1. Investors and Traders may take, as a "below the line" itemized deduction, their medial and health care costs on Schedule A to the extent that the total of these costs exceeds 7.5% of Adjusted Gross Income (AGI), and to the extent that all itemized deductions exceed the automatic standard deduction.
    
2. Traders who are looking to get more tax benefit from their medial and health care costs can do so with the use of a separate trading entity (or a spouse) which helps transforms these to "above the line" deductions, taken before computing your AGI.  The resulting lower AGI, in turn, frees up more of your other itemized deductions to lower your tax bill even further.
    
3. Using a spouse or an entity (other than a C-corporation) allows you the ability to transform or reclassify a portion of your net taxable income into "earned income" which then allows you to deduct 100% of your health insurance for 2003 and beyond (this is up from 70% form 2002).  But be aware that you may not take this deduction for any month in which you were eligible to participate in any subsidized health plan maintained by your employer or your spouse's employer.
    
4. Using a C-corporation allows you the ability to transform or reclassify a portion of your net taxable income into "earned income" which then allows you to deduct 100% of your health insurance, co-pays, prescription drugs, non-prescription medicines and so on.  Further you may take these deduction even during any month in which you were eligible to participate in any subsidized health plan maintained by your employer or your spouse's employer.

Most health insurance plans must be established under your business. You may be allowed this deduction whether you paid the premiums yourself or your partnership or S corporation paid them and you included the premium amounts in your gross income. Take the deduction on line 29 of Form 1040.

HSA's may be established by employees themselves.
As a result, look for clamping down on the HSA loophole, Kiplinger's May 2, 2008 Tax Letter says.  Until then, taxpayer's remain on the honor system that the HSA is being used for qualifying medical expenses.

Medical Savings Accounts or MSA's:
http://website101.com/Health_Insurance/medical-savings-accounts.html

How a Health Savings Account Plan Works to Save You Money:
http://www.msainfo.net/howitworks.html

HSA/HRA/FSA Summary Chart:
http://www.bene-care.com/HSA-HRA-FSA.aspx

Health Savings Account Answers:
http://www.kiplinger.com/features/archives/2004/02/hsa.html

How Flexible Spending Accounts Work:
http://health.howstuffworks.com/fsa1.htm

How MSAs Work:
http://www.healthinsurance.info/plans/MSA.HTM

How HSA's work:
http://www.ehealthinsurance.com/ehi/NewHelpCenter.ds?entry=faqId=HI1;categoryId=HI1-7;entryId=1

HSA FAQ:
http://www.mypaperlessoffice.com/faq.htm

HSA Provider: 800-761-2400 ex#2424:
http://www.mscu.net/www/hsa_info.asp

BizPlan Sec 105 provider:
https://www1.tasconline.com/buytasc/bizplan/

Base Sec 105 provider:
http://www.baseonline.com/105hra_eligibility.html

The offsetting "downside" to using an entity are the Secretary of the State fees and CPA fees and the fact that "earned income" is subject to Social Security taxes in addition to regular Income taxes. On the other hand, in addition to being allowed a medical deduction, the "earned income" also allows you to fund a retirement plan and take a corresponding deduction for that each year!  The use of an LLC may offer your some limited level of asset protection as well.  A Family General Partnership entity may eliminate some of all of the Secretary of the State fees, but it offers no asset protection.

The downside of using a C-corporation is that it generally requires the use of a 2^nd entity (often this is an LLC) which entails some additional Secretary of the State fees and CPA fees.  On the other hand, often the C-corporation is domiciled in the State of Nevada or Delaware to eliminate or defer some State income taxes and to shift a small portion of your trading income to the lower 15% tax bracket.

Reimbursements by an employer of amounts paid by an employee for medicines and drugs purchased by the employee without a physician's prescription are excludable from gross income under § 105(b). However, amounts paid by an employee for dietary supplements and vitamins that are merely beneficial to the general health of the employee or the employee's spouse or dependents, are not reimbursable or excludable from gross income under § 105(b).

Using a C-corporation, over-the-counter drugs can be paid for with pre-tax dollars through health care flexible spending accounts. . Thus, reimbursements by health flexible spending arrangements (FSAs) and other employer health plans for the cost of over-the-counter drugs available without prescription are not subject to tax if properly substantiated by the employee. 

Flexible Spending Accounts are an important tool in helping people meet their health care costs. Since many prescription drugs have moved to the over-the-counter market, this tax benefit makes paying for them a little bit easier to swallow.

Drugs are increasingly becoming available over-the-counter without prescription. Many health plans no longer cover the cost of these drugs as over-the-counter. While an over-the-counter drug is less expensive than the prescription drug, the cost to many consumers increases because the price paid by the consumer for the over-the-counter drug is greater than the co-payment by the consumer when the drug was covered by insurance. This is especially an issue for individuals who remedy chronic health problems by regularly taking an over-the-counter medicine.

Revenue Ruling 2003-102 explains that the statutory exclusion for reimbursements of employee health expenses is broader than the itemized deduction for medical expenses (which does not apply to nonprescription drugs). Thus, the guidance clarifies that employer reimbursements of employee health expenses that are nonprescription drugs, including reimbursements through health FSAs and Health Reimbursement Arrangements (HRAs), are excluded from income like other employer reimbursements of employee health expenses. This will result in savings to consumers with access to employer plans who may purchase nonprescription drugs. 

However, for Investors and non-corporate traders taking an itemized medical expenses deduction, the cost of such over-the-counter drugs continues to be non-deductible.  In addition, the cost of dietary supplements such as vitamins that are merely beneficial to the employee's health are not excluded from income.  Reduced-calorie diet foods is not a medical expense if these foods substitute for food you would normally consume to satisfy your nutritional requirements

Beginning with 2004 a tax deductible Health Savings Account may be established if you are covered by a "high-deductible health plan" and you have no other health insurance covering yourself.  HSAs are IRA-like accounts that can receive tax deductible contributions from individuals and make tax-free distributions to cover medical expenses. Annual contribution limits are $2,600 for individuals and $5,150 for families.

The following information comes from IRS Publication 535

Deductible Premiums

You generally can deduct premiums you pay for the following kinds of insurance related to your trade or business.

1. Insurance that covers fire, storm, theft, accident, or similar losses.
2. Credit insurance that covers losses from business bad debts.
3. Group hospitalization and medical insurance for employees, including long-term care insurance.
   • a. If a partnership pays accident and health insurance premiums for its partners, it generally can deduct them as guaranteed payments to partners.
   • b. If an S corporation pays accident and health insurance premiums for its 2%shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages subject to federal income tax withholding. See Publication 15-B.
   • see IRS Notice 2008-1  "Special Rules for Health Insurance Costs of 2-Percent Shareholder-Employees"
4. Liability insurance.
5. Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients.
6. Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault.
   • a. If a partnership pays workers' compensation premiums for its partners, it generally can deduct them as guaranteed payments to partners.
   • b. If an S corporation pays workers' compensation premiums for its 2%shareholder-employees, it generally can deduct them, but must also include them in the shareholder's wages.
7. Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law.
8. Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness.
9. Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. If you operate a vehicle partly for personal use, deduct only the part of the insurance premium that applies to the business use of the vehicle. If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums.
10. Life insurance covering your officers and employees if you are not directly or indirectly a beneficiary under the contract.
11. Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause.

Self-Employed Health Insurance Deduction

You may be able to deduct 100% of the amount paid for medical and dental insurance and qualified long-term care insurance for you, your spouse, and your dependents if you are one of the following.

• A self-employed individual with a net profit reported on Schedule C, C-EZ, or F.
• A partner with net earnings from self-employment reported on Schedule K-1 (Form 1065), box 14, code A.
• A shareholder owning more than 2% of the outstanding stock of an S corporation with wages from the corporation reported on Form W-2.

The insurance plan must be established under your business. You may be allowed this deduction whether you paid the premiums yourself or your partnership or S corporation paid them and you included the premium amounts in your gross income. Take the deduction on line 29 of Form 1040.

More than one health plan and business.
If you have more than one health plan during the year and each plan is established under a different business, you must use separate worksheets (Worksheet 7-A) to figure each plan's net earnings limit. Include the premium you paid under each plan on line 1 or line 2 of that separate worksheet and your net profit (or wages) from that business on line 4 (or line 11). For a plan that provides long-term care insurance, the total of the amounts entered for each person on line 2 of all worksheets cannot be more than the appropriate limit shown on line 2 for that person.
 

Worksheet 7-A. Self-Employed Health Insurance Deduction Worksheet (Keep for your records.)
----------------------------------------------------------------------
1. Enter total payments made during the year for health
insurance coverage established under your business
for you, your spouse, and your dependents. (Do not
include payments for any month you were eligible
to participate in a health plan subsidized by your
or your spouse's employer or any amount you claim
on line 4 of Form 8885. Also, do not include
payments for qualified long-term care insurance.) 1. _______

2. For coverage under a qualified long-term care
insurance contract, enter for each person covered
the smaller of the following amounts.

a) Total payments made for that person during the
year.

b) The amount shown below. (Use the person's age
at the end of the year.)

$270--if that person is age 40 or younger
$510--if age 41 to 50
$1,020--if age 51 to 60
$2,720--if age 61 to 70
$3,400--if age 71 or older

(Do not include payments for any month you were
eligible to participate in a long-term care
insurance plan subsidized by your or your spouse's
employer.) If more than one person is covered,
figure separately the amount to enter for each
person. Then enter the total of those amounts 2. _______

3. Add the total of lines 1 and 2 3. _______

4. Enter your net profit* and any other earned
income** from the trade or business under which the
insurance plan is established. (If the business is
an S corporation, skip to line 11.) 4. _______

5. Enter the total of all net profits* from: line 31,
Schedule C (Form 1040); line 3,
Schedule C-EZ (Form 1040); line 36,
Schedule F (Form 1040); or box 14, code A,
Schedule K-1 (Form 1065); plus any other income
allocable to the profitable businesses. See the
instructions for Schedule SE (Form 1040). (Do not
include any net losses shown on these schedules.) 5. _______

6. Divide line 4 by line 5 6. _______

7. Multiply Form 1040, line 27 by the percentage on
line 6 7. _______

8. Subtract line 7 from line 4 8. _______

9. Enter the amount, if any, from Form 1040, line 28,
attributable to the same trade or business in which
the insurance plan is established 9. _______

10. Subtract line 9 from line 8 10. _______

11. Enter your wages from an S corporation in which you
are a more-than-2% shareholder and in which the
insurance plan is established 11. _______

12. Enter the amount from Form 2555, line 43,
attributable to the amount entered on line 4 or 11
above, or the amount from Form 2555-EZ, line 18,
attributable to the amount entered on line 11 above 12. _______

13. Subtract line 12 from line 10 or 11, whichever
applies 13. _______

14. Compare the amounts on lines 3 and 13 above. Enter
the smaller of the two amounts here and on Form 1040,
line 29. (Do not include this amount when figuring a
medical expense deduction on Schedule A (Form 1040).) 14. _______
----------------------------------------------------------------------
* If you used either optional method to figure your net earnings from
self-employment from any business, do not enter your net profit from
the business. Instead, enter the amount attributable to that business
from Schedule SE, line 4b.

** Earned income includes net earnings and gains from the sale,
transfer, or licensing of property you created. It does not include
capital gain income.
======================================================================
 

Colin M. Cody, CPA, CMA
TraderStatus.com LLC
6004 Main Street
Trumbull, Connecticut 06611-2400

(203) 268-7000