This is the seventh in a series of WorkCite articles concerning the recently enacted Patient Protection and Affordable Care Act and its companion bill, the Health Care and Education Reconciliation Act of 2010 (referred to collectively as the Act).
For tax years beginning in 2013, covered health insurers will be denied federal income tax deductions for compensation they pay to any director, officer, employee or other service provider in excess of $500,000 annually.
The new restriction is found in Section 9014 of the Act. Although Section 9014 does not impact insurers’ federal income tax liabilities until 2013, it is in effect immediately as to compensation earned in 2010, 2011 or 2012, but deferred until 2013 or later, as explained below.
Section 9014 will apply to any remuneration that is otherwise deductible, whether or not paid in cash.
Covered Health Insurers
In general, a “covered health insurer” for purposes of Section 9014 is any health insurance issuer that, for tax years beginning in or after 2013, receives at least 25% of its annual gross premiums from providing “minimum essential coverage” under the Act. Minimum essential coverage is the health coverage which, starting in 2014, an individual must obtain in order to avoid paying a penalty under the Act. It includes employer-sponsored group health coverage (whether or not the employer’s plan is “grandfathered” under the Act) and coverage obtained in the individual insurance market.
Effect on Deferred Compensation
A covered health insurer may not avoid the $500,000 limitation by spreading out the payment of compensation over multiple years. Section 9014 of the Act provides that any “deferred deduction remuneration,” defined as any compensation for services performed during one taxable year but deductible in a subsequent taxable year, is non-deductible to the extent it exceeds unused “room” left in the $500,000 cap for the year in which the services are performed.
Example: E is paid $400,000 in salary by a covered health insurer in 2013, and is promised an additional $250,000 for services performed in 2013, to be paid in 2015. There is $100,000 in unused “room” left under the $500,000 cap for 2013. In 2015, when the only payment E receives is the $250,000 deferred compensation, only $100,000 of the payment will be deductible.
The $500,000 deduction limitation applies as to any deferred deduction compensation that is earned in a taxable year beginning in or after 2010, but paid (or otherwise becomes deductible) for a taxable year beginning in or after 2013. For tax years beginning in or after 2010, but before 2013, every health insurer (regardless of the amount of minimum health coverage it writes) is treated as a covered health insurer for this purpose.
There is no grandfathering provision in Section 9014 for binding deferred compensation arrangements entered into before the Act was enacted. Other key questions about the deferred deduction restriction – including how to determine the year for which compensation is deferred and whether an employee remains subject to the restriction if the deferred compensation is paid in a year when the payor is not a covered health insurer – are not addressed in the statute.
Comparison to Code Section 162(m)
Section 9014 of the Act implements these changes by amending Section 162(m) of the Internal Revenue Code of 1986 (Code), which applies a $1 million annual compensation deduction limitation to top executives of public companies, subject to an important exception for performance-based compensation. Key differences between the current Code Section 162(m) and Section 9014 include:
|Code Section 162(m), before Amendment by the Act
|Section 9014 of the Act
|Amount of Annual Deduction Limitation
|Public companies only
|Covered health insurers only, whether public or private companies
|Generally top four executive employees (excluding CFO) on last day of taxable year
|All employees and service providers at any time during taxable year
|Performance-Based Compensation, Commissions and Grandfathered Arrangement Exceptions
|Year When Deferred Compensation is Subject to Limitation
|Year when paid (or otherwise deducted)
|Year when earned
Section 9014 is the latest in a series of recent efforts to expand the deduction-prohibiting scope of Section 162(m).
- In early 2008, the IRS announced in Revenue Ruling 2008-13 that performance-based compensation that may be payable (but is not actually paid) on an employee’s termination of employment without regard to the satisfaction of the performance conditions does not qualify for an exemption from Section 162(m), confirming an earlier private letter ruling that had reversed a prior long-standing position.
- Later in 2008, Congress amended Section 162(m) to lower the deduction limit to $500,000 for covered employees at certain financial institutions participating in the government’s Troubled Asset Relief Program (TARP). Section 9014 borrows substantially from this earlier TARP restriction.
- Several bills currently pending in Congress would expand the Section 162(m) deduction limitations and place additional restrictions on the performance-based compensation exemption. S. 3149, the “Wall Street Compensation Reform Act of 2010,” proposed in January this year, would increase the number of employees subject to Section 162(m) and place additional vesting and stock ownership requirements on performance-based compensation at certain large or highly-leveraged public companies. S. 1491, the “Ending Excessive Corporate Deductions for Stock Options Act,” introduced by last summer, would prevent ordinary time-vested stock options from qualifying for the performance-based compensation exemption.
Although prospects for these two bills becoming law are currently weak, the trend is clear: Section 162(m) is on policymakers’ minds and may serve as the preferred vehicle for further efforts to limit executive compensation.
The new Section 162(m) restrictions resulting from Section 9014 are only one of the many ways in which the Act is already impacting employers. We will continue to analyze the Act’s impact in other areas in future WorkCites.
Visit the Healthcare Reform section for additional updates and resources.