A Health Savings Account Could Be a Smart Tax Move

By Kelly M. Walsh, Esq.

If you haven’t thought about it before, now might be the time to consider switching your health insurance to a Health Savings Account. At first glance, the high deductibles and out of pocket maximums associated with these plans look daunting, but there are significant tax benefits. After the Tax Cut and Jobs Act, passed by Congress and signed into law by President Trump on December 22, 2017, the benefits of a Health Savings Account are even greater than before.

A Health Savings Account allows you to set aside your own savings for use on future medical expenses. Although plans will vary, the typical arrangement is that any money you put into your Health Savings Account is your money to keep, remaining in your account from year to year until you use it. Contributions to Health Savings Accounts, within limits most people are not likely to exceed, are pre-tax dollars. They reduce your taxable income, so you do not have to pay tax on those contributions, whether you use them on medical expenses in that year or not. When you do use the funds on medical expenses, because you never had to pay tax on those funds, you essentially receive a discount on your medical bills in the amount of the taxes you otherwise would have had to pay.

Historically, some have said “so what?” to this tax benefit. Medical and dental expenses are a well-known tax deduction. The same expenses could be reported and deducted from income taxes even if they were not paid out of a Health Savings Account, right? Well, not really. The problem with that is two-fold.

First, deduction of medical expenses is only available if you itemize your deductions. In past years, it was pretty common to itemize deductions. Typically, anyone with a mortgage could itemize deductions on their income taxes and beat the standard deduction. The Tax Cut and Jobs Act increased the standard deduction amounts substantially. As a result, I anticipate very few people will benefit from itemizing deductions on their income taxes. Assuming you are in the majority of people who will be claiming the standard deduction, any expense that you would have had to itemize in order to deduct no longer benefits you for income tax purposes.

Second, there is a threshold on the amount of qualified medical expenses that are deductible. In 2017 and 2018, you could only deduct qualified medical expenses that exceed 7.5% of your adjusted gross income. For example, if your adjusted gross income was $50,000, you would not be able to deduct the first $3,750 that you spent on qualified medical expenses. Few people have enough qualified medical expenses to exceed the 7.5% threshold to deduct. Starting January 1, 2019, that threshold went up. You now have to spend more than 10% of your adjusted gross income on qualified medical expenses before you can deduct a penny. In the previous example, that would be $5,000 of qualified medical expenses. Ouch! You might hit your out of pocket maximum before you reach your 10% number.

If you have a Health Savings Account, the contributions you make to that account are deductible in addition to claiming the standard deduction. There is no limitation that you can only deduct them if they exceed a percentage of your income. In most cases, every dollar you contribute to a Health Savings Account is a dollar on which you are not taxed. You can then pay your medical bills and buy your prescriptions, as well as certain over the counter items, with tax-free money.

To have a Scaringi Law tax attorney advise you on tax law or prepare your taxes return ask about a consultation by calling 717 657 7770.