Looking ahead over the next few decades, the United States has a severe fiscal problem coming down the pike. The oldest of the baby boomers are just now hitting their retirement years. This is a massive chunk of the population that is shortly to qualify for Medicare, and will increasingly be requiring long term care and nursing home services. This population is vastly under insured for this eventuality, and much of the financial burden is going to fall on individuals, family members, and ultimately the Medicaid system.
The problem: The Treasury is already mired in red ink. Congress does not have the resources to pay for this care, without a substantial hike in tax revenues, or draconian cuts elsewhere in the budget.
Both the federal and state governments would like to get out of the business of funding long term care as much as possible, except for the truly indigent. With that in mind, they have come up with a number of tax incentives, encouraging individuals and small business owners alike to purchase their own private long term care insurance coverage.
Individuals
If you are an individual wage earner and you buy your own long term care insurance, or if you are sole proprietor, you may be able to discount part of your long term care insurance premiums. This is a much more favorable tax treatment than life insurance and other forms of coverage enjoy, since life insurance premiums are normally not deductible to the individual. However, the IRS allows you to deduct long term care premiums as a medical expense. You can therefore deduct long term care to the extent your premiums exceed 7.5 percent of your adjusted gross income, as calculated on your IRS Form 1040.
Note that to claim this deduction, you must use the long 1040 form. You cannot take advantage of this deduction if you
Congress is wary of planners using “Cadillac” plans as an income tax shelter, and therefore has set limits on how much long term care insurance premium you can claim as a deduction. The amount of premium you can deduct varies with your age, and applies to tax-qualified long term care insurance plans.
The criteria for a tax-qualified plan are as follows:
- The policy must be guaranteed renewable,
- The policy must provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed,
- The policy must provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract must be used only to reduce future premiums or increase future benefits.
- Generally a tax-qualified policy not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer, or the contract makes per diem or other periodic payments without regard to expenses.
The annual limits on deductibility are as follows:
Taxpayer’s Age (At End of Tax Year) – Deductible Limit | ||
| 40 or less | $ 350 | |
| More than 40 but not more than 50 | $ 660 | |
| More than 50 but not more than 60 | $1,310 | |
| More than 60 but not more than 70 | $3,500 | |
| More than 70 | $4,370 | |
| These limits are indexed to inflation, so they will potentially increase each year. | ||
Example:
Suppose a married couple, ages 53 and 50 buy long term care insurance. The family had other medical expenses that amounted to 7.5 percent of their annual income, so they are able to deduct the cost of their long term care premiums over and above their other medical expenses. The amount of long term care premiums the older spouse can deduct, exceeding 7.5 percent of AGI for the year is $1,310. His spouse can deduct up to $660. But next year, his wife will be age 51, and will fall into the next age category. They can both deduct the maximum amount for 2013 – $1,310 each, plus whatever the inflation adjustment will be.
Note: If you are subject to the alternative minimum tax, or AMT, your AGI threshold for medical expenses is 10 percent, rather than 7.5 percent. Furthermore, you may lose some of your other deductions. Consult a tax advisor for information specific to your individual situation.
Health Savings Account (HSA)
Long term care insurance interfaces well with health savings accounts: HSAs allow you to use tax-free dollars to pay your long term care premiums, up to the dollar limits shown above.
Taxation of benefits
Benefits paid to care providers on your behalf are tax-free to you. If you have an indemnity plan that pays you rather than the care providers, your benefits are tax free, up to a daily limit of $300 for 2011, and $310, for tax year 2012 – and then adjusted for inflation after that.
Considerations
The tax benefits of a long term care policy may not be readily apparent. The deductibility of long term care premiums becomes much more significant when combined with other health care expenses. Since these expenses tend to increase as we get older, a long term care policy that yields no deduction benefit this year may become much more valuable as you get older, and your other medical expenses increase.
Special Treatment for the Self-Employed
Self-employed individuals enjoy a specific tax break when it comes to long term care – they can deduct all their premiums paid for long term care, up to the limits in the table above, without having to exceed the 7.5 percent threshold.
Flexible Spending Account (FSA)
You cannot be reimbursed under an FSA for long term care insurance premiums.
Upcoming: Long Term Care Insurance Tax Considerations for Small Business Owners
For further reading: IRS Publication 502 – Medical and Dental Expenses
