IRS Proposes Regulations on $500,000 Compensation Deduction Limit for Health Insurers: Regulations Follow Prior IRS Guidance, Adding New Exceptions and Rules for Calculating Compensation; Consistent with Prior Guidance, Limit can Apply to Non-Insurers Affiliated with a Health Insurance Provider

Sullivan & Cromwell LLP - April 5, 2013

On April 1, 2013, the IRS proposed regulations on the section of the Patient Protection and Affordable Care Act of 2010 (sometimes referred to as “Obamacare”) that limits to $500,000 the deduction for compensation paid to an “applicable individual” that is attributable to a taxable year in which the payor is a “covered health insurance provider” (a “CHIP”). Under the Internal Revenue Code and the proposed regulations, a CHIP includes not just a health insurance provider itself but also various related parties, even if the related party “is not a health insurance issuer and does not provide health insurance coverage.” Accordingly, groups that contain a health insurance provider should evaluate the potential application of this compensation deduction limitation to all affiliated entities.

Although the proposed regulations largely follow guidance previously issued by the IRS in Notice 2011-2 (the “Notice”), they provide new exceptions and discuss in detail how to determine whether compensation attributable to a particular taxable year of a CHIP exceeds the $500,000 cap. These attribution rules are critical because, unlike similar provisions of the Internal Revenue Code, the deduction limit applies based on when the compensation is deemed earned and not based on when it is actually paid.