The tax treatment of long term care insurance differs somewhat from that afforded to individual/sole proprietors and partners in a partnership. Intuitively, it makes sense: I’ve never visited a corporation in a nursing home!
Long term care insurance is becoming increasingly popular as an employee benefit. Workers can see what is happening to their parents as they age, and awareness of the need to insure against the potential devastating costs of long term custodial care is growing. Some workers are finding out the hard way – through the decline of the health of their own parents as they age – that Medicare does not provide a significant long term care benefit. As the burden of caring for aging baby boomers grows, the awareness of the benefits of long term care should fuel the growth in popularity of these policies, both in the individual and group markets.
Meanwhile, employers, too, are gaining awareness of the value of this benefit. Offering long term care insurance to employees is increasingly seen as a valuable differentiator in the competition for talent in some circles. Currently, employers can offer long term care insurance to employees via voluntary payroll deduction, as part of a cafeteria benefit plan under Section 125, or, given enough employees and participation, as a standard employee benefit, possibly qualifying for simplified or guaranteed issue.
As a rule, a C corporation can deduct the full cost of all qualified long-term care insurance premiums paid as an ordinary business expense, just as they can with wages and health insurance premiums, per IRC Section 162(a). This includes extending coverage to employee family members as well. All premiums are tax deductible to the corporation.
What Defines a “Qualified” Long-Term Care Insurance Policy?
Under the Health Insurance Portability and Accountability Act (HIPAA), a qualified long term care insurance policy will include the following provisions:
Benefits triggered by the inability to perform at least two activities of daily living (ADL): bathing, dressing, eating, toileting, transferring, and continence
The presence of a substantial need for close supervision and assistance due to a severe cognitive impairment, such as Alzheimer’s disease or dementia.
A projected need of 90 days or more.
The policy must not duplicate benefits provided under Medicare.
The terms defining qualified long term care benefits are specifically outlined in IRC Section 7702(B), which establishes that qualified long term care insurance policies are entitled to the same tax treatment as health and accident insurance policies.
Executives and Discrimination Considerations
While business owners and HR specialists must rightly consider the effects of discrimination with regard to ERISA-qualified benefits, long term care insurance is not subject to the same “top hat” restrictions as, say, 401(k) plans. Although both long-term care and pension plans frequently carry the term “qualified,” the term means something very different in each case:
A “qualified” retirement plan is a plan that meets the criteria set forth for favorable tax treatment under the Employee Retirement Income Security Act of 1974, where the term “qualified,” when used with respect to long term care insurance, indicates that the policy meets the criteria for favorable tax treatment outlined in HIPAA. ‘
Because C corporations are independent entities for tax and legal purposes, the corporation can deduct benefits paid to executives just the same as benefits paid to rank and file employees.
In addition, the ERISA standards for non-discrimination do not apply to long term care programs, provided the employer can show that they have developed a “plan of insurance” that covers at least some employees besides owners and officers. A company could extend coverage to all salaried employees, or all manager-level employees, as opposed to covering every rank and file employee.
Employee-paid premiums for QLTC coverage, such as those collected through a voluntary payroll deduction plan, are considered taxable income and may not be included in a Section 1258 plan or a flexible spending account. This means that the employer may not use salary reduction dollars to pay its premium contribution. 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.
Taxability to Employees
Premiums paid on behalf of employees, likewise, are not taxed to those employees. They do not show up as wages or other income on the employee’s W-2. Long term care insurance benefits therefore receive a favorable tax treatment on par with medical insurance benefits, per HIPAA. However, long term care insurance premiums are generally not tax deductible to the employee. As such, they cannot generally be included in a Section 125 or flexible spending account. Employers cannot use dollars from salary reduction to pay long term care premiums.
Looked at another way, you cannot exclude contributions to the cost of long-term care insurance from an employee’s wages subject to federal income tax withholding if the coverage is provided through a flexible spending or similar arrangement. This is a benefit program that reimburses specified expenses up to a maximum amount that is reasonably available to the employee and is less than five times the total cost of the insurance. However, you can exclude these contributions from the employee’s wages subject to social security, Medicare, and federal unemployment (FUTA) taxes. (See IRS Publication 15-B, Employer’s Guide to Fringe Benefits, for more information).[u1]
Benefits to employees and other plan beneficiaries, on the other hand, are likewise tax-free, up to a per diem limit of $310 per day, as of 2012. Amounts paid to nursing facilities and other care providers on behalf of the beneficiary in excess of $310 per day are taxable as income. The $310 threshold is periodically adjusted for inflation.
Special Rules for certain S Corporation Shareholders
Do not treat a 2% shareholder of an S corporation as an employee of the corporation for this purpose. A 2% shareholder is someone who directly or indirectly owns (at any time during the year) more than 2% of the corporation’s stock or stock with more than 2% of the voting power. Treat a 2% shareholder as you would a partner in a partnership for fringe benefit purposes, but do not treat the benefit as a reduction in distributions to the 2% shareholder.