17.4 Reimbursements Reduce Deductible Expenses
Insurance or other reimbursements of your medical costs reduce your potential medical deduction. Reimbursements for loss of earnings or damages for personal injuries and mental suffering do not have to be taken into account. A reimbursement first reduces the medical expense for which it is paid. The excess is then applied to your other deductible medical costs. See Example 1 below.
Personal injury settlements or awards.
Generally, a cash settlement recovered in a personal injury suit does not reduce your medical expense deduction. The settlement is not treated as reimbursement of your medical bills. But when part of the settlement is specifically earmarked by a court or by law for payment of hospital bills, the medical expense deduction is reduced.
If you receive a settlement for a personal injury that is partly allocable to future medical expenses, you reduce medical expenses for these injuries by the allocated amount until it is used up.
Fake claims.
Medical reimbursements for fake injury claims are treated as taxable income; see Example 2 below.
EXAMPLES
1. In 2012, Gail Hurz paid $2,400 in medical insurance premiums, $1,200 for doctor and hospital bills and $750 for prescription drugs. She received reimbursements of $1,175 from group hospitalization insurance ($800 for the doctor and hospital bills and $375 for the drugs.) Her adjusted gross income for 2012 is $32,100. If Gail itemizes, she can claim a medical expense deduction of $767, computed as follows:
| Prescription drugs |
$750 |
| Medical care expenses |
1,200 |
| Premiums |
2,400 |
| Total |
$4,350 |
| Less reimbursement |
1,175 |
|
$3,175 |
| Less: 7.5% of $32,100 |
2,408 |
| Medical expense deduction for 2012 |
$767 |
2. Dodge, with the aid of a “friendly” doctor, arranged to be hospitalized for alleged back injuries and realized over $200,000 from HIP policies. The IRS charged that the insurance proceeds were taxable income. Dodge argued they were tax-free reimbursements of medical costs.
The Tax Court sided with the IRS. The tax-free rules cover the payment of legitimate medical costs. Here there were no legitimate medical costs of actual injuries. Dodge took out the policies in a scam arrangement with the doctor.
Reimbursements in excess of your medical expenses.
If you paid the entire premium for health insurance, you are not taxed on payments from the plan even if they exceed your medical expenses for the year. If you and your employer each contributed to the policy, you generally have to include in income that part of the excess reimbursement that is attributable to employer premium contributions not included in your gross income; see Examples 2–4 below. The taxable excess reimbursement must be reported as “Other income” on Line 21 of Form 1040.
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Caution
Reimbursements Exceeding Expenses
If you have more than one policy and receive reimbursements that exceed your total medical expenses for the year, you must pay tax on all or part of the reimbursement where your employer paid premiums on the policies; see Examples 1–4 in this section.
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However, you do not have to report any excess reimbursements that are tax-free payments for permanent disfigurement or loss of bodily functions (3.2).
If your employer paid the total cost of the policy and the contributions were not taxed to you, you report as income all of your excess reimbursement, unless it covers payment for permanent injury or disfigurement (3.2).
For the treatment of insurance reimbursements of long-term care costs, see 17.15.
EXAMPLES
1. Henry Knight pays premiums of $240 and $120 for two personal health insurance policies. His total medical expenses are $900. He receives $700 from one insurance company and $500 from the other. The excess reimbursement of $300 ($1,200 − $900) is not taxable because he paid the entire premium on the policy.
2. Lionel Guest’s employer paid premiums of $1,800 for two employee health insurance policies covering medical expenses. Guest’s medical expenses in one year are $900. He receives $1,200 from the two companies. The entire $300 excess is taxable because Guest’s employer paid the total cost of the policy and the contributions were not taxed to him.
3. Kay Brown’s employer paid a premium of $1,000 for a group health policy covering Brown, and Brown herself paid $300 for a personal health policy. Her medical expenses are $900. She receives reimbursements of $1,200, $700 under her employer’s policy and $500 under her own policy. Brown’s reimbursements exceed expenses by $300, but the taxable portion attributed to her employer’s premium contribution is $175, computed this way:
| Reimbursement allocated to Brown’s policy ($500 ÷ $1,200) × $900 |
$375 |
| Reimbursement allocated to employer’s policy ($700 ÷ $1,200) × $900 |
$525 |
| Taxable excess allocated to employer’s policy ($700 − $525) |
$175 |
4. Mike Green’s employer paid $1,200 for a health insurance policy but contributed only $450 and deducted $750 from Green’s wages. Green also paid $300 for a personal health insurance policy. His medical expenses are $900. He recovered $700 from the employer’s policy and $500 from his personal policy. The excess attributable to the employer’s policy is $175 (computed as in Example 3 above). However, the taxable portion is only $65.63. Both Green and his employer contributed to the cost of the employer’s policy and a further allocation is necessary:
| Green’s contribution |
$750 |
| Employer’s contribution |
450 |
| Total cost of policy |
$1,200 |
| Ratio of employer’s contribution to annual cost of policy (450 ÷ 1,200, or 37.50%) |
|
| Taxable portion: 37.50% of excess reimbursement of $175 |
$65.63 |
Reimbursement in a later year may be taxed.
If you took a medical expense deduction in one year and are reimbursed for all or part of the expense in a later year, the reimbursement may be taxed in the year received. The reimbursement is generally taxable income to the extent the deduction reduced your tax in the prior year. See the details for figuring taxable income on a recovery of a prior deduction in Chapter 11 (11.6).
EXAMPLES
1. In 2011, Anna Gurchani had adjusted gross income of $32,000. She claimed itemized deductions that exceeded her allowable standard deduction by $1,000; on her Schedule A, Gurchani listed medical expenses of $3,800. She deducted $1,400 for 2011, computed as follows:
| Medical expenses |
$3,800 |
| Less: 7.5% of $32,000 |
2,400 |
| Allowable deduction |
$1,400 |
In 2012 she collects $300 from insurance, reimbursing part of her 2011 medical expenses. If she had collected that amount in 2011, her medical expense deduction would have been $1,100. The entire reimbursement of $300 is subject to tax in 2012. It is the amount by which the 2011 deduction of $1,400 exceeds the deduction of $1,100 that would have been allowed if the reimbursement had been received in 2011.
2. Same facts as in Example 1 above, but Anna did not deduct medical expenses in 2011 because she did not itemize deductions. The reimbursement in 2012 is not taxable.
