On the eve of the annual filing deadline for personal income tax returns, I thought I would tell you about a deduction which can provide you and your business with significant income tax and lifetime planning opportunities. This is the deduction available for long-term care insurance premiums and benefits.

Because providing for a family member’s long-term care is an issue facing many in our community, it is frequently featured on these pages. The increased demand for long-term care services has driven economic growth in this market which has in turn produced a wide array of care options.

As explained in prior articles, there are three options for funding long-term care: (1) self-funding; (2) public assistance; and (3) insurance. For those who cannot or simply prefer not to face the uncertain costs of long-term care, but who do not qualify for public assistance, long-term care insurance offers a prime planning opportunity. To encourage such planning, the federal government and some states have provided tax incentives to individuals and businesses to help offset the cost of long-term care insurance premiums.

Similar to the deductions available for health care expenses, the purchaser of a qualified long-term care policy may deduct premiums, subject to some limitations. The available deduction varies primarily based on certain criteria: (1) the relationship of the purchaser to the insured, (2) the age of the insured and (3) the amount of the premium.

You may deduct premiums you pay for qualified long-term care insurance for yourself, your spouse or a dependent up to a fixed amount that increases with age. In 2004, a thirty-five year old person can to deduct premiums paid in the amount of $250 per year or less, a fifty-five year old may deduct premiums up to $980 per year and a seventy-five year old may deduct premiums of up to $3,250 per year. These maximum deductions are indexed for inflation and change annually. Long-term care premiums are classified together with medical expenses, and are deducted as an itemized deduction on Schedule A of your individual income tax return.

If you work for a business of which you are more than a 2% owner, all long-term care insurance premiums paid for you, your spouse, or a dependent are 100% deductible by the business subject to the dollar limitations imposed on individuals. The premiums payments are not treated as income to you as an employee. If the premium exceeds the amount deductible by the business, then the remaining premium may be deducted by the employee in the same manner as other itemized medical expenses.

Yet another limitation on the business’s deduction is that amount deducted may not exceed the income attributable to the shareholder. There are other limitations which may apply in some circumstances, so be sure to consult a tax professional for more information.

If you are more than a 2% owner of a business, but not an employee, and the business pays your premiums for you, the deduction is treated differently. Although these premiums paid by the business are deductible, the premiums paid are considered income to you and are reported as such to the IRS. You may deduct all premiums paid up to the dollar limitations mentioned above. Any premiums paid in excess of the fixed deduction may be included as an itemized medical expense and be deducted on Schedule A. Your deductions may not exceed your attributable share of the income of the business.

An increasing number of employers are offering long-term care insurance in their employment benefits packages. This is advantageous for both the employer and the employee. So long as the covered employee holds an ownership interest of 2% or less of the employer, the employer can deduct 100% of the premiums paid for policies on the employee, the employee’s spouse and any dependents. Unlike the deductions permitted for individuals, there is no limitation on the dollar amount that is deductible. Additionally, the cost of premiums paid by an employer is not attributable to the employee as income, and is thus a tax free benefit for the employee.

If the time comes when you must rely on the long-term care insurance to pay for personal care, benefits paid under your insurance contract up to a fixed dollar amount under long-term care contracts are not included in the your income. In 2004, the tax free benefit is $230 per day, and this amount is indexed to allow for inflation and growth. In certain circumstances, a portion of the excess daily benefit paid may also be excludable from taxable income, so consult your tax advisor.

As you can see, there are some powerful tax incentives for investing in long-term care insurance. However, you should proceed with caution when selecting a long-term care insurance policy and include your tax advisor and attorney in the selection process. All policies are not created equal. To qualify for the deductions outlined here, the policy must meet certain requirements and contain specified features which are beyond the scope of this article. This article is only an introduction to tax planning opportunities with long-term care insurance, additional limitations exist for each category discussed above. Before you sign up for a long-term care policy, please consult with your attorney and your tax advisor regarding the appropriateness of the plan and the deductibility of the premiums to be paid.

© Sarah J. Lane, 2004