A new Notice provides procedures for a taxpayer to obtain automatic consent to change its method of accounting for unearned premiums because of Code Sec. 833(c)(5). This provision, which was added by the Patient Protection and Affordable Care Act (Affordable Care Act, P.L. 111-148), limits the application of Code Sec. 833 to otherwise-qualifying taxpayers with a medical loss ratio that is not less than 85%.
Background. Code Sec. 833 provides special rules for existing Blue Cross and Blue Shield organizations within the meaning of Code Sec. 833(c)(2) and certain other organizations that are described in Code Sec. 833(c)(3) (generally, other organizations that meet certain community-service-related requirements and substantially all of whose activities involve providing health insurance).
Under Code Sec. 833(c)(5), as amended by the Affordable Care Act, for tax years beginning after Dec. 31, 2009, health organizations whose medical loss ratio is below 85% cannot take advantage of the favorable tax provisions of Code Sec. 833.
An organization's medical loss ratio is equal to the amount expended on reimbursement for clinical services provided to enrollees under its policies during the tax year (as reported under Sec. 2718 of the Public Health Service Act) (the Section 833 MLR Numerator) divided by the organization's total premium revenue (Section 833 MLR Denominator).
In Notice 2010-79, 2010-49 IRB, IRS provided interim guidance on the new Affordable Care Act rule. Among other items, the interim guidance provided that if an affected organization's percentage of total premium revenue expended on reimbursement for clinical services provided to enrollees is less than 85%, then:
1. The organization is not taxable as a stock insurance company by reason of Code Sec. 833(a)(1) (but may be taxable as an insurance company if it otherwise meets the requirements of Code Sec. 831(c));
2. The organization is not allowed the special deduction set forth in Code Sec. 833(b); and
3. The organization takes into account 80%, rather than 100%, of its unearned premiums for purposes of computing premiums earned on insurance contracts during the tax year under Code Sec. 832(b)(4).
Notice 2010-79 provided interim relief for the first tax year beginning after Dec. 31, 2009 (IRS will not treat a taxpayer as losing its status as a stock insurance company by reason of Code Sec. 833(c)(5) if specified conditions are met), and noted that the application of Code Sec. 833 in one tax year followed by nonapplication of that provision in the subsequent tax year (or vice versa) may result in one or more changes in accounting method. For example, accounting for 100% of unearned premiums under Code Sec. 833(a)(3) (dealing with unearned premium reserve) in one year, but only 80% of unearned premiums under Code Sec. 832(b)(4) in the next year, is a change in method of accounting. Likewise, the loss (or recovery) of insurance company status may implicate a number of changes in methods of accounting because some methods of accounting are available only to insurance companies under Subchapter L. The special deduction allowed under Code Sec. 833(a)(3) and Code Sec. 833(b) is not, however, a method of accounting.
How to change accounting method because of Code Sec. 833(c)(5). Notice 2011-4, explains how a change in accounting method is made by an existing Blue Cross or Blue Shield organization within the meaning of Code Sec. 833(c)(2) or an organization described in Code Sec. 833(c)(3), that is required to change its method of accounting for unearned premiums because it fails to meet the MLR requirements of Code Sec. 833(c)(5), or because it meets the MLR requirements after failing to meet those requirements in a prior year.
Affected organizations are told to use the automatic method change procedures in Rev Proc 2008-52, 2008-2 CB 587, as amplified and modified by subsequent procedures, and as modified by Notice 2011-4. In particular, the Code Sec. 481 adjustment period will be accelerated if a taxpayer with a remaining balance of a Code Sec. 481 adjustment that arose because of a change in method of accounting triggered by Code Sec. 833(c)(5) is required to effect another change in method of accounting related to Code Sec. 833(c)(5). Thus, for example, a taxpayer that fails to satisfy the requirements of Code Sec. 833(c)(5) and as a result has a positive Code Sec. 481 adjustment must accelerate the remaining balance, if any, of that adjustment in a subsequent tax year in which the taxpayer meets the Code Sec. 833(c)(5) requirements.
References: For automatic consent accounting method changes, see FTC 2d/FIN ¶G-2203; United States Tax Reporter ¶4464.225; TaxDesk ¶442,606; TG ¶6307.