Most issuers of healthcare insurance likely have heard about the $500,000 limit on deductible compensation that became effective January 1, 2013, but might be surprised to know how much broader the scope of the deduction is compared to the familiar $1 million deduction limit on executive compensation applicable to public companies. Affiliates of those health insurance providers might be even more surprised to learn that the regulations recently proposed by the IRS extend the $500,000 deduction limit to certain subsidiaries and affiliates even though they are not health insurance providers. For example, the deduction limit may apply to a for-profit parent company and its affiliates that do not provide healthcare insurance if at least one affiliate does or to a parent corporation to a captive insurance company. Any for-profit healthcare providers, hospital systems and others considering whether to become a provider of healthcare insurance are cautioned to consider the potential cost of providing non-deductible compensation.
The scope of the limit is broad. Introduced by the Affordable Care Act (ACA), Internal Revenue Code Section 162(m)(6) provides that covered health insurance providers and their non-insurance company affiliates may not deduct compensation and other remuneration in excess of $500,000 per year. The limit applies generally to compensation paid or otherwise deductible (but for the limit) beginning on or after January 1, 2013, and may include payments after 2012 of deferred compensation attributable to services performed during a 2010-2012 transitional period. Deferred compensation attributable to services performed prior to 2010 is entirely excluded.
A covered health insurance provider means any insurance company or similar organization, such as an HMO, that is subject to state insurance law and receives premiums from providing health insurance coverage. The proposed regulations specifically exempt an employer that maintains a self-insured health plan for its employees from the definition of a covered health insurance provider but leave open the possibility that a captive insurance company may be a covered entity. For years after 2012, health insurance providers will be subject to the $500,000 deduction limit for only in years in which 25 percent or more of the total premiums received for health insurance are for "essential healthcare services."
The $500,000 deduction limit will apply to any member of a parent-subsidiary controlled group of corporations, a parent-subsidiary group of trades or business or an affiliated service group in which a covered healthcare provider is a member at any time during the taxable year. Brother-sister commonly controlled groups of businesses are excluded. The affiliate or parent need not be a health insurance provider to be a covered entity. However, the proposed regulations provide a "de minimus" exception for years in which total healthcare premiums are less than two percent of the gross revenues of the health insurance provider and all other members of its affiliated group.
The $500,000 deduction limitation under Section 162(m)(6) is different from the general $1 million limit on deductions for executive compensation under Section 162(m)(1) in the following notable ways:
- The $500,000 limit does not apply to just publically traded entities, but to any private or public covered entity and members of the affiliated group.
- The $500,000 limit applies not just to the top-tier executive, but to all individuals providing services to a covered health insurance provider and its affiliates, including employees, consultants, non-employee directors and independent contractors who do not provide substantial services to unrelated entities.
- There is no exception to the $500,000 limit for performance-based or commission-based compensation, or compensation related to binding contracts. Thus, remuneration subject to the limit includes all types, including equity-based compensation and bonus payments. An exception is provided for benefits earned under qualified plans (including pre-tax deferrals to a 401(k) plan), tax-favored retirement benefits and other similar tax- advantaged arrangements.
- Because the limit applies to the year of the deduction and not necessarily the year of the payment, the $500,000 limit continues to apply after the employee's termination. For example, involuntary severance pay may be attributed to the year of the termination or in a proportional method according to the years in which the services were performed.
- Starting on January 1, 2013, the $500,000 deduction limit applies to vested deferred compensation attributable to services performed on or after January 1, 2010, as long as the employer is a covered entity in the year of the deduction.
Thus, many tools traditionally deployed to address the $1 million deduction limit will not be useful to escape the $500,000 deduction limit. Covered entities and their affiliates to which the deduction limit applies will want to review their current executive compensation packages as they consider strategies and options to address the $500,000 deduction limit.