22nd Annual Health SciencesTax ConferenceExecutive compensation: changes you cannotafford to ignoreDecember 3, 2012
Disclaimer►   Any US tax advice contained herein was not intended or    written to be used, and cannot be used, for the pu...
DisclaimerErnst & Young refers to the global organization of member firms of Ernst & Young GlobalLimited, each of which is...
Presenters►   Julie Smith                                   ►    Catherine Creech    Tax Director                         ...
Topics►   2013 pending tax rate changes►   Planning for 162(m)(6) deduction limits for health insurers►   Compensation iss...
2013 pending tax rate changes
Unless Congress acts …►   For 2013, the top individual federal income tax rates will be:     ►   39.6% (ordinary)     ►   ...
Planning for compensation payments in arising tax rate environment►   Given the pending increase in tax rates, considerati...
Tax technical considerations — method ofaccounting►   Cash method taxpayers    ►    Compensation inclusion and deduction i...
Tax technical considerations — method ofaccounting►   Once the “all events” test is met, deduction timing is also    affec...
Section 409A may affect ability to changetiming of payments►   Acceleration of deferred compensation is generally    prohi...
Section 409A may affect ability to changetiming of payments►   “Short-term deferrals” exception may apply.    ► Accelerati...
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 begin...
Section 162(m)(6)►   Applies to “covered health insurance providers:”    ► For taxable years after December 31, 2009, but ...
Section 162(m)(6)►   Section 162(m)(6) is much broader than the $1 million limitation in Section    162(m)(1):    ►     Ap...
Section 162(m)(6)►   The $500,000 limit is applied by allocating compensation    to the year in which the relevant service...
Section 162(m)(6)►   IRS guidance is expected soon and may include:    ►     A methodology for allocating compensation acr...
Compensation issues in connection withmergers and acquisitions
Transaction-related issues►   Common issues that arise when companies are    undertaking mergers and acquisitions:    ► Is...
Key governing tax code provisions►   Restricted stock, partnership interests and stock options    ►     Section 83 — incom...
Transaction-related issues►   Equity — cashed out or rolled over?    ►     Are the “economics” pre-transaction equivalent ...
Transaction-related issues►   Options and SARs — adjustment of exercise or base    price for dividends under 409A    ►    ...
Transaction-related issues►   Conversions between “shares” and partnership interests    in transactions    ►     Conversio...
Other select compensation issues arisingunder the Affordable Care Act (ACA)
Overview: the ACA amended multiple laws►   Laws affecting employers which were amended by the    ACA include:    ►     Int...
Employer excise taxes►   Understanding the source law for new ACA requirements is important    to determine the financial ...
Key effective dates for employers                                                                  ►   State-based exchang...
Employer reporting requirements►   The ACA establishes new plan information reporting    requirements to employees and to ...
Employer reporting requirements:W-2 reporting►   Beginning with the 2012 Form W-2, employers must report value of    appli...
Changes to FSAs, HSAs, HRAs►   FSA, HSA and HRA dollars may be used for “qualified    medical expenses” (2011).    ►     D...
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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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Executive compensation: changes you cannot afford to ignore

  1. 1. 22nd Annual Health SciencesTax ConferenceExecutive compensation: changes you cannotafford to ignoreDecember 3, 2012
  2. 2. 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.Page 2 Executive compensation: changes you cannot afford to ignore
  3. 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. 4. Presenters► Julie Smith ► Catherine Creech Tax Director Ernst & Young LLP IASIS Healthcare Washington, DC Nashville TN + 1 202 327 8047 catherine.creech@ey.com► Howard Levenson Ernst & Young LLP Washington, DC +1 202 327 8811 howard.levenson@ey.comPage 4 Executive compensation: changes you cannot afford to ignore
  5. 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 the Affordable Care ActPage 5 Executive compensation: changes you cannot afford to ignore
  6. 6. 2013 pending tax rate changes
  7. 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 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.Page 7 Executive compensation: changes you cannot afford to ignore
  8. 8. Planning for compensation payments in arising 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.Page 8 Executive compensation: changes you cannot afford to ignore
  9. 9. Tax technical considerations — method ofaccounting► 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)Page 9 Executive compensation: changes you cannot afford to ignore
  10. 10. Tax technical considerations — method ofaccounting► 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.Page 10 Executive compensation: changes you cannot afford to ignore
  11. 11. Section 409A may affect ability to changetiming 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.Page 11 Executive compensation: changes you cannot afford to ignore
  12. 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 to come to a view on the application of Section 409A.Page 12 Executive compensation: changes you cannot afford to ignore
  13. 13. Health insurer deduction limit — 162(m)(6)
  14. 14. 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.Page 14 Executive compensation: changes you cannot afford to ignore
  15. 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 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.Page 15 Executive compensation: changes you cannot afford to ignore
  16. 16. 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).Page 16 Executive compensation: changes you cannot afford to ignore
  17. 17. 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.Page 17 Executive compensation: changes you cannot afford to ignore
  18. 18. 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?Page 18 Executive compensation: changes you cannot afford to ignore
  19. 19. Compensation issues in connection withmergers and acquisitions
  20. 20. 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?Page 20 Executive compensation: changes you cannot afford to ignore
  21. 21. 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)Page 21 Executive compensation: changes you cannot afford to ignore
  22. 22. Transaction-related issues► 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?Page 22 Executive compensation: changes you cannot afford to ignore
  23. 23. Transaction-related issues► 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.Page 23 Executive compensation: changes you cannot afford to ignore
  24. 24. Transaction-related issues► 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.Page 24 Executive compensation: changes you cannot afford to ignore
  25. 25. Other select compensation issues arisingunder the Affordable Care Act (ACA)
  26. 26. 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).Page 26 Executive compensation: changes you cannot afford to ignore
  27. 27. 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.Page 27 Executive compensation: changes you cannot afford to ignore
  28. 28. Key effective dates for employers ► State-based exchanges ► Reporting value of health ► Individual mandate and premium tax credits benefits on Form W-2 (due ► Employer mandate by January 1, 2013) ► Medicaid expansion ► PCORI fee ► Other insurance market reforms ► Health insurers’ fee ► Employer reporting to the IRS (due by January 31, 2015) ► Reinsurance fee ► Immediate health insurance ► 40% excise tax individual market reforms on high-cost ► Medicare Part D “donut hole” health plans relief begins 2014 2010 2011 2012 2013 Coverage expansions take effect 2017 2018 2020 ► Increase Medicare payroll tax by ► Drug manufacturers’ fee 0.9% on earned income ► Medicare Part D ► Impose 3.8% tax on unearned donut hole closed ► Limitation on over-the-counter income (OTC) drugs for ► States may open ► Eliminate deduction for retiree drug Exchanges to large group FSAs/HSAs/HRAs costs covered by Medicare Part D market ► Increased tax on non-medical subsidy withdrawals from HSAs ► Excise tax on medical devices ► FLSA notices ► $500,000 compensation deduction limitation for health insurance issuersPage 28 Executive compensation: changes you cannot afford to ignore
  29. 29. 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.Page 29 Executive compensation: changes you cannot afford to ignore
  30. 30. 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-taxPage 30 Executive compensation: changes you cannot afford to ignore
  31. 31. 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)Page 31 Executive compensation: changes you cannot afford to ignore

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