Paying for LTC insurance: the C corporation advantage.

The risks of requiring long-term care (LTC) are substantial. Most people who want to protect their assets or choice in caregiver should consider the purchase of insurance, which can also provide tax benefits.

For individuals, the premiums on qualified LTC insurance policies are deductible within annual age-based limits; see Exhibit 1. The qualified expense is a deductible medical expense subject to the 7.5% adjusted gross income (AGI) limit. For many individuals, this translates into no benefit at all, as their total medical and dental expenses do not meet the threshold. Without a tax benefit for deducting the qualified premiums on a Federal return, some states allow a credit for a portion of premiums paid.

For self-employed individuals (including partners and more-than-2% owners of S corporations), the qualified premiums are deductible subject to a 70% limit, which is scheduled to increase to 100% in 2003. The remainder of the premium (30% in 2002) is treated as a medical expense subject to the 7.5% AGI limit.

For C corporations, the premiums are deductible without regard to the age-based limits. Premiums for spouses and dependents are also deductible; there is no requirement to provide the benefit on a nondiscriminatory basis.

Example 1: D is the sole shareholder of a C corporation with 10 employees. The business has done very well and D is proud of all the hard work he has put into this business over the past years. He has no plans to sell the business and is acutely aware of the double taxation on C profits. In an effort to avoid double taxation, D's tax adviser suggested that D fully fund his retirement plan, maximize fringe benefits, make use of a bona fide corporate loan (to the extent of any earnings and profits) and pay out the remainder in salary.

Even after implementing the recommendations, D has been paying himself an annual salary of $150,000 to eliminate any corporate-level tax. D's wife recently received a large salary increase and they now have a combined Federal and state marginal tax rate of 47%.

D and his wife are both 55. Their net worth is over $600,000, and they wish to leave as much of it as possible to their children and favorite charity. They have recently become aware of the need to shop for an LTC insurance policy.

D decides that instead of paying himself an additional $4,000 in salary, the corporation can purchase an LTC insurance policy on his behalf (and include his wife and dependents). This amount is fully deductible by the corporation without regard to a $900 age-based limit.

As a result, D does not have to pay a combined Federal and state tax of $1,880 (0.47 x $4,000) on the additional $4,000, a $58 Medicare tax (employee share, .0145 x $4,000), or a $45 Medicare tax (employer's share (.0145 x $4,000,1ess a $13 tax saving for the corporate deduction)). The net savings are $1,983, or nearly 50% of the premium cost of the LTC insurance.

Under current law, if D had purchased the policy as an individual, he would have been allowed a tax deduction up to $900 of the qualified premiums paid. However, because his medical and dental expenses do not exceed 7.5% of his AGI, the actual tax benefit is zero (see Exhibit 2 for a comparison of the tax consequences of purchasing LTC insurance through various business forms).

Policy Considerations

D's corporation has to consider the extent (if any) to which it is willing to pay for policies for nonowners. Even if the corporation does not pay any nonowner premiums, employees might be eligible for an endorsed group discount (normally 10-20%).

In addition to an insurer's financial strength, and the benefits, costs and benefit triggers, etc., of purchasing an LTC insurance policy, a 10-pay option and a nonforfeiture provision are important in choosing a policy.

The 10-pay rider allows a subscriber to fully pay for a policy in 10 years. While this significantly increases the premium, it cuts down the number of years the subscriber will pay premiums. Also, the subscriber will avoid potential premium increases that take effect after paying the policy. (Most expect premiums to go up in the future, predicting a large increase in claims over the next 10 to 15 years.)

A nonforfeiture provision allows a full return of premiums paid to a subscriber's beneficiary or to the corporation. Under normal circumstances, the additional premiums for the nonforfeiture rider may be better spent on an alternate investment.

Example 2: The facts are the same as in Example 1, and the C corporation purchases a nonforfeiture rider, which adds 75% to its premiums, or $3,000 annually: The insured's life expectancy is 22 years. The net cost of the additional premiums after accounting for tax savings is $1,500. Using a 7% discount rate, the present value of the additional payments over 22 years is $16,592. This additional investment will yield $154,000 ($7,000 x 22 years) to the insured's beneficiary in 22 years. The rate of return on the $16,592 is 10.658%. Note: many carriers reduce the nonforfeiture amount by claims paid under the policy.

In Example 2, the return on the additional premiums paid for the nonforfeiture rider can be appealing, keeping in mind that the value of the nonforfeiture provision depends first on establishing a need for the LTC insurance. Without the need, the $4,000 would be better spent on other benefits or a more appropriate investment vehicle.

With or without a nonforfeiture rider, purchasing LTC insurance through a C corporation provides the most cost-effective way to obtain this coverage.

FROM MICHAEL W. MCGOWAN, CPA, PFS, CFP, MCGOWAN-LAUGHLIN FINANCIAL SERVICES, INC., AND JOHN W. LAUGHLIN, CPA, PA, CHARLOTTE, NC (NEITHER AFFILIATED WITH BAKER TILLY INTERNATIONAL)

Exhibit 1: 2002 Limits on Tax
Deductibility of LTC Insurance Premiums

Age 40 or less        $240
Age 41-50             $450
Age 51-60             $900
Age 61-70             $2,390
71 or older           $2,990

Note: These limits may increase, based on the
medical-care component of the Consumer
Price Index.
Exhibit 2: Tax Benefit Comparisons of Paying for LTC Insurance

                                            C               S
                        Individuals     corporation     corporation

Premium cost                 $4,000          $4,000         $4,000

Entity-level net                N/A           0 (1)          0 (2)
income tax benefit

FICA/Medicare                     0        $103 (5)      $89 (6)/0
savings

Individual tax                 $900      $4,000 (7)       $630 (8)
deduction

Individual tax                0 (9)          $1,880           $296
benefit (47%)

After-tax cost
of $4,000
premium                      $4,000          $2,017         $3,615

                      Self-employed    Partnerships

Premium cost                 $4,000          $4,000

Entity-level net              0 (3)            0 (4)
income tax benefit

FICA/Medicare                     0                0
savings

Individual tax             $630 (8)         $630 (8)
deduction

Individual tax                 $296             $296
benefit (47%)

After-tax cost
of $4,000
premium                      $3,704           $3,704

(1) A C corporation can deduct either the $4,000 salary paid or the
$4,000 LTC insurance premium. D chose to pay for the insurance premiums
versus paying himself an additional $4,000 in salary. For many large
corporations, the choice will not be that simple; as such, the total
tax savings will be the additional $4,000 corporate tax deduction for
the LTC insurance premiums paid.

(2) The S corporation cannot deduct the LTC premiums paid on behalf of
more-than-2% shareholders.

(3) No deduction is allowed in determining net earnings from
self-employment, but the deduction is on adjustment to income. If a
sole proprietor employs his spouse, the cost of her premiums plus those
of her spouse and dependent would be deductible in determining net
earnings from self-employment.

(4) Under Rev. Rul. 91-26, LTC premium payments are either treated as
compensation for services (considered guaranteed payments and deducted
as such) or as a reduction in a partner's distributive share, not
deductible by the partnership.

(5) $4,000 x .029 (Medicare portion only), less the $13 corporate tax
benefit of the employer's half share ($58 x .22).

(6) Assuming that additional salary would be paid in lieu of the LTC
premiums, Medicare savings equal $116 (.029 x $4,000), less the
employer's $58 tax deduction, which would reduce the employee's
flowthrough income (taxed at 47%, or $27).

(7) No tax deduction, but a $4,000 reduction in taxable income (wages).

(8) $900 x 0.6. No benefit for the remaining 30%, as total medical and
dental expenses do not exceed 7.5% of AGI.

(9) Assuming total medical and dental expenses do not exceed 7.5% of
AGI.