NOTE: As of the end of 2004 and the early part of 2005, a tax break for Long Term Care Insurance is being serious discussed by the Bush administration. State budgets are strained by Medicaid costs, and one of the reasons is that many middle and upper-middle income retirees who need to go to a nursing home “spend down” their assets or hide them outright so as to qualify for Medicaid. (This is covered in detail in this text.)
To encourage more people to protect themselves from nursing home costs, the president is supporting allowing people to get a tax break for buying long-term care insurance and one way of accomplishing this, is an above-the-line tax deduction. Rep. Lee Terry (R-NE) introduced legislation that would allow persons to pay their long-term care premiums with tax-deferred funds from their IRA or 401(k) account.
Either way, providing the tax incentives up front so that people buy the coverage will save the federal and state governments billions of dollars in the future. (One can only imagine what this will do for the LTCI industry if it goes through in one or the other format. (ed.)
Because of the Health Insurance Portability and Accountability Act of 1996, (HIPAA) the questions relating to taxation of benefits is clearer to a certain extent. The government included provisions regarding LTCI because it was clear that private insurance could help pay for future long-term care for citizens. The reasoning seemed to be that if some or all of the insurance premiums became deductible, and some or all of the benefits were not taxed, then more people would buy the product, making fewer people for the government to worry about.
Benefits paid to an insured while in a nursing home (needing “substantial assistance”) are not considered as taxable income to the insured, up to $250 per day (2004), or more if one can prove that the expenses exceed the benefit cap (adjusted for inflation). In other words, if the insured spends more on long-term care than the amount that they receive from their LTCI policy benefits, then that additional expense is also tax-free.
In practice, accountants almost universally have not included benefit payments for long-term care as taxable income in the past, with the justification that the ruling had been unclear. Long-term care insurance receives the same tax treatment as accident and health insurance, as of January 1, 1997. Prior to this, Long-term Care Insurance was not treated as a legitimate accident or health insurance product for tax purposes.
The benefit provision of any LTCI policy must be read and fully understood, but particularly if the policy is a non-tax-qualified plan. There is always the possibility that the benefits will be considered income and will be taxable to the insured, unless grandfathered. Unofficially, many tax accountants just cannot believe that the IRS would tax LTCI benefits for an elderly person that is in a nursing home or otherwise needs long-term care. The AARP and the insurance companies, plus long-term care providers who have a horse in that race, plus politicians galore, would all be standing at the steps to the Congress and screaming at the top of their lungs (figuratively speaking, of course).
F If anyone has ever been taxed on their LTCI benefits on non-tax-qualified forms, many experts in taxation are not aware of such events at this time. However, all companies send the policyholders IRS Form 1099 on any claim benefits.
Premiums paid for Tax-qualified Long-term Care Insurance products are tax deductible to the extent that the premiums plus other deductible medical expenses exceed the standard deduction allowed. Services are deductible only to the extent that they are not reimbursed; i.e. only the amounts which are not paid by a non-qualified plan will be deductible.
The amount that may be deducted is shown on the following chart.
Premiums cannot be deducted in excess of the following limits (2004)
Age of Individual Maximum Tax Deductible Premiums 40 or below $250 41 through 50 $470 51 through 60 $940 61 through 70 $2510 71 and above $3130 |
While any tax deduction looks good, these may not actually be of any real value if the person does not itemize his deductions. Those who buy LTCI policies that are tax-qualified, and who file a Form 1040 with itemized deductions may just take the standard deduction, so this would not mean anything to them (Note: Many seniors do not have home mortgages so they do not worry any longer about individual deductions, therefore the deduction of premium would be meaningless to them.)
Also, there is a 7.5% threshold on medical and dental deductions, but for the vast majority of the people, they are not sick enough or uninsured enough to meet this threshold, so the tax deduction of LTCI premiums is useless. It is pointed out in “Choosing the Right Long-Term Care Insurance” (J.K. Lasser) that one situation could arise – a “Catch-22” situation involving those seniors who do not have a drug prescription plan and have major uninsured costs because of their need for prescription drugs. The cost of these drugs could put them over the 7.5% threshold to where the LTCI premiums tax break would be welcome. However, if they are applying for an LTCI policy, the use of these drugs may make them uninsurable for that type of insurance.
Tax-Qualified Plans
If the unreimbursed medical expenses of the insured are more than 7.5% of their adjusted gross income, the premium payment may be deducted. Deductibility depends upon age of the insured (plus any inflation adjustment). See the chart above. If the premium is less than the limit, then the amount of the actual premium can be deducted.
Non-Tax-qualified Plans
Premiums are not deductible.
Tax-Qualified Plans
Benefits received from a Long-term Care Insurance Tax-qualified Policy are not taxed as income on the individual’s tax form. In 2004, for instance, a person could receive up to $250 per day with no taxes due on that amount, but more if expenses exceed the cap.
Non-Tax-qualified Plans
Benefit payments have to be shown as income. Accountants have universally ignored this prior to HIPAA, and continue to ignore this income, considering it as non-taxable. At this time there are no known instances where an LTCI insured receiving benefits has been required specifically to income such benefits on their tax returns.
Tax-qualified Plans
“Triggers” – as explained later in detail – is the physical or mental condition of the insured that determines when benefits will be paid. The tax-qualified plan is usually more restrictive than non-qualified plans as for the “trigger” of a tax-qualified plans, the insured must need “substantial assistance” with as many as two of the six possible Activities of Daily Living (ADLs) in order to qualify for benefits and the “substantial assistance” must be needed for a period of more than 90 days. Note that while disability is defined more strictly, insurers do not follow this definition “to the letter.” The ADLs in a tax-qualified plan are bathing, dressing, toileting, transferring, continence, eating and in California, “ambulating” (which simply means walking). It is very important to be totally familiar with the wording in the policy.
Non-Tax-qualified Plans
There may be various combinations of benefit triggers, and the insured may need to satisfy more than two of them. Group LTCI policies can use any number of standards. The disability does not have to have existed for more than 90 days in nearly all non-tax-qualified plans.
Tax-Qualified Plans
The trigger for cognitive impairment is stricter as the insured must need “substantial supervision” to protect the insured and others from threats to health and safety due to that cognitive impairment.
Non-Tax-qualified Plans
Usually the definition of a qualifying cognitive impairment is less strict and is usually based upon the documentation of a physician, psychologist or psychiatrist. Generally one does not need the same level of supervision to qualify for benefits. Definitions vary among policies. Many non-tax-qualified policies do not require substantial supervision but only “stand-by” assistance – usually defined as having another person close-by physically (“arms-length” in some plans) while the insured is performing any of the ADLs. This “stand-by” assistance is available for an extra premium in some policies, and some insurers do not offer it in their policies.
In a tax-qualified plan, certification by any physician, registered professional nurse, licensed social worker, or other individual who meets such requirements as required by the Secretary of the Treasurer. The insistence of a spouse that an individual needs long-term care does not qualify the insured for treatment, where it may under some non-tax-qualified plans.
Tax-Qualified Plans vs Non-Tax-qualified Plans
“Medical necessity” is NOT a trigger under HIPAA and is a subject of much discussion when comparing a tax-qualified plan with a non-tax-qualified plan. Medically Necessity DOES NOT qualify a person under a tax-qualified plan. Many (if not most) non-qualified plans pay benefits to an insured when the physician certifies the care or services to be Medically Necessary. An example would be where the insured is a diabetic who needs daily insulin shots, but he is not able to administer the shots to himself. Usually, under a non-tax-qualified plan, this would trigger benefits when the doctor writes a letter that stipulates the situation.
This is often used as a sales tool in selling a non-tax-qualified plan but the sales advantage might be mostly in the eye of the salesperson as it is estimated that less than 10 percent of LTCI policies sold are non-tax-qualified.
Incidental ADL’s DO NOT qualify a person for benefits under the tax-qualified plan. Some companies allow benefits to be paid for homemaker services when the insured is unable to perform 2 or more of the Incidental Activities of Daily Living, which includes cooking, shopping, cleaning, telephoning, bill paying and laundry,
If a LTCI policy was purchased prior to 1997, then theses policies are “grandfathered” under HIPAA and they receive the same tax treatment as tax-qualified plans. However, only certain changes can be made to these policies for them to continue receiving the favorable tax treatment. The rules for the restructuring of these policies are very strict, so any changes to grandfathered policies must be done with trepidation and great care.
The person receiving the services must be the taxpayer, the taxpayer’s spouse, or a dependent that receives at least 50% of their support from the taxpayer. In the same vein, the premiums cannot be deducted if the taxpayer pays the Long-term Care Insurance premiums for parents, unless the taxpayer contributes more than 50% of their support. If a taxpayer pays the premiums for his parents (or in-laws) and doesn’t contribute at least 50% of their support, then the premiums for Long-term Care Insurance could be considered a gift, and subject to the $10,000 annually maximum gift tax (per person, per gift). The gift tax provisions would not apply if the taxpayer provides more than 50% of their support.
Many companies are offering recent policyholders the opportunity to change to a tax-qualified plan if they so desire, generally at a different premium basis. Underwriting is usually waived.
F To re-emphasize, Agents must carefully explain that under most of the older plans, one of the benefit “triggers” is “Medically Necessary” only. They will lose this trigger with the new policies.
The tax treatment of long-term care policies that are purchased by corporations are tax favored also because the government continues to show that it wants long-term care to be purchased by private persons and industry, and not by the government. They encourage more corporations to offer LTCI to their employees by allowing the companies to deduction part, if not all, of the premium as a business expense.
F Long-term Care Insurance is a valuable fringe benefit for employees.
This is very important to understand as it is most often given as the reason for the interest in LTCI that seems to have settled over the industry in very recent months. HIPAA does not prohibit preferential treatment for officers and managers; many companies are offering guaranteed-issue LTCI coverage on an individual basis to include even those on a staff basis.
Self-employed individuals, sole proprietors, partners and more-than-2%-shareholders in S corporations, a percentage of the premium may be deducted as a business expense as in individual policies. The rest of the premium may be combined with medical expenses and then deducted up to the 7.5 percent of adjusted gross income threshold.
100% (as of years 2003 and later) of the premiums contributed to a tax-qualified plan by a self-employed person and small businesses – which include owners, partners, shareholders and their spouses - may be deducted.
For an executive in a corporation, the corporation can claim the entire premium cost for employees, their spouses, their dependents, retirees and retirees’ spouses as a business expense and the employee does not have to claim the premium cost as income.
This benefit is so attractive that come companies have made special arrangements with key employees, using LTCI as part of the package. This can be best explained by illustration.
An older key employee (between 60 and 65 for instance) decided to take early retirement with ample retirement funds which he could personally manage (instead of the company money managers). If he is also healthy and could survive nicely on his retirement, it would be difficult to talk him out of it, even if the company wanted to. But in order not to lose the years of expertise, many companies will offer such key employees a new job as an analyst or consultant for special projects, at a reduced salary but he would not be working full time. By keeping him on the payroll, they can also offer to pay for part or all (normally the company would pay half) of his health insurance and they often extend it beyond age 65.
Many times employees at this age are aware of the physical and financial strain of long-term care for a loved one. Unfortunately, the premium for an LTCI policy is rather pricey at older ages but the company can provide the coverage for their employee in a manner where both the company and the employer “win.”
For instance, if the company was going to pay the employee $25,000 annually for consulting on special projects, and the cost of an LTCI policy was $3,500 to cover the employee and his spouse, the company can pay the employee only $21,500 and pick up the premium on the policy. Tax-wise, this is a good move as the employee only has to pay taxes on $21,500, and he does not have to report the $3,500 on his tax return. The company still had a $25,000 deduction – the salary and the premium.
When an employer offers LTCI benefits to employees, care must be taken that it is not considered as part of a cafeteria plan as tax benefits are not extended to LTCI that is part of a cafeteria plan.
The ideal way for a corporation to give an employee a tax benefit is to pay for the entire LTCI premium as an additional fringe benefit with no reduction in salary. This takes it outside of the “cafeteria benefit” arena and since the law does not disallow discrimination in long-term care benefits, the company management can pick and choose the employees that it wants to cover.
Group Long-term Care premiums are deductible the same as a business expense when provided by an employer, subject to current percentages allowed as with other group benefits. Only a “C” Corporation can deduct 100% of Long-term Care Insurance premiums, when such premiums are paid by the corporation on behalf of the employees. (See discussion on Group LTC Insurance)
An employer can be discriminatory with Long-term Care Insurance premiums, and some insurers are stating that the employer can discriminate in any fashion that they choose. Many companies feel that to be conservative, discrimination must be only by class. (Nondiscrimination laws apply to self-insured plans as very little - if any - of these plans are involved in Long-term Care benefits).
Premiums for LTCI for self-employed individuals is limited to the lesser of (1) 100% of the amount paid for health insurance premiums during 2003 for the self-employed individual, spouse and dependent, or (2) the net profit from the trade or business less the amount claimed for a Keogh plan or a SEP deduction on Form 1040, line 31.
If the deduction is not claimed on Schedule C, it is not allowed as a deduction for self-employment purposes but may be claimed on Form 1040 (line 30) as an adjustment of income. Any medical insurance expenses in excess of the allowable deduction may be claimed as an itemized deduction on Schedule A of Form 1040, subject to the 7.5% of adjusted gross income floor for medical expenses.
In 1997, there was a great lobbying effort by the National Association of Elder Law Attorneys to get Section 217 of HIPAA repealed. This provision makes intentional transferring of assets to qualify for Medicaid a criminal offense, thereby eliminating a large portion of the income of those attorneys who specialize in transferring assets so that their clients could qualify for Medicaid, and their assets would be transferred to their heirs or other family members (after proper compensation to the attorney).
A bill repealing this provision was introduced with the argument being made that the Congress certainly did not want to send “Grandmothers” to jail. Congress agreed with this assessment.
STUDY QUESTIONS
1. The taxation of benefits of LTCI is much clearer since
A. Bush was elected President.
B. the Democrats were defeated in Congress.
C. the passage of the Health Insurance Portability and Accountability Act of 1996.
D. the federal government took over total control of the insurance industry.
2. Premiums for tax-qualified LTCI products are taxable
A. if the insured is over age 65.
B. if the insured is under the age of 65.
C. to the extent that the premiums plus other deductible medical expenses exceed the
standard deduction allowed.
D. only if the premiums exceed $200 per month.
3. The common terminology for the physical or mental condition of the insured that determines when benefits will be paid, is
A. the trigger.
B. the deductibles.
C. preexisting condition.
D. the gatekeeper.
4. “Medical necessity” in an LTCI policy
A. is not a trigger under HIPAA.
B. is always a trigger under all LTCI policies.
C. is never a trigger for an LTCI policy.
D. determines what percentage of the daily benefit may be paid.
5. In order for the insured of an LTCI plan to take advantages of the tax breaks under a tax-qualified policy, benefits must be paid to
A. only the taxpayer who receive the services (benefits from the policy).
B. the taxpayer, spouse or a dependent that receives at least 50% support.
C. the employer or spouse of the taxpayer.
D. the Circuit Court for distribution of benefits.
6. A corporation can claim the premium cost for employees, spouses, dependents, retirees and retiree’s spouses as a business expense on their income tax forms, and
A. the employee must claim the cost of the premium as income.
B. the employee must claim 50% of the premium cost as income.
C.. the employer must claim the cost of the premium as income.
D. the employee does not have to claim the premium cost as income.
7. A ideal way for a corporation to give an employee a tax benefit is
A. to make LTCI part of a cafeteria plan.
B. to pay for the entire LTCI premium as an additional benefit with no reduction in
salary.
C. not to pay for any fringe benefit for the employee.
D. to make the employee pay the entire LTCI premium.
8. When an employee offers LTCI benefits to employees, care should be taken so that
A. it would be part of a cafeteria plan.
B. only the officers can qualify.
C. every employee is offered the benefit.
D. it is not part of a cafeteria plan as tax benefits are extended to LTCI that is part
of a cafeteria plan.
9. LTCI premium is an acceptable expenditure for self-employed and small businesses of fewer than 50 employees
A. for the(relatively new) medical savings accounts.
B. for a 401(k) plan.
C. for corporate charitable giving.
D. if the businesses are involved in research and development.
10. An important tax feature of LTCI for self employed persons is that if the deduction is not claimed on Schedule C
A. it will not be allowed on any basis with the IRS.
B. the IRS will demand a penalty of 50% of the premium used for the LTCI.
C. it is not allowed as a deduction for self-employment purposes, but may be claimed
on Form 1040 as an adjustment of income in respect to the 7.5% of adjusted gross
income floor for medical expenses.
D. the LTCI insurer will notify the IRS and it will automatically show as a deduction.
ANSWERS TO STUDY QUESTIONS
1C 2C 3A 4A 5B 6D 7B 8D 9A 10C