Self-employed Individuals Are Allowed To Take A Tax Deduction For Their Medicare Premiums
If you are age 65 or older and self-employed, I have great news, you may be able to take a tax deduction for your Medicare Part A, B, C, and D premiums as well as the premiums that you pay for your Medicare Advantage or Medicare Supplemental coverage.
Self-employed Individuals Are Allowed To Take A Tax Deduction For Their Medicare Premiums
If you are age 65 or older and self-employed, I have great news, you may be able to take a tax deduction for your Medicare Part A, B, C, and D premiums as well as the premiums that you pay for your Medicare Advantage or Medicare Supplemental coverage. This is a huge tax benefit for business owners age 65 and older because most individuals without businesses are not able to deduct their Medicare premiums, so they have to be paid with after-tax dollars.
Individuals Without Businesses
If you do not own a business, you are age 65 or older, and on Medicare, you are only allowed to deduct “medical expenses” that exceed 7.5% of your adjusted gross income (AGI) for that tax year. Medical expenses can include Medicare premiums, deductibles, copays, coinsurance, and other noncovered services that you have to pay out of pocket. For example, if your AGI is $80,000, your total medical expenses would have to be over $6,000 ($80,000 x 7.5%) for the year before you would be eligible to start taking a tax deduction for those expenses.
But it gets worse, medical expenses are an itemized deduction which means you must forgo the standard deduction to claim a tax deduction for those expenses. For 2022, the standard deduction is $12,950 for single filers and $25,900 for married filing joint. Let’s look at another example, you are a married filer, $70,000 in AGI, and your Medicare premiums plus other medical expenses total $12,000 for the year since the 7.5% threshold is $5,250 ($70,000 x 7.5%), you would be eligible to deduct the additional $6,750 ($12,000 - $5,250) in medical expenses if you itemize. However, you would need another $13,600 in tax deductions just to get you up to the standard deduction limit of $25,900 before it would even make sense to itemize.
Self-Employed Medicare Tax Deduction
Self-employed individuals do not have that 7.5% of AGI threshold, they are able to deduct the Medicare premiums against the income generated by the business. A special note in that sentence, “against the income generated by the business”, in other words, the business has to generate a profit in order to take a deduction for the Medicare premiums, so you can’t just create a business, that has no income, for the sole purpose of taking a tax deduction for your Medicare premiums. Also, the IRS does not allow you to use the Medicare expenses to generate a loss.
For business owners, it gets even better, not only can the business owner deduct the Medicare premiums for themselves but they can also deduct the Medicare premiums for their spouse. The standard Medicare Part B premium for 2022 is $170.10 per month for EACH spouse, now let’s assume that they both also have a Medigap policy that costs $200 per month EACH, here’s how the annual deduction would work:
Business Owner Medicare Part B: $2,040 ($170 x 12 months)
Business Owner Medigap Policy: $2,400
Spouse Medicare Part B: $2,040
Spouse Medigap Policy: $2,400
Total Premiums: $8,880
If the business produces $10,000 in net profit for the year, they would be able to deduct the $8,880 against the business income, which allows the business owner to pay the Medicare premiums with pre-tax dollars. No 7.5% AGI threshold to hurdle. The full amount is deductible from dollar one and the business owner could still elect the standard deduction on their personal tax return.
The Tax Deduction Is Limited Only To Medicare Premiums
When we compare the “medical expense” deduction for individual taxpayers that carries the 7.5% AGI threshold and the deduction that business owners can take for Medicare premiums, it’s important to understand that for business owners the deduction only applies to Medicare premiums NOT their total “medical expenses” for the year which include co-pays, coinsurance, and other out of pocket costs. If a business owner has large medical expenses outside of the Medicare premiums that they deducted against the business income, they would still be eligible to itemize on their personal tax return, but the 7.5% AGI threshold for those deductions comes back into play.
What Type of Self-Employed Entities Qualify?
To be eligible to deduct the Medicare premiums as an expense against your business income your business could be set up as a sole proprietor, independent contractor, partnership, LLC, or an S-corp shareholder with at least 2% of the common stock.
The Medicare Premium Deduction Lowers Your AGI
The tax deduction for Medicare Premiums for self-employed individuals is considered an “above the line” deduction, which lowers their AGI, an added benefit that could make that taxpayer eligible for other tax credits and deductions that are income based. If your company is an S-corp, the S-corp can either pay your Medicare Premiums on your behalf as a business expense or the S-corp can reimburse you for the premiums that you paid, report those amounts on your W2, and you can then deduct it on Schedule 1 of your 1040.
Employer-Subsidized Health Plan Limitation
One limitation to be aware of, is if either the business owner or their spouse is eligible to enroll in an employer-subsidized health plan through their employer, you are no longer allowed to deduct the Medicare Premiums against your business income. For example, if you and your spouse are both age 66, and you are self-employed, but your spouse has a W2 job that offers health benefits to cover both them and their spouse, you would not be eligible to deduct the Medicare Premiums against your business income. This is true even if you voluntarily decline the coverage. If you or your spouse is eligible to participate, you cannot take a deduction for their Medicare premiums.
I receive the question, “What if they are only employed for part of the year with health coverage available?” For the month that they were eligible for employer-subsidized health plan, a deduction would not be able to be taken during those months for the Medicare premiums.
On the flip side, if the health plan through their employer is considered “credible coverage” by Medicare, you may not have to worry about Medicare premiums anyways.
Multiple Businesses
If you have multiple businesses, you will have to select a single business to be the “sponsor” of your health plan for the purpose of deducting your Medicare premiums. It’s usually wise to select the business that produces a consistent net profit because net profits are required to deduct all or a portion of the Medicare premium expense.
Forms for Tax Reporting
You will have to keep accurate records to claim this deduction. If you collect Social Security, the Medicare premiums are deducted directly from the social security benefit, but they issue you a SSA-1099 Form at the end of the year which summarized the Medicare Premiums that you paid for Part A and Part B.
If you have a Medigap Policy (Supplemental) with a Part D plan or a Medicare Advantage Plan, you normally make premium payments directly to the insurance company that you have selected to sponsor your plan. You will have to keep records of those premium payments.
No Deduction For Self-Employment Taxes
As a self-employed individual, the Medicare premiums are eligible for a federal, state, and local tax deduction but they do not impact your self-employment taxes which are the taxes that you pay to fund Medicare and Social Security.
Amending Your Tax Returns
If you have been self-employed for a few years, paying Medicare premiums, and are just finding out now about this tax deduction, the IRS allows you to amend your tax returns up to three years from the filing date. But again, the business had to produce a profit during those tax years to be eligible to take the deduction for those Medicare premiums.
DISCLOSURE: This information is for educational purposes only. For tax advice, please consult a tax professional.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Tax Reform: Changes To 529 Accounts & Coverdell IRA's
Included in the new tab bill were some changes to the tax treatment of 529 accounts and Coverdell IRA's. Traditionally, if you used the balance in the 529 account to pay for a "qualified expense", the earnings portion of the account was tax and penalty free which is the largest benefit to using a 529 account as a savings vehicle for college.So what's the
Included in the new tab bill were some changes to the tax treatment of 529 accounts and Coverdell IRA's. Traditionally, if you used the balance in the 529 account to pay for a "qualified expense", the earnings portion of the account was tax and penalty free which is the largest benefit to using a 529 account as a savings vehicle for college.So what's the change? Prior to the Tax Cuts and Jobs Act (tax reform), qualified distributions were only allowed for certain expenses associated with the account beneficiary's college education. Starting in 2018, 529 plans can also be used to pay for qualified expenses for elementary, middle school, and high school.
Kindergarten – 12th Grade Expenses
Tax reform included a provision that will allow owners of 529 account to take tax-free distributions from 529 accounts for K – 12 expenses for the beneficiary named on the account. This is new for 529 accounts. Prior to this provision, 529 accounts could only be used for college expenses. Now 529 account holders can distribute up to $10,000 per student per year for K – 12 qualified expenses. Another important note, this is not limited to expenses associated with private schools. K – 12 qualified expense will be allowed for:
Private School
Public School
Religious Schools
Homeschooling
529 Accounts Will Largely Replace Coverdell IRA's
Prior to this rule change, the only option that parents had to save and accumulate money tax-free to K – 12 expenses for their children were Coverdell IRA's. But Coverdell IRA's had a lot of hang ups
Contributions were limited to $2,000 per year
You could only contribute to a Coverdell IRA if your income was below certain limits
You could not contribution to the Coverdell IRA after your child turned 18
Account balance had to be spend by the time the student was age 30
By contrast, 529 accounts offer a lot more flexibility and higher contributions limits. For example, 529 accounts have no contribution limits. The only limits that account owners need to be aware of are the "gifting limits" since contributions to 529 accounts are considered a "gift" to the beneficiary listed on the account. In 2018, the annual gift exclusion will be $15,000. However, 529 accounts have a provision that allow account owners to make a "5 year election". This election allows account owners to make an upfront contribution of up to 5 times the annual gift exclusion for each beneficiary without trigger the need to file a gift tax return. In 2018, a married couple could contribution up to $150,000 for each child to a 529 account without trigger a gift tax return.If I have a child in private school, they are in 6th grade, and I'm paying $20,000 in tuition each year, that means I have $140,000 that I'm going to spend in tuition between 6th grade – 12th grade and then I have college tuition to pile on top of that amount. Instead of saving that money in an after-tax investment account which is not tax sheltered and I pay capital gains tax when I liquidate the account to pay those expenses, why not setup a 529 account and shelter that huge dollar amount from income tax? It will probably saves me thousands, if not tens of thousands of dollars in taxes, in taxes over the long run. Plus, if I live in a state that allows tax deductions for 529 contributions, I get that benefit as well.
Income Limits and Tax Deductions
Unlike Coverdell IRA's, 529 accounts do not have income restrictions for making contributions. Plus, some states have a state tax deduction for contributions to 529 account. In New York, a married couple filing joint, receive a state tax deduction for up to $10,000 for contribution to 529 account. A quick note, that is $10,000 in aggregate, not $10,000 per child or per account.
Rollovers Count Toward State Tax Deductions
Here is a fun fact. If you live in New York and you have a 529 account established in another state for your child, if you rollover the balance into a NYS 529 account, the rollover balance counts toward your $10,000 annual NYS state tax deduction. Also, you can rollover balances in Coverdell IRA's into 529 accounts and my guess is many people will elect to do so now that 529 account can be used for K – 12 expenses.
Contributions Beyond Age 18
Unlike Coverdell IRA's which restrict contributions once the child reaches age 18, 529 accounts have no age restriction for contributions. We will often encourage clients to continue to contribute their child's 529 account while they are attending college for the sole purpose of continuing to capture the state tax deduction. If you receive the tuition bill in the mail today for $10,000, you can send in a $10,000 check to your 529 account provider as a current year contribution, as soon as the check clears the account you can turn around and request a qualified withdrawal from the account for the tuition bill, and pay the bill with the cash that was distributed from the 529 account. A little extra work but if you live in NYS and you are in a high tax bracket that $10,000 deduction could save you $600 - $700 in state taxes.
What Happens If There Is Money Left In The 529 Account?
If there is money left over in a 529 account after the child has graduated from college, there are a number of options available. For more on this, see our article "5 Options For Money Left Over In College 529 Plans"
Qualified Expenses
The most frequent question that I get is "what is considered a qualified expense for purposes of tax-free withdrawals from a 529 account?" Here is a list of the most common:
Tuition
Room & Board
Technology Items: Computers, Printers, Required Software
Supplies: Books, Notebooks, Pens, Etc.
Just as important, here are a list of expense that are NOT considered a "qualified expense" for purposes of tax free withdrawals from a 529 account:
Transportation & Travel: Expense of going back and forth from school / college
Student Loan Repayment
General Electronics and Cell Phone Plans
Sports and Fitness Club Memberships
Insurance
If there is ever a question as to where or not an expense is a qualified expense or not, I would recommend that you contact the provider of your 529 account before making the withdrawal form your 529 account. If you take a withdrawal for an expense that is not a "qualified expenses" you will pay income taxes and a 10% penalty on the earnings portion of the withdrawal.
Do I Have To Close My Coverdell IRA?
While 529 accounts have a number of advantages compared to Coverdell IRA's, current owners of Coverdell IRAs will not be required to close their accounts. They will continue to operate as they were intended. Like 529 accounts, Coverdell IRA withdrawals will also qualify for the tax-free distributions for K – 12 expenses including the provision for expenses associated with homeschooling.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
