Academic journal article Journal of Accountancy

Long-Term Care Insurance and Tax Planning: Make the Most of Tax Rules for Premiums and Benefits

Academic journal article Journal of Accountancy

Long-Term Care Insurance and Tax Planning: Make the Most of Tax Rules for Premiums and Benefits

Article excerpt

EXECUTIVE SUMMARY

* Long-term care (LTC) insurance benefits are tax-free to the insured for either reimbursement of qualified expenses or payments up to a per-diem limit indexed for inflation--$270 in 2008.

* Premiums for LTC insurance are tax-deductible according to limits that are also indexed to inflation and increase with the age of the insured. For an individual purchaser, however, premiums, along with other qualified medical expenses, are further subject to the floor of 7.5% of adjusted gross income as an itemized deduction.

* More favorable treatment is available to self-employed persons, who may be able to deduct as a trade or business expense premiums (up to the annual limit) of an LTC plan sponsored by their business for themselves or spouse or dependents.

* A company that pays premiums for nonowner employees is generally allowed still more favorable treatment: deduction without regard to the annual limits. LTC insurance is generally not allowable as part of a "cafeteria plan"; however, premiums up to the eligible amount or LTC expenses may be funded through a health savings account, medical savings account or health reimbursement arrangement.

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[ILLUSTRATION OMITTED]

The number of baby boomers in or near retirement is rising, and so too is the demand for long-term care (LTC) insurance. Depending on the age of the insured, such coverage can be expensive, but fortunately for them, Congress and some states have provided income tax incentives for the purchase of certain LTC insurance policies--called "qualified" LTC contracts--in IRC [section] 7702B. CPAs who have a command of these rules will be well-placed to provide valuable advice to clients. To that end, this article provides an overview of the income tax treatment for both premiums paid into and benefits received from qualified LTC insurance contracts for individuals (nongroup policies). As you'll see, benefits and premiums can be excluded or deducted from income--within limits--but the crucial question of who pays can make the difference ultimately whether that's true of any, some or all of the cost.

TAXATION OF BENEFITS

The federal income taxation of benefits received under an LTC policy depends on the type of contract. Under a "per-diem," also known as indemnity-based, policy, the insurance company generally pays the same benefit regardless of the insured's actual LTC expenses. These amounts are received income-tax-free up to the greater of (1) costs incurred for LTC services or (2) a daily limit indexed for inflation--$270 per day in 2008. Any excess amount is taxed. (The taxable amount is further reduced by reimbursements received for LTC services, but with a per-diem policy, that reduction often will be zero). See IRC [section] 7702B(d) and Rev. Proc. 2007-66. Under a "reimbursement" policy, the insurer does not pay a set amount. Instead, it pays for LTC expenses incurred, up to the maximum benefit under the contract. All amounts received under a reimbursement policy are income-tax-free. See IRC [section][section] 7702B(a)(2) and 104(a)(3).

TAXATION OF PREMIUMS

The federal income tax treatment of premiums paid into a qualified LTC policy differs not by the type of contract, but by the type of taxpayer (or in some respects, the relationship between the premium payer and insured/policy owner). There are three categories: individual (good), self-employed (better) and employer-employee (best).

Individual (Good). When individuals personally buy LTC insurance (no business is involved in the purchase) that covers themselves, a spouse or a dependent, they can deduct a portion of the premium. See IRC [section][section] 7702B(a)(4), 213(a) and 213(d)(1). Dependents generally include the taxpayer's children and certain relatives (including parents, siblings, aunts and uncles) for whom the taxpayer provides over half the support. See IRC [section] 152. …

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