Taxation of Long Term Care Insurance

Qualified long-term-care insurance (LTCI) policies are entitled to special tax treatment. To be termed “qualified”, the policy must be guaranteed renewable and cannot have any cash value. A qualified policy requires that a person 1) be expected to require care for at least 90 days, and be unable to perform two or more activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) without substantial assistance; or 2) for at least 90 days, needs substantial assistance due to a severe cognitive impairment. Most policies sold these days are qualified policies, but make sure before you buy.

Benefits Are Usually Federal Income Tax Free

Benefits received under a qualified long-term-care policy are generally federal income tax free because they are considered insurance reimbursements for medical expenses. Amounts you receive from them generally are excludable from income. To claim an exclusion for payments made on a per diem or other periodic basis under a long-term care insurance contract, you must file Form 8853 with your return.

For 2010, this tax-free treatment automatically applies to benefits of up to $290 per day. Even if you receive benefits above the cap, they are still free from federal income tax as long as they don’t exceed your actual long-term-care costs.

Although uncommon, there are non-tax-qualified LTCI policies. These individual policies typically offer more generous benefits and use less restrictive guidelines to trigger them. Benefits from this kind of policy are usually taxable income.

If you collect long-term-care insurance benefits during the year, the total amount will be reported to you on Form 1099-LTC.

Deductibility of Premiums

Because a qualified long-term-care policy is considered health insurance for federal income tax purposes, the premiums are treated as medical expenses for itemized deduction purposes on your Schedule A. However, if your premiums exceed age-based caps, you can only count the capped amount as a medical expense. For 2010, the amount for each individual is $330 for a person under age 41, $620 for ages 41 through 50, $1,230 for ages 51 through 60, $3,290 for ages 61 through 70, and $4,110 for ages 71 and beyond. For example. If you are age 55, the maximum amount of LTCI premium you can deduct as a medical expense is $1,230.

The capped LTCI premium amount gets added to your other medical expenses such as health and dental insurance premiums, insurance co-payments, out-of-pocket prescription costs, and all your other unreimbursed medical expenses. If the total exceeds 7.5% of your adjusted gross income (AGI), you can write off the excess as an itemized medical expense deduction on Schedule A of Form 1040.
If you’re self-employed, you can generally deduct premiums for qualified long-term-care insurance on page 1 of Form 1040 whether you itemize or not. The age-based cap applies here, but the deduction is not subject to the 7.5% AGI limitation.

If the policy is provided by the employer, the premiums are deductible to the employer without regard to the cap and are not taxable to the employee. This applies to both individual and group policies.

Premiums paid for non-qualified long-term-care insurance are non-deductible personal expenses.

Health Savings Accounts

Premiums for qualified LTCI can be paid from a Health Savings Account.

Income Taxation of Premium Refunds

A premium refund to a beneficiary upon death of the insured not is not subject to income tax. A premium refund on complete surrender or cancellation of the LTCI contract is income to the extent any deduction was allowed for the premium payments.

Pennsylvania Income Tax Treatment>

In general, the benefits paid from a LTCI insurance policy are not subject to Pennsylvania Personal Income Tax. The taxpayer receives the contract benefit that the taxpayer paid for by paying the premiums. These benefits are not taxable under Pennsylvania Personal Income Tax law.