Buyer Beware

Tax-qualified long-term-care insurance may not be a client's best bet.

The High Cost of Growing Old
  • In the United States, 54% of women over 65 and 30% of men ultimately will go into a nursing home.
  • In 1998, the average cost of a nursing home was more than $40,000 per year. Monthly skilled nursing-facility costs ranged from a low of $3,397, in New Mexico, to a high of $4,770, in New York.


  • IN AN EFFORT TO GET AMERICANS TO TAKE responsibility for long-term care planning, Congress passed the Health Insurance Portability and Accountability Act. Under the act, premiums for tax-qualified LTC policies are deductible. However, limits on premium deductions and restrictions on benefit payments make these policies a poor choice for most clients.
  • WHEN PURCHASING AN LTC POLICY, INDIVIDUALS should give high priority to policies with the least rigorous eligibility requirements. Most policies have two benefit triggers: proof of the inability to perform a certain number of activities of daily living, or proof the insured is cognitively impaired.
  • SOME LTC POLICIES OFFER A THIRD TRIGGER, generally called a medical-necessity clause. Under this clause the client's own doctor can certify that LTC assistance is medically necessary even if the client has not satisfied either of the other two triggers.
  • TAX-QUALIFIED LTC POLICIES PERMIT ONLY TWO triggers. A medical-necessity clause is not permitted. The IRC also allows tax-qualified policies to recognize as few as five of the usual seven ADLs (activities of daily living) and eliminates ambulation as one of the alternatives. In addition, a licensed health care practitioner must certify the insured as chronically ill.
  • CPAs SHOULD CAUTION CLIENTS THAT THE PURCHASE of LTC insurance should be motivated by need, not by a relatively small tax deduction. Even the few clients who could benefit by purchasing a tax-qualified policy might find those savings come at considerable cost—decreased access to policy benefits.
RICHARD J. BERGSTROM, JD, CFP, is professor of finance, real estate and law at California State Polytechnic University, Pomona. His e-mail address is .

emember the old man who "bumped his head when he went to bed and couldn't get up in the morning?" More elderly than ever before need help getting out of bed in the morning—as well as handling many of the other daily activities of living. To maintain a high quality of life when they grow older, all Americans need to include a long-term-care (LTC) strategy in their financial planning. Failure to factor in the cost of such care continues to be the largest omission of many individual financial plans. CPAs whose practice includes personal financial planning, particularly those interested in expanding into ElderCare—one of the new assurance services—need to know more about LTC alternatives and their costs.

Many people use LTC insurance policies as part of a plan to ensure lifetime care. The Health Insurance Portability and Accountability Act (HIPAA), effective January 1, 1997, created a new type of tax-qualified LTC policy. The act's objective was to encourage individuals to provide for their own long-term care. To induce people to buy LTC insurance, premium payments were made tax deductible. The catch: Policies that qualify may have benefits-eligibility standards so rigorous they could do your client more harm than good in the long run. Even worse, HIPAA may have unintended tax consequences for purchasers of traditional LTC policies.

CPAs should be able to compare the benefits of tax-qualified and non-tax-qualified LTC policies and determine whether a particular LTC policy will provide clients reasonable access to benefits when care is actually needed. Before they can properly advise clients on LTC issues, CPAs may need to lobby for either new legislation or clearer regulations. Such clarification is of critical importance to the nation's elderly.  


Under HIPAA, tax-qualified LTC insurance policies are now treated as accident and health insurance contracts for tax purposes. Individuals who itemize their deductions and whose medical expenses exceed the 7.5% adjusted-gross-income floor can deduct the premiums. The limit on the amount of a premium a taxpayer can deduct is based on the age of the person filing the return (see exhibit 1, page 29). As a tax incentive, this limited deduction is inadequate. A relatively small percentage of a CPA's clients will qualify for the deduction, and the size of the deduction makes it moot.

Exhibit 1: LTC Insurance Premium Deductibility
Age Deduction Limitation
40 and under $ 200
41 to 50 375
51 to 60 750
61 to 70 2,000
and over 71 2,500

The danger to consumers is that in seeking a tax deduction they may be lured into buying an ineffective policy. Other (so-called by default) non-tax-qualified policies are still available from insurance companies and have benefits that are much easier to obtain. The key to understanding these two classes of policies is in the different eligibility requirements (see exhibit 2, page 29).  

Exhibit 2: Eligibility Requirements

Tax-Qualified LTC Plans Non-Tax-Qualified LTC Plans
Common Benefit Triggers Common Benefit Triggers
—Activities of daily living: HIPAA requires that a policy acknowledge only five ADLs. —Activities of daily living: LTC professionals generally acknowledge seven ADLs.
  • Ambulation is not considered an ADL. The insured must be unable to perform two of the other five or six standard ADLs.
  • Written certification from a licensed health care practitioner is required and must verify inability to perform ADLs for least 90 days.
  • Inability to perform "without substantial assistance from another individual."
  • Loss of ambulation is a benefit trigger. Insured must be unable to perform only two of the standard seven ADLs.
  • Loss of ADL often defined as "needing regular human assistance or supervision."
—Cognitive impairment. —Cognitive impairment.
  • Requires "severe" cognitive impairment.
  • Must meet "substantial supervision" test to protect from threats to health and safety.
  • Not described or required to be "severe" cognitive impairment.
  • Definition does not require "substantial supervision" test.
—Doctor's opinion of medical necessity cannot trigger benefits. —Doctor's opinion of medical necessity can trigger benefits.
—Triggers 1 and 2 must be reviewed by a licensed health care provider and written certification must be submitted to insurer every 12 months. —No law requires insurer to receive and review written certification of a licensed health care provider. No law requires insurer to demand proof of a "trigger" for 90 days before benefits can be received.


All LTC policies impose requirements a client must meet to gain access to insurance benefits. These requirements vary greatly from policy to policy. It may be more difficult to secure benefits under an LTC policy than under a life, medical or auto insurance policy. Such benefit eligibility controversies are comparable to those an individual might face in obtaining disability insurance benefits, although the objective proof of lost income reduces the potential for dispute under a disability insurance policy.

When purchasing an LTC policy, individuals should give high priority to those with the least-rigorous eligibility requirements. These requirements act as independent triggers—that is, the insured must satisfy only one requirement, not several, to activate his or her contractual right to receive benefits. The more triggers a policy has, the higher the probability the client will successfully access benefits. The triggers also may have qualifiers, such as "activities of daily living" (ADLs). Most LTC policies contain only two triggers:

1. Proof of the inability to perform a specified number of ADLs.

2. Proof the insured is "cognitively impaired."

The number of recognized ADLs varies from state to state, and the number an insured person must lack the ability to perform to access benefits likewise differs. States with the most rigorous consumer protection tend to require insurance companies to recognize seven ADLs (bathing, continence, dressing, feeding, toileting, transferring—the ability to move in or out of a chair or bed—and ambulating). California, for example, requires that insurers provide consumers the right to access benefits after showing the loss of only two of the seven legally recognized ADLs.

Other insurance companies consider the loss of "instrumental activities of daily living" (IADLs) in allowing access to benefits. IADLs include cooking, shopping for groceries, traveling to and from a doctor, cleaning house, doing laundry, managing medication, paying bills and making telephone calls. A policy might allow a client to access benefits when he or she has lost the ability to perform only one ADL but also can no longer perform two or more IADLs.

Some policies offer a critical third trigger. The most popular is the "medical necessity" clause. If this trigger is satisfied, the insured can obtain benefits even if he or she is not cognitively impaired and even if he or she has not lost the ability to perform the required number of ADLs. While the wording of a third-trigger requirement may vary from company to company, the result is essentially similar to the medical necessity clause. This clause is especially helpful to the insured because it allows access to benefits based on certification by the insured's doctor that LTC assistance is medically necessary, even if the other benefit triggers have not been activated. One insurance company estimates that up to 40% of its home health care benefits were paid under the medical necessity clause.  

Alphabet Soup

ADLs—Activities of daily living.

HIPAA—Health Insurance Portability and Accountability Act.

IADLs—Instrumental activities of daily living.

LTC—Long-term care.


Most LTC policies permit the insurance company, or a designated administrative agent, to determine whether the insured is eligible to receive benefits. Although a third-party agent might appear to be more objective, the insurance company normally chooses the agency and pays for its services—resulting in some inevitable bias.

A minority of companies permit the insured's own physician to determine whether the insured has satisfied the eligibility requirements. Assuming the insured is not making exaggerated or false claims, it is unlikely a physician would refuse to decide in a patient's favor. The tendency of the insured's physician to make this judgment in the client's favor (and against the economic interest of the insurance company) is far preferable for the client.

A policy that contains a medical-necessity trigger empowers the insured's physician to make the decision and substantially increases the accessibility of benefits. It also is important for clients to determine whether all benefits, including home care, are accessible under the medical necessity clause, or by certification of the insured's doctor.  

Exhibit 3: LTC Case Studies

These claims would not have been paid under tax-qualified long-term-care policies.

Client A: This 89-year-old woman resides in an assisted living facility. Her conditions are diabetes, abdominal aortic aneurysm, peripheral vascular disease and osteoarthritis. She receives assistance with one ADL only; however, she is a frail elder and the company is paying benefits under the medically necessary trigger.

Client B: This 77-year-old woman had a laminectomy. She can perform her ADLs, but needs assistance with other instrumental activities. The company has approved a plan of care offering her three hours of help, two days per week for four weeks at a cost of $13 per hour.

Client C: This 81-year-old woman recently had a pacemaker implant. She can perform her ADLs but needs help with shopping, meal preparation, housekeeping and laundry. She is receiving benefits for four hours of care per day, five times per week at $10.50 per hour.

Client D: This 85-year-old woman with rheumatoid arthritis and osteoporosis is another example of a frail elder who needs help to be able to continue living at home. She can perform her ADLs but cannot perform what her physician referred to as "routine activities." The company is paying for three hours per day, five days per week at $10 per hour.

Client E: This 93-year-old man with post-polio syndrome entered an adult living facility. The heath assessment form completed at that time indicated he was independent regarding his ADLs. However, his physician subsequently said that, due to his age and condition, he was simply "unable to care for himself." He now receives benefits he could not have received under tax-qualified and even most non-tax-qualified policies.

Client F: This 83-year-old woman has congestive heart failure and degenerative arthritis. She is confined to a personal-care boarding home. She has panic attacks but is not cognitively impaired. She receives financial coverage for the boarding home because she needs standby assistance with bathing and occasional help with dressing.

Client G: This 84-year-old performs all of her ADLs independently but needs assistance with medication management and other IADLs. She is another frail elder who simply could not safely live at home. She receives benefits to pay the cost of a personal-care facility because she needs a structured and supervised environment.


In selecting a tax-qualified policy, the client must be aware of the potential limitations on access to benefits. A CPA's primary concern should be to make sure that a client—influenced by meager tax benefits from premium deductions—does not purchase a tax-qualified policy that is likely to be insufficient for his or her needs.

Tax-qualified LTC policies permit two triggers only; medical necessity is not one of them. The IRC allows insurance companies writing tax-qualified policies to recognize as few as five ADLs. (Remember, the more activities a policy recognizes, the greater the accessibility of benefits.) The IRC further reduces eligibility by eliminating ambulation as a trigger. At least one survey reports that ambulation is the ADL an individual is most likely to lose. There is a close connection between ambulation (the ability to move about without a wheelchair), transferring and other ADLs such as bathing, dressing and toileting. Furthermore, the IRC does not expressly limit how many ADLs a company can require the insured to have lost as a condition to benefits eligibility.

HIPAA introduces another barrier to eligibility for LTC benefits: No benefits can be paid unless and until a licensed health care practitioner has certified the insured as "chronically ill." The triggers that satisfy this requirement are the loss of at least two ADLs for a period of at least 90 days due to lack of functional capacity, or "requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment."

Although the Treasury Department issued interim guidelines that essentially allow insurance companies to use preexisting standards (notwithstanding the qualifying adjectives substantial and severe ), there appears to be nothing restraining the insurance industry from applying more-stringent standards—now or in the future. Insurance companies could interpret policies requiring "severe cognitive impairment" or "substantial supervision" differently from policies requiring just "cognitive impairment" or "supervision" if it was in their interest to do so.

It is unclear whether an LTC policy that expressly provides benefits for IADLs meets IRC requirements for a tax-qualified LTC policy. It would be impractical for an insurance company to investigate whether an insured was using policy proceeds to pay for help with IADLs vs. ADLs. As a result, most companies don't want to scrutinize or reject benefit claims involving IADLs. The IRS, however, has questioned whether such benefits are consistent with the accident and health insurance code provisions and should, therefore, be treated as taxable income.

Many people who need LTC insurance are relatively young (40 to 65). These individuals often have suffered a relatively short-term episode (an accident, heart attack or stroke) and will recover. Help with the major ADLs can be of substantial benefit in their recovery period. The chronically ill requirement substantially reduces their likelihood of receiving benefits from a tax-qualified LTC policy. An individual who determines that buying a tax-qualified policy is desirable should consider adding a post-acute recovery policy to meet this need. Buyers of nonqualified policies can probably cover this risk—with lower total premiums—by acquiring a policy with no elimination period.

Most of the elderly who need LTC, however, are simply frail individuals who find it difficult to accomplish the ADLs and who also need help with IADLs. Under non-tax-qualified LTC policies, assistance with IADLs caused by frailness is often covered. In fact, some companies will sanction the loss of a certain number of IADLs as triggers, permitting the client to access all of the policy's major benefits.

Insurance companies pay fewer claims under tax-qualified LTC policies than under non-tax-qualified policies. One of the oldest LTC insurance carriers, with one of the largest databases, has done an internal study on this issue. Its research indicates that 20% of the company's nursing-facility claims and 40% of its home-health-care claims would not have been paid had the individuals been required to qualify under the tax-qualified LTC rules. Exhibit 3, at left, illustrates this point with seven thumbnail case histories of individuals who receive benefits but would not have under the tax-qualified LTC policy rules.

Evaluating an LTC Policy

1. Seek out LTC policies that have three or more triggers.

2. Be certain the third trigger is what is generally called a medical-necessity clause. Such a trigger enables the client's physician to certify the need for LTC benefits in the absence of any cognitive impairment, or the impairment of ADLs and IADLs.

3. Obtain a policy that recognizes the greatest number of ADLs and requires the loss of the fewest (one out of seven ADLs or IADLs).

4. Select policies that will permit a client to receive benefits when his or her physician has determined that the client has lost the ability to perform only one ADL but has also lost more than one IADL.

5. Confirm with the insurance company that assistance with IADLs is covered. It would be helpful if the company would specifically name the IADLs for which they are willing to compensate.

6. Select a company that permits the client's physician to determine whether or not the triggers have been satisfied.

7. Purchase a policy that will allow the client to have access to all benefits, including home care, through the medical-necessity trigger with the certification of the client's own physician.

8. If a tax-qualified LTC policy is deemed appropriate, be certain that the payment of benefits for the receipt of IADLs is included and advise the client regarding the current lack of clarity under the IRC.

9. If a tax-qualified policy is purchased, consider selecting a company that permits an exchange to a non-tax-qualified policy.

10. Strongly consider selecting a policy with a 0-day elimination period. Any increase in premium is outweighed by the number of clients who may need to access benefits for relatively short periods of time.

11. If a tax-qualified policy is purchased, consider also buying a post-acute recovery policy to provide supplemental benefits.


Most CPAs believe the receipt of long-term care benefits is not taxable income under the tax law that preceded HIPAA. Many tax authorities representing insurance companies, however, maintain that HIPAA intended to make benefits from non-tax-qualified LTC policies taxable.

The IRS now interprets HIPAA as requiring insurance companies to issue 1099s to all recipients of LTC benefits. This is especially curious since HIPAA did not expressly refer to non-tax-qualified LTC policies. Furthermore, both the Treasury Department and the IRS take the position that at least some LTC benefits were taxable even before HIPAA. The IRS maintains that the previous noncollection of taxes on LTC policies was largely a reporting issue.

While many experts believed Congress would clarify issues related to the taxation of non-tax-qualified LTC policies in 1997, this did not occur. Without new legislation, IRS and Treasury personnel foresee no clarification in the near future. The IRS has said that regulations to clarify the issues are unlikely in the absence of substantial public demand. Having convinced insurance companies to report LTC benefits as income, the IRS is satisfied to make rulings on a case-by-case basis.

Fortunately, however, the IRS and the Treasury Department have said they are willing to hear the opinions of CPAs. If CPAs express interest in having these issues clarified, better regulations may be forthcoming. (See "A Call for CPA Opinions," at right.)

At this point, IRS personnel have identified at least three possible scenarios. The worst case scenario would be that reported income from non-tax-qualified LTC policies would qualify for offsetting deductions under IRC section 213(a). Of course, those deductions would be subject to the 7.5% of AGI floor and other rules effectively limiting deductions. Since the cost of LTC can easily amount to more than $50,000 per year, the deductible portion of LTC costs would quickly exceed the 7.5% of AGI restriction. For most people, deductible medical expenses would offset the income reportable to the IRS.

IRS personnel have said that an even more unfavorable tax consequence is possible. They argue that medical care deductions qualify under section 213(a) only if they are not reimbursed by insurance or otherwise. In other words, even if income is not excludable under IRC section 104 as an accident or health benefit, it nevertheless also may not be deductible under section 213(a).

Yet another possibility is that income from non-tax-qualified LTC policies is excludable under section 104 "to the degree that" it is allocated to health issues. Nevertheless, some argue that LTC payments are largely to the frail elderly, who are not necessarily receiving benefits for medical care but are receiving them because they are frail and cannot perform ADLs and IADLs. At this point it is difficult to agree with the insurance industry's claim that it was successful in bringing about legislation that gives favorable tax incentives to consumers and the private sector to deal with LTC needs. However, the industry-sponsored legislation resulted in a tax incentive for a very small percentage of the population, and has minimal economic significance for those who might benefit from the purchase of a tax-qualified policy. If the proponents of taxing benefit payments from so-called non-tax-qualified LTC policies prevail, there will be a huge disincentive for the majority of Americans to purchase LTC insurance.

At the very least (if LTC benefits are taxable), the effective cost of such insurance will rise and the tax law touted as creating a positive inducement will have resulted in nothing more than a huge revenue increase for federal and state governments.  

A Call for CPA Opinions

The IRS now requires insurance companies to issue 1099s to recipients of LTC insurance benefits. Under each of the scenarios proposed by IRS and Treasury Department personnel, the taxation of benefits from previously untaxed policies (so-called non-tax-qualified LTC policies) is a real possibility. Fortunately, both Treasury and the IRS have expressed an interest in hearing the opinions of CPAs. This important issue could affect the lifestyle of millions of Americans.

When submitting comments, CPAs should refer to notice 97-31. Opinions may be mailed to:

Office of Chief Counsel of the Internal Revenue Service
P.O. Box 7604, Ben Franklin Station
Washington, D.C. 20044

Opinions may also be e-mailed to the IRS at:

The author would appreciate receiving a copy of your letter or e-mail.

Richard J. Bergstrom
SLV Box 7655
Spring Valley Lake, California 92392

Fax: 760-951-0095


Since this issue may not be clarified for years, how should CPAs advise their clients? CPAs can tell them not to buy LTC insurance that offers a relatively small tax deduction at the risk of foregoing access to benefits. Even those who could benefit financially in the short run by purchasing a tax-qualified LTC policy should give careful consideration to the extraordinary cost of the tax savings—in the form of decreased access to benefits—when the time comes for claiming those benefits.

HIPAA requires all companies to permit the exchange of a non-tax-qualified policy for a tax-qualified policy. There is no provision requiring the exchange of a tax-qualified policy for a non-tax-qualified policy. Since the latter provide greater access to benefits, the increase in claims from such a transfer provision would not benefit most insurance companies. Some companies do, however, provide for this limited exchange benefit (see "Evaluating an LTC Policy," page 33).

Obtaining a policy that contains a medical-necessity clause may benefit some clients. The client whose doctor certifies the benefits as being medically necessary may have a better argument (on a case-by-case basis) that such benefits are excludable from income. Remember, however, that most LTC policies do not contain a medical-necessity trigger.  


If the government truly supports taking individual responsibility for LTC financial planning, additional legislation is needed. The IRS position is that deductions and exclusions are "matters of legislative grace" and, in the absence of legislation, non-tax-qualified LTC policies will be judged on a case-by-case basis. The current views of the IRS and Treasury Department would effectively result in tax increases.

Legislative solutions could be as simple as clarifying that HIPAA was never intended to result in the taxation of benefits from any LTC policy. Since premiums from non-tax-qualified policies are never deductible, the legislation could clarify that the benefits from such policies—paid for with aftertax premium dollars—are not taxable. An alternative solution would be to provide that if an LTC policy has been approved by the state in which it was issued, the benefits would not be taxable.

Since the IRS has indicated it will take the opinions of CPAs into consideration, CPAs can help by seeking clarification of the tax treatment of non-tax-qualified LTC policies. IRS personnel agree, however, that legislative action would be best. Direct communication to the Joint Committee on Taxation (see "The Need for New Legislation," at left) could pave the way to a clearer, more beneficial structure for the massive number of citizens who will undoubtedly need LTC. In addition, CPAs should encourage clients to join them in seeking legislation that offers a true incentive for all Americans to plan for LTC costs.


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