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United States Audit and Enterprise Risk
Services Health Care Legislation
Eliminates Tax Deduction Related to Medicare Part D Subsidy — Potential
Accounting Impact This Quarter Financial Reporting Alert 10-3 Updated March 31, 2010 (Originally released March 26,
2010)
On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act (the “Act”) that was passed by the House of Representatives on March 21 and by the Senate on December 24, 2009. The Act is a comprehensive health care reform bill that includes revenue-raising provisions for nearly $400 billion over 10 years through tax increases on high-income individuals, excise taxes on high-cost group health plans, and new fees on selected health-care-related industries. In addition, on March 30, 2010, President Obama signed into law the reconciliation measure, which modifies certain provisions of the Act.
Elimination of the Tax Deduction for the Medicare Part D SubsidyAn
employer offering retiree prescription drug coverage that is at least as
valuable as Medicare Part D coverage is currently entitled to a federal
retiree drug subsidy. Employers can claim a deduction for the entire cost of
providing the prescription drug coverage even though a portion of the cost is
offset by the subsidy they receive. The Act repeals the current rule
permitting deduction of the portion of the drug coverage expense that is
offset by the Medicare Part D subsidy. This provision of the Act was
originally effective for taxable years beginning after December 31, 2010. As
discussed below,
the effective date of this provision has been changed to be effective for
taxable years beginning after December 31, 2012 with the enactment of the
reconciliation measure. Tax Accounting ImplicationsAn
employer’s promise to provide postretirement prescription drug coverage
(“coverage”) is recorded as a component of the other postemployment benefit
(OPEB) obligation. When that coverage benefit meets certain criteria, the
employer becomes eligible to receive the federal retiree drug subsidy, which
is then recorded as an offset against the obligation (the obligation is
recorded net of the subsidy, and the net amount is actuarially determined).
In determining the deferred tax asset related to the OPEB obligation,
companies have been required to “unbundle” this net amount into the
“pre-subsidy” liability and the offsetting subsidy receivable. Because the
obligation has historically been deductible for the full amount paid (i.e.,
the deduction was not reduced by the subsidy), a deferred tax asset has
historically been recorded for the future tax deduction related to the
pre-subsidy amount of the obligation. The subsidy receivable has not required
a deferred tax liability because it has not been taxable when received. With
the change in law, the subsidy will still not be taxed, but an equal amount
of expenditures will not be deductible. Therefore, the expected future tax
deduction will be reduced by an amount equal to the subsidy, and the
corresponding deferred tax asset must be adjusted (reversed in this
instance). In
accordance with ASC 7401 (formerly Statement 1092), the expense associated with adjusting this deferred
tax asset is recognized as tax expense in continuing operations in the period
the change in tax law is enacted. However, if there is a full valuation
allowance recorded against the deferred tax asset, the remeasurement of the
deferred tax asset will not result in tax expense because the deferred tax
asset has been previously reserved. In addition, the deferred tax asset is
not adjusted downward (i.e., no tax expense is recognized) for amounts that
are expected to be settled before the effective date of this provision of the
Act. Reconciliation MeasureThe
reconciliation measure includes a provision that delays the repeal of the
deduction for expenses allocable to the Medicare Part D subsidy by two years.
This change in the effective date will affect the amount of the adjustment of
the deferred tax asset and may reduce the amount of tax expense recognized in
continuing operations. Typically, under U.S. GAAP changes in tax law are
accounted for in the period of enactment (so in the case of the
reconciliation measure, periods ending on or after March 30, 2010). As a
result of the two enactment dates — March 23, 2010, for the Act and March 30,
2010, for the reconciliation measure — entities with a period-end date
between March 23 and March 30, 2010 (e.g., March 28), would typically have to
account for the enactment of the two laws that affect the measurement of the
same deferred tax asset in two separate periods. However, the SEC staff has
indicated in recent discussions that it
would not object if a registrant, in this unusual situation, chose to
account for the effects of the reconciliation measure in financial statements
for periods that ended on or after the enactment date of the Act (e.g.,
periods ending on or after March 23, 2010). Therefore, registrants with a
period-end between the enactment date of the Act on March 23, 2010, and the
enactment date of the reconciliation measure on March 30, 2010, may account
for the provisions of the Act as amended by the reconciliation measure in their
period ending on or after March 23, 2010.
ExampleThe
purpose of this example is to demonstrate the accounting implications of this
provision of the Act as amended by the reconciliation measure. Given the
complexities associated with accounting for this provision, companies may
want to consult with their actuarial, tax, and accounting advisors. Acme
Co. is a calendar-year filer. Assume the following amounts were recorded
before enactment of the Act and reconciliation measure:
* Represents
the present value of the total subsidy expected to be received. The
calculated annual impact of the deduction for the portion of the drug
coverage expense offset by the subsidy (on the APBO) as of the most recent
measurement date is $4,000, $3,800, and $3,500 for 2010, 2011, and 2012,
respectively. First-quarter
journal entry:
* Calculated as (“present value of retiree drug subsidy” less “retiree drug subsidy for 2010 through 2012 expected to be received before the effective date in 2013”) multiplied by the tax rate, or ($40,000 – 4,000 – 3,800 – 3,500) × 35%
__________________ 1 FASB Accounting Standards Codification Topic 740, Income Taxes. 2 FASB Statement No. 109, Accounting for Income Taxes.
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