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Financial Reporting Alert 10-3 (Revised), Health Care Legislation Eliminates Tax Deduction Related to Medicare Part D Subsidy

Updated March 31, 2010 (Originally released March 26, 2010)

This Financial Reporting Alert has been revised to reflect the enactment of the Health Care and Education Affordability Reconciliation Act of 2010 (the “reconciliation measure”) and recent discussions with the SEC staff on the accounting for the reconciliation measure for SEC registrants that have a period-end that falls between March 23 and March 30.


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.

Editor’s Note: This Financial Reporting Alert addresses the accounting implications of the provision of the Act that eliminates the tax deduction for the portion of the prescription drug costs for which the employer receives a Medicare Part D subsidy (i.e., reduced deduction). Watch for additional Deloitte communications on other provisions of the Act. For insight into some of the Act’s other tax provisions, see Deloitte’s Prescription for Change ‘Filled’ — Tax Provisions in the Patient Protection and Affordable Care Act.

Elimination of the Tax Deduction for the Medicare Part D Subsidy

An 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 Implications

An 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 Measure

The 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.

Editor’s Note: The SEC indicated that it would not object if a registrant (that had a period-end date that falls between March 23 and March 30) accounted for the change in its deferred tax asset to reflect the effective date of the Act as amended by the reconciliation measure in the financial statements for the period ended before March 30, 2010. However, any entity that chooses not to follow this approach and account for the enactment of the two laws in different financial statement periods should consult with its auditors or accounting advisors. In addition, the enactment of two laws that affect the measurement of the same deferred tax asset is very unusual; accordingly, the accounting for the enactment of a law in a financial statement period that precedes the enactment date of that law (i.e., including the change to the effective date in the reconciliation measure in financial statements for periods ending before March 30, 2010) is not to be analogized to in other circumstances.

Example

The 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:

Accumulated postretirement benefit obligation (APBO) without subsidy $200,000
APBO, net (with subsidy) 160,000
Present value of retiree drug subsidy* 40,000
Tax rate 35 percent

* 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:

 

Debit

Credit

Tax expense (continuing operations) $10,045  
 Deferred tax asset   $10,045*

* 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%

Editor’s Note: : If, in our example above, Acme Co. had a first-quarter-end of March 28 (between the enactment date of the Act and the enactment date of the reconciliation measure), the first-quarter journal entry may still remain the same given the SEC staff discussions in which the staff indicated that it would not object to registrants that accounted for the provisions of the reconciliation measure in periods ending on or after March 23, 2010.

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1 FASB Accounting Standards Codification Topic 740, Income Taxes

2 FASB Statement No. 109, Accounting for Income Taxes

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