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Health Insurance and Taxation
Terms in this set (13)
To understand how health insurance is taxed, we need to organize coverage into the following groups:
Individually owned; Group; Sole proprietors and partners; Business. Then we'll discuss the taxation of disability insurance, Medicare Supplement insurance, and long-term care insurance. We'll conclude by addressing the taxation of government health programs.
Taxation of Individual Policies
The premiums for individually owned accident, health, disability, or longterm care policies generally are not deductible to the individual taxpayer. However, if the taxpayer's medical expenses exceed 10% of adjusted gross income during a taxable year, any medical expenses, including premiums for accident and health insurance (but not disability insurance), incurred above the 10% threshold can be deducted. For long-term care insurance, there is an annual dollar limit for deductions. This limit is based on the taxpayer's age. Benefits paid by individually owned accident, health, disability, or long-term care policies generally are received income-tax free by the taxpayer, provided the benefits do not exceed actual expenses. Congress has determined that individual long-term care insurance policies must be treated the same as accident and health policies tax wise, as long as such policies are qualified according to federal law. Individual premiums may be deductible if the 10% of adjusted gross income threshold is exceeded. All qualified long-term care policy benefits are received income-tax free, so long as they do not exceed actual expenses. As for nonqualified long-term care policy premiums and benefits, it's not clear what their precise status is. Until Congress or the IRS clarifies that status, however, it would be wise to treat nonqualified policies as if they did not have the tax advantages of qualified policies.
Taxation of Group Policies
The premiums paid by a company for group accident, health, and dental coverage for its employees are generally deductible by the company as a business expense. The premiums are not taxed to the employees. The benefits are received by the employees income-tax free to the extent the benefits do not exceed actual expenses. The premiums paid by a company for group disability insurance for its employees are generally deductible by the company as a business expense. The premiums are not taxed to the employees, but the benefits are taxable. However, if an employee pays all or part of the premiums for group disability coverage, he may not deduct these premiums, but the benefits will be received income-tax free to the extent that the employee paid the premiums. disability benefits are subject to Social Security tax (FICA) and federal unemployment tax (FUTA) for the first six calendar months following the last month the employee was on the job. Group accidental death and dismemberment coverage premiums may be deducted as a business expense by companies. The premiums are not taxable to the employees, and the benefits are received income-tax free. Qualified group long-term care insurance, like individually owned longterm care, is treated the same as other group health policies. Companies offering this coverage may deduct any premiums paid as a business expense. The employee is not taxed on these premiums, and the benefits are tax exempt. Companies offering group long-term care coverage can deduct any premiums paid as a business expense. The employee is not taxed on these premiums, and the benefits are tax exempt. However, these tax advantages do not apply to group long-term care coverage provided through a Section 125 cafeteria plan, and expenses for long-term care services cannot be reimbursed under flexible spending arrangements.
Taxation of Group Policies example
Wanda's company pays the entire premium for her group disability coverage. If Wanda became disabled, all of her benefits from this coverage would be subject to tax. However, if Wanda paid 50% of the premiums, then 50% of her benefits would be tax free. And if she paid 100% of the premiums, all of her benefits would be tax free.
Taxation of Sole Proprietors and Partnerships
Self-employed persons are allowed to deduct from their gross incomes 100% of the amount they pay for health insurance (including qualified longterm care insurance). To claim this deduction, however, self-employed persons must show a net profit for the year; and cannot claim the deduction for any month in which they were eligible to participate in a health plan subsidized by their employer or by the employer of their spouse. Payments of premiums by a partnership for a partner's accident and health insurance policy is generally deductible by the partnership. The amount of the premiums is included in the partner's gross income, but it is deductible on the same basis as that for self-employed persons.
Taxation of Business Policies
The premiums paid for business overhead expense insurance are deductible as a business expense whether the business is a sole proprietorship, partnership, or corporation. The proceeds of business overhead expense insurance, however, are taxable. The premiums paid for a disability policy used to fund a buy-sell agreement are not deductible, nor are the proceeds taxable. Similarly, the premiums paid for a key employee disability policy are not deductible, nor are the proceeds taxable.
Disability Income Insurance
Premiums paid by the insured for individually owned disability income insurance are not tax deductible. However, benefits paid in this type of situation are tax free to the insured. In situations in which the business is providing disability income coverage for its employees, the premium paid by the business is tax deductible as a business expense. This is true whether the coverage is provided by a group policy or individual contracts. Naturally, the benefits received by the employees would then be taxable as income. In situations where the business is providing disability income coverage to protect itself (e.g., key person or disability buy-sell insurance), premiums paid by the business are not tax deductible as a business expense. The basic premise is that either the premium or the benefit will be taxed. If the premium is not deductible to the business, the benefits will be received tax free. If the premium is deductible, then the benefits are taxable as with the BOE policy.
Medicare Supplement and Long-Term Care Insurance
Individual Medicare supplement insurance premiums are considered deductible medical expenses to the extent that the combination of premiums paid plus other unreimbursed medical expenses exceeds 10% of adjusted gross income. Benefits are considered reimbursements for medical expenses already incurred and are therefore received tax free. Premiums paid by an employer for group Medicare supplement insurance are tax deductible to the employer, and benefits are received tax free. The Health Insurance Portability and Accountability Act of 1996 provided that premiums paid for individually owned long-term care insurance are tax deductible to the extent that combined premiums and unreimbursed medical expenses exceed 10% of adjusted gross income. Premiums for group LTC insurance paid by employers are deductible as a business expense, but the coverage cannot be part of a cafeteria plan or flexible spending account. Benefits are received tax free up to specified limits, which are indexed annually for inflation. LTC policies issued on or after January 1, 1997, must meet federal standards for tax-qualified status. LTC policies issued before that date are grandfathered and are automatically tax qualified. The federal standards establish new eligibility requirements. The individual must be certified by a licensed health care professional to be chronically ill with a condition that is expected to last at least 90 days and must have a plan of care. The individual must be recertified as chronically ill on an annual basis. The new federal standards also establish consumer protection standards such as guaranteed renewability and the option to add inflation protection and nonforfeiture benefits (but not in the form of cash surrender values) and impose new disclosure requirements.
Chronically ill means that the individual:
is unable without substantial help from another person to perform at least two of five (or six) activities of daily living for at least 90 days (ADLs include bathing, dressing, toileting, transferring, eating, and continence; state legislatures determine whether to include five or all six of the ADLs); and needs substantial supervision because of a cognitive impairment (i.e., Alzheimer's disease).
Medicare Part A Hospital Insurance is funded by
Social security payroll taxes
Medicare Part B hospital insurance is funded by
Premiums from Beneficiaries and general tax revenue
Social Security Disability Benefits
Social Security disability benefits are financed through a payroll tax. The tax rate is applied to an employee's gross wages (up to the current wage base), and an appropriate amount is deducted from the employee's wages each pay period. A like amount is contributed by the employer. The self-employed must pay 100% of the combined employee/employer tax rate. Although employers may take a tax deduction for contributions on behalf of their employees as a routine and necessary cost of doing business, employees are not entitled to a deduction for their share of the Social Security tax. In other words, employee Social Security taxes are paid with after-tax dollars.
Taxation of Social Security Benefits
Social Security benefits are generally received free of income tax. However, federal income taxes are imposed on some benefits if the taxpayer has a substantial amount of additional income. The specifics of the calculations are not important at this stage of your training. However, it is important to understand that Social Security benefits may not be entirely free from federal income taxes.
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