Taxation of Long-Term Care Insurance

Today, medical science allows people to live longer, meaningful, independent lives; however, it is still likely that elderly individuals will become ill and need care. Long-term care (LTC) is a topic often avoided, but for many individuals it will prove to be one of the most significant issues they will have to deal with during their lifetime. Discussing LTC insurance should be a priority for all professional advisers in order to help protect the best interests of their clients and families as they enter the "golden years" of their lives.

Qualified LTC Insurance Policy

Qualified LTC insurance policies are allowed special tax treatment. However, an LTC policy can cover only qualified long-term care services (defined below). Under Sec. 7702B(b), the contract must:

• In general not pay for or reimburse expenses incurred for services or items if the expenses are reimbursable under Medicare;
• Be guaranteed renewable;
• Not provide for a cash surrender value or all refunds of premiums, and all policyholder dividends under the contract must be applied as a reduction in future premiums or to increase future benefits; and
• Include certain consumer protection clauses.

Under Sec. 7702B(g), an LTC policy is considered to meet the consumer protection requirements if it includes provisions relating to:

1. National Association of Insurance Commissioners model regulations, including:
   • Guaranteed renewal or noncancellability;
   • Prohibitions on limitations and exclusions;
   • Extension of benefits;
   • Continuation or conversion of coverage;
   • Discontinuance and replacement of policies;
   • Unintentional lapse;
   • Disclosure;
   • Prohibitions against post-claim underwriting;
   • Minimum standards;
   • Offers of inflation protection; and
   • Prohibition of preexisting conditions and probationary periods in replacement policies or certificates.
2. Disclosure requirements under Sec. 4980C, including those related to:
   • Application forms and replacement coverage;
   • Reporting requirements;
   • Filing requirements and standards for marketing;
   • Appropriateness of recommended purchase;
   • Standard format of coverage;
   • Requirements to deliver a shopper's guide;
   • Right to return;
   • Requirements for certificates under group plans;
   • Policy summaries;
   • Monthly reports on accelerated death benefits;
   • Incontestability period; and
   • Policy disclosures in the outline of coverage that the policy is intended to be a qualified LTC insurance contract under Sec. 7702B.
3. Nonforfeiture requirements, including (Sec. 7702B(g)(4)):
4. The nonforfeiture provision shall be appropriately captioned;
5. The nonforfeiture provision shall provide for a benefit in the event of a default in the payment of any premiums;
6. The amount of the benefit may be adjusted only to reflect certain factors subsequent to the policy being initially granted; and
7. The nonforfeiture provision shall provide at least one of the following: (1) reduced paid-up insurance, (2) extended term insurance, (3) a shortened benefit period, or (4) other similar offerings approved by the appropriate state regulatory agency.

Qualified Long-Term Care Services

An individual must receive qualified LTC services before filing claims under a qualified LTC policy. Qualified LTC services are defined as necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services that are required by a chronically ill individual and are provided under a plan of care prescribed by a licensed health care practitioner (Sec. 7702B(c)(1)).

The term "chronically ill individual" means any individual who has been certified by a licensed health care practitioner within the prior 12 months as (Sec. 7702B(c)(2)):

1. Being unable to perform (without substantial assistance from another individual) at least two activities of daily living for a period of at least 90 days due to a loss of functional capacity (activities of daily living include eating, toileting, transferring, bathing, dressing, and continence). A qualified LTC insurance contract must take into account at least five such activities in determining whether an individual is chronically ill.
2. Requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.

Taxation of LTC Insurance

Eligible premiums paid for LTC insurance are deductible as medical expenses for individuals subject to the 7.5% adjusted gross income limitation (Sec. 213(d)). For 2008, deductible amounts for eligible premiums based on age are as follows (Rev. Proc. 2007-66):
 

Age before close of tax year	2008 limitation
≤40	$    310
41–50	580
51–60	1,150
61–70	3,080
>70	3,850

Amounts reimbursed under an LTC policy for actual costs incurred are excludible from income. Amounts received under a per diem type policy are not included in income unless the amounts received during the year exceed the greater of (1) actual costs incurred or (2) $270 per day (indexed for 2008) (Sec. 7702B(d); Rev. Proc. 2007-66).

The Future

According to data compiled by the U.S. Department of Health and Human Services National Clearinghouse for Long- Term Care Information, on average an individual who is 65 years old today will require three years of long-term care during his or her life (www.longtermcare.gov/LTC/Main_Site/Understanding_Long_Term_Care/Basics/Basics.aspx). The Department of Health and Human Services also estimates that the cost of a private room in a nursing home is approximately $76,000 a year, while an assisted living facility costs approximately $36,000 (www.longtermcare.gov/LTC/Main_Site/Paying_LTC/Costs_Of_Care/Costs_Of_Care.aspx). Although state-funded programs are available, many will require the individual to liquidate assets (subject to specific state laws) before becoming eligible for state funding assistance. Not all nursing homes and assisted living facilities accept the limited funding provided by state programs, which may cause an individual to be admitted to a facility based on finances instead of personal choice. LTC insurance can help individuals retain their independence and comfort and allow them to live out their lives with dignity and respect. 

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EditorNotes

Michael Koppel is with Gray, Gray & Gray, LLP, in Westwood, MA.

The Tax Adviser would like to acknowledge the special contribution to the December Tax Clinic of Singer Lewak LLP; Mark G. Cook, tax partner in the Irvine, CA, office; and Steve Cupingood, the partner in charge of that firm's tax practice.

For additional information about these items, contact Mr. Koppel at (781) 407-0300 or mkoppel@gggcpas.com.