executive compensation: changes you cannot afford to ignore

22nd Annual Health Sciences Tax Conference Executive compensation: changes you cannot afford to ignore December 3, 2012

Executive compensation: changes you cannot afford to ignore

Disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.


Disclaimer

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client serving member firm of Ernst & Young Global Limited operating in the US. For more information about our organization, please visit www.ey.com. This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP.


Presenters

► Julie Smith Tax Director IASIS Healthcare Nashville TN ► Howard Levenson

Ernst & Young LLP Washington, DC +1 202 327 8811 [email protected]

► Catherine Creech Ernst & Young LLP Washington, DC + 1 202 327 8047

[email protected]


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 the

Affordable Care Act

2013 pending tax rate changes


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 the lesser of: ► Net investment income or ► Adjusted 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 affecting more than 31 million individuals when they file for 2012.


Planning for compensation payments in a rising tax rate environment

► Given the pending increase in tax rates, consideration may be given to the timing of compensation payments.

► Individual recipients subject to US taxation may prefer acceleration of payments in order to realize income subject to lower 2012 rates.

► Health insurers may also prefer to deduct compensation payments in 2012 to avoid the 162(m)(6) deduction limit applicable to 2013 deductions.


Tax technical considerations — method of accounting

► Cash method taxpayers ► Compensation inclusion and deduction in year paid ► Change in inclusion or deduction requires a change in the year of

actual payment

► Accrual method taxpayers ► Timing 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 2013

► Change 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)


Tax technical considerations — method of accounting

► Once the “all events” test is met, deduction timing is also affected by timing of actual payments.

► Deduction occurs in year of accrual if payments are actually made within 2-1/2 months of the close of the year in which liability accrues. ► Bonus accrues on December 31, 2012 and payments are made by

March 15, 2013; deduction is in 2012. ► Bonus accrues on December 31, 2012, and payments are made on

March 16, 2013; deduction is in 2013. ► Note that 2-1/2-month rule generally does not affect the timing of the

income inclusion for the employee/service provider. ► Employee includes compensation for 2013 regardless of whether amounts are

paid on March 15, 2013 or on March 16, 2013. ► But, there may be ramifications under Section 409A.


Section 409A may affect ability to change timing of payments

► Acceleration of deferred compensation is generally prohibited. ► 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 more

than 30 days prior to the scheduled payment date under the deferral arrangement.

► The employee or service provider may not “elect” or control this acceleration.


Section 409A may affect ability to change timing 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 to come to a view on the application of Section 409A.

Health insurer deduction limit — 162(m)(6)


Section 162(m)(6)

► $500,000 deduction limit applies to compensation deductions for health insurers in tax years beginning in 2013. ► Compensation that is earned in tax years beginning after

December 31, 2009 is subject to the limitation if it is paid after 2012.

► Health insurer definition is applied on an IRC Section 414 controlled group basis and applies to all individual service providers. ► Under the statute, service providers who work in businesses

unrelated to health insurance, but still part of the controlled group, are subject to the $500,000 deduction limit.


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 employer’s gross health insurance premiums come from

policies 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 insurance premiums over gross revenues under IRS Notice 2011-2.


Section 162(m)(6)

► Section 162(m)(6) is much broader than the $1 million limitation in Section 162(m)(1): ► Applies to any form of taxable entity, not just publicly held corporations ► Applies to all forms of compensation (no exception for commissions or

performance-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 in

Reg. 1.409A-1(f)(2).


Section 162(m)(6)

► The $500,000 limit is applied by allocating compensation to the year in which the relevant services were performed. ► $500,000 limit is calculated on a person by person and earnings

year basis. ► The deduction limitation applies regardless of whether individuals

are employed as of the payment date. ► Compliance will require tracking of all compensation earned and

ultimately paid to determine allowable tax return deductions in the year of payout.


Section 162(m)(6)

► IRS guidance is expected soon and may include: ► A methodology for allocating compensation across an employee’s

years of services (e.g., in pension plans) ► Further definition of covered service providers whose

compensation for services are covered by the limit (e.g., physicians, brokers)

► How will companies react to the $500,000 limit in future compensation design?

Compensation issues in connection with mergers and acquisitions


Transaction-related issues

► Common issues that arise when companies are undertaking mergers and acquisitions: ► Is compensation cashed out or “rolled over” in a

manner that satisfies 409A? ► Is the taxation event for the employee accelerated or

deferred in the transaction? ► Is the party paying the compensation the party entitled

to the deduction?


Key governing tax code provisions

► Restricted stock, partnership interests and stock options ► Section 83 — income inclusion and deductions ► Section 409A — requirements for deferred comp exemption

► Cash, stock options, Restricted Stock Unit (RSUs), phantom stock and dividend equivalents ► Section 451 and Section 409A — income inclusion ► Section 404(a)(5) — deduction if deferred comp and paid in cash ► Section 461 — deduction if not deferred compensation and paid in

cash ► Section 83 — deduction if paid in stock ► Section 409A — requirements for exemption from/compliance with

deferred comp rules, including specific rules for stock options and stock appreciation rights (SAR)



► Equity — cashed out or rolled over? ► Are the “economics” pre-transaction equivalent or

post-transaction? ► How to determine fair market value (FMV) for converting stock?

► Closing price of date of transaction ► Average price on closing date or over period prior to closing date

► Effect of escrows and earn-outs on employee equity ► What are the ramifications of extending vesting or imposing new

vesting provisions on equity or deferred compensation? ► Can a buyer substitute RSUs for options in the target? ► What are the effects of cashing out options vs exercise of option

and immediate disposition?



► Options and SARs — adjustment of exercise or base price for dividends under 409A ► Reduction in exercise price on account of a dividend is a

modification under Section 409A. ► New grant on “modification” likely results in a violation, except if

option is “underwater.” ► Section 409A exception for adjustments on account of stock

dividends or extraordinary dividends. ► “Aggregate fair market value” of options on ex-dividend date cannot

exceed the “aggregate fair market value” immediately prior. ► Ratio of the exercise price to the FMV of the shares immediately after

the adjustment is not greater than the ratio immediately before the adjustment.



► Conversions between “shares” and partnership interests in transactions ► Conversions between corporate and partnership taxation ► What is effect of transactions on profits interests

► Deductions ► Service recipient receives the deduction, which may be different

from the “payor” in a transaction. ► Determine if the deduction is subject to the “year within

which” rule. ► Regulations under Section 162(m)(1) provide certain transition

rules for initial public offerings and new publicly held companies.

Other select compensation issues arising under the Affordable Care Act (ACA)


Overview: the ACA amended multiple laws

► Laws affecting employers which were amended by the ACA include: ► Internal Revenue Code (IRC) ► Employee Retirement Income Security Act of 1974 (ERISA) ► Fair Labor Standards Act (FLSA) ► Public Health Services Act (PHSA) ► Health Insurance Portability and Accountability Act (HIPAA)

► Because the ACA does not create a single “law,” there is no single regulator for most provisions.

► Guidance is carried out by a triumvirate composed of the Department of Labor (DOL), Health and Human Services (HHS) and Treasury (which includes the IRS).


Employer excise taxes

► Understanding the source law for new ACA requirements is important to determine the financial and tax impact on employers. Requirements arising exclusively under the IRC result in income or excise taxes; requirements arising under identical provisions in the PHSA, ERISA and IRC that address the market reforms may result in a penalty imposed by HHS, a civil action by DOL or a plan participant, or an excise tax under the IRC. For example: ► IRC Section 4980H: imposes an excise tax on large employers for failure

to offer affordable coverage providing minimum value to certain employees

► IRC Section 4980D: imposes an excise tax on employers for failure to meet the group health plan requirements of chapter 100 of the Code. The ACA’s market reforms that are included in the PHSA and ERISA are also incorporated into chapter 100. This excise tax is $100 per day, per individual to whom the failure relates.


Key effective dates for employers

► Reporting value of health benefits on Form W-2 (due by January 1, 2013)

► PCORI fee

► State-based exchanges ► Individual mandate and premium tax credits ► Employer mandate ► Medicaid expansion ► Other insurance market reforms ► Health insurers’ fee ► Employer reporting to the IRS (due by

January 31, 2015) ► Reinsurance fee

► Drug manufacturers’ fee ► Limitation on over-the-counter

(OTC) drugs for FSAs/HSAs/HRAs

► Increased tax on non-medical withdrawals from HSAs

► Increase Medicare payroll tax by 0.9% on earned income

► Impose 3.8% tax on unearned income

► Eliminate deduction for retiree drug costs covered by Medicare Part D subsidy

► Excise tax on medical devices ► FLSA notices ► $500,000 compensation deduction

limitation for health insurance issuers

► Immediate health insurance individual market reforms

► Medicare Part D “donut hole” relief begins

2010 2012 2011 2013 2014

2018 2017 2020

► 40% excise tax on high-cost health plans

► Medicare Part D donut hole closed

Coverage expansions take effect

► States may open Exchanges to large group market


Employer reporting requirements

► The ACA establishes new plan information reporting requirements to employees and to the federal government, including: ► Form W-2 reporting: beginning in 2012, employers must include

the value of the benefit provided by the employer for each employee’s health insurance coverage on the employee’s annual Form W-2.

► Minimum essential coverage reporting: the ACA establishes new employer reporting requirements under IRC Section 6056.

► Exchange options: the ACA amends the FLSA to require employers to inform employees of coverage options.


Employer reporting requirements: W-2 reporting ► Beginning with the 2012 Form W-2, employers must report value of

applicable employer-sponsored coverage on Form W-2 Box 12 using Code DD.

► Treasury/IRS issued Interim Guidance providing that, until further guidance is issued, employers that issue fewer than 250 Forms W-2 are not subject to these reporting requirements.

► Insured or self-insured group health plan must be reported, unless: ► Not subject to federal continuation coverage requirements ► Included in income as excess reimbursement under Section 105(h), or ► Included in income as a shareholder-employee of an S corporation

► Total cost of coverage under all applicable employer-sponsored coverage provided to the employee must be reported. ► Includes both employer and employee portion ► Without regard to whether contributions are pre-tax or post-tax


Changes to FSAs, HSAs, HRAs

► FSA, HSA and HRA dollars may be used for “qualified medical expenses” (2011). ► Definition of “qualified medical expenses” modified to include only

amounts paid for prescribed drugs or insulin ► No OTC drugs unless prescribed by a physician

► Non-medical HSA withdrawal tax increased to 20% (2011) ► FSAs’ contributions limited to $2,500 per year (2013)

executive compensation: changes you cannot afford to ignore

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