Coordinating COBRA and self-employment insurance tax breaks

Dear Tax Talk,
I see that as a self-employed worker, I can deduct 100 percent of my health care premiums. My husband has been unemployed for most of 2004, but we picked up COBRA. I'm the only one working, and self-employed, but we're paying huge health care payments. Can I deduct this? It's his old job's health care premium, but he's not working anymore. -- Caroline

Dear Caroline,
You're in the part of the law that we refer to as Catch-22.

While you're self-employed and probably paying substantial health insurance premiums under COBRA, the law requires that the health insurance plan be established under your business before you can fully deduct the payments. Since COBRA is the continuation of your husband's prior plan, it wouldn't be considered established under your business.

You still might be able to deduct your COBRA premiums as medical expenses to the extent they exceed 7.5 percent of your adjusted gross income.

Internal Revenue Service Publication 502, Medical and Dental Expenses provides additional clarification of the deduction:

If you were self-employed and had a net profit for the year, were a general partner (or a limited partner receiving guaranteed payments), or received wages from an S corporation in which you were a more than 2 percent shareholder (who is treated as a partner), you may be able to deduct, as an adjustment to income, up to 100 percent of the amount paid for medical and qualified long-term care insurance on behalf of yourself, your spouse, and dependents.

The insurance plan must be established under your trade or business, and you cannot take this deduction to the extent that the amount of the deduction is more than your earned income from that trade or business.

Since you lose a substantial part of the deduction, it may make sense to shop around for a plan for your business. Even if the premiums are somewhat more, it may be offset by the tax savings from the 100-percent deduction.