Deducting Medical Insurance

I first discovered I could deduct medical insurance when I had an emergency operation in 2009 that saved my life. The operation, and the subsequent hospital stay, left me with over 60 thousand dollars in medical debt.

After this life-saving event, I was paying off both medical debt and paying for health insurance at the same time. So, quite naturally, I started itemizing my medical expenses on Schedule A. Schedule A, generally speaking, is where you itemize deductions of all kinds.

After I paid off my medical debt, I assumed there was no further benefit to me filling in the medical insurance part of my tax return. I made this assumption based on the fact that my yearly total for medical insurance never reached the level of the standard deduction. Since I was no longer filing Schedule A, and no longer itemizing deductions, I assumed there was no way I could use medical insurance to reduce my taxes.

I was wrong, totally wrong.

It turns out that if you are a small business owner and you do not itemize your deductions on Schedule A, there is still a place to put your medical insurance expenses. That place is Line 29 of Form 1040, long form.

Here's the IRS's rather complicated explanation of line 29:

Health Insurance Tax Breaks for the Self-Employed

Why give small business owners two places to place medical insurance payments? I've tried to figure out the IRS's reasoning on this:

It seems to me that you can place medical insurance payments in 2 different places because this gives small business parity with wage earners. This is especially true for sole proprietors.

When you are an employee for a company, the medical insurance that the company buys for you is an expense. Effectively, medical insurance lowers your wages and thus lowers your taxes. That's my best guess.

Therefore, as a sole proprietor, health insurance should also lower your taxes, even though you pay it yourself. That, to me, seems to be IRS reasoning on the matter.

It makes sense. Whether you are an employee or self-employed, medical insurance should lower your tax burden equally. I believe line 29 of Form 1040, long form, is the equalizer.

Why not have everyone deduct everything medical, including health insurance, exclusively on Schedule A? The reasoning on this is probably that most people do not have enough deductions to itemize on Schedule A. Most people take the standard deduction instead.

So, if there were no special provision for the self-employed to deduct medical insurance that they pay for themselves, there would be no fairness of treatment of wage-earners and the self-employed.

Without line 29, wage earners would be at an advantage over the self-employed because medical insurance is always going to lower their tax burden, but medical insurance would not necessarily lower the tax burden of the self-employed if it were not for line 29 as a special provision.

Admittedly it requires a very broad understanding of economics to understand how health insurance could lower a wage-earners wages and therefore lower the wage-earners taxes. Basically it has to do with the fact that both wages and health insurance are an expense for a business. If health insurance goes up in cost, it suppresses wages because the business owner has to pay the expense, regardless.

How are wages determined? Mostly by the marketplace. The market for wage earners determines how much wage earners earn. For example, in the big city the competition for wage-earners is more intense and thus wage-earners tend to earn bigger hourly rates or bigger salaries.

Health insurance increases the expense to employers and therefore decreases potential wages for all employees when the cost of health insurance goes up. It's simple supply/demand economics.

Of course, there will be those who dispute this. However, even though determining the level of someone's wages is a very approximate thing, it still balances out. A business can never pay employees more than the business receives in revenues. Health insurance also counts against those revenues.

So, in a very approximate way, rising health insurance costs suppress wages. Maybe not this year, but eventually. Eventually it all comes out in the wash as they say.

The over-riding principle of tax forms seems to be balance. Allowing medical insurance payments to be included on line 29 instead of Schedule A is an attempt to bring balance to a highly imperfect tax code. That's my best guess.

Of course, life is never perfectly fair on Earth. However, I do appreciate it when people at least try to be fair.

By the way. You cannot place your medical insurances on both line 29 and Schedule A. You know that, right? I mention this only for extra crystal clear clarity. If you could place medical insurance payments on both line 29 (Form 1040) and Schedule A, the principle of balance would go in reverse. Now small business owners would have the tax advantage over wage earners.

None of the above is written with the intent of suggesting that the tax code is perfectly fair. Rather the intent is to show that even when people are not fair, life somehow is. That is to say, life itself is always seeking a balance in all things.

Ed Abbott