Tax questions about long-term care insurance seem to be developing almost as briskly as LTC products themselves. Following are a few examples.
LTC Riders: In 1996, Congress did answer key questions regarding the tax treatment of LTC riders (such as the excludability of benefits). Still, a number of issues remain open.
For example: Where the cost of a LTC rider is paid through charges (explicit or implicit) assessed against the cash value of the related life insurance contract, should such charges be treated as taxable distributions from the life contract?
The tax law treats an LTC rider as a contract separate from the life contract. Thus, it seems that cash value taken from the life contract to fund the LTC rider should be treated as a distribution.
Other tax rules–regarding the effect of LTC rider charges on life insurance tax-qualification and the deductibility of LTC insurance charges–also seem to support this conclusion. However, this view is not universally accepted in the industry. On the other hand, it does not appear that policyholders have been significantly troubled by tax reporting of such charges.
Another LTC rider question is: How should payment of LTC insurance benefits be taken into account under the tax rules applicable to the related life contract–particularly under Internal Revenue Code section 7702 (defining a “life insurance contract”) and section 7702A (defining a “modified endowment contract”)?
The insurance industry and individual insurers have requested guidance from the Internal Revenue Service and Treasury Department on these issues. In the absence of guidance, companies have adopted a variety of approaches. Given the various reasonable interpretations of existing law, these issues have not been a serious impediment to development of the LTC rider market.
Self-employed versus individual premium deductions: A self-employed individual may deduct a percentage (60% for 2001) of the “eligible” LTC premiums he or she pays. But may such an individual “double-dip”–i.e., take this self-employed deduction, and then take as an itemized deduction the unused portion (40% for 2001) of eligible LTC premiums?
The instructions for IRS Form 1040, Schedule A Itemized Deductions, clarify that the unused portion can be taken as an itemized deduction. To take advantage of this, an individual will need to be in the rare position where he or she can take an itemized deduction for medical expenses, i.e., all medical expenses (not including the self-employed deduction) exceeding 7.5% of the taxpayers adjusted gross income.
If this is the case, a further question is whether a taxpayer would be better off taking the full eligible LTC premiums as an itemized deduction rather than using the self-employed insurance deduction. Once the self-employed deduction is phased-up to 100% (in 2003), this would not be best, given the 7.5% AGI limitation and that itemized deductions are subject to overall reductions for high-income individuals.
Estate planning: In addition to a $10,000 amount (adjusted for inflation), a “qualified transfer” may be made without gift tax being imposed. Such a transfer is a payment to one “who provides medical care (as defined in section 213[d])” with respect to the donee. Some have asked whether LTC premiums may qualify under this rule.
To come within this rule, an insurer would need to be considered a “provider” of medical care. Also, only “eligible” LTC premiumsi.e., the age-based premium limits in section 213(d)(10)could qualify. No guidance has clarified this issue to date.
Use of LTC insurance as executive compensation and with qualified retirement plans: Various questions arise in this area. For example, may the employer deduct the premium if a single premium or 10-pay contract is involved?
Also, may employees be given a choice between receiving the LTC compensation benefit or additional compensation? (On this, the answer is nobecause if it were done, the additional comp would be constructively received and taxable, and the normal exclusion from income applicable to employer-paid premiums for health insurance would not apply. Under present law, LTC insurance cannot be used in connection with a cafeteria plan to prevent this result.)
Another question: May qualified LTC insurance be used in connection with qualified retirement plans? This area is fraught with uncertainty, and considerable care should be taken before using an LTC product in this manner.
One issue, for example, is whether qualified plan monies used to pay LTC premiums would be treated as distributed from the plan. The degree of risk involved may depend on the structure adopted. If the money were treated as distributions, this could raise other more serious concerns, e.g., whether distribution restrictions applicable to certain types of qualified retirement plans (such as section 401[k] and 403[b] plans) have been violated. Other considerations would include requirements relating to incidental benefits and nondiscrimination.
Policymakers are increasingly recognizing the importance of LTC products as a means of planning for the financial burdens of advancing age. Thus, while some of the above questions may remain unresolved for a while, it seems likely that guidance that is reasonable and favorable to the products will come in time in many areas.
Craig Springfield is a partner, and John Spina an associate, with Davis & Harman, LLP, a Washington, D.C., law firm. They may be reached at firstname.lastname@example.org and email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, September 10, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.