Health-Care Tax Breaks / Changes That Took Effect This Year Make It Harder to Take Advantage of Health Care-Related Tax Breaks

• BILL BISCHOFF for the Wall St. Journal writes:  
With the high cost of health insurance and medical care, taxpayers often try to be vigilant about cashing in on health-care-related tax breaks. But changes taking effect this year make that harder than before.

Before 2013, for example, patients could claim an itemized deduction for medical expenses paid for themselves, spouses and dependents to the extent those expenses exceeded 7.5% of adjusted gross income. Under the Affordable Care Act, a higher 10% threshold now applies to most people.

However, the 10% threshold won't take effect for taxpayers or their spouses who will be 65 or older as of Dec. 31 this year. For them, the lower 7.5% threshold will continue to apply until 2017.

Individuals who can elect when medical expenses are incurred may be able to concentrate them in alternating years in order to reap the highest tax benefit.

Take someone under 65, with annual adjusted gross income of $70,000, who expects to incur $14,000 in uninsured medical expenses this year and next, perhaps because of elective surgery, a routine colonoscopy, a new pair of glasses, contact lenses and dental work.

If those costs are evenly spread over two years, the taxpayer can't write off the expenses, because the annual cost—$7,000—doesn't exceed 10% of adjusted gross income, which is also $7,000 in this case. But if the majority of the expenses occur in one year, whatever amount tops the threshold can be taken as a medical expense deduction.

Here are some other tax-related issues regarding health care—and what to do about them:

• Family help. A taxpayer who covers medical expenses for a dependent parent, grandparent or adult child can add those expenses to their own for itemized deduction purposes—but only if the taxpayer provides more than half the dependent's financial support, mainly living expenses, for the year. In some cases, for instance, that could push the taxpayer over the adjusted growth income threshold.

The tax advantage exists even if a taxpayer can't claim a dependent exemption deduction because the person who receives the support has too much income. (For 2013, you can't claim a dependent exemption deduction if the person who receives support has over $3,900 of gross income or files a joint return.)

• A new cap on flexible spending accounts. This year, the health-care overhaul imposes a $2,500 cap on annual contributions to employer-sponsored flexible spending accounts for medical expenses. In the past, there was no limit, though many plans imposed their own cap.

Employee contributions to health-care FSAs are subtracted from taxable salary, and patients can then use the funds to reimburse themselves for costs insurance doesn't cover. Even with the new limit, that tax advantage still exists.

• Long-term care. Most long-term care policies are considered health insurance under tax law, so the premiums count as a medical expense and can be deducted as such. But there are deduction limits tied to a taxpayer's age (see accompanying chart).

6 clients who could benefit from a Roth conversion

TOM NAWROCKI for Life Health Pro writes: The hottest estate planning move last year may well have been the Roth IRA conversion. Fidelity Investments came out with a study last week reporting that December 2012 saw a rise in Roth conversions of 52 percent from the year earlier. For 2012 as a whole, Roth conversions were up 12 percent from 2011.

There was a reason for that: Tax changes that took effect at the beginning of this year made the conversion imperative for a lot of people. With marginal tax rates going up for the highest tax bracket, it made sense for those people to move their money from a regular IRA — which is funded with tax-free dollars but is taxable upon withdrawal — to a Roth, where that money goes in after you’ve paid taxes on it, but is tax-free upon withdrawal. So it made sense that people wanted to push more taxable income into 2012, which had lower marginal rates than 2013.

It wasn’t so long ago that this wasn’t even a valid question for many people. Prior to 2010, only people with adjusted gross income lower than $100,000 were eligible to convert a regular IRA to a Roth. So for many of your clients, this is a relatively new issue.

But what happens in 2013? Does it still make sense for people to convert their regular IRA to a Roth? Here are some folks for whom conversion might still be fiscally advantageous:

• Those who expect to be moving into a higher tax bracket. The impetus behind the flood of conversions in 2012 was that many high-income people anticipated that their marginal income tax rates were going to increase. If your client is on the fast track to the corporate boardroom, or runs a growing practice of one type or another, a conversion could make his or her IRA income tax-free down the line. With a regular IRA, the withdrawals would be taxable. If the client would be in the highest bracket even into old age, the Roth makes sense.
• Clients who are comfortable enough that they want to wait until well after retirement to begin withdrawals. A regular IRA requires that the client begin taking the money out no later than age 70 and a half. A Roth imposes no such limitations. If a client wants to leave that money untouched as long as possible, a Roth makes more sense.

People who aren’t interested in managing a legacy or strong charitable contributions in their retirement years. Since a regular IRA is taxable when the money is withdrawn, it has the possibility of reducing the amount of money available in retirement. Someone who wants to be around to give grandchildren tuition gifts might want to keep that retirement income higher.

• People with temporarily low income. The money converted from a regular IRA to a Roth counts as regular income in the year the conversion is done. So if there’s a lull in your clients’ income — the business has had a down year or your client took a yearlong sabbatical — that might be a good time to make the conversion and pay income tax at the lower rate.
• Clients who are recently widowed. Tax rates for married couples filing jointly are more favorable than those for single filer. If a client has lost his or her spouse this year, it might make sense to convert to a Roth, take the tax hit at the more favorable rate, then receive the tax-free withdrawals in subsequent years when their rates might be higher.
• Clients who expect to gain terrific returns on their investments. Remember, clients are not only exempt from taxes on the withdrawal from the Roth, they are also exempt from taxes on gains from investments within the account.

On the other hand, if your client converted to a Roth at the end of 2012 and is now thinking it was a bad idea, there is still an alternative. The IRS has decreed that any IRA conversions that took place during 2012 can be unwound before Oct. 15, 2013. That little bit of leeway might be enough to entice your clients to just take a look at this estate-planning option.