Today’s blog entry is about CHIPs.  Not the Erik Estrada and John Wilcox variety, but Certain Health Insurance Providers.  The IRS has proposed regulations implementing the $500,000 deduction limit that applies to CHIPs under the President Obama’s health care package.

Why Do You Care?

If you aren’t a health insurance provider, you probably are wondering why you should care about this.  And, right now, you probably don’t.  But the placing further restrictions on the limit on corporate tax deductions under Section 162(m) for all companies is something that is currently on the table in DC.  I think it’s likely that any additional restrictions would mimic, at least in part, the restrictions that apply to health insurance providers. Thus, even if you aren’t CHIP, I think it’s worth five minutes of your time to read today’s blog entry so you have an idea of what might be coming down the pike.

What’s Different? 

The following table provides a quick illustration of how the limit for CHIPs differs from the standard limitation we are all familiar with under Section 162(m). As you can see, it’s about more than just $500,000.

Why You Should be Worried

The new limit that applies to CHIPs has some significant implications for stock compensation.  First, because performance compensation isn’t exempted, stock options and performance awards are subject to the limit (which does have a silver lining in that CHIPs don’t have to worry about meeting 162(m) requirements when implementing these plans–say hello to our long-lost friend, discretionary payouts).

Second, because the limit applies when compensation is earned, not when it is paid, to figure out whether the company can claim its deduction for stock awards, the deduction has to be allocated on a daily pro rata basis over the period the awards was earned. You would expect this to be the vesting period, but it isn’t. For options, the period is measured from grant to exercise; for restricted stock, it’s grant to vest; and for RSUs, it’s grant to payout.  So let’s say an option is exercised just prior to the end of its ten-year contractual term–that’s 11 tax years that the deduction would be allocated over. 

That’s complicated enough, but things get really complicated when you think about the impact on your DTA accruals for tax accounting purposes and the tax benefit assumed for diluted EPS purposes.  Makes you glad your company isn’t a CHIP (unless you are a CHIP, in which case, good luck with all that). 

For more information on the proposed regulations, see the NASPP alert “IRS Proposes Regs on $500,000 Deduction Limit for Heath Insurance Providers.”

– Barbara