Tax-exempt affiliate's pay counts toward insurer compensation cap

Plain-English summary

A covered health insurance provider and a tax-exempt hospital belonged to the same aggregated employer group and both paid an employee during one year. The IRS advised that compensation paid by the tax-exempt hospital still counts when applying section 162(m)(6)'s $500,000 deduction limit. Neither the statute nor the regulations exclude a tax-exempt member of an aggregated group, and its compensation is considered otherwise deductible even if it has no taxable income against which to use the deduction. In the example, the two entities paid $1 million in total compensation, so the $500,000 limit was allocated in proportion to the $750,000 and $250,000 each paid. That produced deduction limits of $375,000 for the insurer and $125,000 for the hospital.

Ruling snapshot

• Question: Does compensation paid by a tax-exempt hospital count when allocating the section 162(m)(6) deduction limit among members of its aggregated group?
• Outcome: advice given, the tax-exempt affiliate's compensation is included and the limit is prorated among group members
• Key authorities: IRC §§ 162(m)(6), 414(b), 501(c)(3), 5000A(f), and 9832(b); Treas. Reg. § 1.162-31(e)(4)

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service
memorandum

Number: 201752008
Release Date: 12/29/2017
CC:TEGE:EB:EC
PRESP-116393-17

UILC: 162.36-09

date: December 04, 2017

to: Mark Hulse, Area Counsel
    CC:TEGEDC:NELI

from: John Richards, Senior Technical Reviewer
      CC:TEGE:EB:EC

subject: Allocating Deduction Limitation under § 162(m)(6)

This Chief Counsel Advice responds to your request for assistance. This advice may
not be used or cited as precedent.

ISSUE

Corporation Y is a tax-exempt hospital and is part of an aggregated group with
Corporation X, a covered health insurance provider. Both Corporations X and Y paid
applicable individual remuneration to Employee A. The regulations under § 162(m)(6)
provide that the § 162(m)(6) deduction limitation must be allocated among members of
an aggregated group. Is remuneration paid by Corporation Y otherwise deductible and
taken into account for purposes of applying the deduction limitation even though
Corporation Y is a tax-exempt entity?

CONCLUSION

Yes, remuneration paid by Corporation Y is otherwise deductible and is taken into
account in applying the deduction limitation under §162(m)(6).

FACTUAL SCENARIO (for illustrative purposes)

For its 2015 taxable year, Corporation X was a covered health insurance provider as
defined in § 162(m)(6)(C)(i)(II). For 2015, Corporation Y was a tax-exempt entity
described in § 501(c)(3). Corporations X and Y were treated as a single employer
under § 414(b). From January 1 to July 31 of 2015, Employee A was an employee of
Corporation X. For the remainder of 2015, Employee A was an employee of
Corporation Y. For 2015, Employee A was an applicable individual within the meaning
of § 162(m)(6)(F). For the 2015 taxable year, Corporations X and Y paid applicable
individual remuneration (as defined in § 162(m)(6)(D)) to Employee A of $750,000 and
$250,000, respectively. Employee A received no other remuneration from Corporations
X and Y in 2015.

LAW

Section 162(a)(1) allows a deduction for all ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or business, including a
reasonable allowance for salaries or other compensation for personal services actually
rendered.

Section 162(m)(6)(A) limits the allowable deduction to $500,000 for applicable individual
remuneration and deferred deduction remuneration attributable to services performed
by applicable individuals that is otherwise deductible by a covered health insurance
provider in taxable years beginning after December 31, 2012.

Section 162(m)(6)(B) provides that the term “disqualified taxable year” means, with
respect to any employer, any taxable year for which such employer is a covered health
insurance provider.

Section 162(m)(6)(C)(i)(II) provides that, for taxable years beginning after December 31,
2012, a covered health insurance provider is any employer that is a health insurance
issuer as defined in §9832(b)(2) and with respect to which not less than 25% of the
gross premiums received from providing health insurance coverage (as defined in
§9832(b)(1)) are from minimum essential coverage (as defined in §5000A(f)). Section
162(m)(6)(C)(ii) provides that two or more persons who are treated as a single employer
under § 414(b), (c), (m), or (o) are treated as a single employer for purposes of
§162(m)(6). Section 1.162-31(b)(2) of the regulations defines an “aggregated group” as
one or more persons treated as a single employer under §162(m)(6)(C)(ii).

Section 162(m)(6)(D) provides that applicable individual remuneration (AIR) for any
disqualified taxable year is the aggregate amount otherwise allowable as a deduction
for such taxable year for remuneration for services performed by such individual
(whether or not during the taxable year), but does not include any deferred deduction
remuneration with respect to services performed during the disqualified taxable year.

Section 162(m)(6)(E) provides that deferred deduction remuneration (DDR) means
remuneration which would be applicable individual remuneration for services performed
in a disqualified taxable year but for the fact that the deduction for such remuneration is
allowable in a subsequent taxable year.

Section 162(m)(6)(F) provides that an applicable individual, with respect to any covered
health insurance provider for any disqualified taxable year, is any individual (i) who is an
officer, director, or employee in such taxable year, or (ii) who provides services for or on
behalf of such covered health insurance provider during such taxable year.

Section 1.162-31(e)(4)(i) of the regulations provides that the total combined deduction
for AIR and DDR attributable to services performed by an applicable individual in a
disqualified taxable year allowed for all members of an aggregated group that are
covered health insurance providers for any taxable year is limited to $500,000.
Therefore, if two or more members of an aggregated group that are covered health
insurance providers may otherwise deduct AIR or DDR attributable to services
performed by an applicable individual in a disqualified taxable year, the AIR and DDR
otherwise deductible by all members of the aggregated group is combined, and the
deduction limitation is applied to the total amount.

Section 1.162-31(e)(4)(ii) of the regulations provides that if the total amount of AIR and
DDR attributable to services performed by an applicable individual in a disqualified
taxable year that is otherwise deductible by two or more members of an aggregated
group in any taxable year exceeds the $500,000 deduction limit (as reduced by
previously deductible AIR or DDR, if applicable), the deduction limit is prorated based
on the AIR or DDR otherwise deductible by the members of the aggregated group in the
taxable year and allocated to each member of the aggregated group. The deduction
limit allocated to each member of the aggregated group is determined by multiplying the
deduction limit for the disqualified taxable year by a fraction, the numerator of which is
the AIR or DDR otherwise deductible by that member in that taxable year that is
attributable to services performed by the applicable individual in the disqualified taxable
year, and the denominator of which is the total AIR or DDR otherwise deductible by all
members of the aggregated group in that taxable year that is attributable to services
performed by the applicable individual in the disqualified taxable year. The amount of
AIR or DDR otherwise deductible by a member of the aggregated group in excess of the
portion of the deduction limit allocated to that member is not deductible in any taxable
year.

ANALYSIS

Corporation X is a covered health insurance provider as defined in § 162(m)(6)(C)(i)(II).
Pursuant to § 162(m)(6)(C)(ii), because Corporations X and Y are treated as a single
employer under §414(b), the two corporations are also treated as a single employer for
purposes of the deduction limitation under § 162(m)(6). Because Corporations X and Y
are members of the same aggregated group, the AIR otherwise deductible by them is
aggregated for purposes of applying the § 162(m)(6) deduction limitation, thus resulting
in a reduced deduction limit for each corporation. See §§ 1.162-31(e)(4)(i) and (ii).

Neither § 162(m)(6) nor the regulations thereunder provide an exception for tax-exempt
entities that are members of an aggregated group. Remuneration paid by a tax-exempt
entity engaged in a related or unrelated trade or business is considered otherwise
deductible regardless of whether the entity may use the deduction (for example,
regardless of whether the entity has taxable income, such as unrelated business
taxable income, against which the deduction may be taken). Accordingly, pursuant to
§1.162-31(e)(4)(ii), because the aggregate $1,000,000 AIR otherwise deductible by
Corporations X and Y for 2015 exceeds the $500,000 deduction limitation for Employee
A for 2015, the deduction limit is prorated and allocated to Corporations X and Y in
proportion to the AIR otherwise deductible by each corporation for 2015. Therefore, the
deduction limit that applies to the AIR otherwise deductible by Corporation X is
$375,000 ($500,000 x ($750,000 / $1,000,000)) and the deduction limit that applies to
the AIR otherwise deductible by Corporation Y is $125,000 ($500,000 x ($250,000 /
$1,000,000)). For the 2015 taxable year, with respect to AIR paid to Employee A,
Corporation X may not deduct $375,000 of the $750,000 of AIR ($750,000 - $375,000).

Please call Ilya Enkishev at (202) 317-5600 if you have any further questions.