Notice 2011-51, 2011-27 IRB
In a Notice, IRS has extended interim guidance on the application of Code Sec. 833(c)(5), which was added by the Patient Protection and Affordable Care Act (PPACA, P.L. 111-148) for tax years beginning after Dec. 31, 2009, and which limits the application of Code Sec. 833 to otherwise-qualifying taxpayers with a medical loss ratio that is not less than 85%. Among other things, the Notice provides that as long as certain requirements are met, IRS will not treat a taxpayer as losing its status as a stock insurance company by reason of Code Sec. 833(c)(5) during any tax year beginning in 2010 and the first tax year beginning after Dec. 31, 2010.
Background. An organization described in Code Sec. 501(c)(3) or Code Sec. 501(c)(4) is exempt from tax only if no substantial part of its activities consists of providing commercial-type insurance. However, special rules apply to certain eligible health insurance organizations. They are (1) Blue Cross and Blue Shield organizations existing on Aug. 16, '86, which have not experienced a material change in structure or operations since that date, and (2) other organizations that meet certain community-service-related requirements and substantially all of whose activities involve providing health insurance. These eligible organizations are generally treated as “stock” property and casualty insurance companies.
They are taxed on their taxable income at regular corporate rates. Taxable income is gross income reduced by deductions. Gross income is investment income, underwriting income, gains from sales or other dispositions of property, and all other items constituting gross income for corporations. Gross income is then reduced by losses and expenses incurred, plus certain other deductions.
There is a special deduction for eligible organizations equal to the excess (if any) of: (1) 25% of the sum of: (i) the claims incurred during the tax year, and liabilities incurred during the year under cost-plus contracts, and (ii) expenses incurred during the tax year for the adjustment, administration, and settlement of claims, or in connection with the administration of cost-plus contracts, over (2) the “adjusted surplus” at the beginning of the tax year.
For tax years ending before '97, this special deduction was limited to large health insurance providers, and Blue Cross/Blue Shield organizations described above. For tax years ending after '96, it was extended to any other organization that met the requirements that applied to existing Blue Cross/Blue Shield organizations, if the organization was organized under and governed by state laws specifically and exclusively applicable to not-for-profit health insurance or health service type organizations, and was not a health maintenance organization, or a Blue Cross or Blue Shield organization.
Further, an insurer's opening and closing balances for the tax year in reserves for certain unearned premiums and premiums received in advance take into account only 80% of the amount otherwise required without regard to this rule. This means that the company's deduction for reserve increases is reduced by 20%.
Affordable Care Act change. 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, including treatment as a stock insurance company and the special deduction discussed above. 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 taxable 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).
Prior interim guidance for 2010—computation. Notice 2010-79, 2010-49 IRB 809, provided that to determine whether a taxpayer's percentage of total premium revenue expended on reimbursement for clinical services provided to enrollees is not less than 85% (and thus satisfies the requirement of Code Sec. 833(c)(5)), taxpayers must use the definition of “reimbursement for clinical services provided to enrollees” carried in interim final regulations set forth by the Department of Health and Human Services (HHS). For purposes of determining whether the 85% requirement of Code Sec. 833(c)(5) is satisfied, IRS won't challenge the inclusion of “amounts expended for activities that improve health care quality” as defined in HHS interim final regulations.
Consequences of noncompliance. Code Sec. 833(c)(5) provides that Code Sec. 833 does not apply to an organization unless the organization's percentage of total premium revenue expended on reimbursement for clinical services provided to enrollees is not less than 85%. Accordingly, the consequences for an organization for which this amount is less than 85% are as follows:
(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).
Transitional relief extended. Notice 2010-79 provided that, notwithstanding the rule in (1) in the list above, a taxpayer won't lose its status as a stock insurance company by reason of Code Sec. 833(c)(5) during the first tax year beginning after Dec. 31, 2009. Notice 2011-51 extended this relief for an additional year for tax years beginning in 2010 and the first tax year beginning after Dec. 31, 2010, if the following conditions are met:
... the taxpayer was described in Code Sec. 833(c) in the immediately preceding tax year;
... the taxpayer would have been taxed as a stock insurance company for the current taxable year but for the enactment of Code Sec. 833(c)(5); and
... the taxpayer would have met the requirements of Code Sec. 831(c) to be taxed as an insurance company for the current taxable year but for its activities in the administration, adjustment or settlement of claims under cost-plus or administrative services-only contracts.
Changes in accounting method. Notice 2010-79, as extended by Notice 2011-51, notes that the application of Code Sec. 833 in one tax year followed by nonapplication of that provision in the subsequent taxable year (or vice versa) may result in one or more changes in accounting method for which a taxpayer must secure consent under the advance consent procedures. 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)(2) and Code Sec. 833(b) is not, however, a method of accounting.
References: For taxation of qualifying health insurance providers, see FTC 2d/FIN ¶E-5624; United States Tax Reporter ¶8334.