Taxation Of Benefits

<div class="Section1">Yes.</div><br /> <div class="Section1"><br /> <br /> As a result of the Pension Protection Act of 2006 (PPA), which went into effect January 1 2010, tax-qualified (TQ) long-term care insurance (LTCI) is now included in the scope of the Section 1035-exchange rules. This means that life, endowment, annuity and qualified LTCI may all be exchanged for qualified LTCI.<br /> <br /> In addition, the presence of a qualified LTCI rider on a life or annuity contract will not cause it to fail to qualify for the purposes of such an exchange. In other words, a taxpayer can exchange an annuity without a long-term care insurance rider for an annuity with such a rider, and still qualify for non-recognition treatment.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> In sum, the IRC provides that the following exchanges are nontaxable:<br /> <blockquote>(1)     the exchange of a life insurance policy for another life insurance policy (with or without a qualified LTC rider), for an endowment or annuity contract (with or without a qualified LTC rider), or for a standalone qualified long-term care insurance contract;<br /> <br /> (2)     the exchange of an endowment contract for an annuity contract (with or without a qualified LTC rider), for an endowment contract under which payments will begin no later than payments would have begun under the contract exchanged, or for a standalone qualified long-term care insurance contract;<br /> <br /> (3)     the exchange of an annuity contract for another annuity contract (with or without a qualified LTC rider); or for a standalone qualified long-term care insurance contract; and<br /> <br /> (4)     the exchange of a long-term care insurance contract for another qualified long-term care insurance contract.<a href="#_ftn2" name="_ftnref2">²</a></blockquote><br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Neither an annuity nor a standalone qualified long-term care insurance contract can be non-taxably exchanged for a life insurance policy (with or without a qualified LTC rider).<br /> <br /> <hr /><br /> <br /> Generally, if an individual surrenders an “old” contract and uses the proceeds to purchase a “new” contract, they are required to recognize any gain over basis as ordinary income for federal tax purposes. But if certain requirements are met, Section 1035 allows them to avoid any recognition of gain. (Among these requirements are that the exchange must take place in a “hands-off” fashion directly between the two insurers. The taxpayer must not receive the proceeds, even if later used to purchase the new contract.)<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Under Section 1035, both the owner and insured under the original contract and the new contract must be identical. For instance, an individually-owned contract cannot be 1035-exchanged into a jointly-owned contract.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Such exchanges may be appropriate when the owner of a life or annuity contract no longer has the need associated with the original contract (wealth accumulation), but <em>does</em> have a long-term care need (wealth protection).<br /> <br /> <hr /><br /> <br /> 1035-exchanges can be either “full” or “partial.” One might employ a “full” exchange when funding a single-pay product such as a combination product, and a “partial” for a limited payment mode such as a 10-pay. As a practical matter where LTCI is concerned, very few carriers are comfortable accepting partial exchanges on this basis from neighboring carriers. Logistically, it is preferable to move all the products under one financial “roof.”<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> The annuities covered by Section 1035 must be non-qualified, and cannot be owned by a trust or corporation. If the annuity is still within its surrender charge period, or the amount to be exchanged exceeds any free withdrawal limit, such amounts will be subject to a surrender charge. If a deferred annuity does not have any gain (as could be the case with a variable annuity in a down market), then there may be little tax benefit to exchanging the annuity for TQ LTCI.<br /> <br /> <hr /><br /> <br /> Having said that, the ability to “wash” gain on non-qualified annuities through either QLTCI or combination products with QLTCI riders is a remarkable tax advantage, and a loophole which may not last forever.<br /> <table border="1" align="center"><br /> <tbody><br /> <tr><br /> <td style="text-align: center;" colspan="3" width="399"><strong>Permitted Section 1035 Exchanges</strong></td><br /> </tr><br /> <tr><br /> <td rowspan="4" width="107">Life Insurance</td><br /> <td rowspan="4" width="158"></td><br /> <td width="134">Life Insurance</td><br /> </tr><br /> <tr><br /> <td width="134">Annuity</td><br /> </tr><br /> <tr><br /> <td width="134">Endowment</td><br /> </tr><br /> <tr><br /> <td width="134">Qualified LTCI</td><br /> </tr><br /> <tr><br /> <td rowspan="2" width="107">Annuity</td><br /> <td rowspan="2" width="158"></td><br /> <td width="134">Annuity</td><br /> </tr><br /> <tr><br /> <td width="134">Qualified LTCI</td><br /> </tr><br /> <tr><br /> <td rowspan="3" width="107">Endowment</td><br /> <td rowspan="3" width="158"></td><br /> <td width="134">Endowment</td><br /> </tr><br /> <tr><br /> <td width="134">Annuity</td><br /> </tr><br /> <tr><br /> <td width="134">Qualified LTCI</td><br /> </tr><br /> <tr><br /> <td width="107">Qualified LTCI</td><br /> <td width="158"></td><br /> <td width="134">Qualified LTCI</td><br /> </tr><br /> </tbody><br /> </table><br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 1035(b)(2), IRC § 105(b)(3).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 1035(a).<br /> <br /> </div>

<div class="Section1">No, they are not.<div class="Section1"><br /> <br /> A qualified long-term care insurance contract is treated as an accident and health insurance contract. <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="477">477</a>. Thus, amounts (other than dividends or premium refunds) received under such a contract are treated as amounts received for personal injuries and sickness and are treated as reimbursement for expenses actually incurred for medical care.<a href="#_ftn1" name="_ftnref1">¹</a> Since amounts received for personal injuries and sickness are generally not includable in gross income, benefits received under qualified long-term care insurance are generally not taxable.<a href="#_ftn2" name="_ftnref2">²</a> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="343">343</a>.<br /> <br /> While there is no limit to the amount of benefits that may be received as reimbursement under a qualified LTC policy, this is not the case when benefits are paid as a &ldquo;per diem&rdquo; (i.e., without regard to the cost of services received). In the latter case, a calculation must be performed.<br /> <br /> The taxpayer totals the sum of all per diem payments received during the year, including amounts received from QLTCI as well as accelerated death benefits received on account of &ldquo;chronic illness&rdquo; under IRC Section&nbsp;101(g), but not including accelerated death benefits received on account of &ldquo;terminal illness&rdquo; under IRC Section&nbsp;101(g).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Next, $420 in 2025<a href="#_ftn4" name="_ftnref4">^&nbsp;4</a> is multiplied by the number of days in the period for which benefits were paid. The greater of this product or actual costs incurred is carried forward. Any reimbursements are then subtracted, and the result becomes the per diem limit, above which amounts received are taxable (Form&nbsp;1040, line 21).<br /> <br /> One frequently finds an oversimplified version of the above process, i.e., that the first $420 per day is excluded from income, with amounts over this threshold taxable to the extent they do not reimburse actual expenses incurred. This suggests that&mdash;as long as per diem payments serve to reimburse expenses&mdash;there is theoretically no taxable upper limit. But as Form 8853 makes clear, amounts <em>under</em> the $420 per day limit can be taxable. This occurs when reimbursements are received during the same period as per diem payments (uncommon, but possible for those who are covered by more than one policy). Since one&rsquo;s expenses have been reimbursed, the per diem policy is serving at this point as nothing more than pure income&mdash;and it is taxed as such (even if it is far below the $420 per day threshold).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect; 7702B(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&sect; 104(a)(3), 105(b).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Amounts paid as accelerated death benefits are fully excludable from income if the insured has been certified by a physician as &ldquo;terminally ill&rdquo; (having an illness or physical condition that can reasonably be expected to result in death within 24 months of the date of certification). Accelerated death benefits paid on behalf of individuals who are certified as &ldquo;chronically ill&rdquo; are excludable from income to the same extent they would be if paid under QLTCI.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; &nbsp; IRC &sect;&sect; 7702B(d)(4), 7702B(d)(5).<br /> <br /> </div></div><br />