axpayers needing to fund large and/or ongoing
medical expenses should explore tax-minimizing ways to pay
them beyond deducting them under the 7.5% of
adjusted-gross-income threshold. Potential alternative
funding vehicles are described below. CPAs should become
familiar with such mechanisms to aid eligible clients.
section 125 cafeteria plans are the most common
taxpayer-friendly medical expense reimbursement arrangements
(after medical insurance). Employee contributions fund
flexible spending accounts (FSA) on a pretax,
salary-reduction basis to provide coverage for specified
expenses (qualified medical expenses or
dependent-care-assistance costs, for example) incurred
during the coverage period.
Reimbursement is subject
to reasonable conditions. Participants must use FSA amounts
for the specified expenses or forfeit any amounts remaining
as of the plan yearend.
alternative may be a health reimbursement account (HRA),
which reimburses employees for medical expenses other
insurance doesn’t cover. In general, employers fund
HRAs—without employee salary reductions—to reimburse workers
for substantiated medical care expenses incurred by the
employee and his or her spouse and dependents. HRAs
typically provide reimbursement up to a maximum dollar
amount per coverage period, and may provide for a
carryforward of any unused amount.
IRA WITHDRAWALS AND 401(k) ROLLOVER BALANCES
Individuals may take
withdrawals as needed from their IRAs and/or certain 401(k)
or other qualified plan account balances (rollover account
balances, for example). This is certainly not preferable
from a retirement planning perspective; the distribution
will reduce the funds available at retirement and typically
will be both taxable and subject to premature withdrawal
penalties in the year withdrawn. However, all or a portion
of these withdrawals may be exempt from the 10% premature
withdrawal penalty under various circumstances.
Hardship withdrawals. Employees can
use 401(k) plans to cover medical expenses. To take a
hardship withdrawal, a participant must establish immediate
and heavy financial need; the requested distribution cannot
exceed the amount required to meet such need. Under
regulations section 1.401(k)-1(d)(2), a distribution is for
immediate and heavy financial need if it will pay for
medical care expenses either previously incurred by or
necessary for the medical care of the employee or his or her
and individuals with long-term special medical needs and
expenses often have unusual tax-planning requirements.
Taxpayers have available only limited avenues to use
deductions to help defray their medical costs. CPAs should
be able to identify such situations and recommend from among
the potentially viable solutions.
information, see the Tax Clinic, edited by Kevin Reilly, in
the October 2003 issue of The Tax Adviser.
—Lesli Laffie, editor
The Tax Adviser
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