Review of Tax Formula from Form 1040
- Gross Income (wages, investment income, business income, etc.)
- Less Adjustments to Gross Income
- Equals Adjusted Gross Income (AGI)
- Less Deductions (either the Standard Deduction or Itemized Deduction, whichever is larger)
- Less Personal Exemptions (eliminated 2018 through 2025)
- Equals Taxable Income
- Calculate Tax (use the rate tables)
- Add Alternative Minimum Tax (AMT) if applicable
- Less Credits (education, child tax credit, foreign tax credit, dependent care expenses)
- Plus Other Taxes
- Less Payments (withholding, estimates, and other credits)
- Equals Tax Owed/Refunded on April 15th
Tax Planning Objective: decrease gross income, increase deductions, or increase tax credits.
Tax Reform Act (just a few of the changes) Effective 2018
Revised tax rate tables that lower the tax rates for 2018 through 2025.
Personal Exemptions eliminated for tax years 2018 through 2025.
Standard Deduction increased to $12,000 for single filers and $24,000 for married filing jointly.
Medical Expense Deduction floor lowers to 7.5% of AGI for tax year 2017 and 2018. After that it reverts to 10% of AGI.
Mortgage Interest Deduction limited to $750,000 of acquisition debt for tax years 2018 through 2025. The $1,000,000 limitation remains for older debt.
Mortgage Interest Deduction for Home Equity Debt suspended for tax years 2018 through 2025.
Child Tax Credit increased to $2,000 per qualifying child. Provision effective tax years 2018 through 2025.
ABLE Account – rollovers from §529 accounts (qualified tuition plans) to ABLE accounts are allowed.
Part 1. Itemized Deduction for Medical Expenses
How Does the Deduction Work? You can deduct, as an itemized deduction, your medical expenses that exceed the AGI floor.
AGI – $100,000
AGI Floor – 7.5%
Medical Expenses – $10,000
Allowed Deduction = $10,000 minus $7,500 (7.5% x $100,000) equals $2,500
Medical Expenses, to be deductible, must be paid for medical care of the taxpayer, spouse, or a dependent of the taxpayer and not be compensated by insurance or otherwise.
Planning a large expenditure? When in doubt get a letter of medical necessity from a physician or psychiatrist and discuss with your tax advisor in advance.
Who is your dependent? Qualifying Child or Qualifying Relative. See Resource List in Part 6.
What Qualifies as Medical Care – IRS Publication 502 – Broad Categories
What is Medical Care? Medical care includes payments for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. Payments for medical care include payments made for transportation primarily for and essential to medical care.
There is no exhaustive list, but here are a few examples…
- Doctor’s, Dentists, Physical and Speech Therapy
- Prescribed medication
- Health care insurance premiums
- You can include in medical expenses fees you pay on a doctor’s recommendation for a child’s tutoring by a teacher who is specially trained and qualified to work with children who have learning disabilities caused by mental or physical impairments, including nervous system disorders.
- You can include in medical expenses the cost (tuition, meals, and lodging) of attending a school that furnishes special education to help a child to overcome learning disabilities. For expenses to be deductible, a doctor must recommend that the child attend the school. Overcoming the learning disabilities must be a principal reason for attending the school, and any ordinary education received must be incidental to the special education provided. Special education includes:
- The cost of attending such a special school will include the cost of transportation, meals and lodging, if supplied, and the cost of ordinary education furnished which is incidental to the special services furnished by the school.
- Transportation deduction using the standard medical mileage rate of 17 cents per mile for 2017. Keep accurate mileage records.
- Technology equipment that helps a person with a speech disability communicate as well as the cost of repairing the equipment.
- What do you buy for the purpose of “diagnosis, cure, mitigation, treatment, or prevention”
- Ipad and iTunes apps? Get a letter of medical necessity from your Doctor.
Home Improvements (Capital Expenses)
- You can include in medical expenses amounts you pay for special equipment installed in a home, or for improvements, if their main purpose is medical care for you, your spouse, or your dependent.
- You can deduct the cost of a permanent improvement to the extent it does not increase the value of your property. The deduction is equal to the cost of improvement minus the increase in value of your property.
You can include in medical expenses amounts paid for admission and transportation to a medical conference if the medical conference concerns the chronic illness of yourself, your spouse, or your dependent. The costs of the medical conference must be primarily for and necessary to the medical care of you, your spouse, or your dependent. The majority of the time spent at the conference must be spent attending sessions on medical information.
Caution: The cost of meals and lodging while attending the conference isn’t deductible as a medical expense.
Trips for Medical Care
The costs of meals and lodging necessarily incurred to bring a patient and persons who must accompany the patient to and from a place of medical treatment are transportation costs, and deductible as medical expenses.
Advance Payments of Future Care
You can include in medical expenses advance payments to a private institution for lifetime care, treatment, and training of your physically or mentally impaired child upon your death or when you become unable to provide care. The payments must be a condition for the institution’s future acceptance of your child and must not be refundable.
Special Diets if Prescribed by a Physician
- Cost of food and beverage that supplements the diet is fully deductible.
- Cost of food and beverage that substitutes for foods and beverages normally consumed. Deduction is equal to excess cost over the cost of normal foods and beverages.
Part 2. Flexible Spending Account and Health Savings Account
Flexible Spending Account
An employer-sponsored benefit program that reimburses medical expenses, subject to maximum dollar limits, generally through the participant’s pre-tax contributions. A pre-tax contribution lowers your gross income.
The contribution limit for 2017 was $2,600. The contribution limit for 2018 is $2,650.
Use-it-or-Lose it. Amounts remaining in the account at the end of the plan year are usually forfeited.
Qualified medical expenses are generally the same as those that qualify as an itemized deduction, except for nonprescription (over-the-counter) medicines.
Health Savings Account
Contributions to HSAs by your employer are not included in your gross income. Contributions made outside of the employment context are deductible from gross income before calculating AGI.
- Must be covered by a high-deductible health plan (HDHP)
- Must not be covered by any other plant that is not a HDHP
- Must not be enrolled in Medicare, and
- Cannot be claimed as a dependent on another person’s tax return.
HSA accounts are not subject to taxation
Distributions from HSAs are excluded from gross income if used to pay or be reimbursed for qualified medical expenses.
Part 3. Tax Credits
Child Tax Credit
Available for a “qualifying child” who is under age 17 at the end of the year, and you must claim the child as a dependent on your tax return.
2017 Tax Year
$1,000 per qualifying child
Income-based phase-out for MFJ begins when modified AGI is over $110,000
2018 through 2025 Tax Year
$2,000 per qualifying child
Income-based phase-out for MFJ begins when modified AGI is over $400,000
Dependent Care Credit
Available to taxpayers who pay qualifying dependent care expenses to allow the taxpayer and the taxpayer’s spouse to work.
Dependent care expenses must be paid for one or more qualifying individuals. A qualifying individual is:
- A dependent under age 13, OR
- Any other dependent who is physically or mentally incapable of caring for himself or herself
For taxpayers whose AGI is greater than $43,000, the credit is equal to 20% of qualified expenses. The maximum amount of qualified expenses to which the credit may be applies is $3,000 if there is one qualified individual and $6,000 if two or more qualified individuals. The dollar limit is reduced by any excludable employer dependent care assistance program payments.
For married taxpayers, expenses are limited to earned income of the lower-earning spouse. This you both have to work.
Employer Provided Dependent Care Assistance Program
This is not a tax credit, but if you participate in an employer provided dependent care assistance program, then the dependent care credit may be reduced or entirely eliminated.
This plan works similar to a flexible spending account. The employer can exclude from the employee’s income up to $5,000. The employee is reimbursed for qualifying dependent care expenses (same as those that count for the credit) up to the amount elected by the employee.
The exclusion from gross income cannot exceed the earned income of the lower-earning spouse if married.
Part 4. Virginia Specific Tax Benefits
ABLE Account Contributions
The amount deducted on any individual income tax return in any taxable year is generally limited to $2,000 per ABLE account. Contributors may carry forward any un-deducted amounts until their contributions have been fully deducted. If the contributor has attained age 70, he may deduct the entire amount contributed to an ABLE account, less any amounts previously deducted. Account hast to be set up through an ABLEnow account.
Child and Dependent Care Expenses
You may claim this deduction on your Virginia return only if you were eligible to claim a credit for child and dependent care expenses on your federal return.
Part 5. Disclaimer
This information has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own, tax, legal and accounting advisors before engaging in any transaction.
Part 6. Resource List
Potential income tax benefits for families with special needs children. https://www.journalofaccountancy.com/issues/2013/jun/20137378.html
IRS Publication 502, Medical and Dental Expenses.
IRS webpage: More Information for People with Disabilities
IRS Publication 3966, Living and Working with Disabilities
IRS Tax Topic Number 602: Child and Dependent Care Credit
IRS News Release: Plan Now to Use Health Flexible Spending Arrangements in 2018
Who is Your Dependant?
A qualifying child is a child who:
- Is your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half brother, half sister, or a descendant of any of them (for example, your grandchild, niece, or nephew),
- Under age 19 at the end of 2017 and younger than you (or your spouse, if filing jointly),
- Under age 24 at the end of 2017, a full-time student, and younger than you (or your spouse, if filing jointly), or
- Any age and permanently and totally disabled,
- Lived with you for more than half of 2017,
- Didn’t provide over half of his or her own support for 2017, and
- Didn’t file a joint return, other than to claim a refund.
A qualifying relative is a person:
- Who is your:
- Son, daughter, stepchild, or foster child, or a descendant of any of them (for example, your grandchild),
- Brother, sister, half brother, half sister, or a son or daughter of any of them,
- Father, mother, or an ancestor or sibling of either of them (for example, your grandmother, grandfather, aunt, or uncle),
- Stepbrother, stepsister, stepfather, stepmother, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law, or
- Any other person (other than your spouse) who lived with you all year as a member of your household if your relationship didn’t violate local law,
- Who wasn’t a qualifying child of any taxpayer for the tax year, and
- For whom you provided over half of the support in the tax year (exceptions apply for children of divorced or separated parents).
How does Congress define “permanent and totally disabled”? An individual is permanently and totally disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. An individual shall not be considered to be permanently and totally disabled unless he furnishes proof of the existence thereof in such form and manner, and at such times, as the Secretary may require. Internal Revenue Code, § 22
About G. Christopher Wright
Christopher Wright is an attorney and a Certified Public Accountant. He practices law from his office in Old Town Alexandria. He is an attorney with the law firm of Vogelman, Turner & Wright, P.C. His practice focuses on estate planning and tax law.
Posted in: Tax Law