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Tax Talk with George Saenz

Ask the tax adviser

Health insurance premiums

Dear Tax Talk:
I now work for a small company where I have to pay 100 percent for my own health insurance, which is substantial. I itemize my tax returns. Is my health care insurance premium deductible? If so, to what extent?

Dear Chandra:
If you have to cough up all the money for your health insurance, there's a better solution than claiming it as a deduction.

While health insurance premiums are deductible medical expenses, you have to combine it with all your medical expenses. Assuming it's decent insurance, then you probably don't have many other medical expenses. Since medical expenses are only deductible to the extent they exceed 7.5 percent of your adjusted gross income, you probably won't get any tax benefit.

For example, if you pay $300 a month for health insurance, that's $3,600 a year and let's say you have $400 in other medical bills giving you $4,000 in total medical. If you make $50,000 a year, 7.5 percent is $3,750 so your deduction is only $250 ($4,000 less $3,750 threshold). You only get the $250 deduction if you otherwise itemize, so you can see this is not a good benefit.

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There's a better solution called a cafeteria plan. A cafeteria plan is a plan designed to provide benefits to employees on a no-tax basis. Some cafeteria plans offer a choice of benefits. Some are established only to pay health insurance premiums, called a premium-only plan. Your employer has to establish the plan, but gets a tax break in doing so. Some employers don't like to offer full cafeteria plans because they are paperwork intensive, but a premium-only plan is simple to administer and saves both you and the employer taxes.

With a cafeteria plan, the employer saves the matching part of FICA taxes and the employee saves both FICA and income tax on the medical insurance premiums. Since the employers share of FICA is 7.65 percent, if he has 10 employees paying $36,000 a year for health insurance he saves $2,754. The employees also save $2,754 plus the income tax on $36,000, which could be 27 percent or more. Collectively these are good tax savings making the plan worthwhile.

Your employer should call his insurance agent or his payroll processing company, if he has one, in order to implement the cafeteria plan. Premiums paid under a cafeteria plan are not deductible as medical expenses by the employee.

-- Posted: March 4, 2003

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See Also
Deductions and credits that can cut your tax bill
Getting the most from itemized deductions
Deducting long-term care insurance premiums
Tax glossary
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