INTRODUCTION SCH A MEDICAL EXPENSES This Difficult Level Practice Return will include an Itemized Deduction for Out-of-Pocket Medical Expenses. As you have learned, Itemized Deductions, including Medical expenses, are shown on the Tax Return on the Sch A form. The most important thing to remember about Itemized Deductions is that the total of Itemized Deductions must amount to more than the Standard Deduction, assigned mostly by Filing Status, before they will have any effect on the customer s federal tax return. Whether the customer uses the Standard Deduction or is able to benefit from using Itemized Deductions, the amount is subtracted from income and reduces the amount of taxable income on the tax return. One of the most frequent support phone calls we receive at Tax Assist during filing season has to do with Itemized Deductions. The question goes something like, Can they deduct The answer is often, Yes, but it might not do them any good. This is where the Standard versus Itemized Deduction often comes into play on a tax return. While a taxpayer may be entitled to deduct a certain item, the benefit of the Deduction can depend on several other factors. Nowhere is this truer than in the case of Out-of-Pocket Medical Expenses on the Sch A. Read on to learn more about this subject. MEDICAL EXPENSES AS ITEMIZED DEDUCTIONS What s the Catch? Listed later are the most common medical expenses that are allowed for a deduction on Sch A. You will see that there are many. Just about any kind of medical, dental, eye care or health insurance premium paid out-of-pocket by the taxpayer and not reimbursed from an employer or insurance company is an allowable Deduction. It sounds simple doesn t it? Here is where it gets more complicated: 1. You MUST BE ABLE TO ITEMIZE DEDUCTIONS to claim these expenses. Unless a taxpayer s total Itemized Deductions add up to MORE than the Standard Deduction, the taxpayer will not benefit from using them. So, while the taxpayer may have deductible medical expenses the only way they can benefit from including them on the return is if the total of all Itemized Deductions exceeds the Standard Deduction. 2. And there s another trick, too for person s under 65 years old, medical expenses are only deductible to the extent that they exceed 10% of your Adjusted Gross Income (AGI). For example: If your AGI is $75,000, the first $7,500 of qualified expenses (10% of $75,000) DON T EVEN COUNT for itemized deduction purposes. Note: There is a temporary exemption to the 10% rate from Jan. 1, 2013 to Dec. 31, 2016 for individuals age 65 and older and their spouses. If you or your spouses are 65 years or older or turned 65 during the tax year you are allowed to deduct unreimbursed medical care expenses that exceed 7.5% of your adjusted gross income. The threshold remains at 7.5% of AGI for those taxpayers until Dec. 31, 2016. As you can see, Medical Expenses paid are a good example of the answer cited earlier to the question: Can they deduct? The answer is often, Yes, but it might not do them any good.
MEDICAL EXPENSES - What is Deductible? The IRS says that Medical expenses can be deducted on the Sch A if amounts are paid for the diagnoses, cure, treatment, or prevention of a disease or ailment affecting any part or function of the body. Allowable expenses may be used when paid for yourself, your spouse and your dependents. Listed below are some examples of the most common deductible medical expenses: Artificial limbs Artificial teeth Birth control pills prescribed by a doctor Contact lenses, including equipment and materials for using contacts Cosmetic surgery to improve a deformity related to a congenital abnormality, accident or disease Doctor or physician expenses, including Eye doctors and dentists Drug addiction treatment, including in-patient treatment Eye surgery, such as Lasik or a similar procedure, when it is not for cosmetic purposes only Hospital care Insurance premiums for medical care coverage Laboratory fees Lodging expenses while away from home to receive medical care in a hospital or medical facility Long-term care insurance and long-term care expenses (there are limitations to what you can deduct) Medical aids, including wheelchairs, hearing aids and batteries, eyeglasses, contact lenses, crutches Prescription Medicines and drugs Nursing care Nursing home expenses, including the entire cost of medical care, plus meals and lodging if the main reason for being in the home is to obtain medical care Oxygen and oxygen equipment Smoking cessation programs (does not have to be recommended by a physician) Transportation costs for obtaining medical care Weight loss program, if it is recommended by a doctor to treat a specific medical condition or to cure any specific ailment or disease X-ray services
MEDICAL EXPENSES - What is NOT Deductible? Here are some examples, cited by the IRS, of Expenses that ARE NOT deductible as Medical Expenses on Sch A: Health club dues, gym membership fees, or spa dues Electrolysis or hair removal The cost of diet food or nutritional supplements (vitamins, herbal supplements, "natural medicines") Teeth whitening Veterinary fees Cosmetic surgery unless it was necessary to improve a deformity related to a congenital abnormality, an injury from an accident or trauma, or a disfiguring disease Life insurance or income protection policies The Medicare tax on your wages and tips or the Medicare tax paid as part of the self-employment tax or household employment taxes Babysitting, childcare, and nursing care for a healthy baby Illegal operations or drugs Imported drugs not approved by the US Food and Drug Administration (FDA). This includes foreignmade versions of US-approved drugs manufactured without FDA approval Non-prescription medicines (including nicotine gum and certain nicotine patches) Travel your doctor told you to take for rest or a change Funeral, burial, or cremation costs
RETURN SCENARIO FRED FEVERISH Practice Return Difficult Level - #3 Fred Feverish has come straight from a Doctor s appointment to have his taxes prepared. Fred works as a Pharmacy Technician. He has never been married and lives alone. Fred has had a rough year health-wise. He s been in and out of the hospital with a mysterious illness and has paid quite a bit in out-of-pocket medical expense this year for items that were not covered by insurance. He has provided you with records and receipts of all his out-of-pocket medical expenses and a Summary of the total amount he paid in 2015. Fred has a mortgage on his home and also paid the real estate taxes due on the property during 2015 as part of the mortgage. He did not itemize deductions on his 2014 return but thinks the medical expenses may help him out this year for itemizing. He had Health Insurance for the entire year provided by his employer. His home phone number is 815-635-6578. Fred does not want to pay you up-front for the tax preparation fees. He would like to apply for a RAC/ERC/RT Bank Product for any Federal refund. He also wants to include any state refund with the Bank Product by applying for a State RAC. Your State Driver s License License # FEV577899 First Name: FRED Last Name: FEVERISH DOB: 02/15/1969 654 SICK AS A DOG LANE Your Hometown, Your State, Zip Issued: 02/18/2015 Expires: 02/18/2020 Fred Feverish s Social Security Number Mgr. use: 731-yourEFIN Emp. 2 use: 732-yourEFIN Emp. 3 use: 733-yourEFIN Emp. 4 use: 734-yourEFIN Emp. 5 use: 735-yourEFIN Signed: Fred Feverish Page 1
b Employer identification number (EIN) a Employee s social security number OMB No. 1545-0008 Safe, accurate, FAST! Use Visit the IRS website at www.irs.gov/efile 1 Wages, tips, other compensation 2 Federal income tax withheld c Employer s name, address, and ZIP code 3 Social security wages 4 Social security tax withheld 5 Medicare wages and tips 6 Medicare tax withheld 7 Social security tips 8 Allocated tips d Control number 9 10 Dependent care benefits e Employee s first name and initial Last name Suff. 11 Nonqualified plans 12a See instructions for box 12 C 13 Statutory employee 14 Other f Employee s address and ZIP code 15 State Employer s state ID number 16 State wages, tips, etc. 17 State income tax 18 Local wages, tips, etc. 19 Local income tax 20 Locality name Retirement plan Third-party sick pay o d e 12b C o d e 12c C o d e 12d C o d e Wage and Tax Form W-2 Copy B To Be Filed With Employee s FEDERAL Tax Return. This information is being furnished to the Internal Revenue Service. Statement 2015 Department of the Treasury Internal Revenue Service
Practice Return Difficult Level - #3 HELPFUL HINTS - ADDING THE SCH A/ENTERING ITEMIZED DEDUCTIONS The client has presented us with documents and information about Mortgage Interest and Real Estate Taxes paid for the home as well as contributions made to Charity. These ITEMIZED DEDUCTIONS are included in the Tax Return on the Schedule A. If the total of the Itemized Deductions is greater than the STANDARD DEDUCTION for the return, the client will benefit from using them. Since we have only entered the W2s, the software is calculating that the 1040A form may be used. After our Sch A information is entered, the software will calculate to form 1040. A 1040 is required whenever Sch A is significant. 1. Before we start adding the Itemized Deductions, it would help to see how the Standard or Itemized Deductions show up on the tax return. In the Attached Forms list, double-click on the. Scroll down on the form to Line 24A. There you will see the explanation for Line 24A and the amount is there currently. Note that Line 24A is $6,300. Remember, we learned that a taxpayer will use either the Standard Deduction assigned by Filing Status OR Itemized Deductions, whichever is greater. In this case, since the Filing Status is Single and we have not entered any Itemized Deductions yet, the amount on the Line is $6,300 the amount for a Single filing status on 2015 income tax returns. After we correctly enter our Sch A info, we will go to Line 40 on the 1040 to see what happens there AFTER the Itemized Deductions have been added. For now, we can move on to adding our Sch A and entering our Itemized Deductions. Itemized Deductions that go on a Sch A work differently from many other forms. Instead of adding a form and completing it, we take INFORMATION from documents to be entered on our Sch A in the proper places. 2. To add Sch A, click on the Add Form button. In the All Forms & Schedules at the bottom left, in the Enter Schedule/Form Number field type the letter A. The form that window will direct you to the Sch A in the list. Double-click the form to open it. Page 2
Practice Return Difficult Level - #3 3. As you can see by looking over the form, the Sch A has several Sections. The top Section of the form is titled: Medical and Dental Expenses. It is shown below: Fred has provided records, receipts and a Summary of all his out-of-pocket medical expenses for the year. An example of what that might look like is shown below. We will use that information to enter the amount in the Medical and Dental Expenses section of the Sch A. 4. As a preparer, you now have a choice as to how you show the Medical Expenses on the Sch A. The simplest way is to enter the TOTAL of expenses directly in the space provided. If you do that it would look something like this: Page 3
Practice Return Difficult Level - #3 Another way to show the Medical Expenses would be to use a Worksheet to show a further breakdown of the expenses, much like they are shown on the taxpayer s summary. To do that, you would get into the field where Medical Expenses are shown and click the button in the Active Options window. That will bring up a Worksheet with several spaces to breakdown and further identify the Medical Expenses paid. The Worksheet might look something like this: Using this method, when you close the Worksheet, the Medical Expense section of the Sch A will look like this: 5. No matter what method you use to enter the Medical Expenses, you will note that the final result to the return is identical. A total of $4,048 in Out-of-Pocket Expense and amount of $840 that counts towards the taxpayer s Sch A Itemized Deductions. Do you know why only $840 counts? 6. We learned in the Introduction to this Practice Return that Medical Expenses must be more than 10% of Adjusted Gross Income (AGI) before they start to count on the Sch A. Note, that the software does the math for you. The taxpayer s AGI is $32,084. That number times 10% is $3,208. Since the total Medical Expense is $4,048 the amount that counts toward Itemized Deductions is $840. [4,048 minus 3,208 = 840] Page 4
Practice Return Difficult Level - #3 7. Continue completing the Sch A by using the 1098 form shown below to enter the Real Estate Taxes and Mortgage Interest in the appropriate spots as you did on CE #1 and #2 in this Series. 2015 8. If you have correctly entered the Sch A Deductions, the total of the Deductions (Medical Expenses, Taxes Paid, Interest Paid) is shown on the Sch A, Line 29 Total Itemized Deductions. 9. Now that we ve completed adding our Itemized Deductions, we can look back the the Return and see what has changed. In the Attached Forms list, double-click on the. Scroll down on the form to Line 40. There you will see the explanation for Line 40 and the amount is there currently. Remember, before creating the Sch A and entering the Itemized Deductions, the amount on Line 40 was $6,300 the amount for a Single filing status on 2015 income tax returns. Now that we have entered total Sch A Itemized Deductions that are greater than the Standard Deduction, that Sch A amount appears here, increasing the deduction the taxpayer can take from taxable income. Page 5
Practice Return Difficult Level - #3 HELPFUL HINTS SPECIAL VERIFY MESSAGES FOR SCH A RETURN One of the first Verify messages you will see relates to whether or not the client Itemized Deductions in the prior tax year. In this case, we said in the Return Scenario that the client DID NOT itemize deductions in the prior year. You can remove the Verify message by putting an X in the No box. If the client HAD itemized in the prior year you would need to continue the Worksheet, using amounts from the prior year to determine whether any part a prior year state refund would be taxable. Another Verify message you will most likely see appears on the right here. It requires some explanation as shown in the next paragraph. When a tax return includes a Sch A where the TOTAL ITEMIZED DEDUCTIONS are unusually high based on the amount of INCOME on the return, the software gives the Preparer what amounts to a heads-up. It protects you as the Preparer and the Taxpayer by asking for further explanation of the Sch A Itemized Deductions. When you click on this Verify Message the form shown below will pop-up on the screen. The Verify message and this form are simply asking for a further explanation of the Itemized Deductions since they are high in relation to the Income on the return. To clear this Verify Message, you might enter something like this: Page 6
Practice Return - Difficult Level - #3 CORRECT REFUNDS FEDERAL - $1,365 STATES (if applicable) ALABAMA - $791 GEORGIA - $519 IDAHO - $352 ILLINOIS - $533 (SCH ICR County = SANGAMON Property Number = 154897777) INDIANA - $81 (GRANT MARION COMMUNITY MARION COUNTY) KENTUCKY - $319 LOUISIANA - $839 MISSISSIPPI - $779 MISSOURI - $729 NEW MEXICO -886 $ (NM Residents) OKLAHOMA - $611 SOUTH CAROLINA - $590 WISCONSIN $571 (Paid Real Estate Taxes - $1,045)