TAX QUALIFIED VERSUS NON TAX QUALIFIED

LONG TERM CARE POLICIES

Congress approved tax qualified policies (TQ) as an incentive to purchasers. Some premiums may be deducted and the receipt of "benefits"are not taxable. On the surface, this appears to be a great benefit to consumers- but further review indicates that the advantages may be illusory.

First, tax qualified policies are more restrictive. There are 6 ADL's (activities of daily living) versus 7 for the non tax qualified (NTQ). The additional ADL of ambulating should provide quicker coverage overall.

TQ policies require that care is required for at least 90 days- if not, benefits will not commence. This is not particularly onerous but, nonetheless, applies a restriction not evidenced in the NTQ policies.

Probably the most troublesome issue is the requirement of SEVERE cognitive impairment for the TQ policy versus cognitive impairment for the NTQ policy. The point being this- "severe" is NOT defined by ANY company. Therefore it is left to the discretion of the company to define when and how coverage will be instituted. However, it has been my experience that definitions that are either unclear or, further, not even defined, lead to questionable coverage later on.

(Note- most recently I have seen some apparent changes indicating "severe" will fall under the definition of "substantial supervision". This may adjust my thinking into the future as I read more policies.)  

The issue may become particularly taxing if a loved one is impacted by Alzheimers. At what point does the individual reach the severe stage? In such regard, and due to my prior research, I obtained a physician's definition of severe Alzheimers. It read as follows:

Severe Stage

Memory loss nearly complete

Severe disorientation and confusion

Speech declines to a few intelligible words

Loss of physical functions like walking and sitting up

Loss of bladder and bowel control

Loss of appetite

Total dependence on caregiver

I submit that if the company were to use this "accepted" definition, coverage for cognitive impairment may never happen until the later stages of the disease. Since the term "severe" is NOT defined contractually, I am extremely skeptical of proper coverage and would opt not to use such contracts.

But what about the tax ramifications of the NTQ policy- wouldn't the significantly higher taxes offset the better coverage? Again, further research was required including a direct discussion with the Internal Revenue Service. I do not present my position as a tax authority nor the conclusions as definitive statements of either CPA's, the IRS or any of the LTC companies. But I do believe it contains a real life element that requires a refocusing of NTQ policies.

First, let's dismiss the element of premium deductions. In a TQ policy, there is ONLY a deduction for premiums when they are included as part of medical expenses which only receive a deduction when exceeding 7.5% of AGI. In essence therefore, deductions of premiums are limited at best.

The real crux is the potential taxation of benefits for those people purchasing NTQ policies. In such regards, assume that the patient has an income from various sources of $50,000. And they then receive a "benefit" of an additional $50,000 upon entering a nursing home. On its face, it appears that the income has soared to $100,000. Not so- not only in my opinion but of most CPA's. The point being is that while there was receipt of $50,000, it was transferred to the nursing home as a medical expense. Therefore, 7.5% of (assume) $100,000 AGI equals $7,500 which is a deduction against the full $100,000 of income. This means that the taxable income is increased to just $57,500. Assume a 30% overall tax bracket and the additional tax liability is $2,250. So, is the extra cost worth it? Recognize that if the issue for coverage had been "severe" cognitive impairment under the TQ policy, perhaps only limited care would have been provided. It is my opinion that it is better to pay tax on $50,000 of coverage than it is to NOT get care and be taxed on Nothing. Further, with congress seeking to get more people to buy LTC policies so that the government does not have to take care of them, there is a good possibility that in subsequent years the tax laws will change providing tax exemption for all LTC policies. But that is NOT a certainty. One needs to weigh all factors before selecting one over another.

Are there caveats to this tax treatment? Yes. I do not believe the coverage for Adult Day Care would fall into the "medically necessary" category and therefore might be taxed. Home health care providing homemaker services- laundry, meal preparation, etc. would clearly seem to be taxable. The same might be said about certain Assisted Living Facilities since they do not require the same intensity of medical care as a nursing home. That said, such individuals entering such a facility are still impacted by at least two ADL's or cognitive impairment- not for retirement purposes- and may still deduct "legitimate"costs, if not all. In my discussion with the IRS in August , 2000, they have no definitive guidelines on the issue and indicate they would have to review on a case by case basis if an audit should occur. You should review this commentary with your CPA.

In summary, Congress will provide prescription drug benefits to the elderly but in no way has a surplus to pay for nursing home care. The recent tax credit for caregivers also indicates the necessity of granting additional leeway for medical/home health and nursing home care. The purchase of a private policy is mandatory for proper care. I also believe that much, if not all, of the receipt of such NTQ benefits can be a medical deduction against 7.5% of Adjusted Gross Income. Further, such a policy provides better and faster care.

Errold Moody, September 2000