Long Term Care Insurance Premiums Tax Deductions

AT I&E, we make it our goal to stay up to date on the LTC marketplace to help our visitors and clients locate the best long term care insurance companies. We believe education is in large part the most important factor for anyone who is deciding on getting a long-term care insurance. Therefore, it is imperative that we provide the answers to our clients questions, which includes the following important topic:

Is Long Term Care Insurance Tax Deductible?

The U.S. congress introduced “tax qualified” long-term care insurance (“LTCI”) plans with the 1996 passage of the Health Insurance Portability and Accountability Act (“HIPAA”).

Since HIPAA’s enactment, LTCI plans – providing coverage for home care, assisted living, nursing homes, and similar long-term medical care – have become increasingly popular, due to both the aging population and the favorable tax treatment afforded to qualified plans.

To be considered “qualified,” the LTCI plan must meet certain requirements, though, practically speaking, the vast majority of long-term care plans on the market now are tax qualified.

However, to date, premiums for asset based long term care insurance policies, which are a hybrid long term care with life insurance or an annuity, are not tax deductible.

What are the requirements for a tax-qualified long-term care policy?

Among the potential long-term care insurance benefits is the ability to deduct your premiums if your plan is considered “tax-qualified”.

In general, a tax-qualified LTCI policy must comply with the regulations issued by the National Association of Insurance Commissioners (NAIC).(1)

The plan must be purchased for the taxpayer or the taxpayer’s spouse or dependents, including dependent parents.

To be tax-qualified, a policy must be guaranteed renewable (except for non-payment) and offer inflation adjustment and nonforfeiture protection, though the insured is free to reject either or both terms.(2)

Coverage is triggered under tax-qualified plans by either the severe cognitive impairment of the insured or the insured’s inability to perform at least two activities of daily living (eating, dressing, bathing, transferring, continence, toileting) for a period of at least 90 days.

The advantage of a tax-qualified plan over non-qualified coverage is that qualified plan premiums can be deducted, subject to certain limitations.

Although non-qualified plans do not receive favorable tax treatment, LTCI policies purchased prior to 1997 and approved by the applicable state insurance commissioner are “grandfathered in,” and therefore can be tax-qualified even if the plan does not precisely meet the current standards.

When are the premiums for a tax-qualified LTCI plan deductible?

For most people, when there is a tax incentive out there, it pays to pursue it if it makes sense for your situation. Anyone considering long-term care insurance costs would want to also determine if there are certain tax benefits to the plan to help reduce the overall cost of the plan.

Premium payments for tax-qualified LTCI policies are deductible as medical expenses under federal income tax rules (and in a few states), though the total amount of the deduction is subject to age-based caps.(3)

For most individual returns, the taxpayer must itemize his or her deductions in order to deduct the LTCI premiums. That is, the deduction is usually not available if the taxpayer claims the standard deduction.

Assuming the taxpayer itemizes, LTCI premiums will be deductible to the extent the premiums, when added to all other non-reimbursed medical expenses, exceed 7.5% of the taxpayer’s adjusted gross income (“AGI”).  The 7.5% threshold is scheduled to increase to 10.00% beginning with the 2019 tax year.(4)

As discussed below, self-employed taxpayers and certain business owners can deduct LTCI premiums “above-the-line” as a self-employed health insurance expense, and the deduction is therefore not subject to the income threshold.

Once the 7.5% threshold is reached, the total available deduction is capped according to the age of the insured, with the maximum deduction amounts adjusted annually for inflation.

For 2020, the LTCI premium deduction caps are:

• $430 for age 40 or below;
• $810 for ages 41 through 50;
• $1,630 for ages 51 through 60;
• $4,350 for ages 61 through 69; and
• $5,430 for insured’s over 70.

Attained Age Before Close of Year	2020	2019	2018
40 or Less	$430	$420	$420
More Than 40 But No More Than 50	$810	$790	$780
More Than 50 But No More Than 60	$1,630	$1,580	$1,560
More Than 60 But No More Than 70	$4,350	$4,220	$4,160
More Than 70	$5,430	$5,270	$5,200

Importantly, the insured’s age is measured as of the last day of the tax year.

As an example, let’s say a 59-year-old taxpayer purchases an LTCI policy with annual premiums of $3,000.  Our taxpayer will be able to deduct up to $1,560 (the maximum amount for the age bracket) of the premiums, but only to the extent the premiums, taken together with other medical expenses, exceed 7.5% of the taxpayer’s AGI.

So, if the taxpayer’s AGI is $50,000, and the taxpayer has other expenses totaling at least $3,750 (7.5% of AGI), the taxpayer can deduct the entire maximum amount of $1,560.

On the other hand, if the taxpayer’s other medical expenses only total $500, the premiums added to other expenses will only amount to $3,500, which is less than 7.5% of the taxpayer’s AGI, and the taxpayer would therefore be unable to claim the LTCI premium deduction.

As this example illustrates, deductions for LTCI premiums depend considerably on both the taxpayer’s income and other medical expenses.  As a result, the actual deduction available can vary from year to year, even if the taxpayer remains within the same age bracket.

What if long-term care insurance premiums are paid by an employer?

For tax purposes, LTCI premiums paid by an employer receive the most favorable treatment.  On the business’s end, the premiums paid by the employer as compensation to the employee are deductible as a business expense.

Even more, the employer’s cost of the premiums for a tax-qualified plan are treated as reimbursement for employee medical expenses and are therefore not considered as income to the employee.

So, the employee is not taxed on the premiums either.  If the premium costs are shared by the employer and employee, the employer’s portion will not be taxable to either party, but the portion paid by the employee will be subject to the 7.5% AGI threshold and age-based caps discussed above.

Are long-term care insurance premiums paid by a business tax-free if the employee owns the business?

For business-owners, paying LTCI premiums through a business is generally more advantageous than purchasing the policy individually, but the premiums might not be fully deductible as a business expense if the insured owns the business. The extent to which the premiums will be deductible depends in large part on how the business is structured.

Sole Proprietors

Sole proprietors can deduct as a business expense LTCI premiums paid by the business for its employees.  If the coverage is for the business-owner him or herself, the premiums can be deducted as a self-employed health insurance expense.(6)

The maximum deduction amount is still limited by the age-based caps, but, because self-employed health insurance is an “above-the-line” deduction (as opposed to the “below-the-line” deduction for medical expenses), the 7.5% income threshold won’t apply.

Thus, self-employed taxpayers may be able to deduct LTCI premiums in situations in which a traditionally employed taxpayer might not receive the deduction, or might receive a smaller deduction, due to the income threshold.

Partnerships and Co-owned LLC’s Taxed as Partnerships

A partnership, or an LLC taxed like a partnership, can deduct premiums for a partner’s LTCI coverage if the premiums are paid by the business.

However, the cost of the premiums is then treated as taxable income to the partner for whom the coverage was purchased.

As with a sole proprietor, the partner can deduct the LTCI premiums “above-the-line,” so the 7.5% threshold is inapplicable.

But, to receive this favorable treatment, the premiums must actually be paid by the business.

S Corporations

If the owner of an S Corp owns more than 2% of the business at any point in the tax year, the owner will be treated like a partner in a partnership for LTCI premium deduction purposes.

That is, if the premiums are paid by the business, they can be deducted by the entity as a business expense, but the cost constitutes taxable income to the insured business-owner, who may deduct the premiums subject to the age caps, but with the 7.5% threshold inapplicable.

If the insured business-owner owns less than 2% of the business, he or she is treated as an employee and therefore the premiums are a business expense for the business and not taxable income for the insured.

Keep in mind, though, the IRS’ family attribution rules apply to LTCI deductions, so shares owned by the insured’s spouse, children, grandchildren, and parents might increase the insured’s ownership interest in the business and affect whether he or she will be treated as an employee or owner.

C Corporations

If the business is a C Corp, as long as the shareholder is actually an employee of the business and the LTCI premium payments are reasonable compensation for the services rendered, the payments made on behalf of the shareholding employee are treated the same as with any other employee.

The important distinction is whether the benefit appears to be compensation to an employee rather than a dividend to a shareholder.  If the premium payments look more like a shareholder dividend, the payments will be taxable income to the insured shareholder.

For this reason, if a C Corp limits the class of employees for whom it pays LTCI premiums to shareholding employees, it risks losing the favorable tax treatment.

Can LTCI premiums be paid through an HSA?

Although the general rule is that HSA funds cannot be used to purchase health insurance, premiums for LTCI policies fall under a special exception and can therefore be paid from an HSA.(7)

If HSA funds are used, the total amount of premium payments from the HSA should be limited based upon the age-based caps.  An LTCI premium payment from an HSA that goes beyond the cap will be treated as a taxable withdrawal.

So, if total premium costs exceed the limit, the taxpayer should pay the excess from another source.

Notably, if LTCI premiums are paid through an HSA, the premiums cannot also be deducted as a medical expense.  This is because the contributions to the HSA were already pre-tax.

Are benefits from a tax-qualified LTCI policy taxable income?

For the most part, benefits received through a tax-qualified LTCI policy are not taxable as income to the beneficiary as long as the benefits were paid due to a triggering event – either the insured’s inability to perform two or more activities of daily living without assistance for at least 90 days or the insured’s severe cognitive impairment.  In either event, a licensed medical professional must provide a plan of care for the insured.

Qualified LTCI policies generally pay out in one of two ways.

“Per diem policies” pay a specified amount for each day that the insured requires long-term care.  Benefits received through per diem policies are not taxable except to the extent that the payment amount exceeds either the actual costs of the insured’s long-term care expenses or $360 per day, whichever is greater.  As with the age-based caps, the maximum per diem payment is adjusted for inflation from year to year.

LTCI policies can also pay benefits on a reimbursement basis so that the insured is paid for long-term care expenses at the actual cost of the care.  Because payments do not exceed the insured’s actual long-term care expenses, benefits paid under “reimbursement policies” are never taxable income – as long as the policy is tax-qualified.

For a deep dive on this subject see Maximizing Tax Deductions For Long-Term Care (LTC) Insurance by Michael Kitces