The Tax Status of LTCI Policies
For many years the tax treatment of long-term care insurance was in dispute — whether LTCI was a type of health insurance (making premiums deductible and benefits excludable from income) or something else entirely. This changed with the enactment of the Health Insurance Portability and Accountability Act of 1996 (HIPAA), which established a new class of LTCI policies: federally tax-qualified (TQ) policies.
Federally tax-qualified (TQ) policies now make up a very large majority of LTCI policies sold and have become the industry standard. Their benefits are generally tax-free, and premiums may in some circumstances be partially tax-deductible.
Nonqualified (NQ) policies continue to be marketed but do not enjoy the tax advantages of TQ policies. Their tax status is “pre-HIPAA” — whether benefits are taxable remains unresolved, and premium payments are not tax-deductible.
Grandfathered policies are those that were already in force before January 1, 1997, when HIPAA’s long-term care provisions took effect. These policies are deemed tax-qualified even if they do not meet all HIPAA requirements. An important restriction applies: an insurer cannot make changes so substantial that it is in effect issuing a new policy that does not meet HIPAA standards — if such changes are made, the policy may lose its grandfathered status.
Requirements for TQ Status
The cover page of a tax-qualified LTCI policy must:
- Clearly indicate that the policy is intended to be federally tax-qualified. A typical statement: “This policy is intended to be a qualified long-term care insurance contract under Section 7702B(b) of the Internal Revenue Code.”
- Notify the insured that for 30 days after delivery he has the right to return the policy for a full refund of all premiums and fees paid, even though the policy has already gone into effect. (Called the 30-day free look or right to return provision.)
- If the policy includes a preexisting condition exclusion, explain this on the cover page.
A TQ policy must pay benefits only for “qualified long-term care services” — defined as “necessary diagnostic, preventative, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services” required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed healthcare practitioner.
HIPAA uses a purpose-based approach rather than naming specific services. Any service serving one of the approved purposes is acceptable — this provides flexibility and accommodates newly developed services without requiring a change in the law.
A chronically ill individual is one who is expected to be unable to perform at least two of the standard ADLs without substantial assistance for at least 90 days, or one who suffers a severe cognitive impairment requiring substantial supervision to protect her health and safety.
Services must be appropriate for the insured’s impairment, ensured by requiring a plan of care prescribed by a licensed healthcare practitioner. Plans of care should be reviewed and updated frequently as a person’s condition changes. HIPAA requires insurers to obtain recertification of impairment every 12 months.
A TQ policy may generally not make payments not intended to cover qualified long-term care services, with limited exceptions for nonforfeiture benefits and policy dividends. A TQ policy also may not pay benefits for a service to the extent that Medicare pays for the same service (to prevent double benefits) — though this does not apply to indemnity or disability policies.
HIPAA requires TQ policies to include many of the consumer protection provisions mandated by the NAIC LTCI Model Act and Model Regulation. A TQ policy must:
- Be either guaranteed renewable or noncancellable
- Include a third-party notification of lapse provision
- Offer an inflation protection option
- Offer a nonforfeiture option
- Follow the NAIC rules on permitted exclusions
Tax Treatment of TQ Policy Benefits
Benefits paid by TQ reimbursement LTCI policies are not considered income for purposes of federal income tax — they are entirely tax-free.
Benefits paid by TQ indemnity or disability policies (referred to by the IRS as per diem policies because they pay a flat dollar amount per day) may be taxed if they exceed $430 per day (2026, adjusted annually for inflation). However, if the insured can furnish proof that qualified long-term care expenses exceeded this limit, benefit payments up to the actual amount of expenses may still be excluded from taxable income, even if they exceed the per diem limit.
Gary (reimbursement): Has a TQ reimbursement policy with a $300/day benefit. He receives benefit amounts ranging from $225 to $300, depending on his covered expenses. Since all benefits go to pay for care, the entire amount each day is tax-free.
David (disability): Has a TQ policy paying $500/day on a disability basis. He is paid $500 for every day he meets a benefit trigger, even though his actual long-term care expenses range from $350 to $420. Only $430 of each daily benefit is tax-free; the other $70 is taxed as ordinary income.
Robert (disability, high expenses): Also has a TQ disability policy paying $500/day. His actual expenses range from $400 to $550. For days with expenses of $430 or less, only $430 is tax-free. For days where he can show qualified expenses exceeding $430, his benefits are tax-free up to the actual amount of incurred expenses.