Executive Compensation-IRS Issues Proposed Regulations On IRC Section 162(m)(6) $500,000 Limit On The Annual Deduction For Compensation Paid To An Individual By A Health Insurance Company

The Internal Revenue Service (the “IRS”) has issued proposed regulations on the $500,000 limit under IRC section 162(m)(6) on the annual deduction for compensation paid to an individual by a covered health insurance provider. A “covered health insurance provider” is, generally, an insurance company for which at least 25% of its gross premiums are for minimum essential health care coverage. An employer may rely on the proposed regulations until final regulations are issued. The proposed regulations are over 100 pages long. In sum, the proposed regulations provide the following:

In General. For taxable years beginning after 2012, section 162(m)(6) limits to $500,000 the allowable deduction for the aggregate individual remuneration and deferred deduction remuneration attributable to services performed by an individual for a covered health insurance provider in a taxable year beginning after 2012 which (but for section 162(m)(6)) is otherwise deductible for federal income tax purposes. “Individual remuneration” is pay for services that is not deferred deduction remuneration . “Deferred deduction remuneration” is pay for services that is deductible in a future taxable year.

Tax Years Starting Before 2013. Deferred deduction remuneration attributable to services performed in a taxable year beginning after 2009 and before 2013, which otherwise becomes deductible in a taxable year beginning after 2012, is also subject to the $500,000 deduction limit, determined as if the deduction limit applied to taxable years beginning after 2009.

How The Limit Works. If individual remuneration, deferred deduction remuneration, or a combination of the two that is attributable to services performed by an individual for a covered health insurance provider in a taxable year: (1) exceeds $500,000, the excess is not allowable as a deduction in any taxable year or (2) is less than $500,000, the remuneration generally may be deducted by the covered health insurance provider in the taxable year(s) in which the amount is otherwise deductible.

Example: In Year 1, a covered health insurance provider pays $400,000 in salary (individual remuneration) to an individual. It also credits $300,000 to an account for the individual under a nonqualified deferred compensation plan, which is payable in Year 5 (deferred deduction remuneration). The $300,000 credit is fully vested in Year 1 and is attributable to services provided by the individual in that year. In Year 1, the covered health insurance provider may deduct the $400,000 of individual remuneration, since this amount is less than the $500,000 deduction limit. In Year 5, the covered health insurance provider pays the $300,000 that was credited under the nonqualified deferred compensation plan for services provided by the individual in Year 1. Because the aggregated individual remuneration and deferred deduction remuneration attributable to services performed by the individual in Year 1 exceeds the $500,000 deduction limit by $200,000 ($400,000 + $300,000 = $700,000), the covered health insurance provider can deduct only $100,000 of the $300,000 payment in year 5, and the remaining $200,000 is not deductible by the covered health insurance provider in any year.