Internal Revenue Code Section 162(m)(6)'s limit on compensation deductions for "covered health insurance providers" (CHIPs) has impacted the financial statements of some health insurers for several years, but the limitation is first effective for deductions for compensation paid in 2013. On April 2, 2013, the IRS issued proposed regulations, the first formal guidance on this provision since Notice 2011-2. Notice 2011-2 provided some relief for companies that are not CHIPS as of January 1, 2013, for reinsurers, and for companies with very limited revenue from providing minimum essential coverage.
The proposed regulations continue the relief provided in Notice 2011-2. They also address some critical issues related to compensation and entities impacted by the limitation and how to apply the limit to "deferred deduction remuneration" (that is, compensation earned in one year and paid in another). While the regulations leave some problematic issues unresolved, the IRS requests comments on those issues.
Guidance on Entities and Compensation Impacted by Limitation
In addition to adopting the guidance provided in Notice 2011-2, the proposed regulations provide that:
- While an employer is not a CHIP solely because it maintains a self-insured medical reimbursement plan (even if funded through a VEBA), a captive insurance company may be a CHIP;
- Payments by a health insurer to a third party for managing or providing health care services are not premiums from providing health insurance coverage for purposes of determining whether that third party is a CHIP; and
- Equity-based compensation granted in a taxable year beginning before January 1, 2010, is not subject to Section 162(m)(6), even if it vests later. Similarly, for account and non-account balance plans, the account balance or present value of the benefit (regardless of whether vested) at the end of the last tax year beginning before January 1, 2010, will not be subject to 162(m)(6).
The regulations leave unresolved the issue of whether Section 162(m)(6) applies to remuneration paid to entities other than natural persons (for example, corporations or partnerships for which doctors are performing services). The IRS cites a concern that companies will try to escape the limitation by, for example, encouraging service providers to incorporate, and it invites comments on this issue.
Guidance on How to Apply Limitation to Deferred Deduction Remuneration
Unlike the $1 million deduction limitation under Section 162(m)(1) (which applies to compensation in the year in which it would be otherwise deductible), the Section 162(m)(6) limitation applies to "deferred deduction remuneration" in earlier years — generally the year or years in which earned. That requires companies to attribute deferred deduction remuneration among prior years and to test those amounts against the unused deduction limitations for those years. In attributing deferred deduction remuneration, companies looked to the limited guidance provided under a TARP-related provision (Code Section 162(m)(5)) in Notice 2008-94. The proposed regulations go into greater detail than that Notice and provide examples of how the attribution rules work. The proposed regulations also offer some choice of attribution methods; however, as the preamble notes, the ability to change any choice may be limited, so it is important for companies to model different scenarios before making those choices. Below are some of the key proposed provisions on attributing deferred deduction remuneration:
Account Balance Plans. Account balance plans have a choice between:
- The "standard" method, which attributes the increase in account balance (principal contributions and earnings or interest) for a taxable year to that year, regardless of when the services were performed that entitled the employee to the principal contribution associated with the earnings or interest; and
- The "alternative" method, in which the earnings or interest associated with any principal contribution are attributed to the same year as the principal contribution.
Non-Account Balance Plans. The treatment is similar to the "standard" method for account balance plans: the present value of the benefit is calculated at the end of the tax year, applying the rules for calculations under Section 3121(v), and is compared to the present value at the end of the prior year, with any increase attributed to the current year.
Impact of Vesting Schedules. If the compensation was subject to risk of forfeiture, it is first attributed as described above; then, the total amount attributable to the tax years over which the benefit vests is reallocated on a pro rata basis to each year within the vesting period, based on the vesting period days within each year. The regulations do not specifically address differences in how this might work for plans with cliff vesting versus plans with graded vesting schedules. The regular attribution method applies once the benefit is vested.
Correlating Payment With Attribution Year. When amounts become deductible and it is possible to attribute them to more than one year, they are attributed to the earliest year first, and then the next earliest, etc. The available deduction for a tax year is always used first for current remuneration — remuneration that is subject to Section 162(m)(6) but is not deferred deduction remuneration.
Stock Options and Stock Appreciation Rights (SARs). The value of an option or SAR when exercised is attributed on a pro rata daily basis over a period beginning at grant and ending at exercise, excluding any days on which the individual is not a service provider.
Restricted Stock. Restricted stock remuneration is attributed on a pro rata daily basis over a period beginning when the individual first has a legally binding right and ending when the stock vests or becomes transferable, excluding any days on which the individual is not a service provider.
Restricted Stock Units (RSUs). RSU remuneration is attributed on a pro rata daily basis over a period beginning when the individual first has a legally binding right and ending when the remuneration is first includible in income (no separate rule appears to apply to RSUs that involve a deferral), excluding any days on which the individual is not a service provider.
The proposed regulations cover many more issues, and the IRS requests input on specific issues it has yet to address. For example, no guidance is provided on how to attribute adjustments in the value of compensation that occur in periods during which no services are provided. This issue will come up often — for example, any time payments are made other than in a lump sum upon termination of employment for non-account based plans and for account-based plans using the standard attribution method. Doubtless, there are many more issues companies have identified, or will encounter, as they determine the tax impact of Section 162(m)(6) and prepare to comply for 2013.