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.