IRS Posts Retiree Drug Subsidy Taxation FAQs

The Internal Revenue Service has posted on its website frequently asked questions (FAQs) regarding Retiree Drug Subsidy (RDS) taxation. These FAQs include scenarios on RDS-related tax provisions for plan sponsors.

Background. Under Code Sec. 139A, special subsidy payments (a retiree drug subsidy, or RDS, payment) are not included in the gross income of plan sponsors. Plan sponsors receive RDS payments based on the allowable retiree costs for certain qualified retiree prescription drug plans.

Generally, taxpayers may not deduct costs that are reimbursed, for which they have a right of reimbursement, or that relate to income on which the taxpayers were not taxed (excluded income). However, for taxable years beginning on or before Dec. 31, 2012, Code Sec. 139A provides an exception that allows plan sponsors to disregard the excluded income for purposes of determining the deductibility of their costs for the plan year for which they received the subsidy. This exception generally results in a greater deductible amount than if the exception did not apply.

For taxable years beginning after Dec. 31, 2012, Code Sec. 139A has been amended to remove the language that allows plan sponsors to disregard the excluded income for purposes of determining whether a deduction is allowable for subsidized costs. Accordingly, plan sponsors may continue to exclude the RDS payments from gross income, but will be subject to the normal rules disallowing a deduction for expenses for which the sponsors are reimbursed, have a right of reimbursement, or relate to excluded income.

Federal tax consequences. The FAQs provide information on the federal tax consequences to a plan sponsor that pays or incurs retiree prescription drug costs in a plan year, receives or has a right to receive an RDS payment related to those costs, and undergoes reconciliation in a later year.

Among the issues that the FAQs address is how RDS payments affect the amount allowable as a deduction for costs incurred in 2012 and 2013 where a plan sponsor’s taxable year and plan year are different.

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