In the case of employer-provided medical expense insurance benefits, employer contributions are deductible by the employer and are generally not taxable income to the employee. Benefits received by an employee are not taxable to an employee unless they exceed the medical expenses incurred. In self-insured medical expense reimbursement plans, benefits to highly compensated employees may be taxable if the plan discriminates in favor of such individuals. Because health insurance benefits realistically are not available for other types of consumption or for savings, it is logical that they should not be subject to a tax levied on net income. Another important policy justification for the health benefit exclusion is to encourage the purchase of private insurance to minimize the role of government in bearing the burden of health care costs.
Disability Income Benefits
As with all types of health insurance benefits, premiums (or other employer contributions) paid by an employer for disability income insurance for employees are generally tax deductible by the employer and are not taxable income to the employee. Employee contributions, on the other hand, are not tax deductible by the employee. Consistent with these two rules, the payment of benefits under an insured plan or a non-insured salary continuation plan result in taxable income to the employee to the extent that benefits received are attributable to employer contributions. Thus, under a noncontributory plan, the benefits are included in an employee’s gross income. Under a partially contributory plan, benefits attributable to employee contributions are received free of federal income taxation and benefits attributable to employer contributions are includable in gross income (employees are eligible for a tax credit, however). A tax credit is available to persons who are totally and permanently disabled. This credit is taken on the employee’s federal income tax return. The maximum credit is $750 for a single person and $1,125 for a married person filing jointly.
Long-Term Care Plans
It is easy to conclude that health insurance benefits utilized to pay for an operation or a physician’s examination should, as a matter of public and tax policy, be excludable from income. However, uncertainty has existed about the tax treatment of LTC mainly because LTC involves a combination of services, some of which are health care and others of which appear more like personal items (e.g., room and board in an assisted living facility). This uncertainty was resolved for certain types of policies with enactment of HIPAA. The legislation clarified that qualified LTC costs and benefits generally will be treated the same as other health costs and benefits.
If policies and insurers follow the consumer protection standards included in the law, such policies receive the following tax treatment:
• In general, benefits are excluded from taxable income. Benefits paid by per diem—based policies are tax free up to $175 a day, indexed for inflation. Insurers must report to the IRS the amount of LTC insurance benefits paid.
• Insurance premiums and out-of-pocket spending for LTC services qualify as medical expense deductions subject to the standard limitation. There are limits on the premium deduction based on age.
• Self-employed individuals can deduct LTC insurance premiums from their income, beginning with 40 percent in 1997 and ultimately reaching 80 percent of the premium in 2006.
• Employer contributions to an employee’s LTC premium are excluded from taxable income of the employee. LTC insurance cannot be offered, however, as part of a cafeteria plan.
Passage of HIPAA is expected to increase interest in LTC insurance through the tax changes. Additionally, many consumers will learn about ETC insurance for the first time as a result of learning about the new tax treatment.