Tax preferences and LTC benefits

There is a long-standing tradition in employee benefits where benefits are tax preferred. Prior to the passage of HIPAA, long-term care benefits had an unclear tax status, primarily because the majority of the cost is for benefits in the future (and tax deferrals make Washington nervous). As long-term care emerges as a mainstream benefit, the tax picture is getting clearer. HIPAA helped clarify some of these issues.

HIPAA expanded the definition of medical care to include “Qualified Long-Term Care Services.” This expansion then ripples through the other sections of the IRS code to allow tax-preferred coverage of these services by an employer. 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. 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. Benefits paid under a qualified long-term care insurance contract are not taxable.

In addition, The Medicare Modernization Act of 2003 enabled employees to contribute to long-term care insurance on a tax-preferred basis through either a Health Reimbursement Account (HRA) or a Health Savings Account (HSA). HRAs may be established when a high-deductible medical plan is present and amounts, up to a limit, may be contributed to HRAs on a tax preferred basis. Qualified medical expenses may be paid from HRAs without incurring tax and if no expenses are incurred, the remaining amounts are rolled over from one year to the next - also without tax. Since long-term care premiums can be paid from these accounts as a qualified medical expense, this allows employees to pay for long-term care insurance on a tax-preferred basis. HSAs are very similar to HRAs, however, they must be fully funded by the employer, so this gives no additional tax preference to employee contributions.

Finally, Congress is looking at allowing LTC premiums to be paid from a Section 125 Plan, which effectively makes them tax preferred. The Section 125 Plan provides tax savings by reducing employee medical premiums from their gross salary prior to calculation of federal income and social security taxes, as allowed under Internal Revenue Code (IRC) Section 125.

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.