The Basics of the Tax Treatment of Long-Term Care Insurance
By Craig Springfield, Alison Peak and Prasanthi Goda
Long-Term Care News, April 2024
This article provides an overview of the federal income tax treatment of long-term care (LTC) insurance, focusing on qualified long-term care insurance (QLTCI) and combination contracts.
HIPAA’s Tax Clarifications
Before the enactment of the Health Insurance Portability and Accountability Act of 1996 (HIPAA),[1] there was considerable uncertainty regarding the federal income tax treatment of LTC insurance for the treatment of both insurance benefits and premiums. This uncertainty existed because LTC insurance typically covers medical costs (which may qualify for favorable tax treatment) but also other costs such as room and board that are personal in nature (and generally would not receive favorable tax treatment).
In this regard, section 104(a)(3)[2] generally excludes from gross income amounts received through accident or health insurance for personal injuries or sickness. Also, section 213 generally allows a deduction for medical expenses if the taxpayer itemizes deductions and to the extent medical expenses exceed 7.5% of adjusted gross income. Under section 162(l), self-employed individuals generally can deduct medical expenses without these limitations. Sections 105 and 106 generally provide similar favorable tax treatment for employer-purchased accident and health coverage. What was unclear pre-HIPAA, however, was whether LTC insurance should be treated like other typical health coverage under these Code provisions.
Congress largely resolved this uncertainty through the enactment of section 7702B as part of HIPAA. This provision defines “qualified long-term care insurance contract” and generally provides for federal tax purposes that:
- such contracts are treated as accident and health insurance, and any plan of an employer providing such coverage is treated as an accident and health plan with respect to such coverage;[3]
- insurance benefits received are treated as received for personal injuries and sickness and as reimbursements for expenses actually incurred for medical care;[4] and
- premiums are treated as payments for insurance coverage of medical care.[5]
As a result, QLTCI is generally taxed just like other health insurance, both for premiums and benefits. One exception is that premiums can be deducted only to the extent of “eligible long-term care premiums,” which vary based on the age of the insured and are indexed for inflation.[6] Also, nonreimbursement QLTCI insurance benefits are excludable from income only to the extent of a “per diem limitation,” which is indexed for inflation; for 2024, this amount is $410 per day or the equivalent in the case of payments on another basis, such as $149,650 annually, subject to certain adjustments.[7] Further, employer-paid premiums are generally excludable from the employee’s income under section 106, and QLTCI benefits are generally excludable from income under section 105(b). QLTCI cannot be offered, however, under a cafeteria plan where an employee has a choice between receiving QLTCI coverage or cash compensation or other benefits. HIPAA’s tax clarifications did not address the federal tax treatment of other LTC insurance contracts.
Qualification Requirements
In defining QLTCI, Congress had two goals: first, to protect federal Treasury revenues, and second, to protect consumers. Rules to accomplish the former goal generally limit the investment orientation of QLTCI. For example, such contracts can cover only qualified long-term care services that are “necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services” required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed health care practitioner.[8] For this purpose, a “chronically ill individual” is an individual who has been certified by a licensed health care practitioner within the prior 12 months as either (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, or (2) requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.[9]
Limiting the permissible insurance coverage ensures that beneficial tax treatment applies only where insureds have reached a minimum threshold of impairment. QLTCI contracts also may not provide any cash value and cannot be borrowed against,[10] generally cannot cover expenses covered by Medicare,[11] and must apply any premium refunds and dividends to reduce future premiums or increase future benefits.[12] It is permissible, however, to provide a refund upon full termination of a contract, such as upon the insured’s death.[13] Because of these restrictions, QLTCI cannot provide any insurance benefit prior to certification of the insured’s chronic illness. This raises a question regarding the degree to which insurers may undertake certain actions earlier, such as for risk mitigation.[14]
Most QLTCI consumer protections are imposed by reference to certain rules of the National Association of Insurance Commissioners’ (NAIC’s) Long-Term Care Insurance Model Act and Regulation, as adopted as of January 1993.[15] Some are qualification requirements,[16] whereas others are enforced through a tax penalty.[17] These requirements address topics such as guaranteed renewability, inflation protection, restrictions on preexisting conditions and restrictions on limitations or exclusions from coverage. Also, Treasury regulations generally (but not always) defer to state interpretations of NAIC requirements.[18] In addition, QLTCI contracts generally must offer a nonforfeiture benefit, such as reduced paid-up coverage, that applies upon a default in any premium payment.[19] QLTCI also must state that it is intended to be QLTCI.[20]
Combination Products
HIPAA also clarified the tax treatment of life insurance–QLTCI combination products, generally providing QLTCI riders with the same tax treatment of benefits as for stand-alone QLTCI.[21] (The Pension Protection Act of 2006 extends similar tax clarifications to non-qualified annuity–QLTCI contracts.[22]) Under these clarifications, the LTC portion of the contract (whether qualified or nonqualified) is treated as a separate contract for federal tax purposes.[23] This treatment allows the LTC portion of the contract to satisfy the qualification rules for QLTCI by disregarding the underlying life insurance contract. Thus, for example, the insurance coverage and cash values under the life insurance portion of the contract will not disqualify the LTC portion of the contract. The separate contract rule generally does not extend to qualified arrangements.
Congress also enacted section 101(g) as part of HIPAA, which excludes chronic and terminal illness accelerated death benefits under life insurance contracts from gross income, subject to the per diem limitation for chronic illness benefits. These rules are similar in some respects to those in section 7702B, for example, the same definition of “chronically ill individual” applies.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.
Craig Springfield, JD, LLM, is a partner at Davis & Harman LLP. Craig can be reached at crspringfield@davis-harman.com.
Alison Peak, JD, LLM, is a partner at Davis & Harman LLP. Alison can be reached at arpeak@davis-harman.com.
Prasanthi Goda, JD, LLM, is an associate at Davis & Harman LLP. Prasanthi can be reached at pspgoda@davis-harman.com.