10
Leimberg’s
Think About It
Think About It is written by
Stephan R. Leimberg, JD, CLU
and co-authored by Linas Sudzius
DECEMBER 2009 # 406
LONG TERM CARE INSURANCE:
THE BEST EMPLOYEE BENEFIT?
Introduction
Financial professionals working with closely-held business owners are on a constant search for tax leverage with regard to fringe benefits for the owners and their employees.
Pension plans create income tax deductions for the business, and allow employees to exclude contributions from their taxable income. However, the employer must include all eligible employees in the plan, and retirement benefits are generally taxable to the participants.
Nonqualified arrangements that might include life insurance can generally be more selective in terms of participation, but the income tax results are generally not as favorable—especially for the business owners.
Disability income insurance coverage provided by the business can also be selective, and the premium can be deductible. However, the owner-employee with disability income coverage must generally choose between excluding the premium from income or getting a tax-free benefit in the event of a claim.
Could the best employee benefit be long term care insurance?
Long term care insurance coverage (LTCi) has been available for insureds for more than 40 years. LTCi was originally designed to cover the costs associated with confinement in a nursing home. Most policies now provide benefits in situations where an individual needs special care at home or in another specialized non-hospital residence.
Individuals who receive LTCi benefits are generally not sick, but are usually either suffering from a disabling mental impairment, such as dementia, or they are unable to perform the at least two of the basicactivities of daily living(ADLs). The ADLs are dressing, bathing, eating, toileting, keeping continent, moving from one place to another and walking.
LTCi was developed to provide money to individuals for situations not covered bytraditional health insurance,or by government programs such as Medicare or Medicaid.
Medicare pays only for medically necessary skilled nursing facility or home health care, and then only in limited circumstances for a limited duration. Medicare does not pay for custodial care. Custodial care is the type of service that provides non-professional assistance for everyday activities, such as ADLs.
Medicaid is a government program that does pay for custodial care. However, its benefits are available only to those who have very limited assets and income.
In order to encourage businesses to provide LTCi to employees, the federal government has created a number of tax and administrative incentives. Those closely-held business employers who are looking for a tax-favored, high-value benefit to implement for key employees should consider LTCi.
Basic Types of Individual Long Term Care Insurance
Long term care coverage is generally available as group insurance. It is also possible to buy as part of an individual life policy or annuity policy. For the purpose of the discussion of long term care insurance’s advantages in the employment context, we will discuss only individual LTCi.
Indemnity or Expense Incurred Coverage
From a benefits perspective, two main types of individual LTCi policies are available; indemnity or expense incurred policies.
An indemnity policy, sometimes referred to as a per diem policy, pays a fixed dollar benefit regardless of actual long term care expenses incurred. An expense-incurred policy reimburses expenses for long-term care services received, up to a maximum dollar amount per day, week, or month.
Nearly all policies also impose a lifetime maximum on the amount of benefits that the insured can receive.
The insured usually can purchase a choice of daily benefit amounts ranging from $50 to more than $300 per day for nursing home coverage. For those on claim while staying at home, the daily benefit for the policy may be less than for nursing home care.
Individual policies may offer a variety of riders, including inflation adjustments for benefits, return of premium, shared benefits between spouses and waiver of premium.
Tax-Qualified Policies
All individual LTCi policiesare either tax-qualified or non-tax-qualified. The requirements for a policy to be tax-qualified were originally defined by the Health Insurance Portability and Accountability Act (HIPAA) in 1996.
Most LTCi policies issued prior to 1997 are tax-qualified. Those issued in 1997 or later must meet certain requirements for tax-qualified status.
Among other requirements, a tax-qualified plan must cover only qualified long term care services. Qualified services are those generally given by long term care providers to chronically ill individuals, and must be given according to a plan of care prescribed by a licensed health care practitioner.
A policy may still be considered to be tax-qualified if it pays an indemnity benefit to a chronically ill insured.
An insured must be chronically ill in order to qualify for benefits under a tax-qualified policy. An insured is considered chronically ill if unable to perform at least two ADLs, or if the insured needs supervision to protect health and safety because of a cognitive impairment.
A non-tax-qualified plan is one that does not meet the requirements of a tax-qualified LTCi policy. One common difference is that non-tax-qualified plans may have a more liberal qualification trigger for payment of benefits than tax-qualified plans.
For the purpose of this newsletter, we will assume that we are dealing with tax-qualified LTCi policies for the purpose of the discussion that follows. For non-tax-qualified policies, the favorable tax treatment of benefits and deduction for premiums—especially for individuals or the self-employed—may be unavailable.
Tax Advantages of LTCi for Individuals
There are two main potential advantages of LTCi for the insured policyowner:
1. The long term care benefit is income tax free when paid.
2. The premium paid for LTCi is potentially income tax deductible.
Tax Free Benefits
The maximum tax-free benefit payable under a tax-qualified LTC policy in 2009 is the greater of
· $280 per day, or
· actual amounts paid for qualified long term care services.
Qualified long term care services are the necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are:
1. Required by a chronically ill individual, and
2. Provided pursuant to a plan of care prescribed by a licensed health care practitioner.
Deductible Premium
Not every taxpayer will be able to deduct the premiums for LTCi. The premiums are considered to be a medical expense, and are only currently deductible by those taxpayers who itemize. Further, the medical expense deduction is only available to the extent that total medical expenses exceed 7.5% of the taxpayer’s adjusted gross income (AGI).
To make deductibility even more problematic, the amount of premium that is potentially deductible is limited to the lesser of the actual amount paid, or the LTCi age-based table amount, shown on the following chart:
Attained Age Before the Close of the Taxable Year / 200940 or younger / $320
Older than 40 but not more than 50 / $600
Older than 50 but not more than 60 / $1,190
Older than 60 but not more than 70 / $3,180
Older than 70 / $3,980
Here’s an example with regard to premium deductibility. Say that Martha, age 64, is a single taxpayer who has $80,000 of adjusted gross income in 2009. She is paying $3,600 annually for her LTCi policy. Martha has $4,500 of other medical expenses, and she itemizes on her tax return.
Martha must first calculate the AGI threshold for her medical expense deduction. Multiplying $80,000 by 7.5% equals $6,000. Only those medical expenses in excess of $6,000 are deductible.
Martha is paying $3,600 a year for LTCi, but the chart amount for her age is only $3,180. She must use the smaller chart number. Adding her other medical expenses of $4,500 to her chart number of $3,180 yields a sum of $7,680. That exceeds the AGI threshold by $1,680—which is the amount of her medical expense deduction for 2009.
Thinking of it another way from Martha’s perspective—only $1,680 of her $3,600 LTCi premium is deductible.
LTCi For C Corporation Employers
While the tax advantages of LTCi for individuals may be limited, the tax and other advantages for business owners can be more attractive.
C corporation employers have the greatest number of potential advantages for implementing LTCi plans for their employees.
1. The premium is deductible by the corporation.
2. There is no practical limit to the amount of premium that can be paid by the employer’s for an employee’s policy.
3. The company can pick the employees to be covered by the plan.
4. The premium paid by the corporation is not included in the employee’s taxable income.
5. The benefits paid to the insured are tax free.
6. Spouse and dependent family members of participating employees may also be included under the plan.
Deductible Premium
LTCi premiums payable by a company are deductible as ordinary and necessary business expenses under Code Section 162.
No Practical Limit on the Amount of Premium
The amount of premium that a business contributes to LTCi on behalf of an employee is virtually unlimited—subject only to the idea that the employee’s overall compensation package is reasonable.
Participation Can Be Limited
Code Section 7702 B (a) (1) states that qualified LTCi policies are accident and health insurance contracts. LTCi plans provided by an employer are governed by the tax rules to which health insurance plans are subject.
Health plans provided by an employer through insurance coverage do not need to follow the nondiscrimination rules of Section 105(h) of the Code.
Code Sections 105 and 106 make reference to health plans sponsored by an employer. Treasury Regulations Section 1.105-5 provides
a plan may cover one or more employees, and there may be different plans for different employees or classes of employees. An accident or health plan may be insured or noninsured, and it is not necessary that the plan be in writing or that the employee's rights to benefits under the plan be enforceable.
Case law supports creating a class of participating employees so long as the participation requirement is something other than stock ownership. For example, the LTCi plan might include only officers of the company, even if the only company officers are also the company stockholders.
To comply with the regulations, and to meet the welfare benefit plan requirements of ERISA, it is recommended that the sponsoring employer have a written document describing the scope of the LTCi plan, the classification of employees covered and the manner of coverage.
LTCi Premium is Excluded from the Employee’s Income
Code Section 106 says that the premiums paid by an employer to a health plan are not included in the employee’s taxable income.
Family Members Can Be Included
Section 105(b) of the Code allows employers to include spouses and income-tax dependents of participating employees within the scope of a health plan. Since LTCi plans are health plans for the purpose of Section 105(b), that means that the spouse or income-tax dependents of a participating employee can also be included in the LTCi plan so long as the employer permits.
Benefits are Tax Free
Section 105(a) states that most benefits received by an employee through accident or health insurance for personal injuries or sickness are included in gross income if the contributions by the employer were not included in the employee’s gross income. This rule is the one that makes disability income benefits taxable if the premiums are paid for by the employer and not included in the employee’s income.
Section 105(b), however, provides that an employee does not have to include in taxable income most payments received for medical care, as defined in Code Section 213(d). Section 213(d) says benefits paid under a tax-qualified LTCi contract are payments for medical care.
Thus, benefits received by an employee under a LTCi contract, even where the employer pays the premium, are excluded from income.
LTCi For S Corporations, Partnerships and Proprietors
When an S corporation, partnership or sole proprietor (self-employed entity) implements an LTCi plan for a non-owner, the advantages are exactly the same as they are for a C corporation. However, where the self-employed entity covers an employee that also owns 2% or more of the business, the federal income tax results change slightly.
The business can still provide an owner-employee a selective LTCi benefit that can include spouse and dependents, with the benefits being tax-free. However, the tax treatment of the employer’s premium contribution differs.
Those owning more than 2% of self-employed entities are considered to be self-employed for the purpose of health insurance tax rules. Traditionally, the amount of health insurance premium that could be excluded from the income of a self-employed person was limited.
Since 2003, self-employed individuals can exclude 100% of most business-paid health insurance premiums from taxable income. The amount of LTCi premium that can be excluded from income for self-employed taxpayers is limited to the age-based LTCi table amount. See Revenue Code Section 162 (l)(2)(c). The amounts paid for health insurance premiums for the self-employed are also subject to self-employment taxes—unlike the premiums paid for non-owner employees.
How does the calculation of taxable income work for a self-employed individual?
Say that Phil, age 58, is a sole proprietor whose business has potentially taxable earnings in 2009, prior to consideration LTCi premiums, of $100,000. Phil’s business is paying an annual premium of $1,800 for Phil’s tax-qualified LTCi policy.
According to the age-based LTCi table, the maximum premium Phil can exclude from his business taxable income in 2009 is $1,190. So the business’s taxable income for federal income tax purposes would be $98,810, and his taxable income for self-employment tax purposes would be $100,000.
The Coming Changes to LTC Riders in 2010
Life and annuity companies have offered a variety of long term care riders to their policies in the past. Some riders have acted in the nature of an accelerated death benefit, and the issuing company did not charge separately for the rider. Other designs offered supplemental LTC benefits for an extra charge.
Where a life or annuity product offered a for-charge LTC rider, those riders were treated as non-qualified riders for tax purposes. That meant that any amounts used to pay the costs of the rider were considered to be taxable distributions from the life or annuity contract.