A Medicare tax break / Some self-employed can deduct Medicare insurance premium

Bill Bischoff for MarketWatch.com writes: If you work for yourself, I hope you already know about the deduction for self-employed health insurance premiums. It is allowed for sole proprietors (including single-member LLC owners who are treated as sole proprietors for tax purposes), partners (including members of LLCs who are treated as partners for tax purposes), and S corporation shareholder-employees.

Self-Employed Health Insurance Deduction Basics

You can claim the self-employed health insurance deduction for qualified health premiums to cover you (the self-employed person), your spouse and dependents, and your under-age-27 children (whether they are dependents or not). The deduction is claimed on Page 1 of your Form 1040 (on Line 29 of the 2012 version of Form 1040).

Because the deduction is claimed on Page 1, it reduces your adjusted gross income (AGI), which in turn reduces the odds that you’ll be hit with various unfavorable AGI-based rules (like the one that causes more of your Social Security benefits to be taxable).

Because the deduction is claimed on Page 1, it is also exempt from the general rule that says only medical expenses in excess of 7.5% of your AGI can be deducted.

Premiums for Medicare Insurance Count

Last year, the IRS finally admitted that Medicare insurance premiums can be counted as qualified health insurance premiums for purposes of the self-employed health insurance deduction. Some tax pros, including yours truly, had long believed this to be true, but the Form 1040 instructions and IRS publications provided no support. The Chief Counsel Advice (CCA) cured that problem.

Even better, the CCA explicitly states that premiums for all four Medicare Parts (A, B, C, and D) can qualify for the self-employed health insurance deduction. This blanket statement applies to Medicare premiums to cover the self-employed individual, the spouse, dependents, and under-age-27 children—as long as the basic self-employed health insurance requirements are satisfied (see “Basic Requirements for Claiming the Self-Employed Health Insurance Deduction” on page 2 of this story).

Medicare Part A is commonly called hospital insurance coverage. Most eligible individuals are automatically covered for Part A without having to pay premiums because the Part A premiums are considered to be paid from Medicare taxes on wages while the individual (or spouse) is working. However, some individuals must pay premiums to get Part A coverage. If that is your situation, the Part A premiums for 2012 could have been as much as $451 per month per covered person. So they could have amounted to significant dollars (up to $5,412 per covered person for last year).

Medicare Part B is commonly called medical insurance coverage, and Part B together with Part A is often called “original” Medicare. Part B mainly covers doctors and outpatient services, and most people must pay monthly premiums for this Medicare cornerstone. For 2012, most folks paid the standard Part B premium of $99.90 per month ($1,199 for each covered person for the year). Higher-income individuals could have paid up to $319.70 per month for 2012 (up to $3,836 for each covered person). Once again, we can be talking about significant dollars here—especially if you’re married and both you and your spouse paid Part B premiums last year. (Your Part B premiums could have been subtracted from your Social Security benefits or paid in the same fashion as other health insurance bills.)

Medicare Part C is for private Medicare Advantage health plan coverage, which is supplemental to the government-provided Part A and Part B coverage. Medicare Advantage plans include HMO, PPO, and fee-for-service arrangements. Premiums vary depending on the plan. If you have Part C coverage, you don’t need Medigap coverage (described below).

Medicare Part D is for private prescription drug coverage. Premiums vary depending on the plan. Higher-income folks pay an “adjustment amount” in addition to their basic plan premiums. For 2012, the adjustment amount could have been up to $66.40 per month (up to $797 for each covered person for the year).

Medigap Insurance is private supplemental insurance similar to Part C coverage. If you have Medigap coverage, you don’t need Part C coverage and vice versa. Premiums for Medigap policies vary depending on the plan. While the CCA doesn't explicitly say that Medigap premiums qualify for the self-employed health insurance deduction, there is no reason to think it doesn’t.

The Bottom Line

The government’s recent admission that Medicare premiums can be counted for purposes of the self-employed health insurance deduction is great news for self-employed seniors, because Medicare premiums can amount to significant dollars. So being able to deduct those premiums can result in significant tax savings. Thank you IRS!

Basic Requirements for Claiming the Self-Employed Health Insurance Deduction

Eligibility Is Determined Month-by-Month: The deduction can only be claimed for premiums that are paid for months during which the individual wasn't eligible to participate in any subsidized health plan offered by the individual’s employer or the spouse’s employer.

Earned Income Limitation Applies: The deduction cannot exceed the earned income from the business activity for which the health insurance plan is established. For example, if your plan is established for a partnership activity from which you have net Schedule E income of only $10,000, your deduction cannot exceed $10,000.