By Russ Banham
There are significant federal tax benefits in purchasing long-term care insurance, but like everything else in life and business the devil is in the details.
Fortunately, the Health Insurance Portability and Accountability Act (HIPAA) provides some clarifications. In general, the income from a long-term care insurance policy is non-taxable, and the premiums paid to buy the insurance are tax deductible. Similar tax advantages exist at the state level, but each state treats the subject differently.
The fact that there are tax benefits to purchasing long-term care coverage testifies to the vital social importance of this under-utilized insurance product. The following are answers to some frequently asked questions:
Q. What is the tax treatment for an individual long-term care insurance policy?
A. According to the Internal Revenue Service (Publication 525), long-term care insurance is treated much like health insurance—the dollar amounts the policyholder receives (other than dividends and premium refunds) for personal injury or sickness generally are excludable from income, and the premiums paid generally are tax deductible. Long-term care policies must have these features to qualify for the deductions: be guaranteed renewable; not provide for a cash surrender value or other money that can be paid, assigned, pledged or borrowed; and not pay for or reimburse expenses that would be reimbursed under Medicare.
Q. Are there considerations regarding a person’s health to receive the tax benefits from long-term care insurance?
A. The short answer is yes—to qualify for the tax treatment an individual must have been certified as “chronically ill” by a licensed health care practitioner within the previous twelve months. A chronically ill person is defined as someone unable to perform at least two activities of daily living, such as eating, bathing, dressing and continence, without substantial assistance from another individual for at least 90 days. Chronic illness also is described as severe cognitive impairment requiring substantial supervision.
Q. What about the specific long-term care services received—are there tax treatment issues with regard to the types and durations of these services?
A. Other than the aforementioned need to pursue a plan of care prescribed by a licensed health care practitioner, the IRS also requires that this plan calls involve medical or care services that are diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative. For individuals with severe cognitive impairment, the maintenance and personal care services provided must have a primary purpose of assisting the person with his or her disabilities and/or protect them from threats to their health and safety.
Q. Are there limits in the tax deductibility of qualified long-term care premiums for individuals who itemize their tax deductions?
A. The federal tax code has a 7.5 percent floor governing medical expenses deductions taken on Schedule A (Form 1040), meaning that the premium expense is deductible to the extent that it exceeds 7.5 percent of the individual’s Adjusted Gross Income. There are other considerations with regard to the policyholder’s age. For example, under IRS Code 213(d), someone 40 years of age or less can include up to $330 as medical expenses for calendar year 2010, while someone 71 and older can include up to $4,110. In between, there is a rising scale as one ages.
Q. I’m self-employed and have purchased a long-term care insurance policy. Will the premiums I pay to the insurance company be deductible?
A. Yes, and in your case the out-of-pocket premiums are fully 100 percent deductible, up to the eligible amounts described above with regard to age. There is a catch, however. If your spouse is eligible to participate in a subsidized long-term care insurance plan paid for in part or in full by his or her employer, you may not deduct the premiums.
Q. If I purchase a qualified long-term care insurance policy, am I allowed to take tax deductions for meals, medicines and medical conferences I attend?
A. Generally, the answers are yes. With regard to meals, if they are provided by the hospital or medical care facility providing care then these costs are tax deductible. Medical conference costs are deductible if the conference is primarily for and necessary to the medical care of you, your spouse or dependent. Expenses for prescribed drugs and medicines are tax deductible.
Q. What about the costs of a nursing home or nursing services provided at my home—are these expenses tax deductible?
A. The costs of care in a nursing home or similar institution, as well as the wages and other amounts paid for nursing services at home, can be included as medical expenses deductions. In such cases the services provided must be connected with the individual’s chronic illness. Related expenses, such as a nursing attendant’s meals and the costs of moving into a larger apartment to provide space for the attendant, also may be deductible.
Q. Can an employer receive a tax deduction for the premiums paid to provide employees and their spouses and dependents with qualified long-term care insurance?
A. A Subchapter C Corporation is entitled to take a 100 percent deduction as a business expense on the total premium paid. Different rules apply to a Limited Liability Company and a partnership, however. In such cases, seek legal or tax assistance from an expert, as the complexities are many.
Q. Are there long-term care insurance tax incentives on a state-by-state basis?
A. Broadly speaking, the answer is yes, although these incentives differ. For example, Colorado residents may be granted a credit equaling 25 percent of the premiums paid (or $150) per long-term care policy, whereas California residents may deduct the total cost of long-term care insurance premiums paid in a given tax year. The National Association of Insurance Commissioners advises soliciting information on the tax implications of long-term care insurance from state insurance departments.
Q. Are there consumer protections that long-term care insurance companies must oblige?
A. Yes, under HIPAA long-term care insurers must provide potential buyers a “Shopper’s Guide” and a description of coverage benefits and limitations to allow comparisons among different policies.
Obviously, these are short responses to frequently asked questions. Readers are advised to seek fuller explanations from their financial advisors or to contact state and federal tax and/or insurance authorities for additional information.
Russ Banham is a veteran financial journalist. His articles have appeared in Forbes, The Economist, CFO, and U.S. News & World Report. His latest book is The Fight for Fairfax.
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