The Combo-Concept

Life/LTCi Combos a Powerful Employer-Provided Benefit

How HIPAA opened the door for tax-qualified Long Term Care

by David A. Gresham, JD

Mr. Gresham is advanced markets analysis manager with OneAmerica Financial Partners, in Indianapolis, In. Connect with him by e-mail: [email protected]

The Health Insurance Portability and Accountability Act of 1996 (HIPAA) set forth the requirements for tax-qualified Long Term Care (LTC) policies and provided that LTC insurance premiums qualified as “medical care” for income tax deduction purposes.

HIPAA also stated that life insurance and LTC benefits could be combined in one policy. If the provisions for payment of LTCi-benefits complies with the law, those benefits will be received income tax free. Additionally, if the policy pays no LTC benefits and the policy pays its life insurance death benefit on the insured’s death, then that benefit will be received income tax free.

The typical configuration of a life insurance LTC combination policy involves what is basically a prepayment of a permanent life insurance policy’s death benefit for qualified LTC claims. For example, a policy may provide that the maximum monthly LTC benefit is two percent of the policy’s death benefit.

Thus, if the policy had a $250,000 death benefit, the maximum monthly LTC benefit would be $5,000 per month for 50 months. Each payment of LTC benefits would correspondingly reduce the policy death benefit. If the full payment of $5,000 were to be paid for 50 months, the policy death benefit would likewise be exhausted.

Continuation of Benefit

An additional consideration in the analysis of combination policies is the ability to purchase Continuation of Benefit (COB) protection with these policies. COB coverage takes effect after the LTC benefit balance on the base policy has been exhausted. COB coverage will continue benefits for a predetermined period of time, and lifetime coverage is available. There is additional premium for this extended coverage and it is medically underwritten. Premiums are generally noncancelable and may be paid on a single premium, a 10-pay or an annual basis.

From the above example in which a combination policy was prepaying two percent of the death benefit each month over a period of fifty months: this insured may have concerns that coverage will be exhausted if he or she lives longer than fifty months while on claim. COB coverage will begin in month fifty-one when the base coverage runs out.

Depending on the type of employer and the nature of the relationship between the employer and employee, there may be substantial tax benefit through the provision of combination policies as an employment benefit. The following discussion assumes that benefits paid from LTC coverage in all cases are qualified under HIPPA. Also, the discussion assumes all premium is paid by the employer, and the policy is owned by the employee. Further, it is assumed that the employer, other than paying premium, has no interest in the policy.

Age-Related LTCi Deductions

For individually purchased policies, the LTC premium deduction is limited by an age-related table that sets a cap on the deduction. The table limits are adjusted annually for inflation, and the following table sets forth the deduction limits for 2016:

Age of insured                                                     Annual Premium Deduction Limit

Under 41                                                                                 $390

41 – 50                                                                                    $730

51 – 60                                                                                    $1,460

61 – 70                                                                                    $3,900

Over 70                                                                                   $4,870

Note that only COB or separate rider charges for LTC coverage are deductible as amounts paid for medical care. The tax treatment of the base life insurance premium is different.

Depending on the type of employer and the nature of the relationship between the employer and employee, there may be substantial tax benefit through the provision of combination policies as an employment benefit.

A sole proprietor can deduct his or her Long Term Care Insurance (LTCI) premiums up to the age-related cap. This is done as an adjustment to gross income on line 29 of IRS Form 1040. The portion of the premium in excess of the cap is not deductible as a medical expense. The 10 percent of AGI threshold for deductibility of medical expenses on an itemized individual return does not apply.

LTCI premiums paid by the sole proprietor for employees are deductible by the sole proprietor, and the deduction is not limited by the age-related cap. The LTCI premium is treated as a business expense for medical insurance premiums. Employees are not taxed on premiums paid by their employer for LTCI on the employee.*
The base life insurance premiums for policies insuring the sole proprietor are not deductible by the sole proprietor. The base life insurance policy premiums on policies insuring employees are deductible by the sole proprietor as compensation paid to the employee. The base life insurance policy premiums are reportable in income by the employee as compensation received.

Partners, LLC Members & S-Corps

LTCI premiums paid by partnerships, limited liability companies taxed as partnerships, and S corporations are deductible by the employer, and the deduction is not limited by the age-related cap. The LTCI premiums are treated as a business expense for medical insurance premiums. If the premium is for LTCI on a partner, this assumes the premium payment is “guaranteed” meaning the LTCI premium payment is not deducted from the partner’s draw from partnership profits.

For partners, LLC members and S corporation greater than 2% shareholder employees, the LTCI premium payment is treated as income from self-employment which is reported on Schedule K-1 for partners and LLC members, and on Form W-2 for greater than 2% shareholder employees. The owner employee can deduct his or her LTCI premiums up to the age-related cap. This is done as an adjustment to gross income on line 29 of IRS Form 1040. The portion of the premium in excess of the cap is not deductible as a medical expense. The 10 percent of AGI threshold for deductibility of medical expenses on an itemized individual return does not apply.

As with sole proprietorships, non-owning employees (not subject to family attribution under code section 318) are not taxed on premiums paid by their employer for LTCI on the employee.*

The base life insurance policy premiums on policies insuring employees are deductible by the employer as compensation paid to the employee and reportable in income by the employee as compensation received. This is Schedule K-1 self-employment income for partners and LLC members, and is Form W-2 income for non-owner employees and S corporation owner employees.

C-Corp Applications

LTCI premiums paid by C corporations are deductible by the employer, and the deduction is not limited by the age-related cap. The LTCI premium is treated as a business expense for medical insurance premiums. A C corporation may establish a plan under IRC section 105 to provide LTCI benefits only to a select group of employees. The plan should be in writing and approved by the corporation’s legal counsel. It should define which employees are eligible using reasonable classifications related to employment status such as compensation, job title or years of service.

The entire LTCI premium paid by a C corporation is excluded from the employee’s income. This exclusion applies to shareholder employees in C corporations and to non-owning employees.*

Therefore, C corporations which pay LTCI premiums through a valid IRC section 105 plan for employee coverage may deduct the premiums and are not limited by the age-related cap. Nor are C corporations limited by the 10 percent AGI floor. Such coverage is also not taxable to the employees. Hence, C corporation shareholder employees, where the corporation has retained earnings, may find asset-based LTCI policies with comprehensive COB coverage attractive. The COB premium is deductible to the corporation without limit, the COB premium is not taxable to the shareholder employee, and LTC benefit payments are income tax free.

The base life insurance policy premiums on policies insuring employees are deductible by the C corporation as compensation paid to the employee. The base life insurance premiums are reportable in income by the employee as compensation received. ◊

 

 

* The LTC coverage may be on the employee, the employee’s spouse, or a dependent of the employee for the exclusion from income to apply.