1. Are long-term care insurance contracts subject to specific tax provisions?
A. Yes. The Health Insurance Portability Accountability Act (HIPAA) of 1966 does include provisions for favorable tax treatment of “qualified” long-term care insurance contracts. The provisions affect features such as premiums, benefits, employer contributions and medical expense deductions.
2. Are the premiums that are paid on long-term care policies deductible in any way?
A. Self-employed individuals-including sole proprietors, partners, and more than 2% shareholders of an S-Corporation, can generally deduct a percentage of eligible premiums paid for qualified long-term care plans as health insurance costs.
3. How does a long-term care insurance policy qualify for HIPAA’s favorable tax treatment?
A. A long-term care insurance policy may provide insurance protection only for “qualified long-term services.”
4. Are there specific guidelines for tax treatment of premiums and benefits under tax qualified long-term care policies?
A. HIPAA, amended the federal tax code so that, regarding premiums for individual tax payers, individuals can include, as deductible medical expenses:
• Their eligible LTC premiums; and
• Their non-reimbursable expenses for LTC services, excluding the cost of services provided by family members or relatives. Individuals can deduct their medical expenses incurred for themselves and their dependents as itemized deductions to the extent that the expenses exceed 7.5% of the individuals adjusted gross income. The amount of eligible LTC premiums is based on the individual’s age and is adjusted annually based on increases in the medical care component of the Consumer Price Index.
Benefits paid to an individual under a qualified LTC plan are generally excluded from federal taxable income. For full reimbursement policies, the full amount of the benefit should be tax-free.
5. How does this rule apply to an indemnity policy?
A. Because an indemnity policy can pay in excess of actual expenses, it works a little differently and there is a tax-free benefit cap. Unless the insured can show that LTC expenses exceed cap, tax-free treatment is limited to $220/day for 2003 and $230/day for 2004. Also, the tax-free cap may be reduced by other LTC reimbursements, such as another LTC policy and life insurance policy that pays benefits for LTC services.
6. Does the Health Insurance Portability and Accountability Act include those long-term care insurance policies purchased before the act was established?
A. Yes, HIPAA mandated that policies purchased and issued before January 1, 1997, be “grandfathered” (covered by HIPAA) so benefits would be paid out tax-free to the insured.
7. What are the tax incentives for purchasing a long-term care insurance policy?
A. The tax incentives for purchasing a long-term care insurance policy include:
o No federal tax on benefits
o C-Corporations can fully deduct LTC premiums paid for employees including owners and their spouses, even if they discriminate in providing coverage. Premiums paid by the corporation are not considered income to employees. Benefits paid are still treated as non-taxable income.
o S-Corporations, partnerships and LLCs have the same benefits as C-Corporations for employees owning less than a 2% interest. Owners with more than 2% interest are considered self-employed. Owners treat premium as income, but can then deduct certain amounts.
o Self-employed individuals can use some of the premium as an above-the-line business expense. The remainder can be added to non-reimbursed medical expenses.
A limited ability to deduct premiums on a 1040 return. A certain amount of premium can be added to non-reimbursed medical expenses. Very few individuals benefit from this. At least 21 states provide either a tax deduction or credit for residents who purchase policies.
8. Were there any other significant changes to pre-1997 long-term care insurance policies and/or benefits implemented by HIPAA?
A. Yes. Most of the pre-1997 policies required three “eligibility benefit triggers” (any one trigger qualified the insured) to qualify for benefits. HIPAA changed that requirement, making it more difficult to qualify for benefits with the newer policies (Tax-Qualified after 1/1/97). The number of Activities of Daily Living (ADLs) was changed from seven to six, dropping “ambulation,” the first activity people are most likely to need assistance with.
9. Are non-tax-qualified and tax-qualified policies specific to individual situations?
A. Yes. There are situations where non-tax-qualified policies are appropriate more so than tax-qualified policies.
10. Are these tax-qualified and non-tax-qualified policies interchangeable?
A. Yes. Some insurance companies allow the insured to switch from a non-qualified to a tax-qualified policy to best meet their needs when a claim is imminent.
11. What is the advantage of the homestead exemption?
A. Under the homestead exemption the first and second liens required by the reverse mortgage plus the home exemption amount may exceed the fair market value of the home. The homeowner can then establish that there is nothing remaining for other judgment creditors to collect even if the house is sold. This exemption planning uses up the home equity with first and second mortgages and can make the residence judgment-proof against non-mortgage creditors.
12. Are there different tax implications for regular mortgages and reverse mortgages?
A. Reverse mortgages are treated similarly to regular mortgages. Interest on reverse mortgages is classified as qualified residence interest, is deductible, and is subject to limitations from adjusted gross income. The interest is only deductible when it is paid. For a reverse mortgage the interest is usually paid when the loan is repaid at the time of death or when the borrower leaves the residence. Loan proceeds used to pay accrued interest or points on the same loan are not deductible until the loan is repaid.
13. The differences between a tax-qualified and non-tax-qualified policy are?
A. A tax-qualified policy typically displays the following features:
• Premiums are treated as an annual medical expense for deduction purposes against your income.
• Benefits from the policy are not treated as income from a tax perspective.
• Federal guidelines define an inability to perform 2 of 6 ADL’s as the benefit triggers.
• “Medical Necessity” cannot be used as a “Benefit Trigger.”
• Your disability must be of duration of at least 90 days.
• Cognitive impairment must require supervision.
• The policy is guaranteed renewable.
• The policy does not have a cash surrender value.
A non-tax qualified typically displays these features:
• Premiums are not deductible in any fashion.
• While the tax treatment is unclear, it is possible benefits may be treated as income from a tax perspective during a claim period.
• These polices have benefit triggers other than an inability to perform 2 0f 6 ADL’s.
• A “Medical Necessity” can be offered as a “Benefit Trigger.”
• A policy is not required to have an expectation that the disability will be of 90-day duration.
• Cognitive impairments do not require substantial supervision.
• The policy may have a cash surrender value.
14. Will the premium charges associated with the long-term care insurance, that are channeled and distributed from the cash value of a life insurance or annuity contract, be treated as taxable distributions?
A. No, the premium charges associated with the long-term care insurance, that are channeled and distributed from the cash value of a life insurance or annuity contract, will not be treated as taxable distributions from the insurance or annuity contract. However, distributions excluded from income that are used to cover the cost of long-term care insurance will reduce the owner’s investment in the contract (but not below zero) when determining gain on future taxable distributions.
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