When determining how much, if any, of a refund for long-term care insurance premiums is included in income, the following considerations must be taken into account:
1. Tax Benefit Test: If the taxpayer received a tax benefit by deducting the long-term care insurance premiums as a medical deduction in a prior year, the refund would be taxable to the extent of the benefit received.
When determining the taxable portion of a refund of long-term care (LTC) premiums under the tax benefit rule, the annually inflation-adjusted LTC premium limitation is relevant. This limitation affects the amount of LTC premiums that can be treated as medical expenses for deduction purposes on your tax return.
According to IRC Sec 213(d)(10), the maximum amount of long-term care premiums that can be considered medical expenses is indexed for inflation and varies depending on the age of the insured. If you receive a refund for LTC premiums and had previously deducted these premiums as medical expenses, the refund is taxable to the extent that you received a tax benefit from those deductions. However, only the deductible portion of the premiums (up to the applicable inflation-adjusted limitation) that contributed to the tax benefit would be included in taxable income.
To summarize, if you receive a refund for LTC premiums and previously deducted those premiums, the taxable portion is determined by considering the portion of the refunded premiums that was deducted and provided a tax benefit, constrained by the inflation-adjusted LTC premium limits for the relevant tax years.
2. Look Back Years: When applying the tax benefit rule, specifically under IRC Sec 111, the taxpayer or their advisors typically use a six-year lookback period. This is in line with the regulations that require disclosures if the transaction of interest occurred within the six-year period immediately preceding the taxpayer's most recent taxable year.
This six-year timeframe aligns with other IRS provisions such as the requirement for material advisors of transactions of interest to maintain lists of advisees, provided the transaction did not occur more than six years ago. It's essentially a rule of thumb for how far back one needs to consider when determining the tax benefit from a prior deduction.
3. Deceased Taxpayer: If the taxpayer is deceased at the time the refund is received, it becomes income in respect of a decedent (IRD). This means it would be taxable to the extent it would have been taxable to the taxpayer if they had received the refund while still living.
4. Application to Future Premiums: If the refund is applied to future premiums, it is generally not taxable unless otherwise specified by certain rules, like those concerning the death of the taxpayer, as there will be no future premiums to pay in that case.