Your long-term care insurance policy may pay out tens of thousands of dollars per year in benefits if you end up needing care. However, the IRS paperwork for these policies can be confusing, and you may be wondering whether you'll be taxed on any of the benefits you receive. Here's what you need to know about long-term care benefit taxes.

Are Long-Term Care Benefits Taxable?

When you receive benefits from a long-term care insurance policy, you typically won't owe taxes. The IRS treats these payouts similarly to reimbursements for medical expenses, which they don't consider taxable income.

This applies if the insurance company pays your long-term care bills directly or if they send you cash as a per diem to cover your bills. If you receive money from a hybrid life insurance policy with a long-term care rider (an extra benefit that pays out while you're in need of long-term care), this tax policy also applies. Another tax advantage for standalone long-term care insurance is that your plan's premiums are tax-deductible as well. This is based on your age and the percentage (7.5% or more) of your adjusted gross income spent on combined medical expenses.

What About the Tax Paperwork?

People might think long-term care benefits are taxable because of how the paperwork goes out. When you receive benefits, the insurance company sends you a 1099-LTC tax form showing what they paid, which may lead you to believe you owe taxes.

However, the 1099-LTC form helps with IRS record-keeping — it doesn't mean you owe income tax on long-term care. When your insurance company pays your bills directly or reimburses you, you don't need to file anything. If they pay you a per diem, you need to record how much you receive plus your long-term care expenses on IRS Form 8853. In nearly all cases, the end result is that you won't owe any taxes on your benefits.

Are There Any Exceptions?

If you receive cash on a per diem basis, there is a limit to how much of it can be tax-free. As of 2021, the maximum is up to $400 per day. This is true even if your daily long-term care expenses are under $400. If your policy pays more than the limit and your expenses are lower than what you receive, the excess counts as taxable income. For example, if you receive $450 a day and your expenses are only $400 a day, the extra $50 is taxable.

The rules also depend on whether you have a tax-qualified or non-tax-qualified policy. For a policy to be tax-qualified, it must meet certain rules determined by the IRS, such as paying out only if you have a condition predicted to last longer than 90 days. A stay in a short-term care facility wouldn't qualify.

Insurers have some flexibility in designing the benefits of nonqualified policies, but the tax treatment is not as generous and doesn't allow deduction of premiums. Also, the IRS hasn't declared whether benefits from a nonqualified policy will count as taxable income in the future, so while it doesn't currently tax these benefits, this regulation could change.

How Can You Prepare for Taxes?

You should ask your insurer whether your long-term care insurance policy is tax-qualified or nonqualified. These days, most policies are qualified, but if yours is nonqualified, you may want to prepare by saving for potential taxes. Alternatively, you could explore converting your policy into a qualified one. If your policy offers a per diem benefit, you could also ask your insurer whether it's possible to remain within the daily limit so that you can receive everything tax-free.

For more advice, consult with your insurance professional or a tax advisor specializing in insurance planning. You'll likely receive everything tax-free, but you want to know for certain what's outlined in your contract.