HIPAA and the tax status of LTC insurance

There is a long-standing tradition in employee benefits in which benefits are tax preferred.  Tax preference generally means that an employer’s cost associated with providing these employee benefits is tax deductible.  For some coverages, this extends to the employee and for long-term coverages, tax-deductibility is allowed for certain future expected costs.  For example, the employer costs associated with prefunding pension benefits are fully tax-deductible. 

Prior to the passage of HIPAA, long-term care benefits had no tax preference primarily because the majority of the cost was for benefits in the future.  As long-term care emerges as a mainstream benefit, the tax picture is getting clearer.  HIPAA helped clarify many of the issues to support this emergence.

What was the LTC benefit payment tax status prior to HIPAA?

Prior to HIPAA, Section 213 of the IRS Code defined “medical care” benefits as amounts paid for “the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body,” or for transportation or insurance related to these items.  This definition did not cover ongoing custodial care.  Section 213 drives what can be deducted by an individual taxpayer on the tax return, and it also indicates what type of services may be covered by an employer (under Sections 105, 106, and 125) on a tax-deductible basis.  Such benefits are not taxable to an employee.  Since the definition did not cover most long-term care services, it was unclear whether long-term care benefits received in an employee benefits plan would be included in the income of employees.  

How did HIPAA impact this status?

HIPAA expanded the definition of medical care to include “Qualified Long-Term Care Services.”  This expansion ripples through the other sections of the IRS code to allow tax-preferred coverage of these services by an employer.  Under HIPAA, Qualified Long-Term Care Services are diagnostic, preventive, therapeutic or rehabilitation services; services related to curing or treating a disease, or mitigating damage from one; or maintenance and personal care services that:

i. are required by a “chronically ill individual;” and ii. are provided under a plan of care prescribed by a licensed health care practitioner.

Further regulations define qualified long-term care insurance (as opposed to benefits), which must provide qualified long-term care services under a contract that is guaranteed renewable, does not duplicate Medicare and does not provide any cash value.  There are also monetary limits of how much may be paid for such insurance.  Employers may deduct premiums for qualified long-term care insurance.  Premiums – up to a specified limit by age – may be treated as medical care for an individual’s tax return, meaning that the premiums plus other medical expenses may be deducted if they exceed 7.5% of a taxpayer’s adjusted gross income.  They may also be paid out of accounts for medical benefits, such as HRAs or HSAs.  Benefits paid under a qualified long-term care insurance contract are not taxable.

There are ongoing debates to further expand the tax-deductibility of long-term care coverage, especially to allow the employer to deduct premiums under a Section 125 plan.  

Why is true group long-term care so important?

• Many Americans will have no way to pay for long-term care services when they are needed.
• Insurance for long-term care will not become widespread if only available on an individual basis, which means that the change will need to come first from employers.
• Group coverage needs to include employer contributions to make it affordable to employees and vesting to make it affordable to employers.