Tax Treatment of Long-Term Care
Insurance Policie Part III

The Taxation Treatment

“The IRS has been mute on how it will treat the taxation of non-tax-qualified, long-term care insurance policies, particularly the taxation of benefits. Congress is unsure about whether to force the IRS to make a ruling. Long-term care insurance companies have taken their usual conservative position of not giving tax advice when a tax issue is in doubt.

“The doubt here lies in two areas: the tax deductibility of premiums and the taxation of benefits. Let’s look at the premium issue first. New IRS forms only allow tax deductibility of tax-qualified long-term care insurance premiums.

“The IRS included instructions on deductions in Scheduled A, in its “Publication 502.” The IRS states that one “can deduct insurance premiums for qualified long-term care insurance contracts—-subject to additional limitations.” It also says that one can include “qualified long-term care insurance premiums up to listed amounts as medical expenses under “Form 1040, Scheduled A.”

“The IRS describes which expenses are not deducible, including insurance premiums for certain types of policies. The IRS infers that these premiums would not be listed as allowable deductions. It sounds to me like the premium issue has been resolved. Premiums for non-tax-qualified, long term care insurance policies are not an allowable deducible medical expense.

“What about the taxation of benefits of these policies? It seems to me that the insurance companies are doing the industry a disservice by not clarifying this issue. They claim that the issue is clouded because there are three options that the IRS could take:

  • Long-term care policies are like disability policies, so benefits would be treated like income and would be fully taxable.
  • Long-term care policies are unlike disability policies, so benefits would not be taxable.
  • Long-term care benefits would be taxable but would also qualify as a medical deduction under Form 1040 Schedule A, subject to the current floor of 7.5% of adjusted gross income.

“They claim that it is impossible to tell which of these three options will represent the ultimate ruling. Admittedly, laws have been interpreted in very weird ways, and in politics, anything can happen.

“By its silence, I believe that the IRS has already chosen the third option that long-term care benefits would be taxable, but would also qualify as a medical deduction under Form 1040 Scheduled A, subject to the current floor of 7.5% of adjusted gross income. The IRS has redesigned the current 1040 income tax froms to administer this option. The new Form 1099-LTC requires insurance companies to report all benefits paid in a calendar year to anyone. The form allows the insurance company and the taxpayer to indicate whether the income is from a “tax-qualified policy” and whether the patient is “chronically ill.” So, if the insurance company does not indicate that a policy is tax-qualified, the taxpayer has the option of not indicating the type of policy involved. But, the bottom line is that the income must be reported. “Publication 502” states, “Long-term care insurance contracts are generally treated as accident and health insurance contracts. Amounts you receive from them.generally are excludable from income as amounts received for personal injury or sickness.”

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