxpayer's adjusted gross income (AGI). This percentage continues to evolve due to different laws (the most recent being between 7.5% and 10%), but it is still high enough to prevent most people from qualifying. The percentage is equal to 7.5% of the adjusted gross revenues for fiscal years 2020 and 2021.
If you have large medical bills pending, you can increase your deduction by scheduling other bills or medical procedures in the same year. One caveat is that if you receive a refund check the following year from your insurance company, you must report the amount of the refunded deductible as income the following year.
For example, suppose you deducted $17,000 for surgery in one year and your insurance company sent you a check for $10,000 for the surgery the following year. In that case, that amount should be reported as income the year the check arrives.
If your insurance company can cover medical expenses in the future, do not declare this deduction. You can still send an amended return for the year you received the deduction if your insurance claim was denied.
Unemployment benefits/worker's compensation
It is important to distinguish between unemployment benefits paid by a public unemployment agency and worker's allowance granted to workers who cannot perform their duties due to an accident.
Unemployment benefits are always taxable because they are seen as a substitute for normal income. You will receive a Form 1099-G listing the total unemployment benefits received that year, and this amount should be reported on IRS Form 1040. Worker's compensation benefits you receive should not be recorded as income. This also includes the survival benefits.
Self Employed Deductions
Self-employed taxpayers and other entities can deduct business-related insurance premiums, including dental and health insurance premiums, as well as long-term care premiums. Auto insurance can also be deducted if the taxpayer chooses to report actual expenses and does not charge the standard mileage rate.
Be sure to keep track of all premiums paid for qualifying insurance costs, as well as any other deductible expenses you intend to claim, such as computer equipment or a home office.
Other eligible plans
Qualifying plans aren't the only type of retirement savings vehicle that tax-deductible premiums can fund - 412(i) plans are also tax-deferred. This defined benefit plan can offer substantial deductions to small business owners who want to recoup their retirement savings and receive a guaranteed income stream in the future.
A 412(i) plan is funded exclusively from insurance products, such as cash life insurance or a fixed annuity policy. The plan holder can deduct up to thousands of dollars in contributions to this plan annually.
Participants in a standard qualified plan, such as 401(k) plan through an employer, may purchase a limited amount of permanent or term life insurance, subject to specific restrictions. But coverage should be considered "incidental" according to Internal Revenue Service regulations. An insurance policy is considered "incidental" if "less than 50% of the employer's contribution is credited to each member's account, according to the IRS. It is used to purchase life insurance policies in the life of the participant."
Life insurance death benefits paid under qualifying plans are tax-exempt, and this insurance can be used to pay plan income taxes that will be distributed on the participant's death.
Are life insurance premiums deductible from income tax?
Life insurance can help provide a measure of family safety for your loved ones if something happens to you. You might be wondering if life insurance premiums are deductible from your income tax return, and the answer is usually no. But the premiums are deductible as business-related expenses (if the insured is an employee or an officer of the company and the company is not a direct or indirect beneficiary of the policy).
Although death benefits for beneficiaries are often tax-exempt, business life insurance death benefits may be taxable in some cases. However, employers who offer group life insurance to employees can deduct premiums paid for the first $50,000 of employee benefits, and amounts up to this limit are not considered employee income.
Life insurance premiums can often be deducted for most unqualified plans, such as deferred compensation or executive bonuses. The awards are generally considered executive compensation per the rules of these plans. Nevertheless, in some cases, the deduction cannot be made until the employee has received the benefit implicitly
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Bottom Line
These are just a few of the often-overlooked insurance benefits and tax deductions that individuals and businesses are entitled to. There are other deductions that are related to the compensation, production, and depreciation of buildings and equipment. Talking to your accountant or other tax professional can help you determine what tax deductions you can claim to minimize what you owe.
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