Is Cancer Insurance Tax Deductible?

Cancer insurance is a supplemental policy designed to provide financial support upon a cancer diagnosis. These policies pay benefits directly to the policyholder for a wide range of expenses, including medical bills not covered by primary health insurance and non-medical costs like transportation or lost income. This article explains the Internal Revenue Service (IRS) rules that govern whether cancer insurance premiums can be deducted and how any benefits received from the policy are taxed.

Deductibility as a Medical Expense

Premiums paid for a cancer insurance policy may be tax-deductible as a medical expense under two conditions. First, a taxpayer must itemize deductions on Schedule A (Form 1040), which means forgoing the standard deduction. A taxpayer will generally only benefit from itemizing if their total itemized deductions exceed their available standard deduction amount.

The second condition is that total qualifying medical expenses must surpass 7.5% of the taxpayer’s Adjusted Gross Income (AGI). AGI is a measure of income calculated from gross income, adjusted for certain above-the-line deductions. Only the portion of total medical expenses that exceeds this 7.5% threshold can be included as an itemized deduction.

The nature of the cancer policy itself also affects its deductibility. For a premium to be considered a valid medical expense, the policy must cover the costs of medical care, such as diagnosing, treating, or preventing a disease. If a policy primarily provides a guaranteed income or supplemental pay during a period of illness, rather than covering medical treatment costs, the premiums are generally not deductible.

Calculating the Medical Expense Deduction

To determine the deductible amount, a taxpayer must first aggregate all qualifying, unreimbursed medical expenses for the year. This includes cancer insurance premiums along with other costs like doctor and dentist fees, prescription drugs, and transportation for medical care. The sum of these expenses is the total reported on Schedule A (Form 1040) before limitations are applied.

The next step is applying the 7.5% AGI floor. For example, if a taxpayer has an AGI of $60,000, the threshold is $4,500. If their total qualifying medical expenses for the year were $7,000, they could deduct the amount that exceeds the floor, which would be $2,500 ($7,000 – $4,500). If their total medical expenses were $4,000, they would not be able to deduct any costs because they do not exceed the AGI threshold.

The IRS provides detailed guidance on what constitutes a medical expense in Publication 502. Specified disease insurance, like a cancer policy, qualifies as long as it pays benefits toward the costs of medical treatment. You should keep detailed records of all medical expenses, including premium statements, to substantiate the deduction.

Tax Implications of Policy Benefits

The tax treatment of benefits from a cancer insurance policy depends on how the premiums were paid. If premiums were paid with after-tax dollars and not deducted on a tax return, any benefits received are generally not considered taxable income. In this common scenario for individual policyholders, the payments are treated as compensation for losses, not as income.

If the benefits received exceed the actual unreimbursed medical expenses incurred, the excess amount may be taxable. For instance, if a policy pays a $15,000 lump sum and the policyholder’s unreimbursed medical expenses are $10,000, the remaining $5,000 could be subject to income tax.

The situation changes if an employer pays the premiums for an employee using pre-tax dollars, such as through a cafeteria plan. In this case, the benefits received from the policy are generally included in the employee’s gross income. However, this amount may be reduced by the actual unreimbursed medical expenses the employee paid.

Using Tax-Advantaged Health Accounts

Health Savings Accounts (HSAs) and Flexible Spending Arrangements (FSAs) allow individuals to set aside pre-tax money for qualified medical expenses. However, the IRS generally does not permit using funds from these accounts to pay for insurance premiums, including those for cancer-specific policies. This rule prevents what would amount to a double tax benefit.

There are a few narrow exceptions where HSA funds can be used to pay for insurance premiums. These situations include paying for health coverage while receiving unemployment benefits or paying for COBRA continuation coverage premiums. These exceptions do not typically apply to supplemental policies like cancer insurance but rather to major medical plan premiums.

Therefore, for most individuals, cancer insurance premiums cannot be paid or reimbursed through an HSA or FSA. Taxpayers should rely on the itemized deduction rules for any potential tax benefit related to their cancer policy premiums, keeping these accounts separate for direct medical outlays.