CHAPTER V -  TAXATION OF LONG TERM CARE INSURANCE

LTCI TAX ADVANTAGES

The Federal Government and many state governments have provided tax advantages for those who purchase long-term care insurance. Some of the tax regulations are long, lengthy and almost uncomprehensible.  For purposes of this text, this information is kept as short and consise as possible.

Besides, laws and regulations change frequently and are subject to differing interpretations.   This text or the Continuing Education school does not provide any legal, accounting, or tax planning advice, and nothing herein should be construed as such.  If expert advice is needed, then in all likelihood the services of a competent, licensed tax attorney or consulting should be obtained.

TAX-QUALIFIED LONG-TERM CARE INSURANCE POLICIES

In 1996 Congress passed the Health Insurance Portability and Accountability Act (HIPAA) which provided, in part, the criteria for establishing tax-qualified long-term care insurance policies.  Essentially, HIPAA provided that benefits paid under a long-term care insurance policy would not be taxable if the long-term care insurance policy met minimum eligibility criteria.  As a result of HIPAA, it is easy to tell which long-term care insurance policies are intended to be tax-qualified because there will be an identifying paragraph on the front page of the contract.

Check the section on Taxation for more information.  At this point it is good to know the difference between a "qualified" and a "non-qualified" LTCI policy.

Long-term care insurance policies pay benefits in one of two ways - through either a Reimbursement Model or an Indemnity Model.

REIMBURSEMENT MODEL

Simply put, Reimbursement Model policies repay the insured for qualifying long-term care expenses that he or she incurred, subject to the amount of coverage purchased.

 

 

Tax Treatment of Benefits Received

For policies that pay benefits under the Reimbursement Model, the benefits received are considered to be a reimbursement for expenses incurred for medical services. This is true regardless of whether the Tax-Qualified Long-Term Care Insurance policy reimburses pays benefits on a daily, weekly, monthly or other periodic basis (IRC Sec. 7702B(a)). As a result, benefits under a Reimbursement Model are generally not considered income.

Indemnity Model

Indemnity Model policies pay the insured person a flat amount regardless of the amount of the insured person's expenses.

 

TAX TREATMENT OF BENEFITS

For Tax- Qualified Long-Term Care Insurance policies that pay benefits under an Indemnity Model, benefit payments are subject to a daily dollar cap.

If the individual taxpayer receives Tax-Qualified Long-Term Care Insurance benefits in excess of this annual daily limit, those "excess benefits" will be considered income for tax purposes.  However, the taxpayer may exclude from income the "excess benefits" to the extent of the individual's actual unreimbursed Tax-Qualified Long-Term Care expenses.  Note, however, according to available reports, the IRS has never gone after a person who receives long-term care benefits (from any source) for not reporting income from LTCI benefits.  However, they have the legal right to do so.

Individual Taxpayers

Deductibility of Premium Payments
Individuals who purchase and pay for Tax-Qualified Long-Term Care Insurance policies for themselves, their spouses, and their tax dependents may claim the premiums paid as deductible personal medical expenses if the Individual itemizes his or her taxes (See Internal Revenue Code (IRC) Sec. 213(a) and IRC Sec. 213(d)(1)(D)).

However, any Tax-Qualified Long-Term Care Insurance expenses are deductible by an individual tax payer only to the extent that the individual's total unreimbursed medical care expenses exceed 7.5% of his or her Adjusted Gross Income.

Further, the amount of the Tax-Qualified Long-Term Care Insurance premiums that may be deducted is subject to the following dollar limits based on the insured's attained age before the close of the tax year (IRC Sec 213(d)(10)).

SOLE PROPRIETOR

Deductibility of Employer-Paid Premiums 
Sole Proprietors who purchase and pay for Tax-Qualified Long-Term Care Insurance policies for themselves, their spouses and their tax dependents may claim a deduction for the premiums paid as medical care expenses (IRC Sec. 162(l)(1)(A) and Sec. 213). 

Prior to tax year 2003, only a percentage of the eligible Tax-Qualified Long-Term Care Insurance premiums paid by a self-employed individual were deductible as medical care expenses. However in tax year 2003 and thereafter, the full amount of the Tax-Qualified Long-Term Care Insurance premiums paid by the self-employed individual may be deducted (IRC Sec. 162(l)(1)(B). See the following table for more information. 

 

Further, as in the case of individual taxpayers, the amount of the Tax-Qualified Long-Term Care Insurance premiums that a self-employed individual may deduct as Self-Employed Health Insurance is subject to the following dollar limits. 

PARTNERSHIPS

Business Deductibility of Partnership-Paid Premiums

On Behalf of a Partner
A Partnership that purchases Tax-Qualified Long-Term Care Insurance on behalf of a Partner may deduct the premiums paid as an ordinary business expense—same for Tax-Qualified Long-Term Care Insurance purchased for the Partner's spouse or other tax dependent.

On Behalf of an Employee
A Partnership that purchases Tax-Qualified Long-Term Care Insurance on behalf of an Employee may deduct the premiums paid as an ordinary business expense—same for Tax-Qualified Long-Term Care Insurance purchased for the Employee's spouse or other tax dependent.

TAX CONSEQUENCES OF PARTNERSHIP-PAID PREMIUMS

For the Employee
Employer-paid Long-Term Care Insurance premiums would not be included in the Employee's gross income (IRC Sec. 106)

For a Partner
The entire amount of the Tax-Qualified Long-Term Care Insurance premiums paid by the Partnership is includable in the partner's gross income.  The same is true for partnership-paid Tax-Qualified Long-Term Care Insurance premiums paid on behalf of the Partner's spouse or other tax dependents. 

In this case, the partner is treated as a self-employed individual for tax purposes and the Tax-Qualified Long-Term Care Insurance premiums received would be subject to the same tax rules as apply to Sole Proprietors. 

In tax years prior to 2003, any Tax-Qualified Long-Term Care Insurance premiums over and above the Percentage of Tax-Qualified Long-Term Care Insurance Premium Deductible as Self-Employed Health Insurance may be added to the Partner's other unreimbursed medical expenses calculating the Partner's medical expense deductions. 

C-CORPORATIONS

Business Deductibility of Employer-Paid Premiums

On Behalf of an Employee
A C-Corporation that purchases Tax-Qualified Long-Term Care Insurance on behalf of an Employee may deduct the premiums paid as an ordinary business expense—same for Tax-Qualified Long-Term Care Insurance purchased for the Employee's spouse or other tax dependent.

On Behalf of an Employee Stockholder
A C-Corporation that purchases Tax-Qualified Long-Term Care Insurance on behalf of an Employee Stockholder may deduct the premiums paid as an ordinary business expense—same for Tax-Qualified Long-Term Care Insurance purchased for the Employee Stockholder's spouse or other tax dependent. 

On Behalf of a Stockholder (Owner) Who is not an Employee
A C-Corporation that purchases Tax-Qualified Long-Term Care Insurance for a shareholder who is not an employee does not receive a deduction for the premiums paid.

TAX CONSEQUENCES OF C-CORP-PAID PREMIUMS

For an Employee
Employer-paid Long-Term Care Insurance premiums would not be included in the Employee's gross income (IRC Sec. 106). This would also apply to premiums paid on behalf of the employee's spouse and other tax dependents.

For an Employee Stockholder
Provided that the Stockholder is also a bona fide Employee of the C-Corporation, Tax-Qualified Long-Term Care Insurance premiums paid by the C-Corporation on behalf of the Employee are fully deductible assuming the C-Corporation retains no interest in the policy. This would also apply to premiums paid on behalf of the employee's spouse and other tax dependents.

For a Stockholder who is not an Employee
Tax-Qualified Long-Term Care Insurance premiums paid by a C-Corporation on behalf of a Stockholder who is not an Employee of the C-Corporation would represent dividend income for the Stockholder.  

 

 S-CORPORATIONS

Deductibility of Employer-Paid Premiums
For purposes of determining tax liabilities with regards to S-Corporations, the tax code looks to the individual's ownership rights in the company.   An employee who owns 2% or more of the S-Corporation is deemed to be an Employee/Owner, while one who owns less than 2% is treated as only an employee.  

On Behalf of an Employee (Less than 2% Shareholder)
Tax-Qualified Long-Term Care Insurance premiums paid by a S-Corporation on behalf of an employee are fully deductible providing the S-Corporation retains no interest in the policy.  This would also apply to premiums paid on behalf of the employee's spouse and other tax dependents.

 On Behalf of an Employee/Owner (Shareholder of 2% or greater)
Tax-Qualified Long-Term Care Insurance premiums paid by an S-Corporation on behalf of a 2%+ shareholder are deductible by the S-Corporation providing the S-Corporation retains no interest in the policy. This would also apply to premiums paid on behalf of the employee's spouse and other tax dependents.

Tax Consequences of Employer-Paid Premiums

For an Employee
Employer-paid Long-Term Care Insurance premiums would not be included in the Employee's gross income (IRC Sec. 106).  This would also apply to premiums paid on behalf of the employee's spouse and other tax dependents.

For an Employee/Owner (Shareholder of 2% or greater)
The entire amount of the Tax-Qualified Long-Term Care Insurance premiums paid by the S-Corporation is includable in the employee/owner's gross income.  The same holds true for S-Corporation -paid Tax-Qualified Long-Term Care Insurance premiums paid on behalf of the employee/owner's spouse or other tax dependents.  

In this case, the employee/owner is treated as a self-employed individual for tax purposes and the Tax-Qualified Long-Term Care Insurance premiums received would be subject to the same tax rules as apply to Sole Proprietors.  

In tax years prior to 2003, any Tax-Qualified Long-Term Care Insurance premiums over and above the Percentage of Tax-Qualified Long-Term Care Insurance Premium Deductible as Self-Employed Health Insurance may be added to the employee/owner's other unreimbursed medical expenses when calculating the employee/owner's medical expense deductions.

LIMITED LIABILITY & PROFESSIONAL CORPORATIONS

Generally
A Limited Liability Company is a statutory business that may be treated as a corporation, a partnership, or a sole proprietorship for tax purposes.  As a result, to determine the tax implications of LLC-purchased Long-Term Care Insurance, one must first determine by which method the LLC is treated for federal income tax purposes.

Therefore:

• A LLC treated as Sole Proprietorship would look to the Sole Proprietor regulations for guidance;
• A LLC treated as a Partnership would look to the Partnership regulations for guidance; and
• A LLC treated as a Corporation would look to the Corporation regulations for guidance.

PROFESSIONAL CORPORATIONS/ PROFESSIONAL ASSOCIATIONS (PCS/PAS)

Generally
Professional Corporations and Associations have the ability to select the method by which the entity will be treated for federal income tax purposes.

Generally, Professional Corporations may elect to be treated as either a C-Corporation or an S-Corporation.  The status is elected by the entity. As a result, to determine the tax implications of PC-purchased Long-Term Care Insurance, one must first determine by which method the PC is treated for federal income tax purposes.

Thus it follows:

• A PC treated as C-Corporation would look to the C-Corporation regulations for guidance; and
• A PC treated as an S-Corporation would look to the S-Corporation regulations for guidance.

 

 

 

STUDY QUESTIONS

CHAPTER FIVE

 

1.  HIPAA provided that benefits paid under a long-term care insurance policy would not be taxable if

      A.  the premiums were paid annually.

      B.  the long-term care insurance policy met minimum eligibility criteria.  

      C.  the benefits were paid annually.

      D.  there were no inflation protection.

 

2.  For policies that pay benefits under the Reimbursement Model, the benefits received

      A.  are considered to be a reimbursement for expenses incurred for medical services.

      B.  must  be paid quarterly or they will all be taxed at capital gains rates.

      C.  will be taxed at capital gains rates.

      D.  must not exceed more than 110% of the daily benefit or the entire amount is taxed as ordinary income.

 

3.  For Tax- Qualified Long-Term Care Insurance policies that pay benefits under an Indemnity Model,

      A.  there is no cap and no floor.

      B.  the minimum payment must be based on a minimum of $50 per day .

      C.  benefit payments are subject to a daily dollar cap

      D.  benefits cannot exceed 3 times the required Medicaid daily benefit.

 

4.  Tax-Qualified Long-Term Care Insurance expenses are deductible by an individual tax payer

      A.  only to the extent that the individual's total unreimbursed medical care expenses exceed    7.5%

      B.  regardless of amount.

      C.  as a cost of doing business.

      D.  not to exceed $500 per month or 6% of the gross annual income, whichever is less.

 

5.  A Partnership that purchases Tax-Qualified Long-Term Care Insurance on behalf of a Partner

      A.  may claim no deduction.

      B.  may deduct the percent of premium that equals the percent of ownership of the business.

      C.  may deduct the premiums paid as an ordinary business expense

      D.  can only claim a tax deduction equal to any claims paid.

 

6.  For taxation of an LTCO policy, an employee who owns 2% or more of the S-Corporation is deemed to be an Employee/Owner, while one who owns less than 2%

      A.  is treated as a corporate owner.

      B.  may be taxed only on the benefits paid.        

      C.  must pay capital gains taxes on the premiums paid by the corporation.

      D.  is treated as only an employee.     

 

7.  Employer-paid -premiums on a LTCI policy would not be included in the Employee's gross income,

      A.  but would not apply to premiums paid on behalf of the spouse.

      B.  this would also apply to premiums paid on behalf of the employee's spouse and      other tax dependents.

      C.  unless the employee was an officer in the company.

      D.  provided the premiums do not exceed $100 per month.

 

ANSWER TO STUDY QUESTIONS

1B     2A     3C     4A     5C     6D     7B