In 1996, the Health Insurance Portability and Accountability Act (HIPAA) was signed into law. Besides improving the continuity of group health insurance for individuals moving from one employer to another, HIPAA addresses certain tax breaks for Long-Term Care (LTC) insurance premiums and benefits. Before HIPAA, it was uncertain whether LTC insurance would be treated as health insurance for purposes of tax laws already on the books — such as Internal Revenue Code (IRC) Sections 104, 105, 106, and 162. Generally, these IRC sections allow employers to deduct premiums paid for health and disability insurance; and employees to exclude these employer-provided benefits from their taxable incomes. HIPAA added IRC Section 7702B which provides that qualified LTC insurance contracts will be treated, for tax purposes, as accident and health insurance, subject to certain additional rules and limits.

Tax Laws and Long-Term Care Insurance

What defines a Qualified Long-Term Care Policy?

In order to be tax-qualified, the LTC policy must contain certain required provisions.¹ Many of these provisions pertain to the manner in which future benefit payments can be triggered. If the policy contains all of the required language, it can generally be considered a Qualified Long-Term Care (QLTC) insurance contract for tax purposes.

Following are a few of the most important new provisions an LTC policy must comply with in order to qualify for tax-favored treatment.²

• The policy must be guaranteed renewable.
• In order for benefits to be paid, there must be the expectation that the disability will be long-term.
• The individual must be certified by a licensed health care practitioner within the last 12 months as "chronically ill."
• The certification must be based on one or both of the following events. First is the inability to perform, without human help, at least two of six Activities of Daily Living (ADLs) for at least 90 days. The ADLs are eating, toileting, transferring, bathing, dressing, and continence. The policy must use at least five of these to measure ADL dependency. Second is the need for substantial supervision due to severe cognitive impairment in order to protect the individual from threats to health and safety.
• Non-forfeiture benefits and benefit increase options (inflation protection) must be offered to the insured, but are not required as part of the policy.
• Benefits under a QLTC policy cannot duplicate Medicare benefits.

How the Laws Work

Tax Treatment for Businesses

If an employer contributes to the premium cost of QLTC insurance for eligible employees and dependents pursuant to a plan, the contributions will generally be excludable from the employee's income³ and generally deductible for the business.⁴

Corporations: The officers and owners of a C corporation may be employees, and therefore the corporation's contributions to the premium cost of QLTC policies for its employee-officers may be deductible by the corporation and not taxable to the employees if the contributions are made pursuant to an employee benefit plan. If the QLTC employee benefit plan is insured, it need not conform to any non-discrimination rules and may be available only to a select group of employees.⁵ But, the corporation must be able to show, if challenged by the IRS, that the plan covers owner-employees as employees and not as owners.⁶ QLTC coverage may not be included in a Section 125⁷ plan or a flexible spending account.⁸ This means that the employer may not use salary reduction dollars to pay its premium contribution and the employee's premium contribution, if any, must be paid with after-tax dollars. The QLTC plan may be offered to retired employees, eligible dependents of employees and retirees, including dependent parents, and surviving eligible dependents after an employee's death.⁹

Pass-through entities: The owners of businesses that are organized as sole-proprietorships, partnerships, or Sub-S corporations do not qualify for the same tax treatment for QLTC policies. Instead, limited deductions are available for these individuals under IRC Section 162(l). Eligible LTC premiums for self-employed individuals are the same as for individuals who itemize. For the tax year 2003, the percentage of premium paid for health insurance — including eligible Long-Term Care premiums — that can be deducted is 100%. While owners of pass-through entities are limited in the amount of QLTC premiums they may deduct for themselves as described in this paragraph, these entities may establish QLTC plans and deduct for their employees the full amount of premiums as described previously under "Corporations."¹⁰ An owner (or "owner/employee") is defined as an individual who owns 2% or more of the business.¹¹

Tax Treatment for Individuals Who Itemize

Taxpayers who itemize may, beginning with tax year 1997, deduct the cost of eligible LTC premiums as a medical expense on what we know of as Schedule A. Note: there is an age-based limit on the amount of premiums for purposes of this deduction, which may be less than the actual policy cost.¹² For 2004, at age 40 and under, it's $260 in premium; from ages 41-50, it's $490; for ages 51-60, it's $980; for ages 61-70, it's $2,600; and for those older than 70, the allowable premium is $3,250. The deductibility of premiums by self-employed individuals discussed above is also limited to eligible LTC premiums.¹³ The eligible long-term care premium limits are adjusted annually for inflation. When allowable medical expenses listed on Schedule A, including eligible LTC premiums, exceed 7.5% of the taxpayer's adjusted gross income, the excess over 7.5% is deductible.

Individuals who have other large medical expenses and a low adjusted gross income (AGI) may find that the premiums they pay for a QLTC policy result in some tax savings under the foregoing provisions.

¹ 26 IRC Section 7702B(b)
² 26 IRC Section 7702B(b)
³ 26 IRC Section 106(a)
⁴ 26 IRC Section 162(a)
⁵ 26 IRC Section 106
⁶ Larkin v. C.I.R., 394 F.2d 494 (C.A.1, 1968)
⁷ 26 IRC Section 125(f)
⁸ 26 IRC Section 106(c)
⁹ 26 IRC Section 105(b), 152(a)
¹⁰ 26 IRC Section 106(a), 162(a)
¹¹ 26 IRC Section 1372
¹² 26 IRC Section 213(c)(10)
¹³ 26 IRC Section 162(l)(1)(C)

New York Life's Long-Term Care Insurance policies are issued on policy form series ILTC-4300 and INH-4300 for tax-qualified and ILTC-4400 and INH-4400 for non tax-qualified policies (non tax-qualified is available in CA only). The policy form numbers vary by state and are identified with the two-letter state identifier and an edition number. Examples of the state versions of the policy form numbers are for Idaho ILTC-4300(ID)(0197) and INH-4300(ID)(0197) and for Pennsylvania ILTC-4300(PA)(0197) and INH-4300(PA)(0197). The INH-4300 series forms are not available in OR, RI, or VT.

This information is being presented to you by New York Life Insurance Company, 51 Madison Avenue, New York, NY 10010. It is intended to be accurate, but neither New York Life nor its agents are in the business of giving tax, legal, financial planning or estate planning advice. You should consult with your own tax, legal, accounting or financial planning professionals for advice on those topics relevant to your particular situation.

New York Life Insurance Company
51 Madison Ave., New York, NY 10010

New York Life Insurance Company
Long-Term Care
7501 N. Capital of Texas Hwy., Suite C-100
Austin, Texas 78731-1774

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