When paying taxes, getting the lowest tax burden depends more on your knowledge than your skill. Unfortunately, many taxpayers fail to take advantage of deductions and credits because they are ignorant of them.
Health and medical costs and insurance premiums are among the most frequently forgotten tax deductions. Although numerous deductions were removed by the 2017 Tax Cuts and Jobs Act (TCJA), most of the ones covered below remained in place.
1. Insurance for Disability
Probably the most frequent premium type that isn't claimed as a tax deduction is disability insurance. If you become disabled and are unable to work, this kind of insurance may be able to supplement your income. However, the deductibility of these premiums is difficult and constrained.
Self-employed taxpayers are allowed to write off "overhead insurance that covers for business overhead expenses you have during long periods of disability caused by your injury or illness," according to the Internal Revenue Service (IRS).
However, "premiums for a policy that provides for lost wages due to illness or incapacity cannot be deducted."
In essence, the type of disability insurance that pays business overhead costs while you're on leave is the only one that qualifies for a deduction. This insurance would pay for expenses like rent and utilities that cannot be avoided during a disability leave.
Any policy proceeds paid after deducting the premium will be considered taxable income. Contrarily, if you pay the premium and do not deduct the premium, the policy benefits will not be taxed. Some taxpayers use this strategy so that, if they become disabled, they can receive tax-free benefits to cover their business overhead costs. Proceeds are also taxed if your disability insurance was purchased with after-tax cash rather than by your employer.
2. Health Savings Accounts
People without access to standard group health insurance should be aware of another insurance-related tax benefit called a Health Savings Account (HSA), which combines a tax-advantaged savings component with a high-deductible health insurance policy.
Even for people who don't itemize on Schedule C, all HSA contributions are tax deductible up to the legal limit. If you have a single coverage plan, you can contribute up to $3,650 (instead of $3,600 in 2021), and if you have a family plan, you can contribute up to $7,300 (instead of $7,200 in 2021), with an additional $1,000 contribution allowed for taxpayers over the age of 55.67
Like a 401(k), employers can also contribute to an HSA on behalf of employees (k). However, the annual contribution cap for each type of coverage cannot be exceeded by the sum of employer and employee contributions.
3. Health Care Costs
Only when medical costs exceed a specific threshold as a percentage of the taxpayer's adjusted gross income are they eligible for deductions (AGI). Due to various laws, that percentage is constantly changing (most recently ranging from 7.5% to 10%), but it always remains high enough to prevent most people from qualifying. The percentage for the 2020 and 2021 tax years is 7.5% of your AGI.
If you have a lot of unpaid medical bills, you can increase your deduction by planning additional medical procedures or costs for the same year. One restriction is that you must report the amount of the deduction that was reimbursed as income the following year if you receive a reimbursement check from your insurance provider.
For instance, if you deducted $17,000 for surgery one year and received a $10,000 check from your insurance company the following year, you would need to report that money as income the next year.
Do not claim this deduction if there is a possibility that your insurance provider will eventually pay for your medical expenses. If your insurance claim is rejected, you can always file an amended return for the year in which you would have gotten the deduction.
4. Workers' compensation and unemployment
It is crucial to distinguish between workers' compensation, which is given to employees who are unable to perform their jobs due to an injury, and unemployment benefits, which are granted through a state unemployment agency.
Benefits from unemployment are usually taxable since they are viewed as a substitute for regularly earned income. Your total unemployment benefits for the entire year will be listed on a Form 1099-G, and you must report this sum on IRS Form 1040. You should not report any income from your workers' compensation payouts. This also covers benefits for survivors.
5. Self-Employed Tax Deductions
Self-employed taxpayers and other legal entities may write off the cost of long-term care insurance as well as other business-related insurance premiums.
If the taxpayer chooses to record actual expenses rather than using the standard mileage rate, they may also deduct the cost of their vehicle insurance.
6. Additional Eligible Plans
Other retirement savings vehicles, such as 412(e)(3) plans that can be funded with tax-deductible premiums besides qualified plans. These defined-benefit plans can offer significant deductions for small-business owners hoping to make up for their retirement savings and earn a guaranteed income stream in the future. 15
The plan owner may deduct up to hundreds of thousands of dollars in annual payments to these plans, which are supported exclusively by insurance products such as fixed annuities and cash-value life insurance.
Subject to certain limitations, participants in typical eligible plans, such as an employer's 401(k) plan, may purchase a set amount of either term or permanent life insurance. However, the insurance must be regarded as "incidental" by IRS guidelines. 16
If "less than 50% of the employer contribution credited to each participant's account is used to acquire conventional life insurance policies on the participant's life," an insurance policy is deemed "incidental," according to the IRS.
Life insurance death benefits received from eligible plans are tax-free. This insurance can be used to cover the taxes due on the distribution of the participant's plan proceeds upon death.
7. Can Life Insurance Premiums Be Deducted From Taxes?
If something were to happen to you, life insurance could assist you in giving your loved ones a certain level of family security. The answer to whether life insurance premiums are tax deductible is typically no.
However, the cost of premiums is tax deductible as a business expense (if the insured is an employee or a corporate officer of the company, and if the company is not a direct or indirect beneficiary of the policy)