Back in the "old days", out-of-pocket medical expenses could be deducted from your taxes if you itemized your deductions. Unfortunately, in the past 20+ years, the Internal Revenue Service (IRS) virtually put a stop to that. Now, only medical expenses in excess of 7.5% of your Adjusted Gross Income (AGI) are eligible for deduction. If you and your wife have an AGI of $120,000, then the first $9,000 of medical expenses cannot be deducted. Except for those facing serious medical conditions with little insurance coverage, most taxpayers will not reach that level of medical expenses during one year.
But there's hope! If your employer offers a Section 125 plan (a.k.a. medical savings plan or flexible spending plan), then you can put away pre-tax dollars for medical expenses during each year. In fact, most Section 125 plans also allow you to set aside pre-tax dollars for childcare expenses as well.
Let's do the math...
Assuming you set aside $2,000 for medical expenses, your paycheck will only show a reduction of approximately $1,200 (assuming a 40% combined Federal, FICA, and State tax rate). That's a savings of $800!
As you incur medical expenses throughout the year, you will submit claim forms showing these out-of-pocket costs. Some Section 125 administrators, like ADP, offer flexible spending credit cards to make things even easier. Walk in to your local drugstore and use a special credit card for any eligible medical or prescription expenses. The amount will get deducted directly from your Section 125 account.
So, this sounds great, but there's a catch. You need to do a good job of estimating your future medical expenses before the year starts. If you set aside too much money, your employer has the right to keep the excess amount that you do not spend. So like "The Price is Right", you must estimate your medical expenses without going over.
So check with your employer to see if they offer a Section 125 / Medical Savings Plan and be sure to check out all of the terms and conditions of the plan.