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Health Care Decision Reaffirms Numerous Tax Increases for 2013

By Catherine Gordon | January 02, 2013

Although most media coverage of the Supreme Court's decision on health care focused on the mandate for individuals to purchase insurance, the Court's ruling that the law was constitutional left numerous other tax law changes in place. Since the dust has cleared and, unless ObamaCare is repealed, the taxes remain in place, it's time to ensure you're fully aware of what taxes may affect you.

Medical Expense Deduction Threshold Increase

Most individuals filing their annual income tax return can choose whether to claim the standard deduction or to itemize their deductions. One of the most valuable itemized deductions is the deduction for qualifying unreimbursed medical expenses. Currently, only the unreimbursed expense amount that is over 7.5 percent of your adjusted gross income is deductible.

Higher Threshold for 2013. Under the Patient Protection and Affordable Care Act (ACA), the amount of qualifying unreimbursed medical expenses eligible for the deduction must be over 10 percent of adjusted gross income as of January 1, 2013.

If you’re age 65 or over before the end of the year the deduction is claimed, you catch a break. For these taxpayers, the threshold remains at 7.5 percent of adjusted gross income through 2016.

Tip

If you’re married and you and your spouse find yourselves in a situation where claiming the medical expense deduction is thwarted by the higher adjusted gross income threshold, you may want to consider filing your tax returns separately rather than jointly. 

However, making this decision should not be based solely on qualifying to deduct unreimbursed medical expenses. Filing status has various implications on your tax liability bottom line. Consult your tax professional to make the most beneficial overall choice.

Health Care FSA Limitations Imposed

A popular employee benefit, health care flexible spending arrangements (FSAs) allow employees to use payroll deductions to put pre-tax dollars into an account and then use the funds during the year for reimbursement of certain types of health care expenses, including insurance deductibles and copayments.

Currently, the maximum amount that an employee can typically contribute to an FSA is $5,000. Beginning in 2013, this amount will drop by 50 percent, down to only $2,500. (That $2,500 amount will be adjusted annually for inflation beginning in 2014.)

Nonprescription Drug Expenses Ineligible for Reimbursement. Since January 1, 2011, only prescribed medicines and drugs or insulin are considered reimbursable medical expenses for FSA purposes. This change is part of the ACA's revised definition of medicines and drugs to exclude over-the counter medications as qualifying for FSA reimbursement.

Tip

There is recent legislative activity to repeal the disqualification of over-the-counter drug expenses for FSAs. Stay tuned for possible developments on this issue.

Tax Increase for Health and Medical Savings Account Unused Distributions

Health Savings Accounts (HSAs) and their predecessor, Archer Medical Savings Accounts (MSAs), are accounts used to pay or reimburse qualified medical expenses. HSAs are funded by contributions made by self-employed individuals and employees and the contributions are deductible in computing adjusted gross income.

Amounts left over at the end of the year in an HSA or a MSA can be used for future years' qualifying medical expenses. However, distributions made from HSAs and MSAs that are not used for a beneficiary’s qualified medical expenses are included in the beneficiary’s gross income, subject to certain exceptions, and taxed as ordinary income. Generally, these distributions are also subject to an additional tax.

For distributions made for 2011 and forward, the health care reform act raised the additional tax as follows:

  • For HSAs, the additional tax for distributions included in gross income rose from 10 percent to 20 percent of the amount included in gross income.
  • For MSAs, the additional tax for distributions included in gross income rose from 15 percent to 20 percent of the amount included in gross income.

Adoption Tax Credit Enhancements Expire

The adoption tax credit offsets qualified adoption expenses for taxpayers, phasing out for those with over a certain amount of adjusted gross income for the year the expenses are incurred.

The ACA made the adoption credit refundable (you may be eligible even if you don't owe taxes or if the taxes you owe are less than the credit) for 2010 and 2011 and increased the amount of the possible credit to $13,360 for 2011.

Currently, the ACA enhancement to the credit is expired.

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Tip

The Tax Relief Act of 2010, kept the adoption tax credit alive through 2012 (the credit amount is $12,650 for 2012), but as a non-refundable credit.

Legislative action or inaction will determine the fate and form of the adoption credit for post-2012 years.

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