Choosing whether to purchase long-term care insurance may be one of the most important decisions a person makes during his or her life time. Long-term care provides the help an individual needs in the unlikely event they are unable to care for themselves because of a prolonged illness or disability. Long-term care differs from traditional medical care in that, medical care serves to rehabilitate or correct certain medical problems, where as long-term care helps to maintain a person’s lifestyle.
1 . Overview
Long-term care insurance is not health insurance or long-term disability insurance, i.e., not income-replacement insurance. Rather, long-term care insurance pays a daily benefit when one needs help to perform certain enumerated activities of daily living (bathing, eating, dressing, etc.). Obviously, the need can arise for anyone at any age, but it is more common as people get older.
Typically, benefits from a long-term care policy can range from $75 daily to $200 or more. Benefits can be paid for a year, two, several, or for life. Benefits generally start from the time the insured is found unable to care for him/herself. Premiums vary depending on age at the time of enrollment and the level of benefits chosen.
Some experts recommend that all working people have health and long-term disability (income protection) insurance but that people delay buying a long-term care policy (even though premiums are lower the younger you are when you enroll) until they are in their fifties. Others espouse buying the policy as early as possible to obtain the protection, and purchase a policy using a single lump sum payment to protect against adverse future claims experience that would increase rates.
The cost of long-term care varies depending upon the kind of services provided under the policy. For example, skilled services, such as nursing or therapy, will cost more than support services such as homemaker or personal care services. In addition, home care services can generally be provided at a lower cost than in a nursing family. The cost of long-term care is increasing each year. The average daily rate paid by Medicaid for nursing home care is about $32,000-$35,000 per year, depending on the geographic area. The recent rate of increases in costs is greater than the inflation rate.
The Health Insurance Portability and Accountability Act of 1996 amended the rules relating to the tax treatment of long-term care insurance. A long-term care insurance contract is treated as an accident and health insurance contract. I.R.C. §7702B. Until there is further clarification from the IRS on tax treatment of non-tax qualified (“NTQ”) long term care insurance policies, one should only consider purchase of a TQ policy rather than one that is NTQ. Not only is the deductibility (at least in part) of premiums important, the benefits from qualified plans are guaranteed not to be considered as taxable income. The IRS has not yet ruled on taxability of benefits received under a NTQ LTCI policy. So there is a risk that one would have to pay taxes on everything received under a non-qualified contract.
2 . “Qualified” Long-Term Care Insurance Contracts.
A TQ LTCI policy is an insurance contract issued after 1996 (and contracts issued before 1997 that meet certain state requirements) that only provides coverage of qualified long-term care services. The contract must:
i ) Be guaranteed renewable;
ii ) Generally, not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses;
iii ) Not provide for a cash surrender value or other money that can be paid, assigned, or pledged as collateral for a loan, or borrowed; and
iv ) Provide that all refunds of premiums (other than refunds on the death of the insured or on a complete surrender or cancellation of the contract, which cannot exceed the aggregate premiums paid under the contract) and policyholder dividends are to applied as a reduction of future premiums or to increase future benefits. I.R.C. §7702B(b)(1).
In addition to the above, a TQ LTCI policy must meet certain consumer protection requirements of the Long-Term Care Insurance Model Regulation and the Long-Term Care Insurance Model Act, each promulgated by the National Association of Insurance Commissioners. I.R.C. §§ 7702B(b)(1)(F), (g) and 4980C. These provisions must be offered: (1) guaranteed renewability, (2) restrictions on limitations and exclusions; (3) extension of benefits; (4) continuation of coverage; (5) discontinuance and replacement of policies; (6) unintentional lapses; (7) disclosure; (8) prohibitions on post-claims underwriting; (9) other minimum standards, and (10) inflation protection. Furthermore, a TQ LTCI policy must meet certain consumer disclosure requirements under Code § 4980C(d) and nonforfeitability requirements. I.R.C. § 7702B(g). If a state has not adopted these rules, compliance with the Code’s rules is acceptable. Treas. Reg. § 1.7702B-1(a)(3). If a state has adopted more stringent rules, compliance with those rules is considered compliance with Code §§ 7702B(g) or 4980C. Id. at -1(b).
b. Long-Term Care Services.
The term “qualified long-term care services” means necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal care services, which are (1) required by a chronically ill individual and (2) provided under a plan of care prescribed by a licensed health care practitioner. I.R.C. § 7702B(c)(1). A “chronically ill individual” is defined as an individual who has been certified in the previous 12 months by a licensed health care practitioner as:
i ) being unable to perform (without “substantial assistance” from another) at least two “activities of daily living” for at least 90 days due to loss of functional capacity; or ii ) requiring “substantial supervision” to protect the individual from threats to health and safety due to “severe cognitive impairment”; or iii ) having a similar level of disability as defined in future IRS regulations.
A “licensed health care practitioner” is a physician, registered professional nurse, licensed social worker, or other individual who may be designated in the Treasury Regulations. I.R.C. § 7702B(c)(4).
Long-term care insurance coverage can be provided by a rider to or as part of a life insurance policy. Where this is done, the requirements for a qualified long-term care insurance contract are applied as if the portion of the contract providing such coverage is a separate contract. I.R.C. § 7702B(3) and (4).
c. Grand-fathered Pre-1997 Contracts. Any policies that were issued prior to January 1, 1997, which met the TQ LTCI requirements of the state in which the policy was issued, are generally treated as a TQ LTCI contract. According to the regulations issued pursuant to IRC Sec. 7702B, a policy issued in exchange after December 31, 1996 for an existing policy, is considered a policy issued after this date and certain changes to a pre-1997 policy are treated as the issuance of a new policy. Tax-free exchanges of NTQ for TQ policies were permitted before 1998.
For this purpose, a change that eliminates grand-fathered tax status generally includes: (1) a change in the terms of the policy that alters the amount/timing of an item payable to the policyholder, the insured or the insurance company; (2) a substitution of the insured under an individual policy; or (3) a change in the eligibility for membership in the group covered under a group policy. The Sec. 7702B regulations provide a list of exceptions. See Treas. Reg. § 1.7702B-2. Thus, care should be taken in deciding to “upgrade” in these situations.
d. Substantial Assistance. A competitive contract should have a specific, liberal policy definition of the phrase “substantial” assistance. In order to receive tax-qualified status, a policy must state that in order to trigger benefits, “one policy trigger must be a certification that the insured need “substantial” assistance with 2 of 6 ADLs (Activities of Daily living), defined as eating, toileting, transferring, bathing, dressing, and continence, I.R.C. § 7702B(c)(2)(B). Five of six of these must be included for a LTCI contract to be tax qualified. Id.. As a non-tax matter, it is essential that bathing be included as an ADL.
e. Beware a “Hand’s On” Contract. Where TQ LTCI policies differ most widely is in their definitions of the word “substantial”. A conservative interpretation would mean personal, one-on-one, “hands-on” help from another human being. This wording may not allow benefits until much later on, when one is “on their last legs.” A more desirable interpretation of “substantial” includes “directional” assistance (“Mr. Smith, now it’s time to eat. Pick up your spoon now.”). Another desirable feature is “stand-by” assistance (which means that a human being is nearby to monitor, observe and help if needed).
f. “Reverse Switch” Feature. Most TQ LTCI policies offer conversion from a non-qualified plan to then qualified plan during the first policy year. But a lifetime REVERSE conversion, allowing purchasers to switch from qualified to non-qualified, if it is in their best interest, could be an attractive option, depending on how the IRS rules on the taxability of benefits received from a non-qualified plan. If non-qualified benefits are NOT taxable, then one may be better off switching to the more liberal non-qualified plan, thereby eliminating restrictive technical wording inherent in the qualified plans (the 90+ day certification clause, the lack of a “medical necessity’ trigger, the “substantial assistance” clause, etc.).
g. Other Features to Review.
Desirable provisions in contracts include the following:
- Inflation protection,
- Fixed premiums,
- Waiver of premium,
- Portability (if group policy),
- Premium refund on early death,
- Restoration of benefits (multiple uses),
- Minimum guaranteed benefits to both SNF (skilled nursing facilities) and ALF (assisted living facilities), including skilled intermediate, and custodial benefits, and
- Lifetime benefits (rather than for a specific number of years).
3 . Tax Treatment.
i ) Deductibility.
There are two general classes of payors for tax purposes, namely, individuals and employers. For individuals, a portion of the premium for qualified long term care insurance for individuals (including a spouse and dependents under Code § 152) is treated as amounts paid for medical care under Code §§ 213(d)(1)(D) and 7702B(a)(4). Under Code § 213(d)(1)(l) and (10), “eligible premiums,” which are subject to the applicable annual dollar limits, are deductible only as an itemized expense, and only to the extent they are in excess of the 7.5% of adjusted gross income limit for all “medical care” expenses, including these amounts. “Eligible premiums” are limited to a maximum annual amount, regardless of the policy’s actual cost, depending on the age of the taxpayer, by Code § 213(d)(10), which, for the year 2000, are as follows:
- Age 40 or less $220
- More than 40 but not more than 50 $410
- More than 50 but not more than 60 $820
- More than 60 but not more than 70 $2,200
- More than 70 $2,750
Individuals may deduct eligible premiums for certain TQ LTC insurance providing coverage after age 65 if they pay premiums of equal annual payments for the lesser of (1) at least ten (10) years, or (2) until the taxpayer reaches age 65, but in no event less than five (5) years. In such a case, §213(d)(7) provides that premiums paid during the taxable year by a taxpayer before attaining the age of 65 for insurance covering “medical care” for the taxpayer, spouse, or a dependent after the taxpayer attains the age of 65 shall be treated as expenses paid during the taxable year for insurance which constitutes medical care if premiums for such insurance are payable (on a level basis) under the contract for a period of 10 years or more or until the year in which the taxpayer attains the age of 65, but in no case for a period of less than 5 years.
Amounts paid by an employer to finance sickness and injury benefits for its employees generally constitute ordinary and necessary business expenses deductible under Code § 162(a), provided they are used to pay accident and health insurance premiums or to pay or reimburse benefits directly. In general, the Health Insurance Portability and Accountability Act of 1996 (the “Act”), as clarified by the Taxpayer Relief Act of 1997, amended the rules relating to the tax treatment of long-term care insurance. A TQ LTCI contract is treated as an accident and health insurance contract. I.R.C. § 7702B(a)(1). COBRA health care continuation rules do not apply to coverage under a plan in which substantially all of the coverage is for qualified long-term care services. I.R.C. § 4980B(g)(2.
ii ) No Cafeteria Plan. Employer provided TQ LTCI coverage is not, however, excludible by an employee if provided through a cafeteria plan or a flexible spending account. I.R.C. §§ 106(c)(1) and 125(f). Where an employee elects to be covered by an employer, which then pays the premium and reduces the employee’s salary, this could be considered a de facto cafeteria plan, resulting in taxable income to the employee. The IRS so ruled as to another benefit in PLR 9325023.
b . Specific Business Entities.
i ) Overview. The tax treatment for business owners who are sole proprietors (I.R.C. § 401(c) and § 402(a))partners, including members of LLCs taxed as partnerships (I.R.C. § 401(c) and 1402(a)), and more than 2% shareholders of S corporations (I.R.C. § 1372(a)) are each taxed in the same fashion. As discussed below, owners of the regular “C” corporations who receive TQ LTCI benefits as common law employees receive much more favorable treatment.
ii ) Partnerships. Accident and health insurance premiums paid by a partnership on behalf of a general partner or a limited partner receiving guaranteed payments (IRS Pub. 502, p.7 (1999) are deductible by the partnership under Code § 162(a). The partner will be required to recognize income as a guaranteed payment under Code § 707(c) equal to the amount of accident and health insurance premiums paid for the partner by the partnership. See Rev.Rul. 91-26. If, however, the partnership elects not to pay the premiums or does not otherwise provide LTCI, the partner may purchase a TQ LTCI policy.
In either case, the partner will be able to deduct as a business expense a portion of the amount paid during the taxable year for health insurance coverage for the partner, spouse and dependents. I.R.C. §§ 162(l)(1)(A) and 2(C). A percentage of such eligible TQ LTCI premiums paid during the tax year is deductible as self-employed health insurance, and the balance (or at least a portion, as discussed below) is deductible as a medical expense, subject to the cap and to the 7.5% of adjusted gross income (“AGI”) threshold. I.R.C. §§ 162(l)(3) and 213(d).
The Taxpayer Relief Act of 1997 applies the rules for the deduction for health insurance expenses of a self-employed individual separately with respect to plans that covers medical expenses and those that include coverage for qualified long-term services or that are qualified long-term care insurance contracts. For LTCI premiums, only “eligible” long-term care premiums are taken into account. I.R.C. § 213(d)(1)(D). Eligible long-term care premiums are amounts paid during a tax year for any TQ LTCI contract up to a specified dollar limit (depending on the age of the individual). I.R.C. § 213(d)(10). The specified LTCI dollar limits for 2000 (which are adjusted annually for inflation) are as follows:
- Age 40 or less $220
- More than 40 but not more than 50 410
- More than 50 but not more than 60 820
- More than 60 but not more than 70 2,200
- More than 70 2,750
The percentage of eligible TQ LTCI premium that can be deducted as self-employed health insurance each tax year under Code § 162(l) is:
- Before 1995 25%
- 1996-1996 30%
- 1997 40%
- 1998 45%
- 1999-2001 60%
- 2002 70%
- 2003 100%
The age based annual dollar premium limits apply first, then the percentage limits. The percentage balance left that is nondeductible as a health insurance premium can be applied toward the § 213 itemized deduction, i.e., deductible to the extent it and all other unreimbursed medical care expenses exceed 7.5% of the taxpayer(s) adjusted gross income. I.R.C. § 162(l)(3).
EXAMPLE: In 2000, Sam, a 61 year-old, self-employed individual, purchased a TQ LTCI policy with an annual premium of $2,500. In 2000, 60% of the eligible premium may be deducted as self-employed health insurance. The eligible premium for 2000 is $2,200. Thus, his self-employed health insurance deduction is 60% x $2,200 = $1,320. The remaining $880 ($2,200 – 1,320) may be deducted as a medical expense, provided that he has unreimbursed medical expenses in excess of 7.5% of his adjusted gross income. The remaining $300 ($2,500 – $2,200) is nondeductible.
The limits on deductible TQ LTCI premiums are computed per individual, not per return. Thus, for example, in the case of married taxpayers each of whom is over the age of 70, the limitation for 2000 is $2,750 each. If a husband and wife have both paid eligible long-term care premiums, up to $5,500 can qualify as a deductible medical expense on a joint return.
There are other limitations one needs to be concerned with before purchasing a TQ LTCI contract. First, the partner will not be entitled to a deduction to the extent the amount exceeds earned income from the business for which the medical plan was established. In addition, the deduction is disallowed for any calendar month in which the partner or the partner’s spouse is eligible for employer paid LTCI health benefits. However, an individual’s eligibility for other employer paid health benefits does not affect the individual’s right to deduct TQ LTCI premiums, so long as the individual is not eligible for employer paid LTCI.
To ensure the partner’s deduction of the applicable percentage will not be challenged, if audited, the partnership should specify in the partnership agreement that long-term care insurance is not provided by the partnership (where that is the case), and any expenses paid personally by the partner for such coverage will not be subject to reimbursement from the partnership. This result has become a common drafting practice after several IRS rulings relating to “ordinary and necessary” business expenses under Code § 162(a). See TAMs 930001, 9330004, and 9316003. To be safe, this provision would help ensure that any expense incurred by the partner in purchasing LTCI is that of the partner and not the partnership as well as clarify that the partner is not eligible for employer paid LTCI. While such a provision should not be required because there is no “ordinary and necessary” requirement under Code § 162(l), it is nevertheless advisable because the Code allows deductions for medical expenses by a partner only where not paid by the partnership. For this purpose, regular medical insurance and LTCI are considered separately. See I.R.C. § 162(l)(2)(B).
i ) Sole Proprietors.
The treatment is the same for non-owners as other employees under Code §§ 105 and 106. Sole proprietors are “self-employed individuals,” like partners. I.R.C. §§ 401(c) and 1402(a).
ii ) S Corporations.
Similar to the tax treatment of partnerships, TQ LTCI premiums paid by an S corporation on behalf of an employee or shareholder, regardless of ownership percentage, are deductible by the S corporation as a reasonable and necessary business expense for employees under Code § 162, as long as the corporation retains no interest in the policy. However, the tax consequences to the employee/shareholder will differ depending on whether the taxpayer is an employee of the S corporation and what percentage of stock is owned in the S corporation. If the taxpayer is an employee and less than 2% shareholder, then premiums paid by the S corporation are excludible from income under Code § 106(a), like those paid by a regular “C” corporation.
The 2% shareholder who is a bona fide employee would be treated as a self-employed individual for purposes of any available tax deduction. I.R.C. §§ 162(l)(5) and 1372(a). Thus, as is the case for partners in partnerships, a percentage of eligible TQ LTCI premiums are deductible by the 2% shareholder as self-employed health insurance, and any excess may be added to other unreimbursed medical expenses in applying the 7.5% of AGI test for self-employed individuals. See generally Rev.Rul. 91-26, holding 2. If the taxpayer is a shareholder in the S corporation and is not an employee, then the taxpayer is required under Code § 1372 to include the entire amount of the TQ LTCI premiums paid by the S corporation in their gross income, which are not excludible under Code § 106 due to lack of “employee” status. Spouses, children, grandchilden and parents of more than 2% shareholders are also not eligible for the § 106(a) exclusion and are treated as a more than 2% shareholder. I.R.C. §§ 1372(b) and 318.
iii ) C Corporations.
Where a C corporation purchases a TQ LTCI policy for an employee (including shareholder/employees), the C corporation may deduct the premium under § 162 as long as it is a reasonable and necessary business expense and the C corporation does not retain any interest in the policy.
If the shareholder is a bona fide employee of the C corporation, the single premium is excludible from income under Code § 106 if purchased for the individual due to employee status, not shareholder status. See Bogene, Inc. v. CIR, TCM(CCH) 1968-147 and American Foundry v. CIR, 536 F.2d 289 (9th Cir. 1976). But see Larkin v. U.S., 48 T.C. 629 (1967), aff’d, 394 F.2d 494 (1st Cir. 1968). Similarly, subsequent benefit payments under the TQ LTCI are excludible from income under Code § 105. Since such benefit payments are provided under a policy and there are presently no adverse provisions that discourage discrimination in employer paid health insurance, it is not subject to the discrimination rules of Code § 105(h), which apply to self-insured plans.
If, however, the shareholder is not also a bona fide employee of the corporation, or the payment is due to shareholder (as opposed to employee) status, the premium represents dividend income. The shareholder would then be treated as an individual taxpayer for purposes of any available deduction under Code § 213 (subject to the annual cap for TQ LTCI premium and the 7.5% of AGI threshold). This would be the worst case scenario for the shareholder where a single premium policy was purchased, since there is a large amount of income with a one-time only very limited deduction.
Generally, if an employer pays the premium for TQ LTCI coverage for both an employee and the employee’s spouse, the employer can deduct both premium payments as business expenses. Moreover, employer paid health coverage is excludible from an employee’s gross income as long as the coverage is provided for “tax dependents” of the employee. “Tax dependents” are defined by reference to Code § 152 for standard exemption and other income tax return purposes.
a . “Fund” Treatment.
If the business retains any interest in the TQ LTCI policy, this might enable the IRS to treat the policy as a “welfare benefit fund” under Code § 419, which has special deduction rules that apply instead of those under § 162.
b . Payments to Insureds.
Generally, when an individual taxpayer receives benefits under a TQ LTCI policy (other than policyholder dividends or premium refunds), the benefits are excludible from income as amounts received for personal injuries and sickness, regardless of whether the TQ LTCI policy reimburses actual expenses or pays benefits on a per diem or other periodic basis. I.R.C. §§ 104(a)(3) and 7702B(a)(2). Employer paid TQ LTCI premiums are excluded from a common law employee’s income under Code § 106, as well for spouses, dependents and employees during layoff or after retirement. In addition, benefits paid to providers or to reimburse an employee for qualified payments are excluded under 105(b) except (1) to the extent expenses were deducted by the employee, (2) they are attributable to employer paid premiums and exceed actual LTC expenses, or (3) exceed the per diem or annual payment limits under Code § 7702B.
Per diem payments from a TQ LTCI policy are subject to a dollar cap, under Code § 7702B(d)(4). In 1998, this was $180 daily ($65,700 annually) and in 1999 and 2000 the limit is $190 daily ($69,350 annually). See Rev.Proc. 99-42. This amount must be aggregated with amounts received from accelerated death benefits or viatical settlement from chronically ill patients. I.R.C. § 7702B(d)(1)(B). The dollar cap amount is adjusted by the medical care component of the Consumer Price Index. If the individual taxpayer receives TQ LTCI benefits in excess of the dollar cap, those excess benefits are excludible from income only to the extent of the individual’s actual TQ LTC expenses that are not compensated by insurance or otherwise.
Amounts (other than policyholder dividends, as defined in § 808 or premium refunds) received under a qualified long-term care insurance contract are treated as amounts received for personal injury or sickness and as reimbursement for expenses actually incurred for medical care. Code § 7702B(a)(2). Thus, these amounts are generally excludible from the employees’ income as amounts received for personal injuries and sickness, subject to a per diem limitation under Code §7702B(d).
Code § 7702B(b)(2)(C) allows a TQ LTCI policy to provide a refund (that does not exceed the aggregate premiums paid under the policy) upon either (1) the death of the insured or (2) complete surrender or cancellation of the policy. However, only the latter case (i.e., a refund upon complete surrender or cancellation) does Code § 7702B(b)(2)(C) require that the refund be includible in gross income, to the extent that any deduction or exclusion was allowable with respect to the premiums. The fact that Code § 7702B(b)(2)(C) does not extend this rule to a premium refund upon death suggests that this benefit should not be treated generally as additional long-term care benefit under the policy.
c . Prepaid Premiums.
i ) General.
Long-term care insurance is available with a single lump sum payment. Since there is little experience with claims, some believe this is a “good buy” before the insurance companies have any significant adverse claims experience, on the assumption that the insurance company will not later ask for additional premiums. Generally, the IRS takes the position that a current deduction is not available if the benefit for which the expense is made extends for a period “substantially beyond” the current year or if the payment results in a material distortion of income. In such event, the business would be required to treat the prepaid premiums as a “capital expense” and deduct for each year the pro rata portion of the prepaid premiums applicable to that year. However, it is unclear over what period of time the single premium payment may be deducted by the business. Logical choices would be the individual’s (1) expected tenure with the corporation, (2) life expectancy, or (3) ten years by analogy to I.R.C. § 213(d)(7).
As a result, it would be difficult for a business to deduct all in one year successfully, if audited, a lump sum payment for LTCI insurance. Therefore, the purchase of a TQ LTCI policy with annual premiums would be desirable to ensure the corporation received a deduction for the year in which the premium was attributable. However, in such case this tax benefit would need to be weighed against the economic risk of increased premiums in future years.
Where payments don’t materially distort income and involve “certain overlapping payments,” they can be currently deducted. See Reg. § 1.461-1(a)(3)(i).
Section 263 generally provides that no deduction shall be allowed for the cost of permanent improvements or betterments made to increase the value of any property. Treas. Reg. §1.263(a)-2(a) clarifies that section 263 requires the capitalization of costs incurred to acquire property having a useful life substantially beyond the close of the taxable year. Expenditures that otherwise are deducible under section 162 are not deductible currently if they are also capitalizable under section 263. Sections 161 and 261; INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992), Commissioner v. Lincoln Savings & Loan Association, 403 U.S. 345, 358 (1971). Expenditures which create or enhance a capital asset must be capitalized. Commissioner v. Idaho Power Co., 418 U.S. 1 (1973).
The Service ruled that the taxpayer’s payments of lump sum single payment premiums for prior coverage created a capital asset, namely insurance with future years coverage, requiring capitalization under Lincoln Savings and Idaho Power. The capital asset, insurance coverage, covers all future years and limits Taxpayer’s exposure to the premium paid. See Black Hills Corporation v. Commissioner, 101 T.C. 173 (1993), modified 102 T.C. 505 (1994), aff’d, 73 F.3d 799 (8th Cir. 1996); PNC Bancorp, Inc. v. Commissioner, 110 T.C. No. 27 (June 8, 1998).
ii ) Taxpayers Other Than “C” Corporation Employees.
For any taxpayer whose treatment of TQ LTCI is governed by §213 (e.g., individuals, sole proprietors, partners, members in an LLC taxed as a partnership, and 2% or greater shareholders in an S corporation), subsection 213(d)(10) states as follows: “…the term ‘eligible long-term care premiums’ means the amount paid during a taxable year by any individual for any long-term care insurance contract…..to the extent such amount does not exceed the limitation….”(emphasis added). Thus, the deduction is limited by the dollar ceiling. Since no premiums are made after that year, no deduction is available under the Code’s literal language. As of the date this discussion was written, there are no IRS rulings on this issue.
EXAMPLE: In 2000, Partner, a 54 year-old partner is a law partnership, purchased a TQ LTCI policy with a single sum premium of $30,000. In 2000, 60% under Code § 162(l) of the eligible premium may be deducted as self-employed health insurance. The eligible premium for 2000 is $820 under § 213(d)(10). Thus, the self-employed health insurance deduction is 60% x $820 = $492. The remaining $328 ($820 – $492) is a medical expense, deductible to the extent he has unreimbursed medical expenses in excess of 7.5% of adjusted gross income, including this amount. The remaining $29,180 of the premium ($30,000 – $820) is likely nondeductible.
iii ) “C” Corporation Employees.
Long-term care insurance is available to a C corporation with a lump sum payment. However, if the C corporation purchases a single premium TQ LTCI for an employee, the rules applicable to prepaid expenses would apply to limit the corporation’s deduction in the year the premium was paid.
iv ) Prepaid LTCI In Connection with Lifetime Care.
Certain prepaid health care expenses have specifically been held to be deductible by individual non-business taxpayers under § 213 in the year paid if paid in connection with the purchase of lifetime medical care, such as an allocable part of a lump sum payment to a retirement home for lifetime care prepaid amounts for both lodging and medical care. Rev.Rul. 75-302.
The IRS clarified in 1993 that no current deduction of a lump sum payment is allowed for medical care or insurance extending “substantially beyond the close of the taxable year in situations where the future care is not purchased in connection with obtaining lifetime care.” See Rev.Rul. 93-72, commenting on rulings where a deduction was allowed; Rev.Ruls. 75-302 (retirement home), 75-303 (parents’ payment for lifetime care of handicapped child upon parents’ death or incompetency), and 76-481 (retirement home). Accord, PLRs 8309011 and 8630005. The key concept here is that the Service requires the purchase of lifetime care expenses with TQ LTC insurance. Whether the logic of these rulings allows business deductions for prepaid LTC coverage, which are not allowed by Code § 213, is not stated in these rulings because they were issued prior to the 1996 changes in the Code under HIPAA.
However, the annual ceiling under § 213(d)(10) for deductible LTC premiums by age was enacted after all these rulings as a part of HIPAA in 1996. Thus, these rulings may no longer be applicable, and such payments may be deductible only subject to (1) 213(d)(1) limit for all persons other than common law employees (excluding 2% or more shareholders of “S” Corporations who are treated as self-employed), and (2) the Code § 162(l) percentage for self-employed individuals. But the deduction may not be limited by § 213(d)(10) because the deduction is being claimed for more than premiums, which is all that is addressed in that subsection.
IRS Publication No. 502 (1999), which deals with advance payments for lifetime care states at page 8:
“Generally you are not allowed to include in medical expenses current payments for medical care (including medical insurance) to be provided substantially beyond the end of the year. This rule does not apply in situations where the future care is purchased in connection with obtaining lifetime care of the type described earlier.”
IRS Pub. 502 (1999) also states as follows:
“You can include in medical expenses a part of a life-care fee or “founder’s fee” you pay either monthly or as a lump sum under an agreement with a retirement home. The part of the payment you include is the amount properly allocable to medical care. The agreement must require that you pay a specific fee as a condition for the home’s promise to provide lifetime care that includes medical care. You can include in medical expenses advance payments to a private institution for lifetime care, treatment, and training of your physically or mentally impaired dependent upon your death or when you become unable to provide care. The payments must be a condition for the institution’s future acceptance of your dependent and must not be refundable.”
IRS Publication 502 does not discuss whether the changes to Code § 213(d)(10) alters the above result.
f. Reporting Requirements.
The payor of LTC or accelerated death benefits must file a 1099-LTC and provide a payee statement to the recipient of the benefits. See Code § 6050Q(a)(2) and Ann. 97-10. See also § 6724(d)(1)(B)(ix) and (d)(2)(Q) for failure to file penalties.
By Alson R. Martin and Michael D. Carson*
* Alson R. Martin is a partner and Michael D. Carson is an attorney in one of several Kansas City offices of Shook, Hardy & Bacon L.L.P., which also has offices in Houston, Washington, D.C., San Francisco, Miami, London, Zurich, Geneva, Melbourne and Buenos Aires.
© Alson R. Martin, March 2000