This is the 32nd in a series of WorkCite articles concerning the Patient Protection and Affordable Care Act and its companion statute, the Health Care and Education Reconciliation Act of 2010 (referred to collectively as the Act). This article discusses the proposed regulations (the Regulations) issued by the IRS earlier this month limiting the deductions that certain health insurance issuers may take for compensation paid to their employees and other service providers, excluding certain bona fide independent contractors, to $500,000 per service provider per year, starting in taxable years beginning on or after January 1, 2013.

The Regulations, which implement Section 9014 of the Act, substantially adopt the guidance the IRS previously provided in Notice 2011-02 (which we discussed an earlier article), but also address several new topics, including how the deduction limitation applies to reinsurers and captive insurers, how certain de minimis exceptions are applied in determining whether a health insurance issuer is covered by the limitation, how the limitation applies in the merger and acquisition context and how deferred compensation is allocated to a particular year when it relates to services performed over more than one year.

Section 9014, which added Section 162(m)(6) to the Internal Revenue Code (Code), was intended to prevent health insurance companies from deriving a tax benefit from using the expected new revenues generated by the sale of minimum required insurance coverage in order to increase executive pay. However, covered health insurance providers will be subject to the new deduction limitation regardless of whether they see a substantial increase in revenues from providing minimum essential coverage and regardless of their current executive pay levels.

Code Section 162(m)(1) provides that in the case of any publicly-held corporation, no deduction is allowed for applicable employee remuneration as to any covered employee to the extent that the amount of such remuneration for the taxable year as to such employee exceeds $1,000,000. The Regulations depart from Section 162(m)(1) and the regulations thereunder in several important respects, including:

  • The application of the Regulations to private as well as public companies
  • The $500,000 deduction limit itself
  • The application of the Regulations to all employees and other service providers (excluding certain independent contractors) who provide services at any time during a given taxable year, in contrast to the Section 162(m)(1) regulations, which apply only to the CEO and the three other most highly-compensated executives, excluding the CFO, who are employed on the last day of the year
  • The application of the Regulations to post-2009 deferred compensation as well as current compensation, whereas the Section 162(m)(1) regulations effectively apply only to current compensation
  • The lack of an exemption in the Regulations for stock options and other “performance-based” compensation, where by contrast the Section 162(m)(1) regulations exclude options and “performance-based” compensation from the $1 million limit

The Regulations will apply only to “covered health insurance providers,” which is generally defined for periods after 2012 to mean state-licensed and -regulated insurance companies or HMOs that receive at least 25 percent of their premiums from providing health insurance coverage that qualifies as “minimum essential coverage” (i.e., coverage that an individual must obtain in order to avoid a penalty under the Act), or their 80-percent-or-more controlling parents or 80-percent-or-more controlled subsidiaries (but specifically excluding any brother-sister entity within the controlled group), subject to certain de minimis exceptions.

However, health insurance issuers are also treated as “covered” as to deferred compensation earned in a taxable year beginning after 2009 and before 2013 that is payable or otherwise deductible after 2012 if the issuer received any premiums from providing health insurance coverage during this pre-2013 period (but only if the health insurance issuer is still “covered” in the year in which the deferred compensation is eventually paid or otherwise deductible).

Importantly:

  • The Regulations do not apply to employers who sponsor self-insured group health plans merely because they sponsor such plans.
  • Premiums under an indemnity reinsurance policy (e.g., a policy reinsuring a self-insured group health plan) are not treated as “health insurance premiums” for the purpose of determining whether the reinsurer is “covered.”
  • Captive insurers are treated as covered health insurance providers, however, if they otherwise meet the above definition.