Published on November 8, 2023 | 5 min read | LPL Financial
Kitty O’Neill Collings, an American politician and pioneer in the area of international diplomacy, civil liberties, and social justice, once quipped, “Aging seems to be the only available way to live a long life.” Along with aging comes the certainty that most of us will gradually begin to deteriorate over the years, both physically and mentally, and many of us potentially might require long-term care. Because of this reality, long-term care insurance (LTC) becomes an attractive option. The government won’t help pay for your long-term care bill. Knowing about long-term care insurance and how you can make those premiums work for you may make it easier to create a strategy in preparation for those retirement years. Here are five tax benefits of owning long-term care insurance.
The Internal Revenue Service (IRS) may treat your long-term care insurance benefits as tax-free based on your policy limits and how it is structured. If benefits are considered reimbursement, they are 100% tax-free. If they are indemnity or cash, they are tax-free up to a specified amount per diem (see below in the Tax Deductibility portion).
Under section 7702(b), long-term care insurance has attractive tax benefits. However, only qualified long-term care insurance policies are eligible. The maximum amount eligible for the deduction per person is based on an age-indexed schedule.
| Age at the end of the tax year | 2023 |
|---|---|
| 40 or younger | $480 |
| 41-50 | $890 |
| 51-60 | $1,790 |
| 61-70 | $4,770 |
| 71 and older | $5,960 |
Benefits paid are generally excluded from taxable income. However, some cash products that pay daily or monthly benefits not associated with actual bills are subject to a per diem limitation of $420 a day. Anything over that amount is subject to taxation unless there are bills to support the higher number.
Health Savings Accounts (HSA) are personal savings accounts where you can add pre-tax dollars to pay certain health care costs. If you have an HSA, you can pay your long-term care insurance premiums.
Due to the increasing inflation in 2022, the IRS increased contribution levels for 2023 to $3,850 for individual coverage or $7,750 for family coverage, up from $3,650 and $7,300 in 2022. For those age 55 and older, you are allowed an additional $1,000 contribution for ‘catch up.’
The IRS also includes a 2023 limit for Excepted Benefit Health Reimbursement Arrangements (EBHRAs) at a limit of $1,950, up from $1,800 in 2022.
However, you have to be aware that not all policies have tax incentives. Linked benefit or hybrid life insurance policies do not generally qualify for a possible tax benefit.
If your hybrid long-term care policy meets federal tax guidelines (IRC Section 7702(b)), a percentage of your long-term care premium may be deductible. Also, hybrid policy benefits, for example, long-term care, are tax-free. Not all insurance companies offer this type of product, so it is critical that you review your policy and strategy with a financial professional.
If you are self-employed, you can deduct 100% of your health insurance premiums, including long-term care insurance premiums, without meeting the 7.5% adjusted gross income (AGI) threshold. However, the deduction amount can’t exceed the net profit from your business. Below is a breakdown of how the different tax benefits can be accomplished.
S-corporation – The business should pay shareholder-employee premiums and add the total premium paid to W-2 compensation. This can ensure the individual’s plan is considered an employer plan for tax purposes. It gets more complicated when premiums are paid personally. To be deductible as an employer plan on the owner’s tax return, they must be reimbursed with a written agreement for the plan.
Partnerships – Premium payments through partnerships do not have to be paid by the partner. If you pay the premiums yourself, the partnership must reimburse you and report the premiums as guaranteed payments. Then, you take the self-employment health insurance age-based eligible premium deduction. Premiums paid by the partnership must be added to the partner’s K-1 as a guaranteed payment.
C-corporations – Premium payments are 100% deductible from the corporate tax return and considered a reasonable and necessary business expense. The deduction is not limited to the age-based eligible premiums. Like traditional health and accident insurance premiums, this applies to shareholder W-2 employees, their spouses, and dependents, and the business pays all employee coverage. Employer-paid LTC is excludable from an employee’s gross income, including the shareholder employees’ income, and the benefits are received tax-free. C-corporation paid premiums must be a 100% corporate expense to be deductible. They are excluded from shareholder employees’ incomes, bonuses, expense accounts, or other compensation.
Non-owner Employee – Premiums paid to any non-owner employee and spouse by any business entity are 100% deductible without any limits. Like health care premiums, they are considered a reasonable and necessary business expense. Long-term care insurance paid by an employer is not included in the employee’s gross income, and benefits are tax-free.
Due to the complexity involved with the potential taxation of your long-term care insurance benefits and how this may impact you and your financial goals, it is essential that you consult a financial professional who can help provide guidance and create a strategy that aligns with your retirement plans.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which product(s) may be appropriate for you, consult your financial professional prior to purchasing.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by LPL Marketing Solutions
How Are Long-Term Care Insurance Benefits Taxed? (2023) (annuityexpertadvice.com)
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