Printable versionSend by emailPDF version
July 23, 2013

2013-Issue 30—On April 1, 2013, the Internal Revenue Service issued proposed regulations providing guidance on the $500,000 deduction limitation for compensation paid by covered health insurance providers (CHIPs) to employees. Don't think you're a CHIP? Keep reading, as this net cast by the IRS is likely to snag some companies not in the health insurance industry.


The proposed regulations have their roots in the Patient Protection and Affordable Care Act, which added Section 162(m)(6) to the Internal Revenue Code. The rationale behind the statute was that health insurance companies would realize substantial revenue growth as a result of the Act's individual mandate to obtain health insurance, and that such windfalls should not be used to enrich highly compensated employees of health insurance companies.

Although we've seen this coming for a while, 2013 is the first year in which CHIPs' deduction on employee compensation will be affected. While the proposed regulations share the same code section as the better-known rules that limit the deduction for executive compensation to $1 million, that is where the similarities end. There are significant differences in the coverage and application of the $500,000 deduction limitation for compensation paid by CHIPs to employees.

According to the statute and the proposed regulations, a CHIP is any health insurance issuer that receives at least 25 percent of its health insurance premiums from providing "minimum essential coverage." If one entity of an aggregated group is considered a CHIP, the parent and all members of the aggregated group are also considered CHIPs, unless a de minimis exception is satisfied. To meet the de minimis exception, premiums received related to providing "minimum essential coverage" must be less than 2 percent of the gross revenues of the aggregated group. CHIP status is determined on a year-by-year basis.

So who, besides health insurance companies, will be affected? The preamble to the proposed regulations makes it clear that the Treasury Department and the IRS believe that a captive insurance company (better known simply as a "captive") is a CHIP if it otherwise meets the definition of a health insurance issuer under Section 162(m)(6)(C). Therefore, a captive (and its entire aggregated group) may be treated as a CHIP if it is licensed to engage in the business of insurance in a state and is subject to state law that regulates insurance.

It should be pointed out that medical reimbursement plans that are self-insured through a trust or the general assets of a company are excepted from the rules, and therefore not treated as CHIPs.

The Captive Snag

To illustrate how a company might find itself in a surprising situation, consider this example.

The Jackson Company ("Jackson") provides technology consulting services to the energy industry. Jackson has established a captive insurance company ("Captive") to insure the risks associated with the medical benefits provided to employees of Jackson. Captive, which is subject to state regulation, receives premiums from Jackson (funded in part by Jackson and in part via employee payroll deductions) during the year of $5 million, all of which relate to providing minimum essential coverage. In the ordinary course of its consulting business, Jackson produces $195 million of revenue during the year. Assume that Jackson and Captive are the only two entities in the aggregated group.

Because the premiums received by Captive ($5 million) represent 2.5 percent (more than the 2 percent de minimis threshold) of the gross revenues of the aggregated group ($200 million — $195 million from Jackson and $5 million from Captive), the de minimis exception cannot be invoked. In addition, since more than 25 percent (100 percent) of Captive's revenue is attributable to providing minimum essential coverage, Jackson and Captive are both treated as CHIPs. Therefore, compensation paid to any employee of Jackson or Captive is not deductible to the extent it exceeds $500,000.

It should be noted that the proposed regulations include a one-year grace period related to the de minimis exception. For example, if Jackson was not treated as a CHIP in year 1 solely because it invoked the de minimis exception, it will not be treated as a CHIP in year 2 if it fails to meet the de minimis exception the subsequent year. 

How the Proposed Regulations Differ From Prior Regulations

Many tax practitioners are familiar with Section 162(m). However, as mentioned earlier, the proposed rules differ significantly in scope and application from the original Section 162(m) rules, and in many ways are similar to the special limitations imposed on Troubled Asset Relief Program (TARP) recipients by Section 162(m)(5). The chart below illustrates the differences in application.

As shown above, the proposed regulations (summarized in the rightmost column, under the heading "Health Insurers" §162(m)(6)) apply to all companies that are CHIPs, not just public companies as the broader Section 162(m) rules do. In addition, the proposed regulations cover all employees, as opposed to other areas of Section 162(m), which cover only select members of senior management. Like the TARP Section 162(m) rules, no compensation is exempt from the limitation, even if it is performance-based.

How the Proposed Regulations Work

Unlike the general application of Section 162(m), the $500,000 deduction limit imposed by Section 162(m)(6) is applied based on the year in which the compensation is earned (versus the year in which it would otherwise be deductible).

Continuing from the prior example, assume the Jackson Company, a CHIP, pays Brian, an employee, $400,000 in salary for services performed in 2013. In addition, Brian earns a $300,000 bonus, payable upon December 31, 2013, but for the fact that Brian chose to defer the bonus under a nonqualified deferred compensation plan. As a result of the deferral, the bonus will be paid to Brian in 2017.

Under the "original" Section 162(m) rules, the $400,000 in salary would be tested against the $1 million deduction limitation for 2013, while the $300,000 bonus would be tested against the $1 million deduction limitation for 2017 (the year in which it is paid). However, under the new Section 162(m) rules applicable to CHIPs, both the $400,000 in salary and the $300,000 bonus would be tested against the $500,000 deduction limitation for 2013. Therefore, when the $300,000 bonus is paid in 2017, only $100,000 will be able to be deducted for tax purposes ($500,000 allowed deduction related to 2013 services, less $400,000 in salary already deducted).

The proposed regulations contain special attribution rules for account balance plans, non-account balance plans and long-term incentives (i.e., stock options, restricted stock and restricted stock units). For example, the attribution rules for stock options prescribe that compensation arising from the exercise of stock options is attributable on a daily pro rata basis over the period beginning on the date of grant and ending on the date the option is exercised. Such complex attribution rules require meticulous record keeping and thorough calculations to determine allowable tax deductions for employee compensation.

Alvarez & Marsal Taxand Says:

The proposed Section 162(m) regulations applicable to covered health insurance providers — CHIPs — bring many complexities to the forefront for tax, human resource and accounting professionals. Of note, companies should immediately consider:

  • Whether or not the proposed regulations will affect them. For companies that are not health insurance issuers, consideration should be given to whether the presence of a captive insurance company that insures minimum essential benefits would cause all members of the aggregated group to be treated as covered health insurance providers. If a captive is expected to cause the aggregated group to be treated as CHIPs, consideration should be given to self-insuring employees' medical benefits.
  • Performing sensitivity analyses within the tax department to determine the approximate value of the deduction that will be lost as a result of the proposed rules, as well as updating forecasts.
  • Whether there are appropriate systems and processes in place to track which compensation is deductible vs. non-deductible. As discussed, certain elements of compensation may be "earned" across many years. Further, the year in which the compensation is potentially deductible may occur many years following the year in which the compensation is "earned." Therefore, it is of utmost importance to have procedures and controls in place to track compensation.
  • Whether the proposed regulations warrant examining and adjusting the overall compensation strategy and philosophy of the organization.


J.D. Ivy
Managing Director, Dallas
+1 214 438 1028

Garrett Griffin, Senior Director, contributed to this article.

For More Information

Brian Cumberland
Managing Director, Dallas
+1 214 438 1013

J.D. Ivy
Managing Director, Dallas
+1 214 438 1028

Allison Hoeinghaus
Senior Director, Dallas
+1 214 438 1037

Mark Spittell
Senior Director, Dallas
+1 214 438 1017

Douglas Friesen
Director, Dallas
+1 214 438 8435

Sarah Crawford
Director, Dallas
+1 214 438 1032

Related Issues

Play or Pay vs. Individual Mandate


As provided in Treasury Department Circular 230, this publication is not intended or written by Alvarez & Marsal Taxand, LLC, (or any Taxand member firm) to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer.   

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.

About Alvarez & Marsal Taxand

Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the U.S., and serves the U.K. from its base in London.

Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisors in 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.

To learn more, visit or