executive compensation: changes you cannot afford to ignore

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►2013 pending tax rate changes ►Planning for 162(m)(6) deduction limits for health insurers ►Compensation issues arising in transactions ►Other employee benefits issues arising under the Affordable Care Act

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  • 1. 22nd Annual Health SciencesTax ConferenceExecutive compensation: changes you cannotafford to ignoreDecember 3, 2012

2. Disclaimer Any US tax advice contained herein was not intended orwritten to be used, and cannot be used, for the purpose ofavoiding penalties that may be imposed under the InternalRevenue Code or applicable state or local tax lawprovisions.Page 2Executive compensation: changes you cannot afford to ignore 3. DisclaimerErnst & Young refers to the global organization of member firms of Ernst & Young GlobalLimited, each of which is a separate legal entity. Ernst & Young LLP is a client servingmember firm of Ernst & Young Global Limited operating in the US. For more informationabout our organization, please visit www.ey.com.This presentation is 2012 Ernst & Young LLP. All rights reserved. No part of thisdocument may be reproduced, transmitted or otherwise distributed in any form or byany means, electronic or mechanical, including by photocopying, facsimile transmission,recording, rekeying, or using any information storage and retrieval system, without writtenpermission from Ernst & Young LLP. Any reproduction, transmission or distribution of thisform or any of the material herein is prohibited and is in violation of US and internationallaw. Ernst & Young LLP expressly disclaims any liability in connection with use of thispresentation or its contents by any third party.Views expressed in this presentation are not necessarily those of Ernst & Young LLP.Page 3 Executive compensation: changes you cannot afford to ignore 4. Presenters Julie Smith Catherine CreechTax Director Ernst & Young LLPIASIS Healthcare Washington, DCNashville TN + 1 202 327 8047 catherine.creech@ey.com Howard LevensonErnst & Young LLPWashington, DC+1 202 327 8811howard.levenson@ey.comPage 4 Executive compensation: changes you cannot afford to ignore 5. Topics 2013 pending tax rate changes Planning for 162(m)(6) deduction limits for health insurers Compensation issues arising in transactions Other employee benefits issues arising under theAffordable Care ActPage 5Executive compensation: changes you cannot afford to ignore 6. 2013 pending tax rate changes 7. Unless Congress acts For 2013, the top individual federal income tax rates will be: 39.6% (ordinary) 39.6% (qualified dividends) 20% (capital gains)Phase-out of itemized deductions and personal exemptions will be reinstated. Additional 0.9% Medicare tax will be imposed on wages and self-employment(SE) income over $200,000 for individual and $250,000 for joint filers. 3.8% Medicare contribution tax applies to net investment income, which is thelesser of:Net investment income orAdjusted gross income (AGI) over the threshold ($200,000 for individual and $250,000 for joint filers). Expired alternative minimum tax (AMT) patch will result in AMT affectingmore than 31 million individuals when they file for 2012.Page 7 Executive compensation: changes you cannot afford to ignore 8. Planning for compensation payments in arising tax rate environment Given the pending increase in tax rates, considerationmay be given to the timing of compensation payments. Individual recipients subject to US taxation may preferacceleration of payments in order to realize incomesubject to lower 2012 rates. Health insurers may also prefer to deduct compensationpayments in 2012 to avoid the 162(m)(6) deduction limitapplicable to 2013 deductions.Page 8Executive compensation: changes you cannot afford to ignore 9. Tax technical considerations method ofaccounting Cash method taxpayersCompensation inclusion and deduction in year paidChange in inclusion or deduction requires a change in the year of actual payment Accrual method taxpayersTiming of inclusion or deduction governed by the all events test. E.g., bonus for 2012 is paid only if service providers continue working through the scheduled payment date in February 2013; no accrual until 2013Change in timing may require change in all events that govern the accrual. E.g., elimination of continued services requirement Acceleration of any other pre-conditions to determining liability (not as common in asset management agreements)Page 9Executive compensation: changes you cannot afford to ignore 10. Tax technical considerations method ofaccounting Once the all events test is met, deduction timing is alsoaffected by timing of actual payments. Deduction occurs in year of accrual if payments are actuallymade within 2-1/2 months of the close of the year in whichliability accrues. Bonus accrues on December 31, 2012 and payments are made byMarch 15, 2013; deduction is in 2012. Bonus accrues on December 31, 2012, and payments are made onMarch 16, 2013; deduction is in 2013. Note that 2-1/2-month rule generally does not affect the timing of theincome inclusion for the employee/service provider. Employee includes compensation for 2013 regardless of whether amounts arepaid on March 15, 2013 or on March 16, 2013. But, there may be ramifications under Section 409A.Page 10Executive compensation: changes you cannot afford to ignore 11. Section 409A may affect ability to changetiming of payments Acceleration of deferred compensation is generallyprohibited. Section 409A violation generally results in retroactive income inclusion to the year of vesting, a 20% addition to tax and a premium interest tax. Limited exceptions include a 30-day rule. Employer may exercise discretion to pay no morethan 30 days prior to the scheduled payment dateunder the deferral arrangement. The employee or service provider may not elect orcontrol this acceleration.Page 11 Executive compensation: changes you cannot afford to ignore 12. Section 409A may affect ability to changetiming of payments Short-term deferrals exception may apply. Acceleration of bonuses that are short-term deferrals and not subject to Section 409A generally would not be prohibited. Some pre-2005 deferrals may be grandfathered from Section 409A. An acceleration of a pre-2005 deferral may cause the grandfathered payment to be materially modified and subject to Section 409A, but the material modified arrangement may nonetheless comply with Section 409A because it includes a new fixed payment date in 2012. It is critical to examine the specific terms of the documentation tocome to a view on the application of Section 409A.Page 12Executive compensation: changes you cannot afford to ignore 13. Health insurer deduction limit 162(m)(6) 14. Section 162(m)(6) $500,000 deduction limit applies to compensationdeductions for health insurers in tax years beginningin 2013. Compensation that is earned in tax years beginning afterDecember 31, 2009 is subject to the limitation if it is paid after2012. Health insurer definition is applied on an IRC Section 414controlled group basis and applies to all individualservice providers. Under the statute, service providers who work in businessesunrelated to health insurance, but still part of the controlled group,are subject to the $500,000 deduction limit.Page 14 Executive compensation: changes you cannot afford to ignore 15. Section 162(m)(6) Applies to covered health insurance providers: For taxable years after December 31, 2009, but before January 1, 2013, this includes: Any employer which is a health insurance issuer Receives premiums from providing health insurance coverage For taxable years after December 31, 2012, this includes: Any employer who is a health insurance issuer 25% of the employers gross health insurance premiums come frompolicies providing minimal essential coverage Who is a covered health insurance provider? Companies with captive insurers? Non-traditional insurers? Definition is subject to a 2% de minimis rule based on health insurancepremiums over gross revenues under IRS Notice 2011-2.Page 15Executive compensation: changes you cannot afford to ignore 16. Section 162(m)(6) Section 162(m)(6) is much broader than the $1 million limitation in Section162(m)(1): Applies to any form of taxable entity, not just publicly held corporations Applies to all forms of compensation (no exception for commissions orperformance-based compensation, e.g., stock options) The limit applies to compensation for any individual performing services. E.g., employees, directors and independent contractors Not limited to top officers Questions about independent vendors Current guidance analogizes to the independent vendor rule defined inReg. 1.409A-1(f)(2).Page 16 Executive compensation: changes you cannot afford to ignore 17. Section 162(m)(6) The $500,000 limit is applied by allocating compensationto the year in which the relevant services were performed. $500,000 limit is calculated on a person by person and earningsyear basis. The deduction limitation applies regardless of whether individualsare employed as of the payment date. Compliance will require tracking of all compensation earned andultimately paid to determine allowable tax return deductions in theyear of payout.Page 17 Executive compensation: changes you cannot afford to ignore 18. Section 162(m)(6) IRS guidance is expected soon and may include: A methodology for allocating compensation across an employeesyears of services (e.g., in pension plans) Further definition of covered service providers whosecompensation for services are covered by the limit (e.g.,physicians, brokers) How will companies react to the $500,000 limit in futurecompensation design?Page 18Executive compensation: changes you cannot afford to ignore 19. Compensation issues in connection withmergers and acquisitions 20. Transaction-related issues Common issues that arise when companies areundertaking mergers and acquisitions: Is compensation cashed out or rolled over in amanner that satisfies 409A? Is the taxation event for the employee accelerated ordeferred in the transaction? Is the party paying the compensation the party entitledto the deduction?Page 20 Executive co