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Collecting on cancer insurance

Dear Tax Talk,
I purchased a cancer policy about 20 years ago, which I have been paying for. I am about to file a claim against it for what looks like a substantial amount. Do I have to pay taxes on this money? Thanks! -- Diana

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Dear Diana,
Sorry to hear that you need to cash in on the policy, but I hope that all works out for the best.

Payments received under health and accident plans generally are not taxable unless they were paid under an employer-maintained plan. Since your policy seems to be that of personal insurance, you would not have to include your claim for compensation as income on your tax return.

If your employer paid the premiums but you had to include them in income as additional compensation, the proceeds would still not be taxable to you. If you paid part of the premium, or had to pick up part as income, and your employer paid the other part, then that employer-paid portion of the proceeds would be taxable income.

For example, if you and your employer each paid half of the premiums, then half of the claim would be taxable. In addition, any reimbursement for actual medical expenses, such as drugs, hospital services and physician charges, would reduce the amount that you would be able to claim as a medical expense deduction on schedule A.

If the reimbursement relates to medical expenses that you had deducted in prior years, in which you received a "tax benefit," you would report the reimbursement as miscellaneous income. That's because you received a tax benefit to the extent that the deduction reduced your tax for the year.

To figure out if you received a tax benefit, you would compute the prior year's tax return with and without the reimbursed deduction. Page 19 of Publication 525 provides more information on taxable recoveries and page 14 of the same publication discusses sickness and injury benefits.

Bankrate.com's corrections policy
-- Posted: Sept. 2, 2005
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