Analysis of the Final Tax Reform Bill – Part I: Changes to Equity and Executive Compensation Rules and Elimination of the ACA’s Individual Mandate

On December 15, the House-Senate Conference Committee released the joint explanatory statement and final legislative text (the “Final Bill”) resolving differences between the House- and Senate-passed versions of the Tax Cuts and Jobs Act (the “House Bill” and “Senate Bill,” respectively).  The provisions of the Final Bill related to health reform, equity and executive compensation, deductions and exclusions for employee meals and other fringe benefits, private retirement plan benefit, paid leave, and various reporting, withholding, and income sourcing rules, largely track the bill passed by the Senate.  Many of the changes included in the House Bill but not the Senate Bill were dropped from the Final Bill. (Our earlier coverage of the House and Senate bills can be seen in a series of posts here.)

This post is the first in a series of three posts analyzing provisions of the Final Bill.  (Part II will analyze changes to deductions and exclusions for employee meals and other fringe benefits, changes to private retirement plan benefits, and a new paid leave credit.  Part III will analyze new reporting and withholding requirements and source rules.)  This post analyzes the following provisions:

  • Equity and Executive Compensation– The Final Bill includes provisions similar to the House and Senate Bill provisions that will expand application of the limitation on excessive remuneration to covered employees of publicly‑traded corporations under Code section 162(m); impose an excise tax on excess tax-exempt organization executive compensation; and permit a deferral for up to five years for stocks pursuant to exercise of stock options and settlement of restricted stock units (“RSUs”) issued under broad‑based plans of privately-held corporations.
  • Health Reform– The Final Bill includes the Senate Bill provision setting the individual mandate penalties under the Affordable Care Act (“ACA”) to zero after 2019.

These changes generally would be effective after 2017, except as otherwise noted below.

Equity and Executive Compensation

Modification of Limitation on Excessive Employee Remuneration.  Code section 162(m) currently limits a publicly-traded company’s deduction for compensation paid to a “covered employee” to $1 million, with exceptions for performance-based compensation and commissions.  Similar to the House and Senate bills, section 13601 of the Final Bill would make the following three changes.

  1. Repeal of Exceptions to Deduction Limitations. The Final Bill will eliminate the exceptions for performance-based compensation and commissions under Code section 162(m)(4)(B) and (C).
  2. Changes to the Definition of Covered Employee. Under the Final Bill, the definition of “covered employee” will be amended to align with SEC reporting rules to include any individual who is the principal executive officer or principal financial officer at any time during the tax year and the three highest paid officers for the tax year (as disclosed to shareholders).  Further, if an individual is a covered employee after 2016, the individual would retain the covered‑employee status for all future years.  This change has the effect of subjecting deferred compensation paid in a year after an individual is no longer an officer to the deduction disallowance.
  3. Expansion of Deduction Limitation to Additional Corporations. The Final Bill will amend Code section 162(m)(2) to apply the limitation to any corporation that is an issuer under section 3 of the Securities Exchange Act of 1934 that (1) has a class of securities registered under section 12 of the Act, which would include all U.S. publicly‑traded companies and their foreign affiliates, or (2) is required to file reports under section 15(d) of the Act.  This change will also extend the deduction limitation to corporations beyond those with publicly traded equity securities to include those that are required to file reports solely because they issue public debt.

Transition Relief.  The Final Bill includes the transition relief included in the Senate Bill, so that these changes would apply only to contracts that are entered into—or that are materially modified—after November 2, 2017 (see earlier coverage).  The fact that a deferred compensation plan was in existence on November 2, 2017 is not by itself sufficient to qualify the plan for the exception for binding written contracts.  The Conference Summary clarifies that a renewal of a contract is treated as a new contract entered into on the day the renewal takes effect.  The House Bill does not have a similar transition rule.  The Conference Summary provides an example of how the transition relief works.  Suppose that a publicly‑traded corporation on October 2, 2017 hired an executive that is a covered employee.  Under the employment contract, the executive is eligible to participate in the employer’s deferred compensation plan.  Under the terms of the plan, participation is permitted after 6 months of employment, amounts payable are not subject to discretion, and the corporation does not have the right to amend materially the plan or terminate the plan (except on a prospective basis, i.e., before services are performed for the applicable period for which the compensation is to be paid).  Provided that the other conditions of the written binding contract are met (e.g., that the plan itself is in writing), the payments under the plan to the executive are grandfathered, even though the employee was not actually a participant in the plan on November 2, 2017.

Excise Tax on Excess Tax-Exempt Organization Executive Compensation.  Tracking a similar prevision in both the House and Senate bills, the Final Bill will impose a new employer excise tax with respect to compensation paid post‑2017 by a tax-exempt organization (or a related entity) to a covered employee: (1) to the extent the compensation exceeds $1 million for the tax year; or (2) if the compensation constitutes an “excess parachute payment” (based on a measure of separation pay).  The Final Bill ties the rate to the corporate tax rate, so that the excise tax will automatically match the corporate tax rate if it is changed in the future.  The Final Bill will treat compensation as paid when the right to the compensation is no longer subject to a substantial risk of forfeiture under section 457(f)(3)(B), even if the employee has not yet received the compensation.  In a change from the Senate and House bills, the Final Bill will exclude payments to licensed medical professionals for medical services and, for purposes of excess parachute payments, payments to non-highly compensation employees.  A “covered employee” means an employee who is among the tax-exempt organization’s five highest paid employees, or who was a covered employee for any preceding tax year beginning after 2016.

Five-Year Deferral for Stock Option and RSU Income under Broad-Based Plans of Privately-Held Corporations.  Currently, under Code section 83, the value of shares covered by options without a readily-ascertainable fair market value is includable in income at the time of exercise.  Like the House and Senate bills, the Final Bill will add a new section 83(i) to allow “qualified employees” (excluding the CEO, CFO, and certain other top-compensated employees and 1-percent owners) to elect to defer for up to five years federal income taxation related to “qualified stock.”  Qualified stock means the stock of a privately-held corporation received upon exercise of a stock option or settlement of a RSU that was transferred in connection with the performance of services.  To be effective, an inclusion deferral election must be made no later than 30 days after the first time the employee’s rights in the stock are substantially vested or transferrable.  The inclusion deferral election will also be subject to the following rules:

Broad-Based Plans.  The election will only apply to a privately-held corporation that offers a written plan under which, in the calendar year, not less than 80 percent of all employees who provide services to the corporation in the United States “are granted” (and not merely be eligible for) stock options or RSUs with the “same rights and privileges” to receive the corporation’s stock.  The Final Bill and Summary clarify that stock options and RSUs cannot be aggregated for purposes of satisfying this 80‑percent threshold, and that this threshold is intended to be consistently applied to all eligible employees, whether they are new hires or existing employees. The determination of rights and privileges will be made under rules similar to existing rules under Code section 423(b)(5) (employee stock purchase plans).  Accordingly, the amount of the stock which may be purchased by the employee under the stock option or RSU may bear a uniform relationship to the employee’s total or regular compensation, provided that the number of shares available to each employee is more than a de minimis amount.  The 80‑percent rule is applied to corporations on a controlled group basis pursuant to Code section 414(b).

Stock Repurchase Limitations and Reporting.  An inclusion deferral election is not available if, in the preceding year, the corporation purchased any of its outstanding stock, unless at least 25 percent of the total dollar amount of the stock purchased is qualified stock subject to the election (“deferral stock”).  Generally, in applying this rule, an individual’s deferral stock to which the proposed election has been in effect for the longest period must be counted first.  A corporation that has deferral stock outstanding in the beginning of any calendar year and that purchases any of its outstanding stock during the year must report on its income tax return for that year the total value of the outstanding stock purchased during that year and other information as the IRS may require.

Deferral Period and Income Inclusion.  With respect to stock for which an inclusion deferral election is in place, the deferral period ends and the stock becomes includable in income on the earliest of: (i) the first date the stock becomes transferrable; (ii) the date the recipient first becomes an excluded employee (generally, a 1% owner, an officer, or a highly-compensated employee); (iii) the first date any stock of the corporation becomes readily tradeable on an established securities market; (iv) five years after the earlier of the first date the recipient’s rights in the stock are transferable or are not subject to a substantial risk of forfeiture; or (v) the date on which the employee revokes his or her election.  The amount to be included in income following the deferral period, however, would be determined based on the value of the stock upon substantial vesting, regardless of whether the stock value has declined or increased during the deferral period.

Coordination with Statutory Stock Option Rules.  An inclusion deferral election would be available with respect to statutory stock options.  If an election is made, these options would no longer be treated as statutory stock options or subject to Code sections 422 or 423.  Rather, they would be treated as nonqualified stock options for FICA purposes (in addition to being subject to section 83(i) for income tax purposes).

Coordination with Non-Qualified Deferred Compensation (“NQDC”) Regime and 83(b).  Qualified stock under section 83(i) will not be subject to section 409A.  The inclusion deferral election will not apply to income with respect to unvested stock that is includible in income as a result of an election under Code section 83(b), which permits unvested property to be includable in income in the year of transfer.  The Final Bill specifies that apart from the new section 83(i), section 83 (including section 83(b)) will not apply to RSUs.

Employee Notice.  A corporation that transfers qualified stock to a qualified employee must provide notice to the employee at the time (or a reasonable period before) that the employee’s right to the stock is substantially vested.  The notice must certify that the stock is qualified stock and notify the employee that: (1) if eligible, the employee may make an inclusion deferral election; (2) the amount includible in income is determined based on the value of the stock when it substantially vests, and not when the deferral period ends; (3) the taxable amount will be subject to withholding at the end of the deferral period; and (4) the employee has certain responsibilities with respect to required withholding.  The penalty for failing to provide the notice is $100 per failure, capped at $50,000 for all failures during any calendar year.

Withholding and Form W-2 Reporting.  Following the deferral period, the corporation must withhold federal income taxes on the amount required to be included in income at a rate not less than the highest income tax bracket applicable to the individual taxpayer.  The corporation must report on a Form W-2 the amount of income covered by an inclusion deferral election: (1) for the year of deferral; and (2) for the year the income is required to be included in the employee’s income.  In addition, for any calendar year, the corporation must report on Form W-2 the aggregate amount of income covered by inclusion deferral elections, determined as of the close of the calendar year.  The amounts are treated as non‑cash fringe benefits for purposes of applying the withholding rules, and thus, employers may include them in income pursuant to the rules under IRS Announcement 85-113.

Effective Date.  These changes would generally apply to stock attributable to options exercised or RSUs settled after 2017.  Until the IRS issues regulations on the 80-percent and employer notice requirements, a corporation will be treated as complying with these requirements if it complies with a reasonable good faith interpretation of them.  The Final Bill clarifies that this transition rule only applies with respect to the 80‑perecent and employer notice requirements.  The penalty for failure to provide the employee notice would apply after 2017.

Major NQDC Proposal Not Adopted.  Both the House and the Senate initially proposed, but later revoked these proposals, to repeal Code section 409A and establish a new section 409B that would subject NQDC to taxation upon vesting.  The Final Bill does not revive these changes and accordingly, NQDC is still governed by Code section 409A.

Health Reform

Elimination of Individual Mandate Penalties after 2019.  The Final Bill will zero out penalties for failing to comply with the ACA’s individual mandate, effective in 2019.  Like earlier ACA repeal efforts, the Final Bill will not eliminate the requirement for providers of minimum essential coverage to report coverage on Form 1095-B (or Form 1095-C) or offers of minimum essential coverage on Form 1095-C despite eliminating the penalty imposed on individuals for failing to maintain coverage.  Some of the information reported on these forms would still be necessary for the IRS to administer the premium tax credit, which the Final Bill leaves intact.

Analysis of the Senate Tax Reform Bill – Part I: Elimination of ACA Individual Mandate and Changes to Equity and Executive Compensation Rules

Early Saturday morning, the Senate voted 51-49 to approve a modified version of the Tax Cuts and Jobs Act (the “Senate Bill”). The Senate Bill differs from the House bill (discussed in an earlier series of posts here) passed last month in several respects, and a final negotiated bill will need to pass both chambers before the President can sign it into law. Given the difficulty of moving legislation through the Senate, it seems likely that any enacted legislation would likely be similar to the version passed by the Senate.

This post is the first in a series of three posts analyzing provisions of the Senate Bill. (Part II analyzes changes to deductions and exclusions for employee meals and other fringe benefits, changes to private retirement plan benefits, and a new paid leave credit.  Part III analyzes new reporting and withholding requirements and source rules.)  This post analyzes the following provisions:

  • Health Reform – eliminate the individual mandate penalties under the Affordable Care Act (“ACA”) after 2019.
  • Equity and Executive Compensation – (a) expand application of the limitation on excessive remuneration to covered employees of publicly‑traded corporations under Code section 162(m); (b) impose an excise tax on excess tax-exempt organization executive compensation; and (c) permit a deferral for up to five years for stocks pursuant to exercise of stock options and settlement of restricted stock units (“RSUs”) issued under broad‑based plans of privately-held corporations.

These changes generally would be effective after 2017, except as otherwise noted below.

Health Reform

Elimination of Individual Mandate Penalties after 2019.  Following multiple attempts to repeal and replace the ACA, including the individual and employer mandates (see discussions here), section 11081 of the Senate Bill would zero out penalties for failing to comply with the ACA’s individual mandate, effective starting in 2019.  As we have discussed in a previous post, zeroing out the individual mandate penalty would not directly affect the ACA’s information reporting requirements under Code sections 6055 and 6056.  Like earlier ACA repeal efforts, the Senate Bill does not eliminate the requirement for providers of minimum essential coverage to report coverage on Form 1095-B (or Form 1095-C) or offers of minimum essential coverage on Form 1095-C despite eliminating the penalty imposed on individuals for failing to maintain coverage.  Some of the information reported on these forms would still be necessary for the IRS to administer the premium tax credit, which both the House bill and Senate bill have thus far left intact.

Equity and Executive Compensation

Modification of Limitation on Excessive Employee Remuneration.  Code section 162(m) currently limits a publicly-traded company’s deduction for compensation paid to a “covered employee” to $1 million, with exceptions for performance-based compensation and commissions.  Like the House bill, section 13601 of the Senate Bill would make the following three changes.

  1. Repeal of Exceptions to Deduction Limitations. The Senate Bill would eliminate the exceptions for performance-based compensation and commissions under Code section 162(m)(4)(B) and (C). It is unclear whether the repeal of the performance-based pay exception will reverse the trend toward performance-based compensation, given that many shareholders and shareholder advocates believe that performance-based compensation can align shareholder and executive interests.
  2. Changes to the Definition of Covered Employee. Under the Senate Bill, a “covered employee” would include any individual who is the principal executive officer or principal financial officer at any time during the tax year and the three highest paid officers for the tax year (as disclosed to shareholders).  Further, if an individual is a covered employee after 2016, the individual would retain the covered‑employee status for all future years.
  3. Expansion of Deduction Limitation to Additional Corporations. The Senate Bill would also amend Code section 162(m)(2) to apply the limitation to any corporation that is an issuer under section 3 of the Securities Exchange Act of 1934 that (1) has a class of securities registered under section 12 of the Act or (2) is required to file reports under section 15(d) of the Act.  This change would extend the deduction limitation to corporations beyond those with publicly traded equity securities to include those that are required to file reports solely because they issue public debt.

Transition Relief. Unlike the House bill, the Senate Bill would provide that these changes would only apply to contracts that are entered into—or that are materially modified—after November 2, 2017 (see earlier coverage).  The House bill does not have a similar transition rule.

Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Like the House bill, section 13602 of the Senate Bill would impose a new 20‑percent employer excise tax with respect to compensation paid post‑2017 by a tax-exempt organization (or a related entity) to a covered employee: (1) to the extent the compensation exceeds $1 million for the tax year; or (2) if the compensation constitutes an “excess parachute payment” (based on a measure of separation pay).  For these purposes, a “covered employee” means an employee who is among the tax-exempt organization’s five highest paid employees, or who was a covered employee for any preceding tax year beginning after 2016.

Five-Year Deferral for Stock Option and RSU Income under Broad-Based Plans of Privately-Held Corporations.  Currently, under Code section 83, the value of shares covered by options without a readily-ascertainable fair market value is includable in income at the time of exercise.  Like the House bill, section 13603 of the Senate Bill would allow “qualified employees” (excluding the CEO, CFO, and certain other top-compensated employees) to elect to defer for up to five years federal income taxation related to qualified stock.  Qualified stock means the stock of a privately-held corporation received upon exercise of a stock option or settlement of a RSU that was transferred in connection with the performance of services.  To be effective, an inclusion deferral election must be made no later than 30 days after the first time the employee’s rights in the stock are substantially vested or transferrable.  The inclusion deferral election would also be subject to the following rules:

Broad-Based Plans.  The election would only apply to a privately-held corporation that offers a written plan under which, in the calendar year, not less than 80 percent of all employees who provide services to the corporation in the United States “are granted” (and not merely be eligible for) stock options or RSUs with the “same rights and privileges” to receive the corporation’s stock. The determination of rights and privileges would be made under rules similar to existing rules under Code section 423(b)(5) (employee stock purchase plans).  This cross reference implies that the amount of the stock which may be purchased by the employee under the stock option or RSU may bear a uniform relationship to the employee’s total or regular compensation, provided that the number of shares available to each employee is more than a de minimis amount.

Stock Repurchase Limitations and Reporting.  An inclusion deferral election is not available if, in the preceding year, the corporation purchased any of its outstanding stock, unless at least 25 percent of the total dollar amount of the stock purchased is qualified stock subject to the election (“deferral stock”).  Generally, in applying this rule, an individual’s deferral stock to which the proposed election has been in effect for the longest period must be counted first.  A corporation that has deferral stock outstanding in the beginning of any calendar year and that purchases any of its outstanding stock during the year must report on its income tax return for that year the total value of the outstanding stock purchased during that year and other information as the IRS may require.

Deferral Period and Income Inclusion.  A stock to which an inclusion deferral election applies would be includable in income on the earliest of: (i) the first date the stock becomes transferrable; (ii) the date the recipient first becomes an excluded employee (generally, a 1% owner, an officer, or a highly-compensated employee); (iii) the first date any stock of the corporation becomes readily tradeable on an established securities market; (iv) five years after the earlier of the first date the recipient’s rights in the stock are transferable or are not subject to a substantial risk of forfeiture; or (v) the date on which the employee revokes his or her election (the “deferral period”).  The amount to be included in income following the deferral period, however, would be determined based on the value of the stock upon substantial vesting, regardless of whether the stock value has declined during the deferral period.

Coordination with Statutory Stock Option Rules.  An inclusion deferral election would be available with respect to statutory stock options.  If an election is made, these options would no longer be treated as statutory stock options or subject to Code sections 422 or 423.

Coordination with NQDC Regime and 83(b).  The inclusion deferral election would not apply to income with respect to unvested stock that is includible in income as a result of an election under Code section 83(b), which permits unvested property to be includable in income in the year of transfer.  The Senate Bill also clarifies that, apart from the new section 83(i), section 83 (including section 83(b)) shall not apply to RSUs.

Employee Notice.  A corporation that transfers qualified stock to a qualified employee must provide notice to the employee at the time (or a reasonable period before) that the employee’s right to the stock is substantially vested.  The notice must certify that the stock is qualified stock and notify the employee that: (1) if eligible, the employee may make an inclusion deferral election; (2) the amount includible in income is determined based on the value of the stock when it substantially vests, and not when the deferral period ends; (3) the taxable amount will be subject to withholding at the end of the deferral period; and (4) the employee has certain responsibilities with respect to required withholding.  The penalty for failing to provide the notice is $100 per failure, capped at $50,000 for all failures during any calendar year.

Withholding and Form W-2 Reporting.  Following the deferral period, the corporation must withhold federal income taxes on the amount required to be included in income at a rate not less than the highest income tax bracket applicable to the individual taxpayer.  The corporation must report on a Form W-2 the amount of income covered by an inclusion deferral election: (1) for the year of deferral; and (2) for the year the income is required to be included in the employee’s income.  In addition, for any calendar year, the corporation must report on Form W-2 the aggregate amount of income covered by inclusion deferral elections, determined as of the close of the calendar year.

Effective Date.  These changes would generally apply to stock attributable to options exercised or RSUs settled after 2017.  Until the IRS issues regulations on the 80-percent and employer notice requirements, a corporation will be treated as complying with these requirements if it complies with a reasonable good faith interpretation of them.  The penalty for failure to provide the employee notice would apply after 2017.

Information Reporting Provisions of AHCA Unchanged from Earlier Bill

Yesterday, the House of Representatives narrowly passed the American Health Care Act (AHCA) on a near party-line vote, 217-213.  The legislation would repeal many provisions of the Affordable Care Act (ACA) but would retain and expand many of the ACA’s information reporting requirements.  After the House failed to pass the AHCA in late March, Republicans have worked to secure additional support for the legislation.

Although Republicans made changes to the legislation to enable it to pass the House, those changes do not substantively effect the information reporting provisions, including the new health insurance coverage credit reporting under section 6050X beginning in 2020, Form W-2 reporting of employer offers of coverage beginning in 2020, and the additional reporting required by providers of minimal essential coverage under Code section 6055.  (See earlier coverage here.)

The legislation faces an uncertain future in the Senate, where budget reconciliation rules and tepid support from some Republicans may make it difficult to secure passage.

House Republicans Pull ACA Replacement Bill

Facing likely defeat, Republicans have pulled the American Health Care Act, which would have made numerous changes to the information reporting provisions and employment tax provisions of the Affordable Care Act (ACA) (earlier coverage).   The legislation would have also created a new information reporting requirement by adding Section 6050X to the Code.  The House was scheduled to vote on the legislation this afternoon, but Republicans have struggled to appease both conservative Republicans, who wanted a more completed repeal of the ACA, and moderate Republicans, who were concerned about the potential loss of coverage that could result from the legislation. The decision to pull the bill increases the likelihood that the ACA’s information reporting regime under Sections 6055 and 6056 will remain in place, along with the additional Medicare tax and other provisions of the ACA.

House Republicans’ ACA Repeal-and-Replace Bill Would Change Health Coverage Reporting Requirements

A House Republican bill, entitled the American Health Care Act, would repeal many provisions of the Affordable Care Act (ACA) but retain and expand the information reporting rules.  Released on March 6, the proposal consists of two parts: (1) a bill drafted by the House Ways and Means Committee, to eliminate the ACA’s taxes and income-based subsidies, zero out penalties for the individual and employer mandates, and establish a new individual tax credit; and (2) a bill drafted by the House Energy and Commerce Committee, to freeze and reform Medicaid.

The Ways & Means bill would help taxpayers pay for health insurance by expanding health savings accounts, and by providing an advanceable, refundable tax credit—the “health insurance coverage” credit—for purchasing state-approved, major medical health insurance and unsubsidized COBRA coverage.  Unlike the leaked bill obtained by Politico on February 24, the bills do not cap the tax exclusion for employer-provided health insurance.  Although the legislation is unlikely to pass in its current form, as it is headed for markup by the two Committees later this week, it does provide insight into the thinking of House Republicans.

Those hoping for a full repeal of the ACA’s reporting provisions will be disappointed as the ACA’s reporting regime would largely survive, at least temporarily.  Applicable large employers (ALEs), for instance, would still be required to file Forms 1094-C and 1095-C pursuant to Code section 6056, even though the bill would reduce penalties for failure to comply with the employer mandate to zero beginning in 2016.  Similarly, the Ways & Means bill does not eliminate the requirement for providers of minimum essential coverage to report coverage on Form 1095-B (or Form 1095-C) despite eliminating the penalty on individuals for failing to maintain coverage.

However, the Ways & Means bill would alter health insurance reporting in three ways.  First, the bill would establish new information reporting rules under Code section 6050X for the health insurance coverage credit beginning in 2020.  Second, the bill would expand information reporting under Code section 6055 regarding the ACA’s premium tax credits used for qualifying off-Exchange coverage in 2018 and 2019.  Third, the bill would repeal the additional Medicare tax and thereby eliminate employers’ corresponding reporting and withholding obligations beginning in 2020.

New Reporting Rules for Health Insurance Coverage Credits Beginning in 2020

The bill would replace the ACA’s premium tax credit with the health insurance coverage credit for purchasing eligible health insurance—state-approved, major medical health insurance and unsubsidized COBRA coverage—starting in 2020.  Generally, an individual is eligible for this credit only if he or she lacks access to government health insurance programs or offer of employer coverage.  The credit amount varies from $2,000 to $4,000 annually per person based on age, and phases out for those earning over $75,000 per year ($150,000 for joint filers).  The credit maxes out at $14,000 per family, and is capped by the actual amount paid for eligible health insurance.  Treasury would be required to establish a program for making advance payments of the credit, on behalf of eligible taxpayers, to providers of eligible health insurance or designated health savings accounts no later than 2020.

Reporting for Health Insurance Coverage Credit.  To administer the health insurance coverage credit, the bill would create Code section 6050X that would require providers of eligible health insurance to file information returns with the IRS and furnish taxpayer statements, starting in 2020.  The return must contain the following information: (a) the name, address, and taxpayer identification number (TIN) of each covered individual; (b) the premiums paid under the policy; (c) the amount of advance payments made on behalf of the individual; (d) the months during which the individual is covered under the policy; (e) whether the policy constitutes a high deductible health plan; and (f) any other information as Treasury may prescribe.  The bill does not specify how often providers would be required to file returns reporting this information with the IRS, but it would authorize Treasury to require a provider to report on a monthly basis if the provider receives advance payments.  A provider would also be required to furnish taxpayers, by January 31 of the year after the year of coverage, written statements containing the following information: (a) the name, address, and basic contact information of the covered entity required to file the return; and (b) the information required to be shown on the return with respect to the individual.

Employer Statement for Advance Payment Application.  The advance payment program would require an applicant—if he or she (or any qualifing family member taken into account to determine the credit amount) is employed—to submit a written statement from the applicable employer stating whether the applicant or the qualifying family member is eligible for “other specified coverage” in connection with the employment.  Other specified coverage generally includes coverage under an employer-provided group health plan (other than unsubsidized COBRA continuation coverage or plan providing excepted benefits), Medicare Part A, Medicaid, the Children’s Health Insurance Program, and certain other government sponsored health insurance programs.  An employer shall provide this written statement at the request of any employee once the advance payment program is established.  This statement is not required if the taxpayer simply seeks the credit without advance payment.

Employer Coverage Reporting on Form W-2.  The bill would require reporting of offers of coverage by employers on the Form W-2 beginning with the 2020 tax year.  Employers would be required to report each month in which the employee is eligible for other specified coverage in connection with employment.  This requirement would likely demand a substantial revision to the current Form W-2, which is already crowded with information.  The Form W-2 reporting requirement appears to be intended to replace the reporting rules under Section 6056 based on a statement in the Ways and Means Committee summary.

Although the budget reconciliation rules limit Congress’s ability to repeal the current coverage reporting rules, the Ways and Means Committee states that Treasury can stop enforcing any reporting not required for tax purposes.  Given the elimination of penalties for individuals who fail to maintain minimum essential coverage and ALEs that fail to offer coverage, this statement may serve as a green light to undo many of the Form 1095-B and 1095-C reporting requirements once the ACA’s premium tax credits are eliminated and Form W-2 reporting is in place in 2020.

Reasonable Cause Waiver.  The bill would make these new information returns and written statements subject to the standard information reporting penalties under Code section 6721 (penalties for late, incomplete, or incorrect filing with IRS) and Code section 6722 (penalties for late, incomplete, or incorrect statements furnished to payees).  The bill also extends the reasonable cause waiver under Code section 6724 to information reporting penalties with respect to the new health insurance coverage credit returns, so that the IRS may waive such penalties if the failure is “due to reasonable cause and not to willful neglect.”

Transitional Reporting Rules for Premium Tax Credits in 2018 and 2019

The Ways & Means bill would allow the ACA’s premium tax credits to be used for off-Exchange qualified health plans in 2018 and 2019 before eliminating the credits in 2020.  The premium tax credit is a refundable, income-based credit that helps eligible individuals and families pay premiums for coverage under a “qualified health plan,” which, under current law, only includes plans sold on ACA Exchanges, and does not include catastrophic-only health plans.  The bill, however, would expand the definition of qualified health plan to include off-Exchange and catastrophic-only health insurance plans that otherwise meet the requirements for a qualified health plan, so that these types of plans would also be eligible for the premium tax credit.  Advance payment of the credit is only available for coverage enrolled in through an Exchange.

To aid in the administration of the expanded credit, the bill would amend Code section 6055(b) to require providers of minimum essential coverage to report certain information related to premium tax credits for off-Exchange qualified health plans.  Because employer-sponsored coverage does not qualify for the credit, employers sponsoring self-insured plans generally would not be required to report additional information on the Form 1095-C beyond that already required under Code sections 6055 and 6056.  Health insurance issuers who provide coverage eligible for the credit would be required to report annually to the IRS: (a) a statement that the plan is a qualified health plan (determined without regard to whether the plan is offered on an Exchange); (b) the premiums paid for the coverage; (c) the months during which this coverage was provided to the individual; (d) the adjusted monthly premium for the applicable second lowest cost silver plan for each month of coverage; and (e) any other information as Treasury may prescribe.  These new reporting requirements would apply only in 2018 and 2019, before the premium tax credit is scrapped and replaced by the health insurance coverage credit in 2020.

Repeal of Additional Medicare Tax

The bill would also repeal the additional Medicare tax under Code section 3101(b)(2), beginning in 2018.  This 0.9% tax is imposed on an employee’s wages in excess of a certain threshold (e.g., $200,000 for single filers and $250,000 for joint filers).  Under current law, employers are required to withhold and remit additional Medicare taxes when it pays wages to an employee over $200,000.  The additional Medicare tax has complicated the process for correcting employment tax errors because unlike other FICA taxes (and more like income tax withholding) the additional Medicare tax is paid on the employee’s individual income tax return.  As a result, the employer cannot make changes to the amount of additional Medicare tax reported after the end of the calendar year.  The elimination of the additional Medicare tax will likely be welcomed by employers and employees affected by it.  In addition, the bill would also repeal the net investment income tax that expanded the Medicare portion of FICA taxes to non-wage income for individuals with incomes in excess of certain thresholds.

What to Expect Next

The fate of the legislation is uncertain, and it will likely undergo substantive changes before House Republicans move the bill to the floor.  A key issue that House Republicans are reportedly debating is how to structure the health insurance coverage tax credit.  Additionally, the decision to eliminate the cap on tax breaks for employer-provided health insurance that was included in the draft language leaked in late February may mean that the legislative proposal will need to be amended to include another funding source.  However these issues are resolved, the legislation makes it clear that a health insurance reporting regime is likely to survive Republicans’ ACA repeal-and-replace efforts.  We will continue to monitor further developments on the proposal and its impact on the information reporting regime for health insurance coverage.

IRS Webinar Answers ACA Information Reporting Questions

Last week, the IRS released a webinar on identifying and correcting errors on information returns related to the Affordable Care Act (ACA).  The ACA requires health insurers and some employers to file information returns with the IRS and furnish a copy to the recipient.  The 2015 returns are due by May 31, 2016, if filing on paper, or June 30, 2016, if filing electronically through the ACA Information Reporting (AIR) System.  The IRS webinar addressed frequently asked questions on four topics: correcting specific forms; TIN solicitation and correcting TIN errors; correcting AIR filing; and penalties, exceptions, and penalty relief.

Form-Specific Corrections

To correct errors on Forms 1095-B, 1094-C, and 1095-C, an entity must complete the proper form with the corrected information and mark it as a corrected return.  An entity should not file a return that includes only the corrected information.  Employers used to filing Forms W-2c to correct Forms W-2 will find this approach different from the process with which they are familiar.

To correct a Form 1095-B previously filed with the IRS, an entity should file a complete and corrected Form 1095-B that is marked as corrected, with a Form 1094-B Transmittal (which cannot and should not be marked as corrected).  To correct a Form 1095-C previously filed with the IRS, an entity must file a complete and corrected Form 1095-C that is marked as corrected, with a Form 1094-C Transmittal that is not marked as corrected.  Next, the entity must furnish the employee with a copy of the corrected Form 1095-C.  Employers using the qualifying offer method or the qualifying offer method transition relief for 2015, however, are not required to furnish the copy to the employee in certain cases.

To correct a Form 1094-C that is the authoritative transmittal previously filed with the IRS, an entity should file a standalone Form 1094-C.  An entity need not correct a Form 1094-C that is not the authoritative transmittal.

Some filers have expressed confusion as to why they must file corrected returns given that the IRS has indicated that a recipient of a Form 1095-B or Form 1095-C need not correct their tax return to reflect information reflected on a corrected form.  The webinar makes clear that regardless of that approach, filers must correct returns timely.  In terms of timing, an entity should file a correction as soon as the error is discovered if the filing deadline has already passed.  If an entity has already furnished Forms 1095-B or 1095-C to recipients but finds an error before filing with the IRS, the entity needs to file with the IRS a regular return, i.e., not marked as corrected, containing the accurate information. A new original, i.e., not marked as corrected, form should be provided to the responsible individual or employee as soon as possible.

TIN Solicitation and Error Corrections

In an effort to assuage a key concern of many filing entities, the IRS stated that an error message for missing and/or incorrect information is not a proposed penalty notice.  However, when an entity receives an error message regarding a name/TIN mismatch, the entity should file a correction if it has correct information.  If the entity lacks the TIN, it may use the date of birth and avoid penalties for failure to report a TIN, provided that the entity followed the three-step TIN solicitation process under Notice 2015-68: “(1) the initial solicitation is made at an individual’s first enrollment or, if already enrolled on September 17, 2015, the next open season, (2) the second solicitation is made at a reasonable time thereafter, and (3) the third solicitation is made by December 31 of the year following the initial solicitation.” The webinar is unclear whether the receipt of an error message triggers an obligation for filers to engage in a new round of TIN solicitation.

If an entity has not solicited a TIN, e.g., the individual was already enrolled on September 17, 2015, and the next open season is not until July 2016, the entity may be unable to correct the error before the return filing deadline.  In this case, the entity should still file a correction when it obtains the TIN or the date of birth if the TIN is not provided.  If a Penalty Notice 972CG is issued, the entity will have the opportunity to show whether good-faith relief or a reasonable-cause waiver applies.

AIR Filing Corrections

The IRS also clarified AIR’s transmission responses, which are defined under IRS Publication 5165.  An AIR filing will generate one of five responses: accepted, accepted with errors, partially accepted, rejected, or not found by AIR.  “Accepted with errors” means that AIR found at least one of the submissions had errors, but did not find fatal errors – i.e., the submission had unusable data – which would prompt a “rejected” response.  “Partially accepted” means AIR accepted some of the submissions and rejected others.  If AIR rejected any attempted filings, the entity must cure the problem and transmit the return again rather than use the correction process.

If AIR identifies errors, an entity will receive an acknowledgement in XML with an attached Error Data File.  Again, this error message is not a proposed penalty notice.  Rather, to assist the entity, the Error Date File includes unique IDs to identify the erroneous returns, and error codes and descriptions to identify the specific errors.  After locating and identifying the error, the entity must prepare corrected returns, which must reference the unique IDs of the returns being corrected.  AIR will assign unique IDs to the corrected returns, which the entity can then transmit through AIR.

Penalties and Penalty Relief

ACA-related information reporting is subject to the general penalties under Sections 6721 and 6722 of the Code for failure to (1) furnish correct copies to employees and insured individuals or (2) file complete and accurate information returns with the IRS.  The penalty for each incorrect information return is $260 and up to $3,178,500 for each type of failure, for entities with over $5 million in average annual gross receipts over the last three taxable years.  Only one penalty applies per record, even if the record has multiple errors, such as incorrect TIN and incorrect months of coverage.  For late returns, penalty amounts per return start at $50 and increase to $520, depending when the correction is filed and whether the failure was due to intentional disregard.  Further, a penalty may apply if an entity is required to file electronically because it has 250 or more returns but the entity files on paper and fails to apply for a waiver using Form 8508.

The IRS has provided good-faith relief to entities that file or furnish incorrect or incomplete – but not late – information, including TINs or dates of birth, if the entity can show that it made a good-faith effort to comply with the requirements.  Good-faith relief does not apply to egregious mistakes, e.g., where an entity transmits returns with just names and addresses and no health coverage information.  Further, good-faith relief does not excuse an entity from the continuing obligations to identify and correct errors in returns previously filed with the IRS.  An entity must correct errors within a reasonable period of time after discovering them (corrections must be filed within 30 days).  Importantly, if subsequent events, such as a retroactive enrollment or change in coverage make the information reported on a Form 1095-B or Form 1095-C incorrect, the entity has an affirmative obligation to correct the return even though it was correct when initially filed.

In addition to the good-faith relief, inconsequential errors and omissions are not subject to these penalties.  An error or omission is inconsequential if it does not stop the IRS from correlating the required information with the affected person’s tax return, or otherwise using the return. Errors and omissions are not inconsequential, however, if they pertain to the TIN and/or surnames of the recipient or other covered individuals, or if the return furnished to a recipient is not the appropriate form or substitute form.  Many errors relating to addresses or to an individual’s first name may be inconsequential, and are not required to be corrected.

Another exception is available for a de minimis number of failures to provide correct information if the filing entity corrects that information by August 1 of the calendar year to which the information relates, or November 1 for 2016.  For a calendar year, penalties do not apply to the greater of 10 returns or half a percent of the total number of returns the entity is required to file or furnish.

Finally, a filer may qualify for a reasonable cause waiver under Section 6724 of the Code for a failure that is due to a reasonable cause and not willful neglect.  To establish “reasonable cause,” an entity must show that it acted responsibly before and after the failure occurred and that the entity had significant mitigating factors or the failure was due to events beyond its control.  Significant mitigating factors include, for instance, that an entity was not previously required to file or furnish the particular type of form, and that an entity has an established history of filing complete and accurate information returns.  Events beyond an entity’s control include fire or other casualty that make relevant business records unavailable and prevent the entity from timely filing.