493 / How is a long-term care insurance policy taxed when it is not a qualified long-term care insurance contract?

Only premiums paid for qualified LTC policies are eligible for deduction, so if this is a significant benefit to one’s client, then a tax-qualified (TQ) policy is recommended. Having said that, TQ plans are virtually the only remaining choice today. NTQ sales represent, on average, less than one-half of one percent of all sales.

Planning Point: Even though HIPAA was enacted in 1996, the IRS has yet to publicly rule on the taxability of benefits paid from NTQ plans. (The agency has issued several private letter rulings indicating that—if an individual did not take a premium deduction up front—benefits would be non-taxable on the back end.) Most observers also agree that it would not be Congress’ or the IRS’s intent to tax a benefit which serves only to reimburse the insured. Had they wished, Congress could have very easily addressed NTQ plans on the spot—instead, HIPAA is silent.

IRS Form 8853 (for reporting taxable payments from LTCI, among other things) addresses the topic obliquely. It cautions not to use the form for amounts received from non-qualified LTCI, instead directing taxpayers to use Form 1040, line 21 to report any amount “not excludable as income”. The question remains whether benefits received from NTQ long-term care insurance are includable or excludable from income. On this point, the IRS suggests that amounts paid for “personal injuries or sickness through accident or health insurance” are excludable.

For the first few years following 1997, issuers of NTQ policies were so concerned that consumers were being spooked by the prospect of future taxable benefits that they included “pledges” and “promises” in their newly-issued contracts. These documents gave policyholders the right to exchange their NTQ policies for identical TQ plans, in the event the IRS ruled unfavorably.

Any contract issued before January 1, 1997 that met the long-term care insurance requirements of the state in which the contract was issued is treated for tax purposes as a qualified long-term care insurance contract, regardless of whether the provisions of the contract would have otherwise been eligible. (These are called “grandfathered” policies.) Services provided under such a contract or reimbursed by such a contract are treated as qualified long-term care services ( Q 477) and payments are tax-free.¹

1.     HIPAA ’96, § 321(f)(2). See also Treas. Reg. § 1.7702B-2.