Under the Health Insurance Portability and Accountability Act of 1996, some long-term care insurance (LTCI) premiums and benefits receive favorable income tax treatment. If a given LTCI policy meets federal standards, premium payments may be deductible(1) and benefits received under the policy are not treated as taxable income. In order to qualify for the favorable income tax treatment, a LTCI policy must meet specific standards. Policies that have met the federal guidelines are tax-qualified long-term care policies.
Before the Health Insurance Portability and Accountability Act of 1996, it was unclear whether benefits received under a LTCI policy would be treated as taxable income. Although the rules are now clear for “tax qualified” LTCI policies, the confusion remains for non-qualified policies. Ordinarily, even if LTCI benefits are treated as income, the high (and deductible) medical costs associated with long-term care would substantially reduce any tax liability. There does remain a dispute about whether those expenses will be deductible if they are reimbursed by a LTCI policy. In other words, the possibility exists that LTCI benefits would be taxed and long-term care costs would not be available as an income tax deduction. The IRS has not yet ruled on this issue, however LTCI benefits are not currently being taxed as income.
Source: Fleming & Curti, P.L.C. Tucson, Arizona 85701. www.elder-law.com (520) 622-0400.
Assuming:
- Adjusted gross income is $120,000.00, married filing jointly (before a LTC event).
- There is a long-term care event with $200.00 per day in qualified long-term care expenses for the entire year.
- Expenses are reimbursed by a non-qualified LTCI policy with a $200.00 per day benefit amount.
What if LTCI benefits become taxed as income and qualified long-term care cost are deductible when reimbursed with LTCI benefits?(2)
Cause
Adjusted gross income
Deductible long-term care expenses (adjusted per 502)
LTCI benefit reimbursement (income)
Adjusted gross income after LTC event
Income
$120,000.00
–
$73,000.00
$129,000.00
Expense
–
$64,000.00
–
–
Tax
$23,115.00
–
–
$25,524.00
Income tax owed before LTC event
$23,115.00
Income tax owed after LTC event
$25,524.00
$2,409.00 per year more owed in tax from LTC event
If the long-term care event lasted five years, the total additional tax would be $24,090.00.
What if LTCI benefits become taxed as income and qualified long-term care cost are not deductible when reimbursed with LTCI benefits?(2)
Cause
Adjusted gross income
Deductible long-term care expenses (adjusted per 502)
LTCI benefit reimbursement (income)
Adjusted gross income after LTC event
Income
$120,000.00
–
$73,000.00
$193,000.00
Expense
–
$0
–
–
Tax
$23,115.00
–
–
$43,671.00
Income tax owed before LTC event
$23,115.00
Income tax owed after LTC event
$43,671.00
$20,556.00 per year more owed in tax from LTC event
If the long-term care event lasted five years, the total additional tax would be $102,780.00.
What if LTCI benefits remain untaxed as income and qualified long-term care cost are deductible when reimbursed with LTCI benefits (same as tax-qualified)?(2)
Cause
Adjusted gross income
Deductible long-term care expenses (adjusted per 502)
LTCI benefit reimbursement (not income)
Adjusted gross income after LTC event
Income
$120,000.00
–
$73,000.00
$193,000.00
Expense
–
$64,000.00
–
–
Tax
$23,115.00
–
–
$7,645.00
Income tax owed before LTC event
$23,115.00
Income tax owed after LTC event
$7,645.00
$15,470.00 per year more owed in tax from LTC event
If the long-term care event lasted five years, the total additional tax would be $77,350.00.
Conclusion:
Insurance is to protect individuals from uncertainty, uncertainty that can lead to negative financial consequences. Some of these consequences may be very small and some may be very large. It is best to put your personal financial picture into the above test to determine what the potential tax liability is if the IRS enacts an unfavorable ruling on your non-qualified LTCI policy. If the potential exposure is bearable to you, no change is recommended. If the potential exposure in tax liability is not bearable, you may want to consider changing your non-qualified LTCI policy to a tax-qualified LTCI policy. Be sure to understand the differences between policies when making any changes because your current policy may have benefits not offered in a new policy. Many insurance companies will allow policy holders to switch non-qualified policies to tax-qualified policies prior to filing a claim upon sending a written letter to the company with such request. It is almost always best to change your current policy rather than replace your coverage with a new LTCI policy.