Tax Qualified Long-Term Care Insurance 2008

Tax benefits are not going to sell LTC i  A tax benefit in and of itself doesn’t sell any insurance product. You must first establish the need for the product.  Need to act is based not on the risk of an event happening to the client but the severe consequences to his family if the event ever did.  There are three distinct sets of consequences To his family’s physical and emotional wellbeing; To their retirement portfolio which was never allocated to pay for care Overall business productivity / viability

Consequences to family…  Taking care of chronically ill people makes healthy people chronically ill  Put simply if your client ever needs care, his life doesn’t end, someone else’s life ends  Long-term care doesn’t bring families together, it tears them apart

LTCi…  Allows your client’s wife to maintain her relationship with her husband as his spouse supervising care, not as a spouse providing care  Allows his children to maintain their relationship with their dad as children supervising care, not as children providing care  If single, allows his friends and siblings to maintain their relationship with him as friends and siblings supervising care, not as friends and siblings providing care

Consequences to lifestyle…  Lifestyle is everything to your client. It always includes keeping prior financial commitments  Expenses are matched by income stream generated from the income portfolio. Where is the money going to come from to pay for care?  A thought about self-insuring… $1,000,000 = $50,000 $2,000,000 = $100,000

 LTCi protects, not assets, but income. By doing so, it allows the client’s income portfolio to execute the purpose it was intended… retirement, not paying for care  By protecting income it ultimately protects the investment portfolio and the financial viability of the surviving spouse

Productivity…  Enhances employee productivity Employees do not have to spend as much time out of the office providing care.  Can be used to retain key employees The use of 10-pay on a discriminatory basis helps retain your best employees Tremendous good will generator

 Can act as a form of DI for older shareholders  Is an excellent executive carve-out

The TQ Basics

10 Requirements for tax qualified status A LTCI policy under IRC sec. 7702B(b):  Cannot have a medical trigger.  Must be guaranteed renewable.  Cannot have cash surrender value or money that can be paid, pledged or borrowed.  If the policy pays on reimbursement basis, it cannot pay for benefits if Medicare covers the costs.

11  All refunds or dividends can only be applied to reduce future premiums or increase benefits.  Any refund on a complete surrender or cancellation of the contract shall be includable in gross income to the extent that any deduction or exclusion was allowable with respect to the premiums. IRC § 7702B(b)(2)(C)  Defines chronically ill as a substantial physical condition, certified by a health care practitioner, that is likely to last 90 days.

12  Treated as an accident and health insurance premium. IRC sec. 7702B (a)(1)  Premium deduction based on age. It is referred to as an eligible premium IRC sec.213 (d) (10)  Eligible premium is considered “ medical care." IRC sec.213 (d) (10)  Eligible premium deductible from Health Reimbursement Account or Health Savings Account  The eligible premium cannot be deducted from a FSA because the product does not qualify for 125 “Cafeteria” status Treatment of premium…

eligible premium amounts  40 or less     71 and over 2007 $310 ($290) $580 ($550) $1,150 ($1110) $3,080 ($2950) $3,850 ($3680)

14 Taxability of benefits...  100% of proceeds on a reimbursement policy are tax free.  If indemnity (or cash) the first $270 or actual cost of care is tax free: Policy benefit: $300 per day Actual cost of nursing home: $150 per day Amount subject to tax: $ 30 per day IRC sec. 7702B(a)(2), 7702B(d), 104(a)(3)

15 Individual (non self-employed)  Must file an itemized return (1040 Schedule A).  Eligible, not actual premium is based on age.  Eligible premium added with other health insurance premiums and expenses.  Total must meet 7.5% of AGI.  The excess of 7.5% can be deducted from AGI.

16 Ed Peters is 61 years old. LTCi premium: $4,000  Adjusted gross income (AGI) $75,000  Eligible premium based on age$ 3,080  Other health related expenses$ 1,200  Total health medical$ 4,280  7.5% of $75,000 ($ 5,625)  Excess which can be deducted 0

17 End result?  Deduction worth little because few individuals itemize and even fewer have uncompensated medical expenses that exceed 7.5% of AGI.  If a joint policy is purchased (one owner, two insureds), each spouse can deduct their own eligible premium (subject to 7.5% rule) even though the policy has only one owner.  Taxability of benefit: 100% tax free if reimbursement The first $270 a day or actual cost of care is non- taxable.

Tax advantages to business owners and employees purchasing tax qualified long-term care insurance

19 Self-employed / sole proprietorship  Premium is classified as self-employed health insurance. IRC sec.162(l)  Owner deducts 100% of actual premium from business income, but must report it on line 29, Form 1040 for self- employment tax. IRC sec.162(l)(4)  Owner deducts eligible (not actual) premium from actual premium reported  Eligible premium for spouse and tax dependents are also deductible.

20  Owner deducts 100% of premium for employee. IRC sec. 162(a)  Premium is excluded from employee income & benefit is tax free. IRC Sec. 106(a) & 105(b)  Employer not subject to anti-discrimination rule IRC Section 106

21 Some thoughts…  If spouse is an employee, the company can purchase a policy for her. The total premium is deductible. A paid up option(10-pay, for example) becomes attractive.  If the carrier offers a joint policy, place spouse on payroll. She and owner / husband are the insureds. The entire premium is deductible.  Place one parent on the payroll. He/she buys a joint policy picking up their spouse.

22 Be careful… Can the IRS challenge the deduction based on reasonableness?  Employers can deduct TQ premiums to the extent they are ordinary and necessary business expenses for reasonable compensation paid to employees. Since employers usually pay more for limited pay policies than annual pay policies, reasonableness can be an issue. This is particularly true for policies with the fewest pay periods since they are most expensive. § 162; Treas. Reg. § (a)

Solution: Reduce owner’s salary and give it to spouse / employee

24 Deferred compensation v. health benefit  Another deductibility issue is whether a full ROP is a form of deferred compensation, rather than deferred welfare benefits.  If characterized as deferred compensation, the employer’s deduction is subject to the “matching rule.” This means the employer can’t take the deduction, until the employee includes the compensation in income.

Deductibility of eligible premiums for greater than 2% partners in partnerships

26 Partnerships (Rev Rul )…  Premium classified as self-employed health insurance. IRC sec.162(l)  Premium for partner can be deducted by company. IRC sec.162(a)  Premium is considered a guaranteed payment to partner and reported on Form 1065 & K-I. IRC sec.707(c)  Partner can deduct eligible premium. IRC sec.162(l), 213(D), 213(D(10)  Eligible premium for spouse and tax dependents are also deductible.

27  Premium subject to self-employment tax. IRC sec.162(l)(4)  Owner deducts 100% of premium for employee. IRC sec. 162(a)  Premium is excluded from employee income & benefit is tax free. IRC Sec. 106(a) & 105(b)  Employer not subject to anti-discrimination rule. IRC sec. 106

28 Some thoughts…  If spouse is an employee, the company can purchase a policy for her. The total premium is deductible. Paid up options (10-pay, for example) becomes attractive.  If the carrier offers a joint policy, place spouse on payroll. She and owner / husband are the insureds. The entire premium is deductible.  Put one parent on the payroll. He/she purchases a joint policy, with their spouse as the secondary insured.

29 Greater than 2% shareholders in S-Corporations (Rev Rul ) …  Premium classified as self-employed health insurance. IRC sec.162(l)  Premium for shareholder can be deducted by company. IRC sec.162(a)  Premium is considered a guaranteed payment to shareholder and reported on Form 1120S & Form W-2. IRC sec.707(c)  Shareholder can deduct eligible premium. IRC sec.162(l), 213(D), 213(D(10)

30  Premium subject to self-employment tax. IRC sec.162(l)(4)  Owner deducts 100% of premium for employee. IRC sec. 162(a)  Premium is excluded from employee income & benefit is tax free. IRC Sec. 106(a) & 105(b)  Employer not subject to anti-discrimination rule. IRC sec. 106

31 The problem… Due to rule of attribution, placing a spouse or parents on payroll yields no added tax benefit. They are capped at their eligible premium.

32 Shareholders in a C-corporation  Corporation can deduct premium for any shareholder* regardless of % ownership.  Premium is not income to shareholder / employee.  Shareholder spouse’s premium is fully deductible to company and is not income to her.  Premiums of parents of shareholder is fully deductible if they are claimed as tax dependents. * Shareholder must be an employee. Company must have resolution in place.

33 Split premium: Employer / employee  Employer pays 50% and employee pays 50%.  Assuming employee is not a >2% shareholder, the company can deduct the total of its share of the premium.  Employee pays with after-tax dollars. Premium does not qualify for 125 status.  If employee purchases full non-forfeiture, only one-half of the premium is tax free.

34 LLC & PC LLC for tax purposes*:  A LLC defaults to self-employed individual if only one person.  A LLC defaults to a partnership if more than one person. Professional corporation (PC) for tax purposes:  Taxed either as C corporation or S corporation. * A LLC can choose any filing status (S-corp. / C-corp. etc).

The Right Fastener Company  Three equal shareholders all in their mid to late 50’s. Each draws $100,000 ($ per day). They are exploring a disability buy-out funded by DI  They determine that… It is very expensive Tied to income which fluctuates Ends at 65

 The fact finder determines that the shareholders are concerned about long-term, not short-term, disability because of their age and prior experience.  The agent recommends a cash payment LTCi for $200 per day, paid by the company if the shareholder agrees to reduce their draw by $200 per day.  The shareholders are informed that The policy is not based on income and doesn’t end at age 65 That they can discriminate by class Can be fully deducted because the company files as a C- Corporation

Q & A