On Health Care Costs, Second Homes and Taxes

by Markham Lee

The first of April was an anniversary for me of sorts, because it marked the end of my first year on an employer-sponsored health plan since 2005. Before then, I’ve always paid for my own health insurance on the private market either due to being self-employed, or being in a situation where the coverage my employer provides is lower in quality than the insurance I can buy on my own due to some combination of it being cheaper and/or providing superior coverage.

When I first bought my own insurance in ’05 it was actually pretty good — my premiums were about $144 per month, low co-pays, a $500 reasonable deductible and coverage for things like massages, chiropractor adjustments and physical therapy. However prices increased sharply every year after that, and by the end, I was paying $244 with a $5,000 deductible.

(Note: Since health care cost increases are often laid at the feet of Obamacare, I’ll simply make note of the fact that most of the cost increases occurred prior to Obama taking office let alone the ACA. Things were fairly stable over the last couple of years.)

Despite the “paying more and receiving far less” scenario, the thing that always irritated me the most about health insurance and health care costs is that it’s easier to deduct a vacation home than it is to deduct your medical costs. Especially since between a weird metabolic disorder (that is thankfully well on its way to reversing itself) and some foot surgeries, I’ve racked up some significant medical costs over the years. I never quite understood the logic behind the fact that our government has decided that we should get a taxpayer subsidy for vacation homes, but not for our health care costs.

I know that some conservative of anti-government dependence types will bristle at the idea of calling a tax deduction a taxpayer subsidy, but make no mistake: Anything that involves tax deductions is a subsidy.

Paying for health care premiums on the private market can be frustrating come tax time because unlike when you’re on an employee-sponsored plan your premiums aren’t tax deductible. The savings that come from the tax deduction are fairly significant: Let’s say that your effective tax rate (% of your gross income that goes to taxes as opposed to your top marginal rate or tax bracket) is 25% and your insurance premiums are $200/paycheck, being able to deduct those premiums = a 25% discount or a true cost of $150/paycheck. However if you’re a W2 employee who pays for a non-employee sponsored health care plan, you don’t get the benefit of that deduction or discount.

In a world where an increasing large number of people are working as contractors or temps who may find themselves in situations like I was where paying for private insurance equals vastly superior coverage, this puts you into a bit of a financial quandary. A quandary that wouldn’t exist if all health insurance were treated as fully deductible regardless of how you bought it.

The situation is better for self-employed individuals but with a few wrinkles, according to IRS publication 535 a self-employed person can deduct their health insurance costs if:

• They don’t have the option of getting health insurance through a spouse’s plan
• The plan is established either in the name of the self-employed person, or the business they operate.
• Their business showed a profit that year, a requirement that the deductibility of other business expenses (E.g. paperclips) doesn’t hinge on.

The permutations of the above hit me a few years ago. Up until about five years ago I used to do consulting work via a self-employed 1099 or “corp to corp” arrangement, meaning the company (usually a third party between me and the actual client) paid either my LLC or me directly and I handled my own taxes, benefits and insurance. This meant as long as I had the “name right” for my health insurance I deduct away. However those days are long gone, because for a variety of reasons the major clients in the area aren’t too keen on allowing their consulting firms pay their contractors via these types of arrangements anymore. Everyone has to be a W2, and with that hundreds if not thousands of people like me lost the ability to deduct their insurance premiums.

This is not to say that the technology consulting and staffing firms in my area don’t provide health insurance but that mileage varies, you might get great insurance, you might get good insurance at the cost of a pay cut that exceeds the value of the insurance or the insurance might just be rubbish AND require a pay cut.

I got really lucky with my current employer.

The other piece of this is that a small business owner whose spouse’s employer has awful health insurance, might be find themselves in a situation where they’re losing a tax deduction for no other reason than the fact that they wanted to purchase a better product for themselves or their families.

Taking away a tax deduction simply due to how you choose to buy a product constitutes a punitive tax.

The final wrinkles are that your business has to show a profit for you to deduct your health insurance premiums, and your deduction can’t exceed your business’ earned income. E.g. if you lost $5K last year you can deduct your other business expenses, but not your insurance premiums. If you only made $2K and your health insurance premiums totaled $3K (mine were $2,900 in 2011), you’d only be able to deduct the first $2K.

It’s important to note that these rules apply to self-employed individuals who operate either as sole proprietors, or sub-section “S” corps where all the corporation’s (or business’) income is passed on to the owners via their individual income taxes. These rules don’t apply to C-Corps (most mega corporations), who can deduct 100% of their health care costs whether they’re from health insurance or reimbursing people for out of pocket costs (as long as the plan doesn’t favor owners). This is not to say that self-employed people can’t form C-Corps, but it often comes with other tax implications that make what is very appealing to well multi-million dollar companies not so appealing to say someone whose small business makes $60k/yr. I.e. your profits getting taxed at the corporate level and via the salary you receive from your company.

When it comes to the deductibility of health care premiums, the entire situation seems arbitrary if not punitive. No one should be losing the ability to deduct their health insurance simply because they didn’t meet a set of nebulous criteria where how you buy a product is more important than the product itself; in fact taking away the tax deduction in certain cases constitutes a punitive tax.

Consider the choice I had to make back in ’10: make about $15k/yr less to receive crappy deductible insurance, or not get the deduction (which effectively means I’m subsidizing the insurance of people who get the deduction) to get good insurance and take home more cash. It’s also worth noting that many of my co-workers didn’t know they even had the choice to buy something better on the private market, until someone asked me a question about our company’s plan and I said I wasn’t on it.

While some of the tax credits included in the “Affordable Health Care Act” for small businesses and lower income individuals purchasing private insurance are a start, more must be done so that health insurance premiums are 100% tax deductible, period.

I would argue that the deductibility of health care costs in general is far worse than the insurance premium situation.

According to IRS Publication 502 you’re only able to deduct medical expenses that exceed 7.5% of your adjusted gross income; e.g. you have an adjusted gross income of $50K/yr, you can only deduct medical expenses that exceed $3,750. Making it worse is that you’d have to itemize those deductions to claim them, meaning they have to exceed the current standard tax deduction to be valuable. If you’re single that means that you’d need spend more than $5,900 over the $3,750 to see a benefit, and if you’re married you’d need to spend more than 11,800 + 3,750 or $15,550.00 to see a benefit.

When you consider that 55% of US households earn $50K/year or less, and that $15.5K = 31% of their gross income before taxes, the tax code is positing that a fairly typical household should all but spend itself into bankruptcy before it can deduct its medical expenses.

Meanwhile per IRS publication 936 you can deduct the interest on a vacation home (with certain limitations around how much time you spend there) provided your total mortgage debt for your primary and secondary home doesn’t exceed $1,000,000. Mind you the same issues with the standard deduction come into play (which calls into question the old saw of always buy a house for the tax deduction, but that’s another essay), but it doesn’t change the fact that there are far fewer restrictions on primary and secondary mortgages than health care costs.

Call me crazy, but I don’t think that the mortgage interest for a vacation home should be more deductible than health insurance costs, especially when some of the criteria to earn the deductions are as flimsy as purchasing health insurance through your employer instead of the private market. Better yet why should taxpayers who are struggling with medical bills have to subsidize someone’s vacation home with their tax dollars?

According to a recent Harvard Study 62% of bankruptcies are due to medical expenses, and 78% of those people had insurance. Allowing all medical expenses to be deducted without having to meet the 7.5% standard would go a long way towards easing some of that pain.

I think the solution to this problem is pretty simple: The tax code should be updated to allow all health care costs whether they’re for out of pocket costs or insurance to be 100% tax deductible, period. For the record I understand that doing this may not make any real difference to people who don’t pay taxes, and it will have a cost as far as tax revenue. But I have a solution to the latter part of the equation too: cover the cost by phasing out some of the tax deductions on people with hyper-expensive homes and vacation homes. Of all the things I want to subsidize with my tax dollars, vacation homes and mansions aren’t one of them, I’d much rather subsidize health care.

Markham Lee is a freelance writer based in Seattle who has spilled pixels on topics ranging from music, relationships, television, and those instances where life is stranger than fiction. He’s also working on a science fiction novel he hopes to finish before 2020. His work has been published by Nerve.com, The Frisky, Pop Matters, and Seeking Alpha. You can find more of his writing on his blog, and some of his more random, yet semi-intelligent thoughts on Twitter. Photo: U.S. Navy

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