Publication 502
Medical and Dental Expenses

For use in preparing 2002 Returns

Sale of Medical Property

You may have a taxable gain if you sell medical equipment or property, the cost of which you deducted as a medical expense on your tax return for a previous year. The taxable gain is the amount of the selling price that is more than the equipment's adjusted basis. The adjusted basis is the portion of the equipment's cost that was not deductible because of the 7.5% limit used to compute the medical deduction. Use the formula below to figure the adjusted basis.

Formula 1. Figuring Adjusted Basis

If your allowable itemized deductions were more than your adjusted gross income for the year the cost of the equipment was deducted, the adjusted basis of the equipment is increased by a portion of the surplus itemized deductions. Use the following formula to figure the increase.

Formula 1. Figuring Adjusted Basis Increase Amount

Add the increase to the adjusted basis. The result is the new adjusted basis for purposes of computing the taxable gain. See chapter 3 in Publication 544, Sales and Other Dispositions of Assets, for information on the tax treatment of the gain.

Example of sale of medical property.   You have a heart condition and difficulty breathing. Your doctor prescribed oxygen equipment to help you breathe. Last year, you bought the oxygen equipment for $3,000. You itemized deductions and included it in your medical expense deduction.

Last year you also paid $750 for deductible medical services and $6,400 for other itemized deductions. Your adjusted gross income (AGI) was $5,000.

Taking into account the 7.5% limit on medical expenses, your allowable itemized deductions totaled $9,775, figured as follows:

This year you sold the oxygen equipment for $2,000. You must report on this year's tax return part of the $2,000 as ordinary income. To compute the part of the sales price that is taxable, you must do the following:

• Figure the part of the 7.5% of adjusted gross income limit (the nondeductible limit) that is allocable to the oxygen equipment as the equipment's adjusted basis.
• Figure the part of the surplus itemized deductions that is allocable to the oxygen equipment as an addition to the adjusted basis.
• Determine the gain by subtracting the total adjusted basis from the selling price.

Allocating the nondeductible limit.   As stated above, some of the $375 you were not allowed to deduct as a medical expense on last year's return becomes the adjusted basis of the equipment and can be used to reduce the amount you must now report as income. To determine the part of the 7.5% limit that is allocable to the oxygen equipment (see the first formula shown earlier), multiply the overall nondeductible limit, $375, by the ratio of cost of the equipment, $3,000, to the total medical expenses, $3,750 [$375 × ($3,000 ÷ $3,750) = $300]. Your adjusted basis in the equipment is this $300 portion of the cost of the equipment that last year was nondeductible because of the 7.5% limit.

Allocating surplus deductions.   To determine the part of the surplus itemized deductions that is allocable to the oxygen equipment (see the second formula shown earlier), figure the total available surplus deductions, $4,775 ($9775 allowable itemized deductions minus $5,000 AGI). Then multiply $4775 by the ratio of the deductible portion of the amount paid for the oxygen equipment, $2,700 ($3,000 cost of equipment minus $300 attributable to the 7.5% limit) to the total available deductions, $9,775. In this example the result is $1,319.

Your total adjusted basis in the equipment is $1,619 ($300 + $1,319).

Determining gain.   You realized a gain of $381 ($2,000 - $1,619). This amount represents the recovery of an amount previously deducted for federal income tax purposes and is taxable as ordinary income.

Settlement of Damage Suit

If you receive an amount in settlement of a personal injury suit, the part that is for medical expenses deducted in an earlier year is included in income in the later year if your medical deduction in the earlier year reduced your income tax in that year. See What If You Receive Insurance Reimbursement in a Later Year, discussed earlier.

Future medical expenses.   If you receive an amount in settlement of a damage suit for personal injuries that is properly allocable or determined to be for future medical expenses, you must reduce any medical expenses for these injuries until the amount you received has been completely used.

Health Insurance Credit

Beginning December 2002, there is a new health insurance credit available to certain individuals who receive a pension benefit from the Pension Benefit Guaranty Corporation (PBGC) or who are eligible to receive a trade adjustment allowance (TAA). You only qualify for this credit if you:

1. Are an eligible individual,
2. Pay for qualifying health insurance covering an eligible coverage month for yourself or for yourself and qualifying family members,
3. Do not have other specified coverage, and
4. Are not in prison.

If you qualify, you can claim a credit equal to 65% of the premiums you pay.

Eligible Individual

You are an eligible individual for any month you:

1. Receive a TAA for individuals under the Trade Act of 1974 for at least one day in the month, or would receive a TAA but do not because you have not yet exhausted your unemployment benefits, and are covered under a TAA certification, or
2. Are a worker receiving a supplemental wage allowance under section 246 of the Trade Act of 1974 for such month, or
3. Are at least 55 years old and are receiving pension benefits from the PBGC.

Once you qualify under (1) or (2), you continue to be eligible during the first month that you would otherwise cease to be eligible.

You are not an eligible individual if you can be claimed as a dependent on another person's tax return.

Qualifying Family Member

You can include the premiums you pay for qualifying health insurance for qualifying family members in figuring your credit. Qualifying family members are:

• Your spouse, and
• Your dependents for whom you can claim an exemption on your tax return.

However, if any otherwise qualifying family member has other specified coverage (defined later), then that person is not a qualifying family member. Also, your spouse is not your qualifying family member if:

• Your spouse is also an eligible individual, and
• You file separate returns.

Dependents of divorced parents.   A dependent of divorced parents is treated as the dependent of the custodial parent and not of the noncustodial parent for purposes of this credit even if:

1. The custodial parent cannot claim a dependent's exemption because he or she released his or her claim to the exemption for the year, or
2. There is a pre-1985 decree or agreement that entitles the noncustodial parent to the exemption.

Qualifying Health Insurance

The following health insurance qualifies for the credit.

• COBRA continuation coverage. (This is optional coverage that certain employer-sponsored group health plans must offer to certain employees or former employees and their beneficiaries who have lost coverage because of certain events.)
• Coverage under a group health plan that is available through the employment of your spouse.
• Coverage under individual health insurance if you were covered during the entire 30-day period that ends on the date you separated from the employment which qualified you for the allowance or benefit as an eligible individual (defined earlier). Individual health insurance here means any medical care insurance offered to individuals other than in a group health plan, but it does not include federal or state health insurance coverage.

The following state-sponsored health insurance qualifies for the credit to the extent the sponsoring state elects to have it apply.

• State-based continuation coverage provided by the state under a state law that requires such coverage.
• Coverage offered through a qualified state high-risk pool.
• Coverage under a health insurance program offered to state employees or a similar state-based health insurance program.
• Coverage through an arrangement entered into by the state and a group health plan, an issuer of health insurance coverage, an administrator, or an employer.
• Coverage offered through a state arrangement with a private sector health care coverage purchasing pool.
• Coverage under a state-operated health plan that does not receive any federal financial participation.

Nonqualifying Health Insurance

The following health insurance does not qualify for the credit.

1. Coverage under a flexible spending or similar arrangement, or
2. Any insurance if substantially all of the coverage is:
   1. Accident or disability income insurance (or a combination of the two),
   2. Liability insurance,
   3. A supplement to liability insurance,
   4. Workers' compensation or similar insurance,
   5. Automobile medical payment insurance,
   6. Credit-only insurance,
   7. Coverage for on-site medical clinics,
   8. Limited scope dental or vision benefits,
   9. Benefits for long-term care, nursing home care, home health care, community-based care (or any combination),
   10. Coverage only for a specified disease or illness,
   11. Hospital indemnity or other fixed indemnity insurance, or
   12. Medicare supplemental insurance, Tricare supplemental insurance, or other similar supplemental insurance to an employer-sponsored group health plan.

Eligible Coverage Month

Eligibility for the credit is determined on a monthly basis. December 2002 is the first month that can be an eligible coverage month. You are eligible for a month if, as of the first day of the month, you:

1. Are an eligible individual (defined earlier),
2. Are covered by qualifying health insurance (defined earlier) that you pay for,
3. Do not have other specified coverage (defined later), and
4. Are not imprisoned under federal, state, or local authority.

If you file a joint return, only one spouse has to satisfy the requirements.

Other Specified Coverage

Even if you are otherwise eligible, you are not eligible for the credit for a month if, as of the first day of the month, you have other specified coverage. Other specified coverage is coverage under the following.

1. Any insurance which constitutes medical care (unless substantially all of that insurance is for benefits listed earlier under (2) under Nonqualifying Health Insurance) if at least 50% of the cost of the coverage is paid by an employer (or former employer) of you or your spouse.
2. Any of the following government health programs:
   1. Medicare Part A, Medicare Part B, Medicaid, or the State Children's Health Insurance Program (SCHIP),
   2. The Federal Employees Health Benefit Plan (FEHBP), or
   3. Tricare, the medical and dental care program for members and certain former members of the uniformed services and their dependents.

How To Report

To claim the credit, file Form 8885, Health Insurance Credit for Eligible Recipients, and report the credit on Form 1040, line 68, or Form 1040NR, line 63, and check box c. You cannot claim the credit on Form 1040A or Form 1040EZ.

If you claim this credit, you cannot take the same expenses into account in determining your:

• Medical and dental expenses on Schedule A (Form 1040),
• Self-employed health insurance deduction, or
• Archer Medical Savings Account (MSA) distributions.

Refundable and Advanceable

You can claim this credit and get a refund even if you do not owe any taxes.

Once the program is set up sometime in 2003, you will be able to present a certificate to your health insurance company showing you are eligible for this credit. The Treasury Department will then pay your insurer 65% of your health insurance premiums and you will pay the remaining 35%. The amount of the credit you can claim on your tax return will be reduced by the amount of the credit you receive in advance.

How To Get Tax Help

You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help.

Contacting your Taxpayer Advocate.   If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

• Call the Taxpayer Advocate at
  1-877-777-4778.
• Call, write, or fax the Taxpayer Advocate office in your area.
• Call 1-800-829-4059 if you are a
  TTY/TDD user.

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

Free tax services.   To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.

Personal computer. With your personal computer and modem, you can access the IRS on the Internet at www.irs.gov. While visiting our web site, you can:

• See answers to frequently asked tax questions or request help by e-mail.
• Download forms and publications or search for forms and publications by topic or keyword.
• Order IRS products on-line.
• View forms that may be filled in electronically, print the completed form, and then save the form for recordkeeping.
• View Internal Revenue Bulletins published in the last few years.
• Search regulations and the Internal Revenue Code.
• Receive our electronic newsletters on hot tax issues and news.
• Learn about the benefits of filing electronically (IRS e-file).
• Get information on starting and operating a small business.

You can also reach us with your computer using File Transfer Protocol at ftp.irs.gov.

TaxFax Service. Using the phone attached to your fax machine, you can receive forms and instructions by calling 703-368-9694. Follow the directions from the prompts. When you order forms, enter the catalog number for the form you need. The items you request will be faxed to you.

For help with transmission problems, call the FedWorld Help Desk at 703-487-4608.

Phone. Many services are available by phone.
 

• Ordering forms, instructions, and publications. Call 1-800-829-3676 to order current and prior year forms, instructions, and publications.
• Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
• Solving problems. Take advantage of Everyday Tax Solutions service by calling your local IRS office to set up an in-person appointment at your convenience. Check your local directory assistance or www.irs.gov for the numbers.
• TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829- 4059 to ask tax questions or to order forms and publications.
• TeleTax topics. Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics.

Evaluating the quality of our telephone services. To ensure that IRS representatives give accurate, courteous, and professional answers, we use several methods to evaluate the quality of our telephone services. One method is for a second IRS representative to sometimes listen in on or record telephone calls. Another is to ask some callers to complete a short survey at the end of the call.

Walk-in. Many products and services are available on a walk-in basis.
 

• Products. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Some IRS offices, libraries, grocery stores, copy centers, city and county governments, credit unions, and office supply stores have an extensive collection of products available to print from a CD-ROM or photocopy from reproducible proofs. Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.
• Services. You can walk in to your local IRS office to ask tax questions or get help with a tax problem. Now you can set up an appointment by calling your local IRS office number and, at the prompt, leaving a message requesting Everyday Tax Solutions help. A representative will call you back within 2 business days to schedule an in-person appointment at your convenience.

Mail. You can send your order for forms, instructions, and publications to the Distribution Center nearest to you and receive a response within 10 workdays after your request is received. Find the address that applies to your part of the country.

• Western part of U.S.:
  Western Area Distribution Center
  Rancho Cordova, CA 95743-0001
• Central part of U.S.:
  Central Area Distribution Center
  P.O. Box 8903
  Bloomington, IL 61702-8903
• Eastern part of U.S. and foreign addresses:
  Eastern Area Distribution Center
  P.O. Box 85074
  Richmond, VA 23261-5074

CD-ROM for tax products. You can order IRS Publication 1796, Federal Tax Products on CD-ROM, and obtain:

• Current tax forms, instructions, and publications.
• Prior-year tax forms and instructions.
• Popular tax forms that may be filled in electronically, printed out for submission, and saved for recordkeeping.
• Internal Revenue Bulletins.

The CD-ROM can be purchased from National Technical Information Service (NTIS) by calling 1-877-233-6767 or on the Internet at http://www.irs.gov/cdorders. The first release is available in early January and the final release is available in late February.

CD-ROM for small businesses. IRS Publication 3207, Small Business Resource Guide, is a must for every small business owner or any taxpayer about to start a business. This handy, interactive CD contains all the business tax forms, instructions and publications needed to successfully manage a business. In addition, the CD provides an abundance of other helpful information, such as how to prepare a business plan, finding financing for your business, and much more. The design of the CD makes finding information easy and quick and incorporates file formats and browsers that can be run on virtually any desktop or laptop computer.

It is available in March. You can get a free copy by calling 1-800-829-3676 or by visiting the website at www.irs.gov/smallbiz.