People are living longer, but for many a reality of aging is that at some point they are unable to care for themselves. The costs of retirement homes and in-home care are rising, generating concerns for many on how to pay for the cost of long-term care, if such care becomes necessary. One solution has been the growth of "long-term care" insurance (LTC). Usually purchased prior to the crisis (even when the person is fairly young) and maintained over the years, LTC can cover all or part of the cost of care when needed.
In 1996, Congress passed the Health Insurance Portability and Accountability Act in 1996 (HIPAA). Among its many provisions are some which created more favorable tax treatment for (LTC) insurance premiums under certain circumstances. Although both federal and state laws confer LTC tax benefits, this article focuses on federal benefits.
Federal "Tax-Qualified" Policies
To qualify for HIPAA tax benefits, the taxpayer must maintain a "qualified" LTC policy. There are several statutory requirements for a qualified LTC policy, mainly relating to events that trigger coverage and consumer protection provisions, including:
- The only insurance coverage provided must be for "qualified" LTC services. This means specified, necessary medical services that are required by a "chronically ill" individual, i.e., one unable to perform at least two activities for daily living (e.g., eating, toileting, transferring to and from bed, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity, or one who requires substantial supervision for protection from threats to health and safety due to severe cognitive impairment. Existence of these conditions must be certified by a licensed health care practitioner.
- The insurance policy may not pay or reimburse expenses that are reimbursable under Medicare, or would be absent application of a deductible or co-insurance amount, and unless Medicare is the secondary payor or the contract provides for per diem payments.
- The policy must be guaranteed renewable and not have a cash surrender value or other money that can be paid, assigned, pledged, or borrowed.
- All refunds of premiums and dividends, or like payments, may only be used to reduce future premiums or increase future benefits, except for refunds on death.
- The policy must comply with all other consumer protection provisions of a "model provisions" and "model Act," as required by the Internal Revenue Code, which include noncancellability, limitations on exclusions, extensions of benefits, and other terms.
Non-qualifying policies are available and vary widely in their terms. They may, however, be more lenient in defining what kinds of illness and physical limitations trigger coverage. Premiums for non-qualifying policies are usually not deductible for tax purposes.
Deductibility of Premiums
Premiums paid by an employer for qualified LTC insurance may be excludable from the employee's income. Premiums paid by the taxpayer on such qualified LTC policies (purchased after January 1, 1997) for a taxpayer, spouse, or dependents are deductible in part as medical expenses when filing for federal income taxes.
Only a portion of the premiums paid by the taxpayer is deductible. That portion is based upon the age of the taxpayer and adjusted each year for inflation. That amount is then added to the taxpayer's other medical expenses. Medical expenses are only deductible to the extent they exceed 7.5% of the taxpayer's "adjusted gross income," a figure calculated pursuant to Internal Revenue rules, usually involving adding back in amounts normally not included in gross income.
Taxability of LTC Benefits
Payments/benefits received from a qualified LTC policy may be excluded from income, subject to certain limitations, including:
- The policy must be "federally tax qualified," as described above.
- The payments must be based on actual expenses incurred.
- Payments on a per diem basis are subject to a limit that is the larger of: (1) a set per diem amount, adjusted for inflation every year; or (2) the cost of LTC care services during the period. Amounts received in excess of this limitation must be included in taxable income.
LTC Tax Benefits for the Self-Employed
LTC insurance premiums paid by the self-employed for coverage for themselves, their spouses, and dependents are also deductible (as a valid business expense). Only a portion of the premiums is deductible, as with individuals, and that portion is based on the age of the taxpayer and adjusted yearly for inflation. Unlike for individuals, however, the self-employed may deduct 100% of the remaining amount. For purposes of LTC insurance premiums, "self-employed" includes sole proprietorships, partnerships, shareholders of more than 2% of the stock of "S" corporations, and limited liability corporations.
LTC Tax Benefits to Corporations
A corporation may deduct premiums, as a reasonable and necessary business expense, for qualified LTC insurance as long as payments are made pursuant to an employee benefit plan. Unlike other health and accident plans that have tax benefits, however, a LTC insurance plan may favor officers, owners, and other highly compensated employees, so long as they are really employees of the corporation. Coverage may be made available for the employees, their spouses and dependents; the premiums paid are generally not includable in the employees' incomes for tax purposes.
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