I know this is an old post but I ran across it looking for something else, and thought for the sake of your argument you might find this helpful. The Internal Revenue Code Section 7702B(a)(2) reads:
"amounts (other than policyholder dividends, as defined in section 808, or premium refunds) received under a qualified long-term care insurance contract shall be treated as amounts received for personal injuries and sickness and shall be treated as reimbursement for expenses actually incurred for medical care (as defined in section 213(d)),"
As far as it being taxation of the reimbursement because you can't deduct the expense, I don't think so. If you spend $100 on LTC and get reimbursed $100, then you have really spent $0 and so there's nothing to deduct.
