After months of uncertainty around the outcome of health care legislation, the House approved on Sunday the Patient Protection and Affordable Care Act (PPACA), originally passed by the Senate last December, as well as a health care tax reconciliation bill (H.R. 4872). President Obama is signing PPACA into law today. The Senate is expected to vote on the reconciliation package this week, which would require only a 51-vote majority. One of the revenue-raising provisions of PPACA is the elimination of tax deductibility of retiree health care costs to the extent of federal subsidies received by plan sponsors that provide retiree prescription drug benefits equivalent to Medicare Part D coverage. Employers currently receiving the Part D subsidy will be required to make adjustments to deferred tax asset balances on their balance sheet in the period PPACA is signed into law, generally resulting in significant charges to tax expense in the income statement this quarter. This HRS Insight provides guidance and considerations for employers related to the accounting for this tax law change.
As we previously discussed in HRS Insight 09/32, the Medicare Prescription Drug, Improvement and Modernization Act ("MMA") was signed into law in 2003. The MMA introduced a prescription drug benefit under Medicare Part D, as well as a federal subsidy to sponsors of retiree health benefit plans that provide a benefit that is at least actuarially equivalent to the benefits under Medicare Part D. This subsidy is known as the Retiree Drug Subsidy (RDS). Employers are not currently taxed on the RDS payments they receive.
In response to the 2003 Act, the FASB issued FSP FAS 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The FSP addressed the accounting for the change in the benefit obligation due to the expected subsidies to be received, as well as the accounting for the related tax implications. Since the subsidy was not subject to tax, the guidance indicates that the subsidy's impact on the benefit obligation should have no bearing on any plan-related temporary difference accounted for under ASC 740, Income Taxes (formerly FAS 109, Accounting for Income Taxes). Thus, the measure of any temporary difference related to the benefit obligation is currently determined as if the subsidy did not exist.
Accounting for Deferred Taxes under PPACA
PPACA contains a provision that changes the tax treatment related to the RDS, by requiring the amount of the subsidy received to be offset against the employer's deduction for health care expenses. That is, the change in tax treatment does not affect the taxation of the subsidy itself, but would reduce the employer's deduction for the costs of health care for retirees by the amount of the subsidy received.
As a result, under PPACA, the deductible temporary difference and any related deferred tax asset on the employer's balance sheet associated with the benefit plan will be reduced. Under ASC 740, the impact of the change in tax law The effective date under PPACA is tax years beginning after 12/31/2010. However, the reconciliation package put forth by the House would delay the effective date until tax years beginning after 12/31/2012. The Senate is expected to vote on the reconciliation package shortly. should be immediately recognized in continuing operations in the income statement for the period that includes the enactment date (that is, the date signed into law by President Obama). This is true regardless of the effective date of the change in tax law (though the effective date would likely impact the amount of the change in the deferred tax asset). This immediate income statement recognition is required for the change in tax law even though some portion of the accumulated actuarial gains or losses related to the subsidy may be recorded in accumulated other comprehensive income in the balance sheet.
Observations: The impact of this provision may be significant both economically and from a financial reporting perspective. PPACA effectively results in a new tax that employers will be required to pay on the federal subsidy received for retiree prescription drug benefits. The impact of the new tax will be recognized immediately in the income statement upon enactment of PPACA.
For many employers, the income statement impact can be estimated as the difference in the retiree benefit obligation for prescription drug coverage computed "with" and "without" subsidy, times the corporate tax rate. In addition, the employer's effective tax rate will be adversely affected in future periods by this change. Note, however, for employers that have a full valuation allowance against their deferred tax assets under ASC 740, PPACA will have no immediate net financial statement impact related to the change in tax law.
Plan Changes Prior to Enactment
Some employers made plan changes that would disqualify them from receiving subsidy payments in the future, such as reducing benefits so that they are no longer actuarially equivalent to the benefits under Medicare Part D.
A change such as reducing benefits should be treated as a negative prior service cost under FSP FAS 106-2 (codified in ASC 715-60), even though some of the original gain from the anticipated subsidy remained in accumulated other comprehensive income. In that case, the reduction in the deferred tax asset related to the loss of the expected subsidy would be reflected in other comprehensive income as part of the accounting for the amendment (not directly in the income statement as above). However, this treatment would be appropriate only if the amendment was adopted by the employer prior to the enactment of the new law.
Measuring the Impact
To properly reflect the change in deferred taxes described above, employers need to determine the appropriate adjustment to the deferred tax accounts as of the date of enactment of PPACA. Since the deferred tax balance is derived from the pre-tax benefit obligation balance, questions have arisen as to whether an interim remeasurement of the benefit plan (both the benefit obligation and the fair value of any plan assets) is necessary as of the enactment date.
Generally, the benefit plan accounting guidance requires plan measurements annually, and requires interim remeasurements if a significant event occurs. ASC 715 does not specifically define what a significant event is, but generally implies it is an event that has a significant direct impact on the plan. Examples include significant plan amendments, curtailments, or settlements.
The change in the tax deductibility of future benefit payments resulting from the PPACA does not have any direct impact on the benefit obligations and expense for ASC 715 accounting purposes, since these amounts are already on a pre-tax basis. Thus, in our view, the change in taxability resulting from the PPACA does not represent a significant event requiring interim remeasurement of the plan for ASC 715 accounting purposes. However, some employers may consider that other aspects of the changes required by PPACA will significantly change the benefit obligation, in which case an interim remeasurement would be appropriate.
In any case, in order to comply with the tax accounting guidance and adjust the deferred tax accounts at the enactment date, employers may need to obtain an updated estimate of the plan benefit obligation as of the date of enactment.
Observations: After enactment of PPACA, plan obligations and tax expense will no longer need to be determined following the "with" and "without" subsidy basis outlined in FSP FAS 106-2 par. 19. The unrecognized gain/loss and prior service cost components of AOCI previously tracked on a "without subsidy" basis will no longer be used in determining the postretirement benefit expense for income tax purposes. Employers and their actuaries who previously maintained records following the "with" and "without" subsidy basis will no longer need to do so.
Illustrating the Income Statement Impact
Prior to the MMA in 2003, a company had an unfunded retiree health plan with a benefit obligation of $100. Assuming a 40% tax rate, the company would also have recognized a deferred tax asset of $40 relating to the $100 deductible temporary difference. After the MMA, when taking into consideration the impact of expected subsidies, the benefit obligation is reduced to $70. However, since the subsidy is not taxable, the temporary difference of $40 remains.
Assume that immediately before the PPACA and House reconciliation were signed into law, the employer's benefit obligation remains $70, and the deferred tax asset remains $40. After enactment, the benefit obligation will remain $70, but the deductible temporary difference will decrease from $100 to $75 (note it does not reduce to the full 70 because under the reconciliation bill the subsidy is still tax advantaged until tax years beginning after 12/31/2012). As a result, the deferred tax asset will be reduced by the $25 difference times the company's tax rate, or $10, through a charge to the income tax provision in continuing operations in the income statement.
Deferred tax asset
|Status "without" subsidy|
|Impact of subsidy|
|Status "with" subsidy|
Thus, on enactment of PPACA, the employer will record the following entry:
Deferred tax asset
|Status "with" subsidy under current tax law|
|Reduction of deductible temporary difference through income statement|
|Status "with" subsidy under PPACA as amended|
Dr. Income tax expense 10
Cr. Deferred tax asset 10
Where You Can Find More Information
More information on accounting for changes in deferred taxes resulting from changes in tax law can be found in the PwC Guide to Accounting for Income Taxes, Chapter 7.
We will also be issuing separate HRS Insights on various aspects of the PPACA and its impact on employers.
How PwC Can Help
PwC has considerable expertise in the accounting, tax, actuarial and HR issues related to health care reform and the Medicare Part D subsidies discussed in this publication. Please contact one of the individuals listed below, or your local engagement partner, to further discuss the financial reporting, tax and other implications of this change in health care tax law.