Publications

• 30 Second Ideas
• Accounting Updates
• Alerts
• Articles
• Business Surveys
• Construction Edge
• Healthcare Edge
• Insurance Edge
• Legal Talent
• Manufacturing Edge
• Not-for-Profit Edge
• Quick Links & Good Ideas
• SEC Edge
• Strategy Insights Blog
• Surviving the Upturn
• Tax Highlights

What’s the Deal? Why Are Companies Reporting Large Charges Because of the Health Care Act?

Over the past month, since the passage of the Patient Protection and Affordable Care Act (a.k.a. the Health Care bill), many large and not-so-large publicly traded companies have announced significant charges to their earnings. Why would the simple passage of a bill cost so many corporations so much money? Many of our clients want to know what was in this bill that caused these earnings charges. They have also asked if they will be affected in a similar manner.

The short answer is, not directly. Most of our middle-market clients don’t provide retiree drug benefits; it’s just too expensive. The provision that is causing indigestion is one of the revenue-raising provisions of the bill. To understand this revenue-raising provision, one would need to go back to December 2003 when President George Bush signed the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, which became effective on January 1, 2006. This is the act that provided prescription drug coverage for seniors under Medicare Part D. One of the provisions in that bill was a tax-free governmental reimbursement for a portion of the drug costs that private companies maintain for their retirees. Among the requirements was that the companies' plans must be at least as generous as the government plan and the reimbursement would only cover retired employees who would otherwise obtain coverage under Medicare. The reimbursement was 28% of the eligible costs (around $665 per retiree per year). Again, this reimbursement was not subject to tax and the companies were still able to deduct 100% of the costs of the prescription drug coverage. Consequently, these companies received a tax deduction for 28% of their costs that were not out of pocket, an additional 9.8% benefit (28% times a 35% tax rate).

This particular provision of the 2003 Act was deemed too generous for large corporate taxpayers by many of the supporters of the current health care bill. White House spokesman Robert Gibbs called the 2003 provision a loophole that allowed corporate taxpayers to deduct a federal subsidy. The government expects to raise $4.5 billion over the next decade by taxing these subsidies beginning in 2011 when the new provision becomes effective.

Why are these companies reporting these charges now? Under generally accepted accounting rules, tax-law changes are accounted for in the period when the law passes. Since the law passed in the first quarter of 2010, many companies are calculating the present value of the additional costs of their drug benefit program provided to their retirees. The question that remains unanswered is how many of these companies will now decide that such benefits to their retirees have become too expensive and will move their retirees to the government program? Some estimates have 6 to 7 million retirees currently participating in a private company program and not Medicare Part D. If even one-third of these retirees lose their coverage under their former employer and are moved over to Medicare Part D, the revenue anticipated by the government may never materialize. Also, there may be additional costs above the 28% subsidy formerly provided to private companies that will be incurred with respect to retirees moving out of private coverage to the government program.

Bottom dollar, does this provision have a direct effect on many of our clients? Our thought is not directly, but it may affect all of us indirectly.

For questions or to share your thoughts, please comment below.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.