The 2017 tax law has made planning around medical expenses by the end of this year imperative for financial advisers.
The law, which
overhauled the tax code for individuals and corporations, made it easier for Americans to claim a deduction for unreimbursed medical and dental expenses — out-of-pocket expenses not covered by health insurance.
Prior to the new law, most people could only deduct medical expenses exceeding 10% of their adjusted gross income. The law reduced that threshold to 7.5% of AGI. So, someone with income of $100,000 and out-of-pocket medical costs of $20,000 could deduct $2,500 more this year than under prior rules.
While all other changes to the individual side of the tax ledger are set to expire after 2025, the break for medical deductions expires after this year, meaning the threshold will revert back to 10%. (With the exception of those over 65 years old, who had a 7.5% ceiling before the tax law took effect.)
Advisers have a short window of time to help their clients take advantage of this change in the tax code, making it a unique year-end tax planning opportunity.
"Everything else in the bill has a longer life in it," said Tim Steffen, director of advanced planning in the private wealth management group at Robert W. Baird & Co. "This is the one thing that will change for next year, unless something new comes up."
(More: Everything advisers need to know about the pass-through provision)
Nearly 9 million taxpayers took a deduction for unreimbursed medical expenses in 2016, the latest year for which the Internal Revenue Service has data, for a total of $90.2 billion. According to congressional estimates, reducing the AGI threshold to 7.5% for tax years 2017 and 2018 will cost the federal government $5.2 billion.
Clients can take advantage of the tax break before its expiration by loading up on expenses — such as Lasik surgery, eye glasses and dental work — before year-end. Other out-of-pocket costs like health insurance premiums (including Medicare Parts B and D), co-pays and a portion of premiums on some long-term-care insurance policies also count.
"This is clearly the year to take your medical stuff," said Leon LaBrecque, managing partner at LJPR Financial Advisors.
He cautioned against using a health savings account to pay for medical costs, since clients wouldn't be able to deduct those expenses. However, clients would be able to get reimbursed for these costs in future years in they keep the associated receipts.
Clients also should try to delay things that would increase adjusted gross income, if possible, Mr. Steffen said. For example, realizing capital gains by year-end could inadvertently put a client above the AGI threshold to claim the medical deduction, since those gains count toward income.
The medical deduction may be a reason for spouses to file their taxes as married filing separately, which could yield a significant tax benefit to a spouse with lower income but high medical costs, Mr. LaBrecque said. The caveat is that the other spouse also would have to itemize deductions rather than claim the standard deduction, he said.
The new tax law, which President Donald J. Trump
signed in December 2017, will make it less worthwhile for many taxpayers to itemize deductions overall. Since the law doubled the standard deduction to $12,000 for individuals and $24,000 for married couples, deductions would have to exceed this threshold to make sense. The law made other substantial changes to deductions, including putting a $10,000 cap on deductions for state and local taxes, which used to be unlimited.
