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 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 underutilized insurance product.
Tax Treatment of Premiums
The IRS treats long-term care insurance premiums as a medical expense – and allows you to deduct premiums paid, up to a certain amount depending on your age. For 2015, your allowable deductions are as follows:
Age 40 or less: $410
Over 40 but not more than 50: $770
Over 50 but not more than 60: $1,530
More than 60 but not more than 70: $4,090
Over 70: $5,110
You can deduct these amounts, or the premiums you actually paid, whichever is less. Your age is determined by the age you attained during the tax year 2017.
You can deduct these premiums to the extent your total medical expenses for the year exceed 10% of your adjusted gross income. Exception: If you are age 65 or older, you can deduct medical expenses to the extent they exceed 7.5% of your income, at least through tax year 2018.
The general rule is that employers are allowed to deduct the full amount of premiums paid to cover an employee as an “ordinary and necessary” employee compensation expense.
Specific tax rules for different kinds of business entities are set out below. Note that employers cannot include long-term care insurance as in a “cafeteria plan” under IRC Section 125(f).
If you own a business as a sole proprietor, you can deduct all premiums for long-term care insurance you pay on behalf of your employees as a business expense. You can also deduct 100% of your own premium (skipping the 10% threshold that normally applies to non-business owners), subject to the age and dollar amount limitations listed above.
Premiums paid by a partnership may be taxable to the partner, however, in that they do show up on the partner’s tax returns. But, the partner may take age-related deductions.
Long-term care insurance paid to cover S corporation shareholders owning 20% or more of the company is tax-deductible to the business. Shareholders include the premiums paid in their own gross income on their individual income tax returns.
For C corporations, employer-sponsored long-term care insurance is treated as an accident and health plan under IRC Section 105(b) and 106.
The IRS treats any premiums paid by the corporation on behalf of an owner/employee or shareholder/employee as an employee business expense, normally deductible, if the company can show that it is providing the coverage to the employee in his or her capacity as an employee.
Otherwise, the corporation cannot deduct the premium. Instead, the IRS will consider the premium to be a non-deductible dividend paid out to the shareholder. The shareholder must include this amount in gross income.
Partnerships and LLCs Electing Partnership Status
Partnerships buying long-term care coverage for partners are allowed to deduct any premiums that qualify as “guaranteed payments.” These include any compensation to partners that occurs regardless of partner income, by virtue of the partners’ services to the partnership. For more information on guaranteed payments under this provision, see IRC Section 707(c).
Employer-paid long-term care premiums are usually not taxable to the employee, except when the benefit is paid for within a flexible spending arrangement. In this case, the employee still includes premium in his or her gross income.
Tax treatment of benefits
Individually Owned Polices
If you have an individually owned policy for which you paid the premiums, rather than an employer, any benefits paid out by a qualified long-term care policy are tax-free, as long as any payments above $330 per day do not exceed the actual cost of care.
Generally, any amounts paid by qualified long-term care policies in benefits are considered reimbursements for health care, rather than income – provided they don’t pay out more than the cost of care if the total daily amount paid exceeds $330. Amounts in excess of the cost of care and above $330 per day in 2017 are taxable to the employee.