#270 | Clash of the Insurance Titans
As shared in December, Ramona Neal independently publishes data and articles about Hybrid products and LTC/Chronic Illness riders on her website, Living Benefit Review, https://livingbenefitreview.com. She has graciously offered to publish one of her articles every quarter on The Life Product Review. Ramona is also providing a discounted rate for TLPR subscribers who also want to subscribe to Living Benefit Review. Simply go to her “Join” page, then click Individual subscriptions and fill in your information, click “Have a Coupon?” and enter: Q8UIIGE9M to receive $200 off a $1k annual subscription. Enjoy the article and check out her site
The Hybrid-Linked Benefit product category for life insurance has been growing remarkably. Ten years ago, three insurers were in this market. Today, there are nine companies with two more poised to enter. Hybrid products have become a welcome alternative to Traditional Long Term Care insurance (T-LTC) for both advisors and consumers. All the life insurance Hybrid products offer the security of guaranteed premiums, a guaranteed death benefit and a base guaranteed LTC benefit pool (including those on a VUL and IUL chassis). So, while T-LTC sales declined due to insurers’ mass exodus of this market and due to advisors’ abandonment (to avoid in-force rate increases), Hybrid products continue to flourish.
Some Hybrid insurers promote that individuals can have a portion of their total premium be eligible for a tax deduction. Specifically, if they itemize their taxes, then they may qualify for a deduction of the LTC premium portion, as a medical expense (amount varies by age) subject to the AGI threshold (for total medical expenses in excess of 7.5% of AGI). These insurers also promote the option of using HSA dollars to pay the LTC premium portion (amounts vary by age). They also market lucrative business applications with tax preferred methods of purchasing Hybrid products. The taxation and tax deductions vary depending on the type of entity (C-Corp, S-Corp, Partnership, Sole Proprietor, Voluntary Worksite etc.). See third party site for additional detail and tax flow chart: Rules For Tax Deductibility Of Long-Term Care Insurance (kitces.com)
Two Opposing Views
Yes, Tax Deductible: For the insurers who recognize tax deductibility they do so based off the premise that “separate identifiable” premiums are used to pay the LTC portion of the Hybrid premium. Specifically, the premiums that qualify are the base LTC Rider, the LTC Extension of benefits, and the LTC Inflation benefit. (But not the premiums associated with the life insurance). Examples of citations referenced:
- IRC section 7702B(e) prohibits a deduction for LTC rider premium payments when such payments are made as a charge against the cash surrender value (CSV) of a life insurance contract. However, if the LTC rider premiums are not a charge against the CSV, a deduction may be available (subject to AGI) and only the eligible LTC premiums (varies by age) can be deducted as specified in IRC Sec 213(d)(10).
Not Tax Deductible: At least one market leader takes the position that just because LTC rider charges are “separated” from each premium payment, doesn’t mean that clients are eligible for a tax deduction. They maintain that doing so is inconsistent with the intent of IRC Sec 7702B(e)(1) and (2). They acknowledge that prior to the Pension Protection Act (PPA) of 2006, LTC rider premiums were deductible as a medical expense. However, they stress it was the intent of Congress to change this tax treatment citing:
- IRC Sec 7702B(e)(2) specifically affirms that no portion of the premium for the LTC rider charges is deductible as a medical expense. The regulation states “…if such a payment is made as a charge against the CSV of a life insurance contract”. As a result, some insurers use this to justify allowing the deduction. Basically, their logic appears to be that by intercepting the LTC charges before they become part of the CV in the policy, warrants making the LTC charges deductible as a medical expense.
- Substance over Form: The IRS has long held that the substance of a transaction is more important than the form of the transactions. So, in this instance, it’s notable that the LTC rider cannot be purchased separately from life insurance contract. And should the Hybrid policy itself lapse, then we know the LTC rider(s) also lapse. Furthermore, IRC Sec 7702B(e)(1) states that the LTC riders on a Hybrid product are treated as if it were a separate contract.
Author’s Note: As it relates to “intercepting” the LTC premiums before the remainder premium is allocated to the CV of the life policy, companies can go to great lengths to segregate the LTC premiums from the life premiums. They may even report them separately on client statements. Basically, only the life insurance premium is added to the policies’ CV where monthly deductions and interest crediting apply.
The obvious problem and elephant weighing on the shoulders of Hybrid carriers is that two diametrically opposing views can’t both be correct. Either the LTC rider charges are eligible for tax deductions in certain instances, or they are not. The undeniable conclusion is either:
- If the “Yes, Tax-Deductible” Insurers are Wrong, then Houston, we have a problem. It would mean individual taxpayers and business owners/employees who claimed a deduction made a mistake. It could mean they have to file amended return(s) and even if they don’t, if they are audited, then they could have to pay the back taxes and penalties. And do you know what else it could mean for advisors? Your clients may be outraged, especially if you introduced the idea to begin with. To be fair, it’s unlikely that you personally gave tax advice. Instead, their tax advisor is ultimately accountable (in fact, the attorneys or accountants could be at risk of having preparer penalties levied against them). Still, would they pull their business from you? Will they move their entire portfolio?
- If the “Not Tax-Deductible” Insurers are Wrong, then let me count the ways of lost opportunities. Think about the millions in lost premium for these insurers had they designed their product with “separate identifiable” premiums? Think about the lost tax deduction opportunities for business entities and individual taxpayers who bought their products? For advisors it could mean your clients (especially business owners) are outraged for your not offering a Hybrid solution that could’ve saved them money. Will they write more new business with you? Will they try to rescue their Hybrids and 1035 them to ones which allow for future tax deductions? Is the business currently sitting in free look, at risk of being pulled?
As we can see the ramifications either way are troubling. Nevertheless, I think insurers on both sides have clean hands. Go ahead, take a look at the disclosures on their literature which are always consistent and precisely clear. They Do Not Give Tax or Legal Advice. Period. They are in the business of selling insurance. And it’s good business to promote advanced sales applications and refer advisors/clients to their tax advisors or legal counsel.
The Solution: Where’s the PLR?
Inquiring minds may be wondering where the Private Letter Ruling (PLR) is which could help clear this up? I asked 5 Hybrid insurers a month ago and just as expected haven’t heard a peep (on the record). If a PLR has been filed or a ruling has been secured, then I’m unaware. I speculate that the risk reward trade off makes it not worth filing for the insurers that promote tax deductibility. (i.e., They are confident they are correct, so why file? Plus, they may contemplate there is a small risk the IRS won’t rule in favor of their position).
For those that have designs which don’t support tax deductibility, I speculate it wouldn’t be a priority for them to file one. (Although, if they did secure a ruling which gave them a Green Light on tax deductibility, then their future product design could take advantage of “separate identifiable” premiums to promote the deduction. Plus, they would have bragging rights for having taken the high road for being the first to secure the ruling to begin with).
Unfortunately, getting a PLR is easier said than done. It can be time consuming, and the user fees can be hefty. Then after all the hassle, the reality is, PLR’s should technically not to be relied on as precedent by other taxpayers or IRS personnel anyways. Sigh.
Which View is Right, and Which is Wrong?
When we attempt to consider who got it right and who got it wrong, obviously the tax code is unclear to the point of where even experts sitting in the ivory towers can’t agree. Think about the hundreds of years of combined experience from insurance professionals (attorneys, CPA’s, master’s in taxation, etc.). Needless to say, I have the common sense to not opine. The only thing I can offer is – the same that a gambling man can: a gut instinct rooted in probability. I can offer that 5 out of the 9 Hybrid companies have “modernized” products with “separate identifiable” premium designs and that’s noteworthy (3 of them are “built-in” on a WL chassis). I can offer the fact that one market leader has had this design for 20+ yrs. Accordingly, it stands to reason that numerous prominent CPA firms across the country have thoroughly vetted this with both their individual and business clients.
Let’s assume for a moment that the IRS were teetering on the fence with this issue. The question is, which way would they be more likely to fall? I think a gambling man would consider Congress’s state of mind on the intent of the PPA, together with its guidance on IRC 7702B(e)(1) and (2), combined with the spirit of the definition of qualified LTC in 7702B(b). A primary objective of the PPA was to incentivize the purchase of LTC insurance. We can presume it’s a given, that our government would rather have consumers and insurers pay for care vs. consumers spending down their assets and relying on Medicaid. So, my speculative wager is – with certain product designs, in certain instances, that Yes, taxpayers are eligible for a deduction of qualified LTC premiums. Could it really be this straightforward, where it comes down to a matter of plain policy architecture? Still, the potential impact of the “substance over form doctrine” is troubling. It truly would be helpful to have a PLR.
As Hybrid products continue to grow in popularity, the insurance industry is prepared to welcome new T-LTC companies into the fold with their own Hybrid offerings. These products provide consumers with much needed life insurance and/or LTC. Consequently, regardless of where one stands on this tax controversary… And, regardless of whether you are the product manufacturer, distributor, or the selling agent… May the odds be ever in your favor.
Ramona Neal, CLU, ChFC, CLTC, REBC
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