Tax Treatment of Long Term Care Insurance

The information on this page was taken from the American Association of Long Term Care Insurance website.

Long-Term Care Insurance Tax-Deductibility Rules

Recognizing that government can't pay the bill for long-term care, federal and a growing number of state tax codes now offer tax incentives to encourage Americans to take personal responsibility for their future long-term care needs.

If you would like to capitalize on tax advantaged savings available to those purchasing LTC insurance protection, now is the time to start the process. Click here to complete our simple online questionnaire and get the ball rolling.

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) included provisions for favorable tax treatment of qualified Long-Term Care insurance (LTCi) contracts.

The American Association for Long-Term Care Insurance offers this information to help you better understand the various tax implications relating to LTCi policies. This information is provided for informational purposes only and should not be construed as tax advice. Please consult a tax advisor regarding your particular circumstances.

Individual Purchase

AS YOU AGE... YOUR TAX DEDUCTIBLE LIMIT INCREASES

Tax-qualified LTCi premiums are considered a medical expense. For an individual who itemizes tax deductions, medical expenses are deductible to the extent that they exceed 7.5% of the individual's Adjusted Gross Income (AGI). The amount of the LTCi premium treated as a medical expense is limited to the eligible LTCi premiums, as defined by Internal Revenue Code 213(d), based on the age of the insured individual. That portion of the LTCi premium that exceeds the eligible LTCi premium is not included as a medical expense.

Individual taxpayers can treat premiums paid for tax-qualified long-term care insurance for themselves, their spouse or any tax dependents (such as parents) as a personal medical expense.

The yearly maximum deductible amount for each individual depends on the insured's attained age at the close of the taxable year (see Table 1 for current limits). These deductible maximums are indexed and increase each year for inflation.

Planning Tip: Some LTC insurers offer "shared care" policies where two people share one pool of benefits. This may be used to maximize the eligible tax deductibility when there is a difference in ages between the spouses.

Tax Savings Tip: Long-term care insurance premiums may be paid from a Health Savings Account (HSA) up to the limits shown above.

Taxability of Benefits Received: Generally, benefits received from a tax-qualified LTCi policy that was purchased by an individual are non-taxable and therefore excluded from Adjusted Gross Income. Benefits paid under an indemnity policy are not taxed unless they exceed the higher of the cost of qualified long-term care or $290-per-day (the 2010 limit). The 2011 limit is $300-per-day.

Self-Employed
A self-employed individual can deduct 100% of his/her out-of-pocket long-term care insurance premiums, up to the Eligible Premium amounts listed above [IRC 162(l)]. The portion of LTCi premiums that exceeds the Eligible Premium (see Table 1) amount is not deductible as a medical expense. The deductible amount includes eligible premiums paid for spouses and dependents [IRC 162(l)]. It is not necessary to meet a 7.5% AGI threshold in order to take this deduction.

However, a self-employed individual may not deduct LTCi premiums during any calendar month in which he/she or his/her spouse is eligible to participate in a subsidized LTCi plan (where the employer pays all or part of the premiums for LTCi).

Partnership² Limited Liability Company (LLC)² Subchapter S Corporation
Partners in a business is a partnership, members of an LLC that is taxed as a partnership, and shareholders/employees of Subchapter S Corporations who own more than 2% of the Corporation, are taxed as self-employed individuals. The partnership, LLC or Subchapter S Corporation pays the premium.

The partner, member or shareholder/employee includes the LTCi premium in his/her Adjusted Gross Income, but may deduct up to 100% of the age-based Eligible Premium, as listed in Table 1. It is not necessary to meet a 7.5% AGI threshold.

If the sole shareholder/employee purchases LTCi in his/her own name instead of that of the S Corporation, the S Corporation is not treated as a partnership and the shareholder is not treated as a partner. As such, the shareholder is not treated as self-employed and is only eligible to include his/her eligible LTCi premiums in his/her itemized deductions, which are subject to the 7.5% AGI threshold.

Planning Tip: In a sole proprietor or a partnership situation, the owner/partner who has a spouse who is a true employee can deduct the actual (full) premium for that spouse's policy. If that spouse's policy had a shared benefit rider, that would be included in the deductible premium amount (actual total premium is deductible).

Subchapter C Corporation
When a business purchases a tax-qualified LTCi policy on behalf of any of its employees, or their spouses and dependents, the corporation is entitled to take a 100% deduction as a business expense on the total premium paid. The deduction is not limited to the aged-based Eligible Premiums.

The purchase of a tax-qualified LTCi policy is not subject to any non-discrimination rules, thus allowing an employer to be selective in the classification of employees it elects to cover.

Planning Tip: Premium payments generally will be tax deductible when the class is based on such factors as the officers of the corporation and length of service (e.g. company pays for all those who are Senior Vice President or higher and have been with the company for 12 or more years). Tax rulings have stipulated that the class cannot, however, be based on stock ownership.

Tax Savings Tip: The use of Ten-Pay or Accelerated Premium plans provide higher tax deductions for the Corporation and enable the long-term care insurance premium to be fully paid-up by the time the owner retires (no ongoing premiums) or sells.

Selling Tip: Fiscal Year-End Planning for profitable companies with a retained earnings issue. The fiscal (tax) year for C-Corps generally don't end on December 31st (as they do for 'pass through' entities and individuals). At the beginning of the fourth quarter of their Fiscal Year, profitable companies start looking for tax deductions. Recommend long-term care insurance as an executive benefit... benefits are far more valued than new office furniture.

The premium paid by the business is excluded (not reported) from the employee's Adjusted Gross Income even if the premium exceeds the Eligible Premium amount listed in Table 1.

Employer-Pay Contributory Arrangement on Behalf of an Employee
If an employer pays all or a portion of the tax-qualified LTCi premiums on behalf of an employee, the amount paid is deductible by the employer as a business expense. The deduction is not limited by the age-based limits. The entire employer contribution would also be excluded from the employee's AGI.

If the employer only pays a portion of the premium, the employee is able to apply the balance that he/she pays towards his/her medical expenses, up to the Eligible Premium amount, and would then be entitles to a deduction for medical expenses that exceed 7.5% of AGI.

Gift Tax Exclusion
In addition to the annual Gift Tax Exclusion of $13,000 per donee, a donor has the ability to pay for the medical expenses of the donee [IRC Sec. 2503(e)]. If those medical expenses are tax-qualified LTCi premiums, the exclusion is subject to the age-based limits for Eligible Premium listed in Table 1. An individual (donor) can purchase LTCi policies for family members (donees) and still maintain the annual Gift Tax Exclusion when selecting a Ten-Pay or Accelerated Payment Option.

Return of Premium
The refund is included in the beneficiary's gross income and is taxable, to the extent it was either excluded from the owner's income or deducted by the owner. It must be included as income in the year it is received.

Health Savings Account (HSA)
Tax-qualified LTCi premiums can be reimbursed through an HSA, tax-free up to the Eligible Premium amounts listed in Table 1, even if the HSA is offered through an employer-provided cafeteria plan.

Health Reimbursement Account (HRA)
Reimbursements for insurance covering medical care expenses, as defined in IRC Sec. 213(d), which includes qualified long-term care services and qualified long-term care insurance premiums are allowable under an HRA. Although employers pay for HRAs, an HRA cannot be provided by salary reduction or IRC Sec. 125 plans. As such, the LTCi premiums cannot be paid on a pre-tax basis through an HRA.

Cafeteria Plan
Tax-qualified LTCi premiums cannot be purchased with pre-tax dollars under an employer-provided cafeteria plan. However, LTCi premiums may be paid through an HSA that is offered under an employer-provided cafeteria plan.

Flexible Spending Account (FSA)
Tax-qualified LTCi premiums cannot be reimbursed under an FSA.

STATE DEDUCTIBILITY RULES

Many states offer tax incentives to encourage the purchase of LTCi. Below is a general summary of state specific tax information for your reference. This information is current through December 2008 and is subject to change.

Taxpayers may need to meet state specific requirements to qualify for deductions or credits for LTCi. For information regarding the tax liability of a case, consultation with a tax consultant or legal advisor is recommended.