IRS Issues Final Regulations On Deduction Limitation For Remuneration Paid By Health Insurance Providers

The IRS has released final regulations on the application of the $500,000 deduction limitation for remuneration provided by certain health insurance providers under Code Sec. 162(m)(6), which was added by the Patient Protection and Affordable Care Act (ACA). This section limits to $500,000 the allowable deduction for remuneration attributable to services performed by an applicable individual for a covered health insurance provider (CHIP) in a tax year beginning after Dec. 31, 2012, that would otherwise be deductible. Remuneration attributable to services performed for a CHIP in 2010, 2011, or 2012 that becomes otherwise deductible in 2013 or later is also subject to the $500,000 deduction limitation. The final regulations adopt, as amended, proposed regulations issued in 2013, in light of comments received by the IRS. The regulations are effective on Sept. 23, 2014, and apply to tax years beginning on or after that date. In addition, taxpayers may rely on the final regulations for tax years beginning on or before Sept. 23, 2014. The final regulations were published in the September 23 Federal Register.

Definition of covered health insurance provider. A “covered health insurance provider” is an employer that issues health insurance and receives premiums from providing health insurance coverage, if 25 percent or more of those premiums are from minimum essential coverage, for 2013 and later years; for 2010 through 2012, the definition is the same but without the 25 percent minimum. Two or more persons that are treated as a single employer under Code Sec. 414(b), (c), (m), or (o) also are so treated for purposes of determining whether a person is a CHIP. Each member of an aggregated group that includes a CHIP at any time during the tax year also is a CHIP for purposes of the deduction limitation, even if the member is not a health insurance issuer. The regulations provide rules for determining if a member of an aggregated group is a CHIP. An employer is not a CHIP solely because it maintains a self-insured medical reimbursement plan. Finally, there is a de minimis exception under which a person that would otherwise be a CHIP will not be considered to be one if the premiums the person receives from providing minimum essential coverage are less than two percent of the person’s gross revenue (a “person” here includes all other members of its aggregated group).

Disqualified taxable year. The final regulations provide that a disqualified taxable year is any tax year for which the employer is a CHIP.

Premiums. A health insurance issuer is a CHIP only if it receives premiums. The regulations provide that amounts received under an indemnity reinsurance contract and amounts that are direct service payments are not treated as premiums from providing health insurance coverage for purposes of the deduction limitation. Capitated, prepaid, periodic, or other payments (“direct service payments”) made by a health insurance issuer or other person that receives premiums from providing health insurance coverage to a third party as compensation for providing, managing, or arranging for the provision of health care services by physicians, hospitals, or other health care providers are not treated as premiums from providing health insurance coverage for purposes of the deduction limitation, regardless of whether the third party is subject to health care provider, health insurance, licensing, financial solvency, or other similar regulatory requirements under state law. Premiums under a stop-loss contract will not be considered premiums from providing health care coverage (stop-loss coverage allows an employer to self-insure for a set amount of claims costs, with the stop-loss coverage covering costs above that amount).

Applicable individual. An applicable individual is any individual who, during the tax year, (1) is an officer, director or employee of a CHIP, or (2) provides services for or on behalf of a CHIP. Under the final regulations, remuneration for services performed by an independent contractor to a CHIP will not be subject to the deduction limitation if certain conditions are met. Only an individual can be an applicable individual, and the IRS is concerned that some CHIPs may try to get around the deduction limitation by having employees for some sort of legal entity so as to avoid being classed as an applicable individual. The regulations do not adopt any specific solution to this potential abuse, and decline to rely on information reporting for this purpose. However, the regulations provide that the IRS and the Treasury Department may issue guidance in the future identifying situations in which services performed by an entity will be treated as services performed by an individual.

Applicable individual remuneration. Applicable individual remuneration (AIR) is the aggregate amount that is allowable as a deduction (without regard to Code Sec. 162(m)) with respect to an applicable individual for a disqualified taxable year for remuneration for services performed by an individual, except that AIR does not include any amount that is deferred deduction remuneration.

Deferred deduction remuneration. The final regulations state that deferred deduction remuneration (DDR) is remuneration that would be AIR for services that an applicable individual performs during a disqualified taxable year but for the fact that it is not deductible until a later tax year. This is what generally occurs, for example, with nonqualified deferred compensation.

Attribution of remuneration to services performed in tax years. The deduction limitation applies to AIR and DDR attributable to services performed by an applicable individual for a CHIP in a disqualified taxable year. At the time that an amount of AIR or DDR becomes otherwise deductible, and not before, the remuneration must be attributed to services performed during a particular tax year or years of a CHIP. The final regulations provide that remuneration is not attributable to a tax year during which the applicable individual is not a service provider. An issue raised by the proposed regulations was an appropriate method for attributing increases in an applicable individual’s benefit that accrue in tax years of a CHIP beginning after the individual ceases providing services (post-termination remuneration). The final regulations provide that each payment to or on behalf of an applicable individual will be attributed to tax years of a CHIP during which the applicable individual was a service provider in proportion to the increase in the individual’s benefit under the plan during those years. This approach is adopted for both account balance plans and nonaccount balance plans. Methods for attributing remuneration also are provided in the regulations, including the account balance ratio method and the principal additions method (for account balance plans) and the present value ratio method and the formula benefit ratio method (for nonaccount balance plans). The final regulations adopt, with some modifications, the rules from the proposed regulations concerning equity-based compensation, such as stock options, stock appreciation rights, restricted stock, and restricted stock units. Finally, the regulations also address involuntary separation pay and remuneration subject to a substantial risk of forfeiture.

Application of the $500,000 deduction limitation. The final regulations generally follow the proposed regulations in applying the deduction limitation. If AIR, DDR or a combination of those attributable to services performed by an applicable individual exceeds $500,000, the amount of remuneration exceeding that amount is not deductible in any year. When the deduction limitation is applied to AIR attributable to services performed by an applicable individual in a disqualified tax year, the deduction limit with respect to that applicable individual for that year is reduced, but not below zero, by the amount of the AIR to which the deduction limit is applied. If the applicable individual also has DDR attributable to services performed in that year that becomes otherwise deductible in a later year, the deduction limit, as reduced, is applied to that amount of DDR in the first year in which that DDR becomes otherwise deductible. If the DDR that becomes otherwise deductible is less than the reduced deduction limit, then the full amount of the DDR is deductible in that year. To the extent that the amount of the DDR exceeds the reduced deduction limit, the CHIP’s deduction for the DDR is limited to the amount of the reduced deduction limit and the amount of the DDR that exceeds the deduction limit cannot be deducted in any taxable year. The final regulations also adopt the proposed rules on application of the deduction limitation to payments.

Corporations. The final regulations address corporation transactions, including corporations that become CHIPs, transition period relief, certain applicable individuals not treated as a CHIP but still subject to the deduction limitation, consistency rule relief, and a de minimis rule.

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