489 / Are long-term care insurance premiums paid by an employer includable in employees’ income?

An employer’s plan that provides coverage under a qualified long-term care insurance contract generally is treated as an accident and health plan with respect to that coverage.¹ Thus, premiums for long-term care insurance coverage paid by an employer are not includable in the gross income of employees.²

Planning Point: If the employer only pays a partial amount of an employee’s premium, the employee is still entitled to deduct the balance paid. Of course, as an individual, the employee would include the portion of the qualified LTCI plan paid (up to the age-based eligible amount) with other itemized medical expenses, and deduct the amount that exceeds 7.5 percent of AGI.

Planning Point: When a C Corporation, S Corporation, LLC, partnership or sole proprietor purchases qualified LTCI for its employees, such amounts are not includable in the gross income of said employees. A question arises when these employees are also the owners of the relevant company. If that is the case, the analysis below controls.

Partners of a partnership, members of an LLC (taxed as a partnership) and greater-than-2 percent shareholders of an S corporation are all treated as self-employed individuals for tax purposes. As such, the qualified LTCI premiums paid on their behalf by their businesses are included in their AGI (i.e. passed-through as income); but, they may also turn around and deduct up to 100 percent of their age-based eligible premium (without having to satisfy the AGI threshold applicable to individual filers).

Shareholder/employees of a C corporation (who are treated as employees) and shareholder/employees who own 2 percent-or-less of an S corporation may exclude from their gross income the entire amount of qualified LTCI premium paid on their behalf (even if it exceeds the age-based eligible premium amounts).

Planning Point: Small business owners who have an opportunity to pay for their QLTCI premiums “through the business” can save a lot of money this way. If we imagine an owner (e.g., of a partnership, LLC or S Corp) who pays a premium with after-tax dollars, he has to “gross-up” his paycheck in order to cover the income and payroll taxes necessary to net the proper amount.

Having then paid the premium, the employee might attempt to take a deduction as an Individual, adding age-based eligible premium to other unreimbursed medical expenses, and deducting the portion that exceeds the relevant AGI threshold.

The business could also pay premiums on the employee’s behalf. Although this amount is reported as income to our business owner, the company benefits by avoiding payroll taxes on the amount (and even worker’s compensation). Then, the owner benefits from taking the self-employed health insurance deduction for the full amount of the eligible premium—not just amounts that exceed 7.5 percent of AGI.

1. IRC § 7702B(a)(3).