[Federal Register Volume 79, Number 184 (Tuesday, September 23, 2014)]
[Rules and Regulations]
[Pages 56892-56925]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-22317]



[[Page 56891]]

Vol. 79

Tuesday,

No. 184

September 23, 2014

Part III





Department of the Treasury





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Internal Revenue Service





26 CFR Part 1





The $500,000 Deduction Limitation for Remuneration Provided by Certain 
Health Insurance Providers; Final Rule

  Federal Register / Vol. 79 , No. 184 / Tuesday, September 23, 2014 / 
Rules and Regulations  

[[Page 56892]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9694]
RIN 1545-BK88


The $500,000 Deduction Limitation for Remuneration Provided by 
Certain Health Insurance Providers

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations on the application of 
the $500,000 deduction limitation for remuneration provided by certain 
health insurance providers under section 162(m)(6) of the Internal 
Revenue Code (Code). These regulations affect certain health insurance 
providers providing remuneration that exceeds the deduction limitation.

DATES: Effective date: These regulations are effective on September 23, 
2014.
    Applicability date: For dates of applicability, see Sec.  1.162-
31(j).

FOR FURTHER INFORMATION CONTACT: Ilya Enkishev at (202) 317-5600 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains final amendments to the Income Tax 
Regulations (26 CFR part 1) under section 162(m)(6) of the Code. 
Section 162(m)(6) limits the allowable deduction for remuneration 
attributable to services performed by applicable individuals to certain 
health insurance providers that receive premiums from providing health 
insurance coverage. Section 162(m)(6) was added to the Code by section 
9014 of the Patient Protection and Affordable Care Act (ACA) (Pub. L. 
111-148, 124 Stat. 119, 868 (2010)).
    In general, section 162(m)(6) limits to $500,000 the allowable 
deduction for remuneration attributable to services performed by an 
applicable individual for a covered health insurance provider in a 
taxable year beginning after December 31, 2012, that, but for section 
162(m)(6), is otherwise deductible under chapter 1 of the Code 
(referred to in this preamble and the final regulations as remuneration 
that is otherwise deductible). Remuneration attributable to services 
performed for a covered health insurance provider in a disqualified 
taxable year beginning after December 31, 2009, and before January 1, 
2013, that becomes otherwise deductible in a taxable year beginning 
after December 31, 2012, is also subject to the $500,000 deduction 
limitation, determined as if the deduction limitation applied to 
disqualified taxable years beginning after December 31, 2009. If 
remuneration that is attributable to services performed by an 
applicable individual for a covered health insurance provider in a 
disqualified taxable year exceeds $500,000, the amount of the 
remuneration that exceeds $500,000 is not allowable as a deduction in 
any taxable year.
    On December 23, 2010, the Department of the Treasury (Treasury 
Department) and the IRS released Notice 2011-2 (2011-1 IRB 260), which 
provides guidance on certain issues under section 162(m)(6). A notice 
of proposed rulemaking (REG-106796-12) was published in the Federal 
Register (78 FR 19950) on April 2, 2013 (the proposed regulations). The 
Treasury Department and the IRS received written comments in response 
to the notice and the proposed regulations. After consideration of 
these comments, the Treasury Department adopts the proposed regulations 
as final regulations, with the modifications set forth in this Treasury 
decision.

Summary of Comments and Explanation of Modifications

I. Definition of Covered Health Insurance Provider

A. In General

    Section 162(m)(6)(C) provides that a covered health insurance 
provider is any health insurance issuer described in section 
162(m)(6)(C)(i) and certain persons that are treated as a single 
employer with that health insurance issuer, as described in section 
162(m)(6)(C)(ii). A person may be a covered health insurance provider 
for one taxable year, but not be a covered health insurance provider 
for another taxable year, depending on whether that person meets the 
requirements to be a covered health insurance provider under section 
162(m)(6)(C) for a particular taxable year. These final regulations 
generally adopt the rules described in the proposed regulations for 
determining whether a health insurance issuer or any other person is a 
covered health insurance provider for any taxable year, except as 
described herein.

B. Health Insurance Issuers

    For taxable years beginning after December 31, 2012, section 
162(m)(6)(C)(i)(II) provides that a health insurance issuer (as defined 
in section 9832(b)(2)) is a covered health insurance provider for a 
taxable year if not less than 25 percent of the gross premiums that it 
receives from providing health insurance coverage (as defined in 
section 9832(b)(1)) during the taxable year are from minimum essential 
coverage (as defined in section 5000A(f)). For taxable years beginning 
after December 31, 2009 and before January 1, 2013, section 
162(m)(6)(C)(i)(I) provides that a health insurance issuer (as defined 
in section 9832(b)(2)) is a covered health insurance provider for a 
taxable year if it receives premiums from providing health insurance 
coverage (as defined in section 9832(b)(1)) during the taxable year.

C. Persons Treated as a Single Employer With a Health Insurance 
Provider

    Section 162(m)(6)(C)(ii) provides that two or more persons that are 
treated as a single employer under sections 414(b), (c), (m), or (o) 
are treated as a single employer for purposes of determining whether a 
person is a covered health insurance provider, except that in applying 
section 1563(a) for purposes of these subsections, sections 1563(a)(2) 
and (3) (describing brother-sister controlled groups and combined 
groups) are disregarded. The final regulations, like the proposed 
regulations, generally provide that each member of an aggregated group 
that includes a covered health insurance provider described in section 
162(m)(6)(C)(i) at any time during a taxable year is also a covered 
health insurance provider for purposes of section 162(m)(6), even if 
the member is not a health insurance issuer and does not provide health 
insurance coverage. For this purpose, the final regulations, like the 
proposed regulations, define the term aggregated group as a health 
insurance issuer (as defined in section 9832(b)(2)) and all persons 
that are treated as a single employer with the health insurance issuer 
under sections 414(b), (c), (m) or (o), disregarding sections 
1563(a)(2) and (3) (with respect to controlled groups of corporations) 
and Sec.  1.414(c)-(2)(c) and (d) (with respect to trades or businesses 
under common control).
    The proposed regulations include rules for determining whether a 
member of an aggregated group that is not a health insurance issuer is 
a covered health insurance provider for a particular taxable year. 
Under these rules, the parent entity of an aggregated group is 
generally a covered health insurance provider for its taxable year with 
which, or in which, ends the taxable year of any health insurance 
issuer that is a covered health insurance

[[Page 56893]]

provider in an aggregated group with the parent entity. Each other 
member of the parent entity's aggregated group is a covered health 
insurance provider for its taxable year that ends with, or within, the 
taxable year of the parent entity during which the parent entity is a 
covered health insurance provider. The final regulations generally 
adopt these rules.
    The final regulations, like the proposed regulations, provide that, 
in an aggregated group that is a parent-subsidiary controlled group of 
corporations (within the meaning of section 414(b)) or a parent-
subsidiary group of trades or businesses under common control (within 
the meaning of section 414(c)), the parent entity is the common parent 
of the aggregated group.
    With respect to an aggregated group that is an affiliated service 
group within the meaning of section 414(m) or a group described in 
section 414(o), the final regulations adopt the rules described in the 
proposed regulations and provide that the parent entity is the health 
insurance issuer in the aggregated group. If, however, two or more 
health insurance issuers are members of an aggregated group that is an 
affiliated service group (within the meaning of section 414(m)) or a 
group described in section 414(o), then any health insurance issuer in 
the aggregated group that is designated in writing by the other members 
of the aggregated group is the parent entity for purposes of section 
162(m)(6). If the members of an aggregated group that includes two or 
more health insurance issuers that is an affiliated service group or 
group described in section 414(o) fail to designate a parent entity in 
writing, the members of the group are deemed for all taxable years to 
have a parent entity with a taxable year that is the calendar year.
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments on the circumstances under 
which a new parent entity could be designated, such as when a health 
insurance issuer that has been designated as the parent entity of an 
aggregated group ceases to be a member of the aggregated group as a 
result of a corporate transaction, and any transition rules that may be 
necessary in such situation. One commenter suggested that the final 
regulations should provide that when a parent entity (a predecessor 
parent entity) ceases to be a member of an aggregated group under 
section 414(m) and another health insurance issuer that has the same 
taxable year as the predecessor parent entity remains in the aggregated 
group, the remaining members of the aggregated group must designate 
that health insurance issuer as the new parent entity (the successor 
parent entity). The commenter also suggested that if no health 
insurance issuer remaining in the aggregated group has the same taxable 
year as the predecessor parent entity, then the group should be 
permitted to designate any health insurance issuer in the aggregated 
group as the successor parent entity. The final regulations generally 
adopt these suggestions.
    The final regulations also provide transition rules for determining 
when a member of an aggregated group is a covered health insurance 
provider if, as a result of a change in the identity of the parent 
entity or for any other reason, the taxable year of the parent entity 
is less than 12 consecutive months. The final regulations provide that 
if the taxable year of the parent entity is less than 12 months, then, 
solely for purposes of determining whether it is a covered health 
insurance provider for its short taxable year and for purposes of 
determining whether each other member of the parent entity's aggregated 
group is a covered health insurance provider for its taxable year 
ending with or within the taxable year of the parent entity, the 
taxable year of the parent entity is treated as the 12-month period 
ending on the last day of its short taxable year. The purpose of this 
rule is to ensure consistency and continuity in the treatment of 
members of an aggregated group as covered health insurance providers. 
Without this rule, certain members of an aggregated group that are 
generally treated as covered health insurance providers may not be 
treated as covered health insurance providers for one taxable year 
because they do not have a taxable year ending with or within the short 
taxable year of the parent entity.
    One commenter suggested that an entity should not be a covered 
health insurance provider if all of the services performed by its 
employees and independent contractors are unrelated to the direct or 
indirect generation of health insurance premiums and if the entity is 
geographically separate from any entity within the aggregated group 
that receives premiums from providing health insurance. These final 
regulations do not adopt this suggestion. Such a rule would be 
inconsistent with section 162(m)(6)(C)(ii), which provides that all 
members of an aggregated group that includes a health insurance issuer 
described in section 162(m)(6)(C)(i) are covered health insurance 
providers.

D. United States Possessions

    One commenter suggested that health insurance providers located in 
Puerto Rico should not be considered health insurance issuers under 
section 9832(b)(1) and, therefore, should not be covered health 
insurance providers under section 162(m)(6)(C)(i). The commenter also 
suggested that health insurance companies (and similar health insurance 
providers) located in Puerto Rico should not be considered covered 
health insurance providers under section 162(m)(6)(C) because the 
benefits of the ACA do not inure to Puerto Rican insurance companies 
and because American taxpayers do not subsidize compensation paid by 
health insurance providers in Puerto Rico through tax deductions. These 
final regulations do not adopt this suggestion. In regulations issued 
under section 9010 of the ACA (TD 9643, 78 FR 71476, November 29, 
2013), the Treasury Department and the IRS concluded that a health 
insurance company, health insurance service, or insurance organization 
may be a health insurance issuer under section 9832(b)(2) even if it is 
located in Puerto Rico. Accordingly, a health insurance issuer that is 
otherwise a covered health insurance provider under section 162(m)(6) 
will not fail to be a covered health insurance provider solely because 
it is located in Puerto Rico.

E. Self-insurers

    These final regulations, like the proposed regulations, provide 
that an employer is not a covered health insurance provider solely 
because it maintains a self-insured medical reimbursement plan. For 
this purpose, the term self-insured medical reimbursement plan means a 
separate written plan for the benefit of employees (which may include 
former employees) that provides for reimbursement of employee medical 
expenses referred to in section 105(b) and that does not provide for 
reimbursement under an individual or group policy of accident or health 
insurance issued by a licensed insurance company or under an 
arrangement in the nature of a prepaid health care plan that is 
regulated under federal or state law in a manner similar to the 
regulation of insurance companies, and may include a plan maintained by 
an employee organization described in section 501(c)(9).
    One commenter noted that, in addition to providing a self-insured 
medical reimbursement plan, some employers provide coverage for other

[[Page 56894]]

health care costs through an insurance policy (for example, through 
separate insured coverage for prescription drugs). The commenter 
requested clarification that an employer that maintains a self-insured 
medical reimbursement plan will not be a covered health insurance 
provider solely because the employer provides additional coverage 
through an insurance policy. The Treasury Department and the IRS agree 
that this is correct.

F. De Minimis Exception

    The final regulations retain the de minimis exception described in 
the proposed regulations with certain clarifications. The final 
regulations provide that a person that would otherwise be a covered 
health insurance provider under section 162(m)(6)(C)(i)(II) for any 
taxable year beginning after December 31, 2012, is not a covered health 
insurance provider for that taxable year if the premiums received by 
that person and all other members of its aggregated group from 
providing health insurance coverage that is minimum essential coverage 
are less than two percent of the gross revenue of that person and all 
other members of its aggregated group for that taxable year. For 
taxable years beginning after December 31, 2009, and before January 1, 
2013, a person that would otherwise be a covered health insurance 
provider under section 162(m)(6)(C)(I) is not a covered health 
insurance provider for that taxable year if the premiums received by 
that person and all other members of its aggregated group from 
providing health insurance coverage are less than two percent of the 
gross revenue of that person and all other members of its aggregated 
group for that taxable year.
    Commenters suggested that the two-percent threshold for the de 
minimis exception should be increased to a level as high as five 
percent. In response to Notice 2011-2, which requested comments on the 
de minimis exception, some commenters requested that the threshold not 
be increased because a higher threshold would allow health insurance 
issuers that sell significant amounts of health coverage to be exempt 
from the deduction limit under section 162(m)(6) and thereby provide 
them with a competitive advantage. After careful consideration of all 
comments on the de minimis exception, the Treasury Department and the 
IRS have concluded that the two-percent threshold strikes the 
appropriate balance between exempting persons that receive health 
insurance premiums that are insignificant in relation to their overall 
activities and ensuring that persons that sell a significant amount of 
health insurance are not exempted from the deduction limitation. 
Accordingly, the final regulations do not adopt the suggestion to 
increase the de minimis threshold.

II. Premiums

A. In General

    Section 162(m)(6)(C)(i) provides that a health insurance issuer is 
a covered health insurance provider for a taxable year only if it 
receives premiums from providing health insurance coverage (as defined 
in section 9832(b)(1)). The proposed regulations provide that amounts 
received under an indemnity reinsurance contract and amounts that are 
direct service payments are not treated as premiums from providing 
health insurance coverage for purposes of section 162(m)(6)(C)(i). The 
final regulations generally adopt the rules set forth in the proposed 
regulations.

B. Direct Service Payments

    A health insurance issuer or other person that receives premiums 
from providing health insurance coverage may enter into an arrangement 
with a third party to provide, manage, or arrange for the provision of 
services by physicians, hospitals, or other healthcare providers. In 
connection with this arrangement, the health insurance issuer or other 
person that receives premiums from providing health insurance coverage 
may pay compensation to the third party in the form of capitated, 
prepaid, periodic, or other payments, and the third party may bear some 
or all of the risk that the compensation is insufficient to pay the 
full cost of providing, managing, or arranging for the provision of 
services by physicians, hospitals, or other healthcare providers as 
required under the arrangement. In addition, the third party may be 
subject to healthcare provider, health insurance, licensing, financial 
solvency, or other regulation under state insurance law.
    The final regulations follow the proposed regulations, and provide 
that capitated, prepaid, periodic, or other payments (referred to as 
direct service payments) made by a health insurance issuer or other 
person that receives premiums from providing health insurance coverage 
to a third party as compensation for providing, managing, or arranging 
for the provision of healthcare services by physicians, hospitals, or 
other healthcare providers are not treated as premiums from providing 
health insurance coverage for purposes of section 162(m)(6), regardless 
of whether the third party is subject to healthcare provider, health 
insurance, licensing, financial solvency, or other similar regulatory 
requirements under state law. In the preamble to the proposed 
regulations, the Treasury Department and the IRS requested comments on 
whether capitated, prepaid, or periodic payments made by a government 
entity to a third party to provide, manage, or arrange for the 
provision of services by physicians, hospitals, or other healthcare 
providers should be treated as premiums from providing health insurance 
coverage for purposes of section 162(m)(6).
    One commenter suggested that payments from a government entity to 
certain medical care providers that accept risk-based payments in 
exchange for providing medical care (referred to in this preamble as 
clinical risk-bearing entities) should not be treated as premiums from 
providing health insurance coverage. The commenter observed that the 
term health insurance coverage is defined in section 9832(b)(1) as 
``benefits consisting of medical care (provided directly, through 
insurance or reimbursement, or otherwise) under any hospital or medical 
service policy or certificate, hospital or medical service plan 
contract, or health maintenance organization contract offered by a 
health insurance issuer.'' The commenter asserted that clinical risk-
bearing entities do not provide health insurance coverage under section 
9832(b)(1) because they do not issue policies, certificates, or 
contracts of insurance to the individuals to whom they provide medical 
care. Specifically, the commenter suggested that capitated payments 
under the Medicare Shared Savings program or the Medicare Pioneer ACO 
Program to a clinical risk-bearing entity should not be treated as 
premiums from providing health insurance coverage for this reason.
    The commenter further noted that the definition of the term health 
insurance coverage was added to the Code in 1996 as part of the market 
reforms under the Health Insurance Portability and Accountability Act 
(HIPAA) and that virtually identical definitions of the term health 
insurance coverage were added to the Public Health Service Act (PHSA) 
and the Employee Retirement Income Security Act (ERISA) at that time. 
The commenter pointed out that the Secretaries of the Treasury 
Department, Health and Human Services (HHS), and the Department of 
Labor (DOL) are required to administer the definitions of the term 
health insurance coverage consistently in all three statutes pursuant 
to section 104 of HIPAA.

[[Page 56895]]

    The commenter also noted that the Centers for Medicare and Medicaid 
Services (CMS) have published guidance indicating that payments made by 
a health insurance issuer to a clinical risk-bearing entity may qualify 
as incurred claims for purposes of determining the issuer's Medical 
Loss Ratio under certain circumstances. See CMS, CCIIO Technical 
Guidance (CCIIO 2012-001): Questions and Answers Regarding the Medical 
Loss Ratio Interim Final Rule (February 10, 2012). According to the 
commenter, the treatment of payments to a clinical risk-bearing entity 
as incurred claims suggests that such payments are not premiums from 
providing health insurance coverage. The commenter urged the Treasury 
Department and the IRS to clarify that clinical risk-bearing entities 
are not covered health insurance providers subject to the deduction 
limitation under section 162(m)(6) unless they offer policies, 
certificates, or contracts of insurance to enrollees.
    Another commenter asserted that Medicaid managed care organizations 
(MCOs) and providers of Medicare Advantage and Medicare Part D 
prescription drug plans should not be considered health insurance 
issuers that provide health insurance coverage for purposes of sections 
9832(b)(1) and (2) and 162(m)(6). Like the other commenter, this 
commenter also pointed to guidance issued by CMS to support its 
position. See CMS, CCIIO Technical Guidance (CCIIO 2012-002): Questions 
and Answers Regarding the Medical Loss Ratio Regulation (April 20, 
2012). The commenter urged the Treasury Department and the IRS to treat 
fees paid to companies with healthcare business under governmental 
healthcare programs, including Medicare and Medicaid, as direct service 
payments, and not as premiums for purposes of determining whether a 
person is a health insurance issuer that provides health insurance 
coverage for purposes of Code section 162(m)(6).
    The Treasury Department and the IRS agree with the commenters that 
a person cannot be a covered health insurance provider under section 
162(m)(6) unless it is a health insurance issuer within the meaning of 
section 9832(b)(2) that receives premiums from providing health 
insurance coverage within the meaning of section 9832(b)(1). The 
Treasury Department and the IRS also acknowledge that section 104 of 
HIPAA generally requires the Treasury Department, HHS, and DOL to 
interpret consistently the terms health insurance issuer and health 
insurance coverage, as used in the Code, the PHSA, and ERISA.
    The Treasury Department and the IRS, however, do not adopt the 
suggestion to provide in the final regulations that clinical risk 
bearing entities, Medicare and Medicaid providers, and other recipients 
of payments from government entities in connection with providing 
benefits under government sponsored health care programs are not 
covered health insurance providers or that the amounts received by 
these organizations are not premiums from providing health insurance 
coverage.
    The commenters correctly observe that to be a covered health 
insurance provider under section 162(m)(6), a person must be a health 
insurance issuer (as defined in section 9832(b)(2)) that provides 
health insurance coverage (as defined in section 9832(b)(1)) and meets 
certain other requirements. If the person is not a health insurance 
issuer or does not receive premiums from providing health insurance 
coverage, the person is not a covered health insurance provider.
    The definitions of the terms health insurance coverage and health 
insurance issuer have significant importance in many sections of the 
Code, the PHSA, and ERISA. The Treasury Department and the IRS have 
concluded that it would be inappropriate to provide broad guidance on 
the interpretation of sections 9832(b)(1) and 9832(b)(2) because it 
would require full consideration of the possible effects of that 
guidance on other statutory provisions. The consideration of these 
wide-ranging implications is outside of the scope of these regulations 
under section 162(m)(6). However, additional guidance on the meaning of 
the terms health insurance issuer and health insurance coverage may be 
provided in future regulations, notices, revenue rulings, or other 
guidance of general applicability published in the Internal Revenue 
Bulletin.

C. Stop-Loss Coverage

    Stop-loss coverage allows an employer to self-insure for a set 
amount of claims costs, with the stop-loss coverage covering all or 
most of the claims costs that exceed the set amount. Several commenters 
requested that the final regulations clarify the treatment of stop-loss 
coverage. Specifically, commenters suggested that payments for stop-
loss coverage not be treated as premiums from providing health 
insurance coverage because stop-loss coverage does not provide 
insurance coverage for the health risk of an individual or for medical 
care for an individual. Other commenters suggested that the final 
regulations adopt the model standards of the National Association of 
Insurance Commissioners for determining whether payments for stop-loss 
insurance coverage qualify as premiums from providing health coverage.
    The DOL, HHS, and the Treasury Department have expressed concern 
that employers in small group markets with healthier employees may 
pursue nominally self-insured arrangements with stop-loss coverage at 
low attachment points as functionally equivalent alternatives to 
insured group health plans. The three agencies issued a request for 
information regarding such practices, with a focus on the prevalence 
and consequences of stop-loss coverage at low attachment points. 77 FR 
25788 (May 1, 2012). Because the scope of stop-loss coverage that may 
constitute health insurance, if any, has not been determined, premiums 
under a stop-loss contract will not be considered premiums from 
providing health insurance coverage for purposes of section 162(m)(6) 
until such time and to the extent that future guidance addresses the 
issue of whether and, if so, under what circumstances, stop-loss 
coverage constitutes health insurance.

D. Captive Insurance Companies

    Under the final regulations, as under the proposed regulations, a 
captive insurance company is a covered health insurance provider if it 
is a health insurance issuer that is otherwise described in section 
162(m)(6)(C). One commenter recommended that premiums received by a 
captive insurance company or other health insurance issuer that are 
attributable to coverage provided for current and former employees of 
members of an aggregated group that includes the captive insurance 
company or other health insurance issuer should be excluded from the 
definition of premiums. The commenter also suggested that premiums 
received by a health insurance issuer for providing health insurance 
coverage to current and former employees of other related businesses 
outside of the health insurance issuer's aggregated group should be 
excluded from the definition of premiums under certain circumstances. 
The final regulations do not adopt these suggestions.
    Section 406 of ERISA generally prohibits transactions between an 
employee benefit plan and a party in interest, and, under Section 
3(14)(C) of ERISA, employers are generally parties in interest with 
respect to the plans that they sponsor. In addition, Section 3(14)(G) 
of ERISA provides that entities that are more than 50 percent owned by

[[Page 56896]]

employers are also parties in interest. Accordingly, captive insurance 
companies that are more than 50 percent owned by the sponsor of an 
employee benefit plan are generally parties in interest, and the 
payment of premiums to such a captive insurance company to provide 
insurance to an employee benefit plan maintained by the owner of a 
captive insurance company would generally be a prohibited transaction 
and be subject to an excise tax under section 4975.
    The DOL, however, has granted a prohibited transaction class 
exemption and numerous individual prohibited transaction exemptions 
that apply to captive insurance arrangements in certain circumstances. 
Under the class exemption, a captive insurance company can directly 
insure the employee benefit plan risks of a related employer if the 
captive insurance company and the arrangement meet certain 
requirements, one of which is that at least 50 percent of the captive 
insurer's business is unrelated to the employer sponsor of the plan.
    The individual exemptions apply to circumstances in which a captive 
insurance company provides reinsurance to an unrelated insurance 
company that directly insures the health risks of a plan sponsor's 
employees. Under this type of arrangement, an employer purchases health 
insurance for its employees through an unrelated insurance company and 
pays premiums for that coverage to the unrelated insurance company. The 
unrelated insurance company then reinsures these health risks through 
the employer's captive insurance company under an indemnity reinsurance 
arrangement.
    It is the understanding of the Treasury Department and the IRS that 
employers insuring the health risks of their employees through captive 
insurance companies generally use the approach outlined in the 
individual exemptions to avoid engaging in a prohibited transaction and 
incurring an excise tax under section 4975. Because the amounts 
received by a captive insurance company under this type of arrangement 
are solely payments for providing indemnity reinsurance, those payments 
are not treated as premiums under existing provisions of these 
regulations, and no special rule is needed for these types of payments. 
In the case of captive insurance arrangements that rely on the class 
exemption, the Treasury Department and the IRS have concluded that a 
special rule for premiums paid by a plan sponsor or its related 
businesses or their employees would be inappropriate because the 
captive insurance company would be required under the terms of the 
class exemption to conduct a significant portion of its insurance 
business with unrelated third parties.
    The commenter acknowledged that captive insurance companies 
generally follow the approach outlined in the DOL's individual 
prohibited transaction exemptions but asserted that an exemption for 
captive insurance companies is nonetheless necessary because the law in 
this area may change in the future to permit captive insurance 
companies to receive significant premium payments directly from a 
related employer. The Treasury Department and the IRS have concluded 
that a special exception is not necessary at this time for amounts paid 
to captive insurance companies.

III. Disqualified Taxable Year

    Consistent with section 162(m)(6)(B) and the proposed regulations, 
the final regulations provide that a disqualified taxable year is, with 
respect to any employer, any taxable year for which the employer is a 
covered health insurance provider.

IV. Applicable Individual

    Section 162(m)(6)(F) provides that, with respect to a covered 
health insurance provider for a disqualified taxable year, an 
applicable individual is any individual (i) who is an officer, 
director, or employee in such taxable year, or (ii) who provides 
services for, or on behalf of, the covered health insurance provider 
during the taxable year. The final regulations adopt the proposed 
regulations and provide that remuneration for services performed by an 
independent contractor to a covered health insurance provider will not 
be subject to the deduction limitation under section 162(m)(6) if 
certain conditions are met. The conditions that must be met under the 
final regulations for the independent contractor exception to apply are 
the same as those provided in the proposed regulations.
    Section 162(m)(6)(F) defines an applicable individual as an 
``individual'' described in that section. Therefore, a corporation, 
partnership, or other entity that is not a natural person generally 
would not be an applicable individual. The preamble to the proposed 
regulations explains that the Treasury Department and the IRS are 
concerned that covered health insurance providers may attempt to avoid 
the application of the deduction limitation under section 162(m)(6) by 
encouraging employees and independent contractors who are natural 
persons to form small or single-member personal service corporations or 
other similar entities to provide services that are historically 
provided by natural persons. In the preamble to the proposed 
regulations, the Treasury Department and the IRS invited comments 
regarding how the final regulations might address this potential abuse.
    One commenter suggested that if a covered health insurance provider 
reports remuneration payments on a Form 1099 or W-2 issued directly to 
a natural person, then that person should be the service provider for 
purposes of section 162(m)(6). Conversely, if a covered health 
insurance provider reports remuneration as having been paid to an 
entity other than a natural person, and that reporting is not found to 
be incorrect under section 6041, the entity should be the recipient of 
the remuneration for purposes of section 162(m)(6).
    The final regulations do not adopt these suggestions. In general, 
section 6041 requires information reporting for payments to independent 
contractors and employees. The purpose of section 6041 is simply to 
track payments that may constitute gross income to the payee. Section 
6041 information reporting does not typically require the payor to look 
beyond the identity of the recipient of a payment. Accordingly, it 
would be inappropriate to rely on section 6041 information reporting to 
identify potentially abusive arrangements.
    The Treasury Department and the IRS remain concerned about 
employment arrangements that may be structured for the purpose of 
avoiding the deduction limitation under section 162(m)(6). Accordingly, 
while the final regulations recognize that an applicable individual 
generally will be a natural person, they provide that the Treasury 
Department and the IRS may issue guidance in the future identifying 
situations in which services performed by an entity will be treated as 
services performed by an individual for purposes of section 162(m)(6).

V. Applicable Individual Remuneration (AIR)

    As required under section 162(m)(6)(D), the final regulations, like 
the proposed regulations, provide that AIR is the aggregate amount that 
is allowable as a deduction (determined without regard to section 
162(m)) with respect to an applicable individual for a disqualified 
taxable year for remuneration for services performed by that individual 
(whether or not during the taxable year), except that AIR does not 
include any amount that is deferred deduction remuneration.

[[Page 56897]]

VI. Deferred Deduction Remuneration (DDR)

    Section 162(m)(6)(E) and the final regulations, like the proposed 
regulations, provide that DDR is remuneration that would be AIR for 
services that an applicable individual performs during a disqualified 
taxable year but for the fact that it is not deductible until a later 
taxable year (such as generally occurs, for example, with nonqualified 
deferred compensation).

VII. Attribution of Remuneration to Services Performed in Taxable Years

    The $500,000 deduction limitation under section 162(m)(6) applies 
to the AIR and DDR that is attributable to services performed by an 
applicable individual for a covered health insurance provider in a 
disqualified taxable year. Accordingly, at the time that an amount of 
AIR or DDR for an applicable individual becomes otherwise deductible 
(and not before that time), the remuneration must be attributed to 
services performed by the applicable individual during a particular 
taxable year or years of a covered health insurance provider.

A. In General

    The final regulations, like the proposed regulations, provide that, 
except as otherwise specifically provided in the regulations, 
remuneration is attributable to services performed by an applicable 
individual in the taxable year of the covered health insurance provider 
in which the applicable individual obtains a legally binding right to 
the remuneration. In addition, the final regulations, like the proposed 
regulations, provide that remuneration is not attributable to a taxable 
year during which the applicable individual is not a service provider. 
For these purposes, an individual is a service provider of a covered 
health insurance provider for any period during which the individual is 
an officer, director, or employee of, or providing services for, or on 
behalf of, the covered health insurance provider or any member of its 
aggregated group.
    In the preamble to the proposed regulations, the Treasury 
Department and the IRS requested comments on an appropriate method for 
attributing increases in an applicable individual's benefit that accrue 
in taxable years of a covered health insurance provider beginning after 
the applicable individual ceases providing services (referred to in 
this preamble as post-termination remuneration) to taxable years during 
which the applicable individual was a service provider. Comments were 
specifically requested on the appropriate methods for attributing 
increases under an account balance plan (defined as a plan described in 
Sec.  1.409A-1(c)(2)(i)(A) or (B)) and a nonaccount balance plan 
(defined as a plan described in Sec.  1.409A-1(c)(2)(i)(C)). In the 
context of nonaccount balance plans, one commenter suggested that each 
payment to or on behalf of an applicable individual under a nonaccount 
balance plan should be attributed to taxable years of a covered health 
insurance provider during which the applicable individual was a service 
provider in proportion to the increase in the applicable individual's 
benefit under the plan during those years. For example, if an 
applicable individual is a service provider for a covered health 
insurance provider for two years and participates in a deferred 
compensation plan during that time, and the applicable individual's 
benefit under the plan increases by an equal amount in both of those 
years, then 50 percent of each payment under the plan (whenever the 
payment is made and even if it includes post-termination remuneration) 
would be attributable to services performed in each of the two taxable 
years. According to the commenter, this method would provide a 
relatively simple method for attributing payments, including payments 
that include post-termination remuneration, to services performed in 
taxable years of a covered health insurance provider.
    The Treasury Department and the IRS agree with the commenter that 
this approach to the attribution of deferred compensation payments will 
ease administration for taxpayers and the IRS and will result in a 
consistent and principled attribution of payments to taxable years 
during which an applicable individual is a service provider. Although 
the commenter proposed this attribution method in the context of 
nonaccount balance plans, the Treasury Department and the IRS have 
concluded that this approach is an appropriate method for attributing 
amounts that become otherwise deductible under account balance plans as 
well. Accordingly, the Treasury Department and the IRS generally adopt 
this approach to the attribution of payments from account balance plans 
and nonaccount balance plans.

B. Account Balance Plans

    The proposed regulations provide two methods for attributing 
remuneration under an account balance plan to services performed by an 
applicable individual in a taxable year of the covered health insurance 
provider. The proposed regulations refer to these methods as the 
standard attribution method and the alternative attribution method. 
Under the standard attribution method, the amount of remuneration 
attributable to services performed in a taxable year of a covered 
health insurance provider is equal to the excess of the account balance 
as of the last day of the taxable year, plus any payments made from 
that account during the taxable year, over the account balance as of 
the last day of the immediately preceding taxable year. To the extent 
that an amount that becomes otherwise deductible under an account 
balance plan (such as a payment) could be attributed to services 
performed by an applicable individual in two or more taxable years of a 
covered health insurance provider, the proposed regulations provide 
that the amount must be attributed first to services performed by the 
applicable individual in the earliest taxable year to which the amount 
could be attributed.
    The proposed regulations also provide that, under the standard 
attribution method, any increases or decreases in an account balance 
that occur in taxable years of a covered health insurance provider in 
which an applicable individual is not a service provider must be 
attributed to taxable years during which the applicable individual is a 
service provider and has an account balance under the plan. The 
preamble to the proposed regulations provides that for taxable years 
beginning in 2013, and thereafter until the Treasury Department and the 
IRS issue further guidance prescribing the method for attributing post-
termination remuneration to these taxable years, post-termination 
remuneration may be attributed using any reasonable method to taxable 
years of a covered health insurance provider during which an applicable 
individual is a service provider and has an account balance under the 
plan. For this purpose, a method is reasonable only if it is consistent 
with a reasonable, good faith interpretation of section 162(m)(6) and 
is applied consistently for all remuneration provided by the covered 
health insurance provider under substantially similar plans or 
arrangements.
    Under the alternative method described in the proposed regulations, 
an amount paid to or on behalf of an applicable individual from an 
account balance plan is attributable to services performed by the 
applicable individual in the taxable year of a covered health insurance 
provider in which the principal addition related to the amount

[[Page 56898]]

was credited to the applicable individual's account under the plan. To 
the extent that an amount paid from the plan includes earnings on a 
principal addition (including post-termination remuneration), the 
amount is attributable to services performed in the taxable year in 
which the principal addition was credited to the account.
    The final regulations also provide that two methods are available 
for attributing remuneration under account balance plans. One method, 
which is different from the methods described in the proposed 
regulations, is referred to as the account balance ratio method, and 
the other, which is similar to the alternative method described in the 
proposed regulations, is referred to as the principal additions method. 
The final regulations, like the proposed regulations, provide that a 
covered health insurance provider and each member of its aggregated 
group must use the same method consistently to attribute remuneration 
under all of its account balance plans for all taxable years, with 
certain limited exceptions.
1. Account Balance Ratio Method
    The account balance ratio method is based on the proportional 
attribution principles described previously in section VII.A of this 
preamble. However, it is similar to the standard attribution method 
described in the proposed regulations in that the amount attributed to 
services performed by an applicable individual in a particular taxable 
year of a covered health insurance provider is based on the increase in 
the applicable individual's account balance during that year. Under the 
account balance ratio method, remuneration that becomes otherwise 
deductible (for example, because it is paid or made available to or for 
an applicable individual) is attributed to services performed by the 
applicable individual in each taxable year of the covered health 
insurance provider in which the applicable individual was a service 
provider and for which the account balance increased. The amount 
attributed to each of these taxable years is equal to the total amount 
that becomes otherwise deductible for the year multiplied by a 
fraction. The numerator of the fraction is the increase in the account 
balance for that taxable year, and the denominator of is the sum of all 
increases in the account balance for all taxable years during which the 
applicable individual was a service provider.
    For this purpose, an increase in an account balance occurs for a 
taxable year only if the account balance on the last day of the taxable 
year is greater than the highest account balance on the last day of 
every prior taxable year. The amount of the increase for any taxable 
year is the excess of the account balance as of the last day of the 
taxable year over the highest account balance as of the last day of any 
prior taxable year.
    For example, if an applicable individual's account balance is $10x 
on the last day of Year 1, $5x on the last day of Year 2, $7x on the 
last day of Year 3, and $12x on the last day of Year 4, with the 
fluctuations due solely to changes in investment returns and not due to 
payments under the plan, the only year in which an increase occurs is 
Year 4, and the increase is equal to $2x ($12x-$10x (the highest 
account balance in a prior year)). For post-termination payments, the 
account balance ratio for each taxable year will generally remain 
constant, and the same ratios will generally apply to all future 
payments. The Treasury Department and the IRS anticipate that this 
method will be significantly easier to administer than the standard 
attribution method described in the proposed regulations.
    Under the account balance ratio method, certain adjustments are 
made to account balances for in-service payments and for the payment of 
grandfathered amounts (as described in section XI of this preamble). 
For this purpose, an in-service payment is any payment made in a 
taxable year during which an applicable individual is a service 
provider, and it includes a payment made after an applicable individual 
permanently ceases to be a service provider (for example, because the 
applicable individual retires) if the applicable individual was a 
service provider at any time during the taxable year of the covered 
health insurance provider in which the payment was made. These 
adjustments are necessary because an in-service payment that is made 
from an account balance plan during a year when an applicable 
individual is accumulating benefits would reduce or eliminate any 
increase in the year-end account balance that would have occurred in 
the absence of the in-service payment. The adjustments required for in-
service payments and grandfathered amounts are intended to eliminate 
this effect.
    Under the account balance ratio method, if an applicable individual 
obtains a legally binding right in a taxable year during which the 
applicable individual is a service provider to an additional 
contribution under the plan (other than earnings) that will be made in 
a taxable year in which the applicable individual is not a service 
provider, the additional contribution is attributed to services 
performed in the first taxable year preceding the taxable year of the 
contribution in which the applicable individual was a service provider.
    In response to the request for comments in the proposed regulations 
on an appropriate method for attributing post-termination earnings to 
taxable years in which an applicable individual is a service provider, 
one commenter suggested that any increases (or decreases) in an account 
balance that occur in taxable years in which an applicable individual 
is not a service provider should be attributed pro rata beginning with 
the taxable year in which the applicable individual begins 
participating in the plan and ending with the taxable year in which the 
individual ceases to be a service provider. The final regulations do 
not adopt this suggestion because it could result in an allocation of 
earnings largely unrelated to the years in which amounts were credited 
under the plan as remuneration for services performed.
2. Principal Additions Method
    The alternative method described in the proposed regulations 
provides that a principal addition and earnings (or losses) thereon 
(including earnings and losses in taxable years during which an 
applicable individual is not a service provider) are attributed to the 
taxable year in which the related principal addition is made (including 
earnings and losses that occur in taxable years during which an 
applicable individual is not a service provider). The final regulations 
generally adopt the alternative method with certain modifications and 
refer to it as the principal additions method.
    Under the principal additions method, earnings on a principal 
addition (including post-termination earnings) are attributed to the 
taxable year in which an applicable individual is credited with the 
principal addition under the plan. For example, if a principal addition 
is credited to the account balance of an applicable individual in the 
2015 taxable year, earnings on that principal addition in 2028 are 
treated as additional remuneration for the 2015 taxable year, and not 
the 2028 taxable year.
    When an amount is paid from an account balance plan, it is 
attributed under the principal additions method to services performed 
in the taxable year in which the principal addition to which the amount 
relates was credited under the plan. The final regulations clarify that 
the principal additions method is available only for account balance 
plans that separately account for each principal addition to the plan 
and any

[[Page 56899]]

earnings thereon and that can trace any amount that becomes otherwise 
deductible under the plan, through separate accounting, to a principal 
addition made in a taxable year of a covered health insurance provider. 
The Treasury Department and the IRS understand that certain plans 
already track contributions of principal additions and the earnings 
thereon from the time those principal additions are credited under the 
plan to the time they are paid, generally as part of the administration 
of the plan's method of compliance with section 409A. The ability to 
trace payments from the plan to principal additions made in a 
particular taxable year is integral to the purpose of this attribution 
method, and the Treasury Department and the IRS believe it is 
appropriate to limit the use of this method to plans that maintain the 
separate accounting necessary to trace these amounts.

C. Nonaccount Balance Plans.

    The proposed regulations provide that remuneration under a 
nonaccount balance plan is attributable to services performed by an 
applicable individual in a taxable year based on the increase in the 
present value of the applicable individual's benefit under the plan 
during the taxable year. Under this method, the amount of remuneration 
attributable to services performed in a taxable year of a covered 
health insurance provider is equal to the increase (or decrease) in the 
present value of the future payment or payments due under the plan as 
of the last day of the taxable year of the covered health insurance 
provider, increased by any payments made during that year, over the 
present value of the future payment or payments as of the last day of 
the covered health insurance provider's preceding taxable year. For 
purposes of determining the increase (or decrease) in the present value 
of a future payment or payments, the rules of Sec.  31.3121(v)(2)-
1(c)(2) apply. To the extent that an amount that becomes otherwise 
deductible under a nonaccount balance plan (such as a payment) could be 
attributed to services performed by an applicable individual in two or 
more taxable years of a covered health insurance provider, the proposed 
regulations provide that the amount must be attributed first to 
services performed by the applicable individual in the earliest taxable 
year to which the amount could be attributed.
    In response to comments, the final regulations adopt two different 
attribution methods for nonaccount balance plans based on proportional 
attribution principles and provide that a covered health insurance 
provider may choose either of these two methods to attribute 
remuneration to taxable years under a nonaccount balance plan. These 
two methods are referred to in the final regulations as the present 
value ratio method and the formula benefit ratio method. A covered 
health insurance provider and each member of its aggregated group must 
use the same method consistently to attribute remuneration under all of 
their nonaccount balance plans consistently for all taxable years, with 
certain limited exceptions.
1. Present Value Ratio Method.
    Under the present value ratio method, each time an amount becomes 
otherwise deductible, such as when a payment is made under the plan, 
the amount is attributed to services performed in a taxable year or 
years of a covered health insurance provider during which an applicable 
individual was a service provider and for which there was an increase 
in the present value of payment(s) due under the plan. The amount 
attributed to each of these taxable years is equal to the total amount 
that is otherwise deductible multiplied by a fraction. The numerator of 
the fraction is the increase in the present value of the applicable 
individual's benefit for the taxable year, and the denominator of the 
fraction is the sum of all such increases in present value for all 
taxable years during which the applicable individual was a service 
provider. In other words, each time an amount becomes otherwise 
deductible, the amount is attributed proportionately to each taxable 
year in which the applicable individual was a service provider based on 
the increase in the present value of the applicable individual's 
benefit under the plan during that year.
    For purposes of the present value ratio method, an increase in the 
present value of an applicable individual's benefit occurs for a 
taxable year only if the present value of the benefit on the last day 
of the covered health insurance provider's taxable year is greater than 
the present value of the benefit on the last day of every prior taxable 
year. The amount of the increase for the taxable year is the excess of 
the present value of the benefit on the last day of the taxable year 
over the greatest present value of the benefit on the last day of any 
prior taxable year. If the present value of the applicable individual's 
benefit as of the last day of the taxable year is less than or equal to 
the present value of the benefit on the last day of any prior taxable 
year, there is no increase in the present value for that year for 
purposes of this calculation. For purposes of determining the present 
value of a future payment or payments, the rules of Sec.  
31.3121(v)(2)-1(c)(2) apply. Like the rules under the account balance 
ratio method, the final regulations also provide for adjustments in the 
present value of an applicable individual's benefit to the extent that 
the present value is reduced by in-service payments or includes 
grandfathered amounts.
    Although the present value ratio method adopts proportional 
attribution principles for purposes of attributing each payment to 
services performed by an applicable individual in taxable years of a 
covered health insurance provider, it is similar to the attribution 
method for nonaccount balance plans described in the proposed 
regulations in that amounts paid from the plan are attributed to 
taxable years based on an increase in the present value of the 
applicable individual's benefit. The Treasury Department and the IRS 
believe that the present value ratio method will be significantly 
easier for both taxpayers and the IRS to administer than the nonaccount 
balance attribution method described in the proposed regulations. For 
applicable individuals who begin receiving benefits under a nonaccount 
balance plan after termination of employment, the present value ratio 
for each taxable year will generally remain constant, and the payments 
can be attributed to a taxable year or years simply by multiplying the 
amount of the payment by the applicable fraction or percentage.
2. Formula Benefit Ratio Method.
    In response to the request for comments on the attribution method 
for nonaccount balance plans set forth in the proposed regulations, one 
commenter suggested that covered health insurance providers should not 
be required to determine the present value of an applicable 
individual's benefit for each taxable year to determine the taxable 
years to which an amount should be attributed. The commenter observed 
that plans do not ordinarily determine the present value of benefits on 
an individual basis before amounts are paid, if ever, and that this 
calculation would add significant complexity to process for attributing 
payments to services performed. The commenter suggested that the 
Treasury Department and the IRS provide an alternative attribution 
method based on year-over-year increases in the final benefit that an 
applicable individual is entitled to receive under the plan's benefit 
formula, without reducing that benefit to its present value. These 
final

[[Page 56900]]

regulations generally adopt this suggestion, with minor modifications, 
and refer to the method as the formula benefit ratio method.
    Under the formula benefit ratio method, remuneration provided to an 
applicable individual under a nonaccount balance plan is attributable 
to each taxable year in which the applicable individual provided 
services and for which there was an increase in the formula benefit. 
For these purposes, an applicable individual's formula benefit is the 
benefit that the applicable individual has a legally binding right to 
receive under the plan in the form that the remuneration being 
attributed has become otherwise deductible, which will generally be the 
form in which the remuneration is paid. If a portion of an applicable 
individual's benefit is paid or becomes otherwise deductible in one 
form (for example, a lump sum) and another portion of the benefit is 
paid or becomes otherwise deductible in another form (for example, a 
life annuity), the applicable individual has two separate formula 
benefits under the plan, and any increase in the formula benefit is 
determined separately for each portion of the benefit. If an amount 
becomes otherwise deductible under a plan but is not paid (for example, 
if an individual is in constructive receipt of an amount but does not 
receive payment of that amount), the form in which the benefit will be 
paid, if the actual form of payment is known, must be used to determine 
the formula benefit, and, if the actual form of payment is unknown, the 
formula benefit may be determined using any form of benefit in which 
the amount may be paid under the plan. In that case, the amount would 
not be attributed again when it is ultimately paid because it does not 
become otherwise deductible in the year of actual payment.
    Similar to the manner in which amounts are attributed to services 
provided in taxable years of a covered health insurance provider under 
the account balance ratio method and the present value ratio method, 
the amounts attributable under the formula benefit ratio method to each 
taxable year in which an applicable individual provides services and 
for which there was an increase in the formula benefit is equal to the 
amount that becomes otherwise deductible multiplied by a fraction. The 
numerator of the fraction is the increase in the formula benefit for 
the taxable year, and the denominator is the sum of all such increases 
during which the applicable individual was a service provider (which, 
in most cases, will equal the amount that has become otherwise 
deductible). Thus, each payment is attributed to taxable years based on 
the proportion of the increase in the formula benefit under the plan 
during the taxable year to the total formula benefit to which the 
applicable individual has a legally binding right when the payment is 
made.
    The amount of the increase in the formula benefit for a taxable 
year is equal to the excess of the formula benefit to which the 
individual has a legally binding right under the plan as of the 
measurement date for that taxable year (generally in the actual form of 
payment) over the greatest formula benefit to which the applicable 
individual had a legally binding right under the plan as of any 
measurement date in any earlier taxable year (in that same form of 
payment). Special rules apply for purposes of determining whether an 
increase occurs, and the amount of any increase, in the taxable year in 
which a payment occurs.

D. Equity-Based Remuneration

    The final regulations generally adopt the rules described in the 
proposed regulations for attributing remuneration resulting from 
equity-based compensation, which includes stock options, stock 
appreciation rights (SARs), restricted stock, and restricted stock 
units (RSUs), with certain modifications made in response to comments.
    The proposed regulations provide that remuneration resulting from 
the exercise of stock options and SARs is attributable on a daily pro 
rata basis to services performed by an applicable individual over the 
period beginning on the date of grant of the stock option or SAR and 
ending on the date that the stock option or SAR is exercised, excluding 
any days on which the applicable individual is not a service provider.
    Commenters suggested that, for a stock option or SAR that is 
subject to a substantial risk of forfeiture, a covered health insurance 
provider should be permitted to attribute remuneration resulting from 
the exercise of the stock option or SAR on a daily pro rata basis over 
the period beginning on the date the stock option or SAR is granted and 
ending on either the date the stock option or SAR is exercised or the 
date the stock option or SAR is no longer subject to a substantial risk 
of forfeiture, in either case excluding any days the applicable 
individual is not a service provider. The commenters explained that 
permitting attribution over the vesting period would be simpler for 
some covered health insurance providers because this method is commonly 
used for other financial accounting and regulatory purposes. The final 
regulations adopt this suggestion. However, the final regulations also 
provide that the covered health insurance provider must choose one of 
the two permissible methods and use it consistently for all stock 
options or SARs that it issues, unless certain exceptions apply.
    One commenter suggested that, instead of attributing equity-based 
remuneration on a daily pro rata basis over the period from the grant 
date to the date of exercise or the date of vesting, a covered health 
insurance provider should be permitted to attribute equity-based 
remuneration entirely to the taxable year in which the equity-based 
remuneration vests, is exercised, or is otherwise includible in income. 
Specifically, the commenter suggested that if equity-based remuneration 
vests in connection with a corporate transaction, a covered health 
insurance provider should be permitted to attribute pre-transaction 
appreciation entirely to the year of vesting. The final regulations do 
not adopt this suggestion. Attributing equity-based remuneration with a 
multiple-year vesting period to a single taxable year would not result 
in a reasonable attribution of remuneration to the taxable years in 
which the services were performed to earn the remuneration, as required 
by section 162(m)(6)(A).
    The final regulations reserve on attribution rules applicable to 
grants of equity-based remuneration in situations in which the 
remuneration is determined by reference to equity in an entity treated 
as a partnership for federal tax purposes or by reference to equity 
interests in an entity described in Sec.  1.409A-1(b)(5)(iii) (for 
example a mutual company). However, until the Treasury Department and 
the IRS issue further guidance on the attribution of this type of 
remuneration, the rules applicable to stock options, SARs, restricted 
stock, and RSUs, as described in the final regulations, may be applied 
by analogy (subject to any applicable rule under the Code (including 
subchapter K of the Code) affecting the timing, availability or amount 
of any deduction).

E. Involuntary Separation Pay

    The final regulations, like the proposed regulations, provide that 
involuntary separation pay is attributable to services performed by an 
applicable individual during the taxable year of a covered health 
insurance provider in which the involuntary separation from service 
occurs. Alternatively, involuntary separation pay may be attributable, 
on a daily pro

[[Page 56901]]

rata basis, to services performed by the applicable individual 
beginning on the date that the applicable individual obtains a legally 
binding right to the involuntary separation pay and ending on the date 
of the applicable individual's involuntary separation from service with 
the covered health insurance provider and all members of its aggregated 
group. For this purpose, involuntary separation pay is defined as 
remuneration to which an applicable individual has a right to payment 
solely as a result of an involuntary separation from service. If 
involuntary separation pay is attributed to services performed in 
multiple taxable years, each payment of involuntary separation pay must 
be attributed to the same taxable years in the same proportion that the 
total amount of separation pay is attributed to those taxable years.

F. Substantial Risk of Forfeiture

    The final regulations, like the proposed regulations, provide a 
two-step process for attributing certain remuneration to taxable years 
of the covered health insurance provider if the remuneration is subject 
to a substantial risk of forfeiture for more than one taxable year of a 
covered health insurance provider. This two-step process applies to 
amounts that are attributable under the general rule providing that 
remuneration is attributable to services performed by an applicable 
individual in the taxable year in which an applicable individual 
obtains a legally binding right to the remuneration and under the rules 
for account balance and nonaccount balance plans. Under this two-step 
process, the remuneration that is subject to the substantial risk of 
forfeiture is first attributed to the taxable year or years of the 
covered health insurance provider under the attribution rules that 
otherwise apply. Then, that remuneration is reattributed on a daily pro 
rata basis over the period that it is subject to a substantial risk of 
forfeiture (in other words, reattributed evenly over the vesting 
period).
    One commenter suggested that the final regulations make this two-
step attribution method optional, rather than mandatory, and permit 
covered health insurance providers to choose whether to apply this two-
step method on a plan-by-plan basis. The final regulations do not adopt 
this suggestion. Attributing remuneration evenly over the vesting 
period results in a more accurate matching of remuneration to the 
taxable years in which the services were performed to earn the 
remuneration and is consistent with the treatment of equity-based 
compensation that is subject to a substantial risk of forfeiture.

VII. Application of the $500,000 Deduction Limitation

A. In General

    The final regulations generally adopt the rules described in the 
proposed regulations for applying the $500,000 deduction limitation of 
section 162(m)(6). The deduction limitation applies to the aggregate 
AIR and DDR attributable to services performed by an applicable 
individual for a covered health insurance provider in a disqualified 
taxable year. Accordingly, if AIR, DDR, or a combination of AIR and 
DDR, attributable to services performed by an applicable individual for 
a covered health insurance provider in a disqualified taxable year 
exceeds $500,000, the amount of the remuneration that exceeds $500,000 
is not allowable as a deduction in any taxable year. When the $500,000 
deduction limit is applied to an amount of AIR attributable to services 
performed by an applicable individual in a disqualified taxable year, 
the deduction limit with respect to that applicable individual for that 
disqualified taxable year is reduced, but not below zero, by the amount 
of the AIR to which the deduction limit is applied. If the applicable 
individual also has an amount of DDR attributable to services performed 
in that disqualified taxable year that becomes otherwise deductible in 
a subsequent taxable year, the deduction limit, as reduced, is applied 
to that amount of DDR in the first taxable year in which that DDR 
becomes otherwise deductible. If the amount of the DDR that becomes 
otherwise deductible is less than the reduced deduction limit, then the 
full amount of the DDR is deductible in that taxable year. To the 
extent that the amount of the DDR exceeds the reduced deduction limit, 
the covered health insurance provider's deduction for the DDR is 
limited to the amount of the reduced deduction limit and the amount of 
the DDR that exceeds the deduction limit cannot be deducted in any 
taxable year.

B. Application of Deduction Limitation to Payments

    The final regulations generally adopt rules described in the 
proposed regulations for applying the deduction limitation to payments 
of remuneration. Any payment to an applicable individual may include 
remuneration that is attributable to services performed by the 
applicable individual in one or more taxable years of a covered health 
insurance provider under the rules set out in the final regulations. 
For example, remuneration resulting from the vesting of restricted 
stock that is subject to a substantial risk of forfeiture for five full 
taxable years of a covered health insurance provider is attributable to 
services performed by the applicable individual in each of the five 
years during which the restricted stock was subject to a substantial 
risk of forfeiture. In that case, a separate deduction limit applies to 
each portion of the payment that is attributed to services performed in 
a different disqualified taxable year of the covered health insurance 
provider. Any portion of the payment that is attributed to a 
disqualified taxable year is deductible only to the extent that it does 
not exceed the deduction limit that applies to the applicable 
individual for that disqualified taxable year, as that deduction limit 
may have been previously reduced by the amount of any AIR or DDR 
attributable to services performed in that disqualified taxable year 
that was previously deductible. The final regulations contain several 
examples to illustrate how these rules apply to services performed and 
compensation payments made over multiple taxable years.

VIII. Corporate Transactions

A. In General

    A corporation or other person may become a covered health insurance 
provider as a result of certain transactions such as a merger, 
acquisition or disposition of assets or stock (or other equity 
interests), reorganization, consolidation, separation, or other 
transaction resulting in a change in the composition of an aggregated 
group (generally referred to in this preamble and the final regulations 
as a corporate transaction). For example, as a result of the 
aggregation rules, members of a controlled group of corporations that 
does not include a health insurance issuer may become covered health 
insurance providers if a health insurance issuer that is a covered 
health insurance provider becomes a member of the controlled group.

B. Transition Period Relief

    The final regulations, like the proposed regulations, provide a 
transition period to ease the administrative burden on a person that 
becomes a covered health insurance provider solely as a result of a 
corporate transaction. Specifically, the final regulations provide that 
if a person that is not otherwise a covered health insurance provider 
would become a covered health insurance provider

[[Page 56902]]

solely as a result of a corporate transaction, the person generally is 
not a covered health insurance provider for the taxable year in which 
the transaction occurs (referred to in this preamble and the final 
regulations as transition period relief). The person, however, is a 
covered health insurance provider for any subsequent taxable year if it 
is a covered health insurance provider for the taxable year under the 
generally applicable rules for determining whether a person is a 
covered health insurance provider. A person that is a covered health 
insurance provider immediately before a corporate transaction is not 
eligible for this transition period relief because the person does not 
become a covered health insurance provider solely as a result of the 
corporate transaction (but may be eligible for certain transition 
relief relating to the attribution method it is permitted to use for 
the taxable year in which the corporate transaction occurs).
    One commenter suggested that if a person becomes a covered health 
insurance provider as a result of a corporate transaction, the person 
should not be treated as a covered health insurance provider until the 
first taxable year beginning at least six months after the transaction. 
The commenter asserted that the additional time is necessary to provide 
for an adequate transition period. The final regulations do not adopt 
this suggestion. Section 162(m)(6)(C)(ii) treats the members of an 
aggregated group as a single employer. The statute does not 
specifically provide that a person must be treated as a covered health 
insurance provider for its entire taxable year if it is a member of an 
aggregated group that includes a health insurance issuer for only a 
portion of the year. Therefore, the Treasury Department and the IRS 
have concluded that providing transition relief for corporate 
transactions during the taxable year that the corporate transaction 
occurs is consistent with the statute. However, providing transition 
relief for a taxable year in which a person is a member of an 
aggregated group that includes a health insurance issuer for its entire 
taxable year would be inconsistent with the statute.

C. Certain Applicable Individuals

    The proposed regulations provide that, in certain circumstances, 
the deduction limitation under section 162(m)(6) may apply to a person 
that is not treated as a covered health insurance provider during the 
transition period. Specifically, the proposed regulations provide that 
the transition period otherwise applicable to certain members of an 
aggregated group does not extend to remuneration provided to applicable 
individuals of a health insurance issuer that is a covered health 
insurance provider and that is not eligible for the transition period 
relief because it does not become a covered health insurance provider 
solely as a result of a corporate transaction.
    The final regulations generally adopt this rule, but expand it to 
include applicable individuals of not only health insurance issuers, 
but also other employers that would have been covered health insurance 
providers in the taxable year that the corporate transaction occurs, 
without regard to the corporate transaction. For example, if a 
controlled group of corporations that are not covered health insurance 
providers acquires a health insurance issuer and its non-health 
insurance issuer subsidiary, both of which are covered health insurance 
providers before the corporate transaction, the deduction limitation 
under section 162(m)(6) applies to all remuneration provided to the 
applicable individuals of the health insurance issuer and the non-
health insurance issuer subsidiary, even if the remuneration is 
provided by a member of the acquiring controlled group that is 
otherwise eligible for transition period relief during the year of the 
acquisition.

D. Consistency Rule Relief

    As explained previously in this preamble, a covered health 
insurance provider and all members of its aggregated group that provide 
remuneration under an account balance plan, a nonaccount balance plan, 
or through stock options or SARs generally must use the same 
attribution method for each type of plan (that is, account balance 
plans, nonaccount balance plans, and stock options or SARs) for all 
taxable years. As a result of a corporate transaction, however, a 
covered health insurance provider that uses a particular attribution 
method for one or more of these types of plans may become a member of 
an aggregated group that has a member that uses a different attribution 
method. To maintain consistency within the aggregated group, one or 
more covered health insurance providers would need to change 
attribution methods.
    As noted in the preamble to the proposed regulations, once 
remuneration provided to an applicable individual from a plan has been 
attributed to a taxable year under a particular method (for example, 
because a payment has been made to the applicable individual), it would 
be administratively difficult to change the attribution method for 
amounts that become deductible with respect to that applicable 
individual in future years and still provide a reasonably accurate 
attribution of remuneration from that plan to the taxable years in 
which the applicable individual performed the services to earn the 
remuneration. In addition, the Treasury Department and the IRS are 
concerned that the ability to change attribution methods may lead to 
selective use of methods to maximize deductions. However, recognizing 
that there may be valid business reasons for changing attribution 
methods, such as a merger or acquisition, change in compensation 
structure, or change in accounting method, the Treasury Department and 
the IRS requested comments on the standards that should apply to 
determine whether and when an attribution method may be changed, and 
how that change would apply if deductions for amounts provided under 
the plan or arrangement have already been taken.
    Commenters generally asked for flexibility in applying the 
consistency rules after a corporate transaction. The final regulations 
generally adopt this suggestion and provide that, if a covered health 
insurance provider that uses an attribution method for a particular 
type of plan (that is, an account balance plan, a nonaccount balance 
plan, or a stock option or SAR) becomes a member of an aggregated group 
with one or more covered health insurance providers that used a 
different attribution method for that type of plan before the corporate 
transaction, the covered health insurance provider will not violate the 
otherwise applicable consistency rules for the taxable year in which 
the corporate transaction takes place if it continues to use the same 
attribution method for that type of plan that it used before the 
transaction, even if it is different from the attribution method used 
by other members of the aggregated group. Further, the final 
regulations provide that, in this situation, a member of the aggregated 
group may change its attribution method to be the same as the 
attribution method used by other members of its aggregated group, 
subject to limitations or modifications that the Treasury Department 
and the IRS may provide in future guidance published in the Internal 
Revenue Bulletin.
    One commenter suggested that application of the consistency rules 
following a corporate transaction should not require a retroactive 
change in attribution methods. The commenter noted that changing 
attribution methods retroactively would be administratively difficult. 
The final regulations generally adopt this suggestion and provide that, 
if an attribution method has been used

[[Page 56903]]

to attribute remuneration provided to an applicable individual under an 
account balance plan, a nonaccount balance plan, or a stock option or 
SAR before a corporate transaction, that same method must be used in 
all future taxable years to attribute any remuneration provided to the 
applicable individual under the same type of plan to the extent that 
the applicable individual had a legally binding right to the 
remuneration as of the date of the corporate transaction.
    Because a covered health insurance provider does not need to use an 
attribution method for amounts that become deductible during a taxable 
year until it files its tax return for that taxable year, the Treasury 
Department and the IRS have concluded that the exceptions to the 
consistency rules described in this section of the preamble and the 
final regulations will provide covered health insurance providers 
adequate time to make any adjustments to their attribution methods 
necessary to comply with the otherwise applicable consistency rules.

E. Application of the De Minimis Rule

    One commenter suggested that the final regulations clarify that if 
a person ceases to be a member of an aggregated group, the de minimis 
exception is applied taking into account only the revenues and premiums 
of the person for the period during which it was a member of the 
aggregated group. The final regulations adopt this suggestion.

XI. Grandfathered Amounts Attributable to Services Performed Before 
January 1, 2010

    The deduction limitation under section 162(m)(6) only applies to 
AIR attributable to services performed by an applicable individual in 
taxable years beginning after December 31, 2012 and to DDR attributable 
to services performed by an applicable individual in taxable years 
beginning after December 31, 2009. It does not apply to remuneration 
attributable to services performed in taxable years beginning before 
January 1, 2010.
    The proposed regulations provide that for purposes of determining 
whether remuneration provided under an account balance plan is 
attributable to services performed in taxable years beginning before 
January 1, 2010, a covered health insurance provider is required to use 
the same attribution method that it otherwise uses to attribute 
remuneration to taxable years, except that any substantial risk of 
forfeiture is disregarded.
    A commenter suggested that a covered health insurance provider be 
permitted to use any method that is permissible for purposes of 
attributing remuneration to taxable years for purposes of determining 
the amount of remuneration that is attributable to services performed 
before January 1, 2010, even if the method is different from the method 
it otherwise uses to attribute remuneration to taxable years. The final 
regulations provide that if a covered health insurance provider uses a 
method for attributing amounts that become deductible under an account 
balance plan or a nonaccount balance plan to taxable years beginning 
after December 31, 2009, it must use that same method consistently for 
attributing amounts to taxable years beginning before January 1, 2010, 
except that, if it uses the account balance ratio method to attribute 
remuneration under an account balance plan to taxable years beginning 
after December 31, 2009, it may use the principal additions method to 
attribute amounts to taxable years beginning before January 1, 2010. 
The final regulations require certain adjustments to account balances 
for purposes of applying the account balance ratio method if this is 
done.
    For nonaccount balance plans, the proposed regulations provide that 
the amount attributable to services provided in taxable years beginning 
before January 1, 2010, equals the present value of the remuneration to 
which the applicable individual would have been entitled under the plan 
if the applicable individual voluntarily terminated services without 
cause on the last day of the first taxable year of the covered health 
insurance provider beginning before January 1, 2010. The proposed 
regulations further provide that, for any subsequent taxable year of 
the covered health insurance provider, this amount may increase to the 
present value of the benefit the applicable individual actually becomes 
entitled to receive, in the form and at the time actually paid, 
determined under the terms of the plan (including applicable limits 
under the Code) as in effect on the last day of the first taxable year 
beginning before January 1, 2010, without regard to any further 
services required by the individual after that date or any other events 
affecting the amount of, or the entitlement to, benefits (other than 
the applicable individual's election with respect to the time or form 
of an available benefit).
    The final regulations provide that for purposes of determining 
whether remuneration provided under a nonaccount balance plan is 
attributable to services performed in taxable years beginning before 
January 1, 2010, a covered health insurance provider is required to use 
the attribution method that it otherwise uses to attribute remuneration 
to taxable years. Although the amounts attributable to services 
performed in taxable years beginning before January 1, 2010, are 
determined differently under the final regulations, the amounts 
attributable to services performed in taxable years beginning before 
January 1, 2010, under the formula benefit ratio method generally will 
be similar to the amounts attributable to those years under the 
proposed regulations. For equity-based remuneration, the final 
regulations generally follow the rules described in the proposed 
regulations and provide that any remuneration resulting from equity-
based compensation granted in a taxable year beginning before January 
1, 2010, is not subject to the deduction limitation, regardless of 
whether the equity-based remuneration is subject to a substantial risk 
of forfeiture during a taxable year beginning after December 31, 2009. 
Earnings on these grandfathered amounts, including earnings accruing in 
taxable years beginning after December 31, 2009, are also generally 
treated as remuneration attributable to services performed in taxable 
years beginning before January 1, 2010.
    One commenter suggested that the final regulations should clarify 
that the grandfathering rules apply to remuneration provided under all 
types of arrangements (not only remuneration from account balance 
plans, nonaccount balance plans, and equity-based remuneration) and 
that grandfathered amounts be determined based on the attribution rules 
generally applicable to the arrangement under which remuneration was 
provided. The final regulations adopt this suggestion.

XII. Transition Rules for Certain DDR

    Section 162(m)(6) applies to DDR attributable to services performed 
in a disqualified taxable year beginning after December 31, 2009 that 
is otherwise deductible in a taxable year beginning after December 31, 
2012. As described in section I.B of this preamble, for taxable years 
beginning before January 1, 2013, a covered health insurance provider 
is any health insurance issuer (as defined in section 9832(b)(2)) that 
receives premiums from providing health insurance coverage (as defined 
in section 9832(b)(1)) (a pre-2013 covered health insurance provider). 
For taxable years beginning after December 31, 2012, a covered health 
insurance provider is any health insurance issuer (as defined in 
section 9832(b)(2)) that receives at least 25 percent of its gross 
premiums from providing minimum essential coverage (as defined in 
section

[[Page 56904]]

5000A(f)) (a post-2012 covered health insurance provider). Thus, the 
definition of the term covered health insurance provider is narrower 
for taxable years beginning after December 31, 2012, than it is for 
taxable years beginning before January 1, 2013. The proposed 
regulations include transition rules under which the section 162(m)(6) 
deduction limitation applies to DDR attributable to services performed 
in taxable years beginning after December 31, 2009 and before January 
1, 2013 only if the covered health insurance provider is a pre-2013 
covered health insurance provider for the taxable year to which the DDR 
is attributable and a post-2012 covered health insurance provider for 
the taxable year in which that DDR is otherwise deductible. The final 
regulations retain this transition rule.

XIII. Effective/Applicability Date

    The final regulations are effective on September 23, 2014. The 
final regulations apply to taxable years beginning after September 23, 
2014. In addition, taxpayers may rely on these final regulations for 
taxable years beginning on or before September 23, 2014.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. It also has been determined that section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to these regulations, and because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Code, this regulation has been submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Drafting Information

    The principal author of the regulations is Ilya Enkishev of the 
Office of the Division Counsel/Associate Chief Counsel (Tax Exempt and 
Government Entities). However, other personnel from the IRS and the 
Treasury Department participated in their drafting and development.

List of Subjects in 26 CFR Part 1

    Income Taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *



0
Par. 2. Section 1.162-31 is added to read as follows:


Sec.  1.162-31  The $500,000 deduction limitation for remuneration 
provided by certain health insurance providers.

    (a) Scope. This section sets forth rules regarding the deduction 
limitation under section 162(m)(6), which provides that a covered 
health insurance provider's deduction for applicable individual 
remuneration (AIR) and deferred deduction remuneration (DDR) 
attributable to services performed by an applicable individual in a 
disqualified taxable year is limited to $500,000. Paragraph (b) of this 
section sets forth definitions of the terms used in this section. 
Paragraph (c) of this section explains the general limitation on 
deductions under section 162(m)(6). Paragraph (d) of this section sets 
forth the methods that must be used to attribute AIR and DDR to 
services performed in one or more taxable years of a covered health 
insurance provider. Paragraph (e) of this section sets forth rules on 
how the deduction limit applies to AIR and DDR that is otherwise 
deductible under chapter 1 of the Internal Revenue Code (Code) but for 
the deduction limitation under section 162(m)(6) (referred to in this 
section as remuneration that is otherwise deductible). Paragraph (f) of 
this section sets forth additional rules for persons participating in 
certain corporate transactions. Paragraph (g) of this section explains 
the interaction of section 162(m)(6) with sections 162(m)(1) and 280G. 
Paragraph (h) of this section sets forth rules for determining the 
amounts of remuneration that are not subject to the deduction 
limitation under section 162(m)(6) due to the statutory effective date 
(referred to in this section as grandfathered amounts). Paragraph (i) 
of this section sets forth transition rules for DDR that is 
attributable to services performed in taxable years beginning after 
December 31, 2009 and before January 1, 2013. Paragraph (j) of this 
section sets forth the effective and applicability dates of the rules 
in this section.
    (b) Definitions--(1) Health insurance issuer. For purposes of this 
section, a health insurance issuer is a health insurance issuer as 
defined in section 9832(b)(2).
    (2) Aggregated group. For purposes of this section, an aggregated 
group is a health insurance issuer and each other person that is 
treated as a single employer with the health insurance issuer at any 
time during the taxable year of the health insurance issuer under 
sections 414(b) (controlled groups of corporations), 414(c) 
(partnerships, proprietorships, etc. under common control), 414(m) 
(affiliated service groups), or 414(o), except that the rules in 
section 1563(a)(2) and (3) (with respect to corporations) and Sec.  
1.414(c)-2(c) and (d) (with respect to trades or businesses under 
common control) for brother-sister groups and combined groups are 
disregarded.
    (3) Parent entity--(i) In general. For purposes of this section, a 
parent entity is either--
    (A) The common parent of a parent-subsidiary controlled group of 
corporations (within the meaning of section 414(b)) or a parent-
subsidiary group of trades or businesses under common control (within 
the meaning of section 414(c)) that includes a health insurance issuer, 
or
    (B) the health insurance issuer in an aggregated group that is an 
affiliated service group (within the meaning of section 414(m)) or a 
group described in section 414(o).
    (ii) Certain aggregated groups with multiple health insurance 
issuers--(A) In general. If two or more health insurance issuers are 
members of an aggregated group that is an affiliated service group 
(within the meaning of section 414(m)) or group described in section 
414(o), the parent entity is the health insurance issuer in the 
aggregated group that is designated in writing by the other members of 
the aggregated group to act as the parent entity.
    (B) Successor parent entities. If a health insurance issuer that is 
the parent entity of an aggregated group pursuant to paragraph 
(b)(3)(ii)(A) of this section (a predecessor parent entity) ceases to 
be a member of the aggregated group (for example, as a result of a 
corporate transaction) and, after the predecessor parent entity ceases 
to be a member of the aggregated group, two or more health insurance 
issuers are members of the aggregated group, the new parent entity (the 
successor parent entity) is another member of the aggregated group 
designated in writing by the remaining members of the aggregated group. 
The successor parent

[[Page 56905]]

entity must be a health insurance issuer in the aggregated group that 
has the same taxable year as the predecessor parent entity; provided, 
however, that if no health insurance issuer in the aggregated group has 
the same taxable year as the predecessor parent entity, the members of 
the aggregated group may designate in writing any other health 
insurance issuer in the aggregated group to be the parent entity.
    (C) Failure to designate a parent entity. If the members of an 
aggregated group that includes two or more health insurance issuers and 
that is an affiliated service group (within the meaning of section 
414(m)) or a group described in section 414(o) fail to designate in 
writing a health insurance issuer to act as the parent entity of the 
aggregated group, the parent entity of the aggregated group for all 
taxable years is deemed to be an entity with a taxable year that is the 
calendar year (without regard to whether the aggregated group includes 
or has ever included an entity with a calendar year taxable year) for 
all purposes under this section for which a parent entity's taxable 
year is relevant.
    (4) Covered health insurance provider--(i) In general. For purposes 
of this section and except as otherwise provided in this paragraph 
(b)(4), a covered health insurance provider is--
    (A) A health insurance issuer for any of its taxable years 
beginning after December 31, 2012 in which at least 25 percent of the 
gross premiums it receives from providing health insurance coverage (as 
defined in section 9832(b)(1)) are from providing minimum essential 
coverage (as defined in section 5000A(f)),
    (B) a health insurance issuer for any of its taxable years 
beginning after December 31, 2009 and before January 1, 2013 in which 
it receives premiums from providing health insurance coverage (as 
defined in section 9832(b)(1)),
    (C) the parent entity of an aggregated group of which one or more 
health insurance issuers described in paragraphs (b)(4)(i)(A) or (B) of 
this section are members for the taxable year of the parent entity with 
which, or in which, ends the taxable year of any such health insurance 
issuer; however, if the parent entity of an aggregated group is a 
health insurance issuer described in paragraphs (b)(4)(i)(A) or (B) of 
this section, that health insurance issuer is a covered health 
insurance provider for any taxable year that it is otherwise a covered 
health insurance provider, without regard to whether the taxable year 
of any other health insurance issuer described in paragraphs 
(b)(4)(i)(A) or (B) of this section ends with or within its taxable 
year, and
    (D) each other member of an aggregated group of which one or more 
health insurance issuers described in paragraphs (b)(4)(i)(A) or (B) of 
this section are members for the taxable year of the other member 
ending with, or within, the parent entity's taxable year.
    (ii) Parent entities with short taxable years. If for any reason a 
parent entity has a taxable year that is less than 12 months (for 
example, because the taxable year of a predecessor parent entity ends 
when it ceases to be a member of an aggregated group), then, for 
purposes of determining whether the parent entity and each other member 
of the aggregated group is a covered health insurance provider with 
respect to the parent entity's short taxable year (that is, for 
purposes of determining whether the taxable year of a health insurance 
issuer described in paragraph (b)(4)(i)(A) or (B) of this section ends 
with or within the short taxable year of the parent entity and for 
purposes of determining whether another member of the aggregated group 
has a taxable year ending with or within the short taxable year of the 
parent entity), the taxable year of the parent entity is treated as the 
12-month period ending on the last day of the short taxable year. 
Accordingly, a parent entity is a covered health insurance provider for 
its short taxable year if it is a health insurance issuer described in 
paragraph (b)(4)(i)(A) or (B) of this section or if the taxable year of 
a health insurance issuer described in paragraph (b)(4)(i)(A) or (B) of 
this section in an aggregated group with the parent entity ends with or 
within the 12-month period ending on the last day of the parent 
entity's short taxable year. Similarly, each other member of the parent 
entity's aggregated group is a covered health insurance provider for 
its taxable year ending with or within the 12-month period ending on 
the last day of the parent entity's short taxable year.
    (iii) Predecessor and successor parent entities. If the parent 
entity of an aggregated group changes, the members of the aggregated 
group may be covered health insurance providers based on their 
relationship to either or both parent entities with respect to the 
taxable years of the parent entities in which the change occurs.
    (iv) Self-insured plans. For purposes of this section, a person is 
not a covered health insurance provider solely because it maintains a 
self-insured medical reimbursement plan. For this purpose, a self-
insured medical reimbursement plan is a separate written plan for the 
benefit of employees (including former employees) that provides for 
reimbursement of medical expenses referred to in section 105(b) and 
does not provide for reimbursement under an individual or group policy 
of accident or health insurance issued by a licensed insurance company 
or under an arrangement in the nature of a prepaid health care plan 
that is regulated under federal or state law in a manner similar to the 
regulation of insurance companies, and may include a plan maintained by 
an employee organization described in section 501(c)(9).
    (v) De minimis exception--(A) In general. A health insurance issuer 
and any member of its aggregated group that would otherwise be a 
covered health insurance provider under paragraph (b)(4)(i), (ii), or 
(iii) of this section for a taxable year beginning after December 31, 
2012 is not a covered health insurance provider under this section for 
that taxable year if the premiums received by the health insurance 
issuer and any other health insurance issuers in its aggregated group 
from providing health insurance coverage (as defined in section 
9832(b)(1)) that constitutes minimum essential coverage (as defined in 
section 5000A(f)) are less than two percent of the gross revenues of 
the health insurance issuer and all other members of its aggregated 
group for that taxable year. A health insurance issuer and any member 
of its aggregated group that would otherwise be a covered health 
insurance provider under paragraph (b)(4)(i), (ii), or (iii) of this 
section for a taxable year beginning after December 31, 2009 and before 
January 1, 2013 is not a covered health insurance provider for purposes 
of this section for that taxable year if the premiums received by the 
health insurance issuer and any other health insurance issuers in its 
aggregated group from providing health insurance coverage (as defined 
in section 9832(b)(1)) are less than two percent of the gross revenues 
of the health insurance issuer and all other members of its aggregated 
group for that taxable year. In determining whether premiums constitute 
less than two percent of gross revenues, the amount of gross revenues 
must be determined in accordance with generally accepted accounting 
principles. For the definition of the term premiums, see paragraph 
(b)(5) of this section. A person that would be a covered health 
insurance provider for a taxable year in an aggregated group with a 
predecessor parent entity and that would also be a covered health 
insurance provider for that taxable year

[[Page 56906]]

in an aggregated group with a successor parent entity is not a covered 
health insurance provider under the de minimis exception only if the 
aggregated groups of which the person is a member meet the requirements 
of the de minimis exception based on both the taxable year of the 
predecessor parent entity and the taxable year of the successor parent 
entity.
    (B) One-year de minimis exception transition period. If a health 
insurance issuer or a member of an aggregated group is not a covered 
health insurance provider for a taxable year solely by reason of the de 
minimis exception described in paragraph (b)(4)(v)(A) of this section, 
but fails to meet the requirements of the de minimis exception 
described in paragraph (b)(4)(v)(A) of this section for the immediately 
following taxable year, that health insurance issuer or member of an 
aggregated group will not be a covered health insurance provider for 
that immediately following taxable year.
    (vi) Examples. The following examples illustrate the principles of 
this paragraph (b)(4). For purposes of these examples, each corporation 
has a taxable year that is the calendar year, unless the example 
provides otherwise.

    Example 1.  (i) Corporations Y and Z are members of an 
aggregated group under paragraph (b)(2) of this section. Y is a 
health insurance issuer that is a covered health insurance provider 
pursuant to paragraph (b)(4)(i)(A) of this section and receives 
premiums from providing health insurance coverage that is minimum 
essential coverage during its 2015 taxable year in an amount that is 
less than two percent of the combined gross revenues of Y and Z for 
their 2015 taxable years. Z is not a health insurance issuer.
    (ii) Y and Z are not covered health insurance providers under 
paragraph (b)(4) of this section for their 2015 taxable years 
because they meet the requirements of the de minimis exception under 
paragraph (b)(4)(v)(A) of this section.

    Example 2.  (i) Corporations V, W, and X are members of an 
aggregated group under paragraph (b)(2) of this section. V is a 
health insurance issuer that is a covered health insurance provider 
pursuant to paragraph (b)(4)(i)(A) of this section, but neither W 
nor X is a health insurance issuer. W is the parent entity of the 
aggregated group. V's taxable year ends on December 31, W's taxable 
year ends on June 30, and X's taxable year ends on September 30. For 
its taxable year ending December 31, 2016, V receives $3x of 
premiums from providing minimum essential coverage and has no other 
revenue. For its taxable year ending June 30, 2017, W has $100x in 
gross revenue. For its taxable year ending September 30, 2016, X has 
$60x in gross revenue.
    (ii) But for the de minimis exception, V (the health insurance 
issuer) would be a covered health insurance provider for its taxable 
year ending December 31, 2016; W (the parent entity) would be a 
covered health insurance provider for its taxable year ending June 
30, 2017 (its taxable year with which, or within which, ends the 
taxable year of the health insurance issuer); and X (the other 
member of the aggregated group) would be a covered health insurance 
provider for its taxable year ending on September 30, 2016 (its 
taxable year ending with, or within, the taxable year of the parent 
entity). However, the premiums received by V (the health insurance 
issuer) from providing minimum essential coverage during the taxable 
year that it would otherwise be a covered health insurance provider 
under paragraph (b)(4)(i)(A) of this section are less than two 
percent of the combined gross revenues of V, W, and X for the 
related taxable years that they would otherwise be covered health 
insurance providers under paragraph (b)(4)(i) of this section ($3x 
is less than $3.26x (two percent of $163x)). Therefore, the de 
minimis exception of paragraph (b)(4)(v)(A) of this section applies, 
and V, W, and X are not covered health insurance providers for these 
taxable years.
    Example 3.  (i) The facts are the same as Example 2, except that 
V receives $4x of premiums for providing minimum essential coverage 
for its taxable year ending December 31, 2016. In addition, the 
members of the VWX aggregated group were not covered health 
insurance providers for their taxable years ending December 31, 
2015, June 30, 2016, and September 30, 2015, respectively (their 
immediately preceding taxable years) solely by reason of the de 
minimis exception of paragraph (b)(4)(v)(A) of this section.
    (ii) Although the premiums received by the members of the 
aggregated group from providing minimum essential coverage are more 
than two percent of the gross revenues of the aggregated group for 
the taxable years during which the members would otherwise be 
treated as covered health insurance providers under paragraph 
(b)(4)(i) of this section ($4x is greater than $3.28x (two percent 
of $164x)), they were not covered health insurance providers for 
their immediately preceding taxable years solely because of the de 
minimis exception of paragraph (b)(4)(v)(A) of this section. 
Therefore, V, W, and X are not covered health insurance providers 
for their taxable years ending on December 31, 2016, June 30, 2017, 
and September 30, 2016, respectively, because of the one-year 
transition period under paragraph (b)(4)(v)(B) of this section. 
However, the members of the VWX aggregated group will be covered 
health insurance providers for their subsequent taxable years if 
they would otherwise be covered health insurance providers for those 
taxable years under paragraph (b)(4) of this section.
    Example 4.  (i) Corporations W, X, Y, and Z are members of a 
controlled group described in section 414(b)) that is an aggregated 
group under paragraph (b)(2) of this section. W and X are health 
insurance issuers. Y and Z are not health insurance issuers. W is 
the parent entity of the aggregated group. W's and Y's taxable years 
end on December 31; X's taxable year ends on March 31; and Z's 
taxable year ends on June 30. As a result of a corporate 
transaction, W is no longer a member of the WXYZ aggregated group as 
of September 30, 2016, and W's taxable year ends on that date. 
Following the corporate transaction, X becomes the parent entity of 
the XYZ aggregated group.
    (ii) Because W's taxable year is treated as the 12-month period 
ending on September 30, 2016, W is the parent entity for X's taxable 
year ending March 31, 2016, Z's taxable year ending June 30, 2016, 
and Y's taxable year ending December 31, 2015. Because X's taxable 
year begins on April 1, 2016 and ends on March 31, 2017, for 
purposes of paragraph (b)(4) of this section, X is the parent entity 
for Z's taxable year ending June 30, 2016, Y's taxable year ending 
December 31, 2016, and W's taxable year ending September 30, 2016.
    Example 5. (i) The facts are the same as Example 4. In addition, 
W receives $4x of premiums for providing minimum essential coverage 
and no other revenue for its taxable year beginning January 1, 2016 
and ending September 30, 2016. X receives $2x of premiums for 
providing minimum essential coverage and has no other revenue for 
its taxable year ending March 31, 2016. X receives $1x of premiums 
for providing minimum essential coverage and no other revenue for 
its taxable year ending March 31, 2017. For its taxable year ending 
December 31, 2015, Y has $100x in gross revenue. For its taxable 
year ending December 31, 2016, Y has $200x in gross revenue. For its 
taxable year ending June 30, 2016, Z has $120x in gross revenue 
(none of which constitute premiums for providing health insurance 
coverage that constitutes minimum essential coverage (as defined in 
section 5000A(f)). W, X, Y, and Z did not qualify for the de minimis 
exception in any prior taxable years.
    (ii) For its taxable year ending June 30, 2016, Z does not meet 
the requirements for the de minimis exception described in paragraph 
(b)(4)(v)(A). Even though Z meets the requirements for the de 
minimis exception with respect to the taxable year of parent entity 
X ending March 31, 2017 ($5x is less than two percent of $325x), Z 
does not meet the requirements for the de minimis exception based on 
the premiums and gross revenues of the taxable years of its 
aggregated group members ending with or within the deemed 12-month 
taxable year of parent entity W ending September 30, 2016 ($6x is 
more than two percent of $226x). Therefore, Z is a covered health 
insurance provider for its June 30, 2016 taxable year.
    (iii) For its taxable year ending December 31, 2015, Y does not 
meet the requirements for the de minimis exception described in 
paragraph (b)(4)(v)(A) ($6x is more than two percent of $226x). For 
its taxable year ending December 31, 2016, Y meets the requirements 
for the de minimis exception described in paragraph (b)(4)(v)(A) 
($5x is less than two percent of $325x). Therefore, Y is a covered 
health insurance provider for its December 31, 2015 taxable year, 
but is not a covered health insurance provider for its December 31, 
2016 taxable year.
    (iv) For its taxable year ending September 30, 2016, W does not 
meet the requirements

[[Page 56907]]

for the de minimis exception described in paragraph (b)(4)(v)(A). 
Even though W meets the requirements for the de minimis exception 
with respect to X's taxable year ending March 31, 2017 ($5x is less 
than two percent of $325x), W does not meet the requirements for the 
de minimis exception with respect its taxable year ending September 
30, 2016 ($6x is more than two percent of $226x). Therefore, W is a 
covered health insurance provider for its September 30, 2016 taxable 
year.
    (v) For its taxable year ending March 31, 2016, X does not meet 
the requirements for the de minimis exception ($6x is more than two 
percent of $226x). For its taxable year ending March, 31 2017, X 
meets the requirements for the de minimis exception ($5x is less 
than two percent of $325x). Therefore, X is a covered health 
insurance provider for its March 31, 2016 taxable year, but is not a 
covered health insurance provider for its March 31, 2017 taxable 
year.
    (5) Premiums--(i) For purposes of this section, the term premiums 
means premiums written (including premiums written for assumption 
reinsurance, but reduced by assumption reinsurance ceded (as described 
in paragraph (b)(5)(ii) of this section), excluding indemnity 
reinsurance written (as described in paragraph (b)(5)(iii) of this 
section) and direct service payments (as described in paragraph 
(b)(5)(iv) of this section), but without reduction for ceding 
commissions or medical loss ratio rebates, determined in a manner 
consistent with the requirements for reporting under the Supplemental 
Health Care Exhibit published by the National Association of Insurance 
Commissioners or the MLR Annual Reporting Form filed with the Center 
for Medicare & Medicaid Services' Center for Consumer Information and 
Insurance Oversight of the U.S. Department of Health and Human Services 
(or any successor or replacement exhibits or forms).
    (ii) Assumption reinsurance. For purposes of this paragraph (b)(5), 
the term assumption reinsurance means reinsurance for which there is a 
novation and the reinsurer takes over the entire risk of loss pursuant 
to a new contract.
    (iii) Indemnity reinsurance. For purposes of this paragraph (b)(5), 
the term indemnity reinsurance means reinsurance provided pursuant to 
an agreement between a health insurance issuer and a reinsuring company 
under which the reinsuring company agrees to indemnify the health 
insurance issuer for all or part of the risk of loss under policies 
specified in the agreement, and the health insurance issuer retains its 
liability to provide health insurance coverage (as defined in section 
9832(b)(1)) to, and its contractual relationship with, the insured.
    (iv) Direct service payments. For purposes of this paragraph 
(b)(5), the term direct service payment means a capitated, prepaid, 
periodic, or other payment made by a health insurance issuer or another 
entity that receives premiums from providing health insurance coverage 
(as defined in section 9832(b)(1)) to another organization as 
compensation for providing, managing, or arranging for the provision of 
healthcare services by physicians, hospitals, or other healthcare 
providers, regardless of whether the organization that receives the 
compensation is subject to healthcare provider, health insurance, 
health plan licensing, financial solvency, or other similar regulatory 
requirements under state insurance law.
    (6) Disqualified taxable year. For purposes of this section, the 
term disqualified taxable year means, with respect to any person, any 
taxable year for which the person is a covered health insurance 
provider.
    (7) Applicable individual--(i) In general. For purposes of this 
section, except as provided in paragraph (b)(7)(ii) of this section, 
the term applicable individual means, with respect to any covered 
health insurance provider for any disqualified taxable year, any 
individual (or any other person described in guidance of general 
applicability published in the Internal Revenue Bulletin)--
    (A) who is an officer, director, or employee in that taxable year, 
or
    (B) who provides services for or on behalf of the covered health 
insurance provider during that taxable year.
    (ii) Independent contractors--Remuneration for services performed 
by an independent contractor for a covered health insurance provider is 
subject to the deduction limitation under section 162(m)(6). However, 
an independent contractor is not an applicable individual with respect 
to a covered health insurance provider for a disqualified taxable year 
if each of the following requirements is satisfied:
    (A) The independent contractor is actively engaged in the trade or 
business of providing services to recipients, other than as an employee 
or as a member of the board of directors of a corporation (or similar 
position with respect to an entity that is not a corporation);
    (B) The independent contractor provides significant services (as 
defined in Sec.  1.409A-1(f)(2)(iii)) to two or more persons to which 
the independent contractor is not related and that are not related to 
one another (as defined in Sec.  1.409A-1(f)(2)(ii)); and
    (C) The independent contractor is not related to the covered health 
insurance provider or any member of its aggregated group, applying the 
definition of related person contained in Sec.  1.409A-1(f)(2)(ii), 
subject to the modification that for purposes of applying the 
references to sections 267(b) and 707(b)(1), the language ``20 
percent'' is not used instead of ``50 percent'' each place ``50 
percent'' appears in sections 267(b) and 707(b)(1).
    (8) Service provider. For purposes of this section, the term 
service provider means, with respect to a covered health insurance 
provider for any period, an individual who is an officer, director, or 
employee, or who provides services for, or on behalf of, the covered 
health insurance provider or any member of its aggregated group.
    (9) Remuneration--(i) In general. For purposes of this section, 
except as provided in paragraph (b)(9)(ii) of this section, the term 
remuneration has the same meaning as the term applicable employee 
remuneration, as defined in section 162(m)(4), but without regard to 
the exceptions under section 162(m)(4)(B) (remuneration payable on a 
commission basis), section 162(m)(4)(C) (performance-based 
compensation), and section 162(m)(4)(D) (existing binding contracts), 
and the regulations under those sections.
    (ii) Exceptions. For purposes of this section, remuneration does 
not include--
    (A) A payment made to, or for the benefit of, an applicable 
individual from or to a trust described in section 401(a) within the 
meaning of section 3121(a)(5)(A),
    (B) A payment made under an annuity plan described in section 
403(a) within the meaning of section 3121(a)(5)(B),
    (C) A payment made under a simplified employee pension plan 
described in section 408(k)(1) within the meaning of section 
3121(a)(5)(C),
    (D) A payment made under an annuity contract described in section 
403(b) within the meaning of section 3121(a)(5)(D),
    (E) Salary reduction contributions described in section 3121(v)(1), 
and
    (F) Remuneration consisting of any benefit provided to, or on 
behalf of, an employee if, at the time the benefit is provided, it is 
reasonable to believe that the employee will be able to exclude the 
value of the benefit from gross income.
    (10) Applicable Individual Remuneration or AIR. For purposes of 
this section, the term applicable individual remuneration or AIR means, 
with respect to any applicable individual for any disqualified taxable 
year, the aggregate amount allowable as a deduction under this chapter 
for that taxable year (determined without regard

[[Page 56908]]

to section 162(m)) for remuneration for services performed by that 
applicable individual (whether or not in that taxable year). AIR does 
not include any DDR with respect to services performed during any 
taxable year. AIR for a disqualified taxable year may include 
remuneration for services performed in a taxable year before the 
taxable year in which the deduction for the remuneration is allowable. 
For example, a discretionary bonus granted and paid to an applicable 
individual in a disqualified taxable year in recognition of services 
performed in prior taxable years is AIR for the disqualified taxable 
year in which the bonus is granted and paid. In addition, a grant of 
restricted stock in a disqualified taxable year with respect to which 
an applicable individual makes an election under section 83(b) is AIR 
for the disqualified taxable year of the covered health insurance 
provider in which the grant of the restricted stock is made. See 
paragraph (b)(9)(ii) of this section for certain remuneration that is 
not treated as AIR for purposes of this section.
    (11) Deferred Deduction Remuneration or DDR. For purposes of this 
section, the term deferred deduction remuneration or DDR means 
remuneration that would be AIR for services performed in a disqualified 
taxable year but for the fact that the deduction (determined without 
regard to section 162(m)(6)) for the remuneration is allowable in a 
subsequent taxable year. Whether remuneration is DDR is determined 
without regard to when the remuneration is paid, except to the extent 
that the timing of the payment affects the taxable year in which the 
remuneration is otherwise deductible. For example, payments that are 
otherwise deductible by a covered health insurance provider in an 
initial taxable year, but are paid to an applicable individual by the 
15th day of the third month of the immediately subsequent taxable year 
of the covered health insurance provider (as described in Sec.  
1.404(b)-1T, Q&A-2(b)(1)), are AIR for the initial taxable year (and 
not DDR) because the deduction for the payments is allowable in the 
initial taxable year, and not a subsequent taxable year. Except as 
otherwise provided in paragraph (i) of this section (regarding 
transition rules for certain DDR attributable to services performed in 
taxable years beginning before January 1, 2013), DDR that is 
attributable to services performed in a disqualified taxable year of a 
covered health insurance provider is subject to the section 162(m)(6) 
deduction limitation even if the taxable year in which the remuneration 
is otherwise deductible is not a disqualified taxable year. Similarly, 
DDR is subject to the section 162(m)(6) deduction limitation regardless 
of whether an applicable individual is a service provider of the 
covered health insurance provider in the taxable year in which the DDR 
is otherwise deductible. However, remuneration that is attributable to 
services performed in a taxable year that is not a disqualified taxable 
year is not DDR even if the remuneration is otherwise deductible in a 
disqualified taxable year. See also paragraph (b)(9)(ii) of this 
section for certain remuneration that is not treated as DDR for 
purposes of this section.
    (12) Substantial risk of forfeiture. For purposes of this section, 
the term substantial risk of forfeiture has the same meaning as 
provided in Sec.  1.409A-1(d).
    (13) In-service payment. An in-service payment is any amount that 
is paid with respect to an applicable individual from an account 
balance plan described in Sec.  1.409A-1(c)(2)(i)(A) or (B) or a 
nonaccount balance plan described in Sec.  1.409A-1(c)(2)(i)(C) in a 
taxable year of a covered health insurance provider during which at any 
time the applicable individual is a service provider (including amounts 
that became otherwise deductible, but were not paid, in a previous 
taxable year of a covered health insurance provider). Amounts that are 
paid in the last year that an applicable individual is a service 
provider (for example, amounts paid at separation from service) are in-
service payments if the applicable individual is a service provider at 
any time during the taxable year of the covered health insurance 
provider in which the payment is made.
    (14) Payment year. For purposes of this section, the term payment 
year means the taxable year of a covered health insurance provider for 
which remuneration becomes otherwise deductible.
    (15) Measurement date. For purposes of this section, the term 
measurement date means the last day of the taxable year of a covered 
health insurance provider.
    (c) Deduction Limitation--(1) AIR. For any disqualified taxable 
year beginning after December 31, 2012, no deduction is allowed under 
this chapter for AIR that is attributable to services performed by an 
applicable individual in that taxable year to the extent that the 
amount of that remuneration exceeds $500,000.
    (2) DDR. For any taxable year beginning after December 31, 2012, no 
deduction is allowed under this chapter for DDR that is attributable to 
services performed by an applicable individual in any disqualified 
taxable year beginning after December 31, 2009, to the extent that the 
amount of such remuneration exceeds $500,000 reduced (but not below 
zero) by the sum of:
    (i) The AIR for that applicable individual for that disqualified 
taxable year; and
    (ii) The portion of the DDR for those services that was subject to 
the deduction limitation under section 162(m)(6)(A)(ii) and this 
paragraph (c)(2) in a preceding taxable year, or would have been 
subject to the deduction limitation under section 162(m)(6)(A)(ii) and 
this paragraph (c)(2) in a preceding taxable year if section 162(m)(6) 
was effective for taxable years beginning after December 31, 2009 and 
before January 1, 2013.
    (d) Services to which remuneration is attributable--(1) Attribution 
to a taxable year-(i) In general. The deduction limitation under 
section 162(m)(6) applies to AIR and DDR attributable to services 
performed by an applicable individual in a disqualified taxable year of 
a covered health insurance provider. When an amount of AIR or DDR 
becomes otherwise deductible (and not before that time), that 
remuneration must be attributed to services performed by an applicable 
individual in a taxable year of the covered health insurance provider 
in accordance with the rules of this paragraph (d). After the 
remuneration has been attributed to services performed by an applicable 
individual in a taxable year of a covered health insurance provider, 
the rules of paragraph (e) of this section are then applied to 
determine whether the deduction with respect to the remuneration is 
limited by section 162(m)(6).
    (ii) Overview. Paragraphs (d)(1)(iii) through (v) of this section, 
and paragraph (d)(2) of this section, set forth rules of general 
applicability for attributing remuneration to services performed by an 
applicable individual in a taxable year of a covered health insurance 
provider. Paragraph (d)(3) sets forth two methods for attributing 
remuneration provided under an account balance plan--the account 
balance ratio method (described in paragraph (d)(3)(ii) of this 
section) and the principal additions method (described in paragraph 
(d)(3)(iii) of this section). Paragraph (d)(4) of this section sets 
forth two methods for attributing remuneration provided under a 
nonaccount balance plan--the present value ratio method (described in 
paragraph (d)(4)(ii) of this section) and

[[Page 56909]]

the formula benefit ratio method (described in paragraph (d)(4)(iii) of 
this section). Paragraph (d)(5) of this section sets forth rules for 
attributing remuneration resulting from equity-based remuneration (such 
as stock options, stock appreciation rights, restricted stock, and 
restricted stock units). Paragraph (d)(6) of this section sets forth 
rules for attributing remuneration that is involuntary separation pay. 
Paragraph (d)(7) of this section sets forth rules for attributing 
remuneration that is received under a reimbursement arrangement, and 
paragraph (d)(8) of this section sets forth rules for attributing 
remuneration that results from a split-dollar life insurance 
arrangement.
    (iii) No attribution to taxable years during which no services are 
performed or before a legally binding right arises-(A) In general. For 
purposes of this section, remuneration is not attributable--
    (1) To a taxable year of a covered health insurance provider ending 
before the later of the date the applicable individual begins providing 
services to the covered health insurance provider (or any member of its 
aggregated group) and the date the applicable individual obtains a 
legally binding right to the remuneration, or
    (2) To any other taxable year of a covered health insurance 
provider during which the applicable individual is not a service 
provider.
    (B) Attribution of remuneration before the commencement of services 
or a legally binding right arises. To the extent that remuneration 
would otherwise be attributable in accordance with paragraphs (d)(2) 
through (11) of this section to a taxable year ending before the later 
of the date an applicable individual begins providing services to a 
covered health insurance provider (or any member of its aggregated 
group) and the date the applicable individual obtains a legally binding 
right to the remuneration, the remuneration is attributed to services 
performed in the taxable year in which the later of these dates occurs. 
For example, if an applicable individual obtains a contractual right to 
remuneration in a taxable year of a covered health insurance provider 
and the remuneration would otherwise be attributable to that taxable 
year pursuant to paragraph (d)(2) of this section, but the applicable 
individual does not begin providing services to the covered health 
insurance provider until the next taxable year, the remuneration is 
attributable to the taxable year in which the applicable individual 
begins providing services.
    (iv) Attribution to 12-month periods. To the extent that a covered 
health insurance provider is required to attribute remuneration on a 
daily pro rata basis under this paragraph (d), it may treat any 12-
month period as having 365 days (and so may ignore the extra day in 
leap years).
    (v) Remuneration subject to nonlapse restriction or similar 
formula. For purposes of this section, if stock or other property is 
subject to a nonlapse restriction (as defined in Sec.  1.83-3(h)), or 
if the remuneration payable to an applicable individual is determined 
under a formula that, if applied to stock or other property, would be a 
nonlapse restriction, the amount of the remuneration and the 
attribution of that remuneration to taxable years must be determined 
based upon application of the nonlapse restriction or formula. For 
example, if the earnings or losses on an account under an account 
balance plan are determined based upon the performance of company 
stock, the valuation of which is based on a formula that if applied to 
the stock would be a nonlapse restriction, then that formula must be 
used consistently for purposes of determining the amount of the 
remuneration credited to that account balance in taxable years and the 
attribution of that remuneration to taxable years.
    (2) Legally binding right. Unless attributable to services 
performed in a different taxable year pursuant to paragraphs (d)(3) 
through (11) of this section, remuneration is attributable to services 
performed in the taxable year of a covered health insurance provider in 
which an applicable individual obtains a legally binding right to the 
remuneration. An applicable individual does not have a legally binding 
right to remuneration if the remuneration may be reduced unilaterally 
or eliminated by a covered health insurance provider or other person 
after the services creating the right to the remuneration have been 
performed. However, if the facts and circumstances indicate that the 
discretion to reduce or eliminate the remuneration is available or 
exercisable only upon a condition, or the discretion to reduce or 
eliminate the remuneration lacks substantive significance, an 
applicable individual will be considered to have a legally binding 
right to the remuneration. For this purpose, remuneration is not 
considered to be subject to unilateral reduction or elimination merely 
because it may be reduced or eliminated by operation of the objective 
terms of a plan, such as the application of a nondiscretionary, 
objective provision creating a substantial risk of forfeiture.
    (3) Account balance plans--(i) In general. When remuneration for 
services performed by an applicable individual for a covered health 
insurance provider becomes otherwise deductible (for example, because 
the amount was paid or made available during that taxable year) from a 
plan described in Sec.  1.409A-1(c)(2)(i)(A) or (B) (an account balance 
plan), that remuneration must be attributed to services performed by 
the applicable individual in a taxable year of the covered health 
insurance provider in accordance with an attribution method described 
in either paragraph (d)(3)(ii) or (d)(3)(iii) of this section. However, 
except as provided in paragraphs (d)(3)(ii)(D) and (f)(3) of this 
section, the covered health insurance provider and all members of its 
aggregated group must apply the same attribution method under this 
paragraph (d)(3) consistently for all taxable years beginning after 
September 23, 2014 for all amounts that become otherwise deductible 
under all account balance plans.
    (ii) Account balance ratio method--(A) In general. Under this 
method, remuneration for services performed by an applicable individual 
for a covered health insurance provider that becomes otherwise 
deductible under an account balance plan must be attributed to services 
performed by the applicable individual in each taxable year of the 
covered health insurance provider ending with or before the payment 
year during which the applicable individual was a service provider and 
for which the account balance of the applicable individual increased 
(determined in accordance with paragraph (d)(3)(ii)(B) and (C) of this 
section). The amount attributed to each such taxable year is equal to 
the amount of remuneration that becomes otherwise deductible multiplied 
by a fraction, the numerator of which is the increase in the applicable 
individual's account balance under the plan for the taxable year, and 
the denominator of which is the sum of all such increases for all 
taxable years during which the applicable individual was a service 
provider. Thus, remuneration that becomes otherwise deductible under a 
plan is attributed to a taxable year of the covered health insurance 
provider in proportion to the increase in the applicable individual's 
account balance for that taxable year.
    (B) Increase in the account balance. For purposes of this paragraph 
(d)(3)(ii), an increase in an account balance under an account balance 
plan occurs for a taxable year if the account balance as of the 
measurement date in that taxable year is greater than the account 
balance as of the measurement date in every

[[Page 56910]]

earlier taxable year. In that case, the amount of the increase for that 
taxable year is equal to the excess of the applicable individual's 
account balance as of the measurement date for that taxable year over 
the greatest of the applicable individual's account balances under the 
plan as of the measurement date in every earlier taxable year. If the 
applicable individual's account balance as of the measurement date in a 
taxable year is less than or equal to the applicable individual's 
account balance as of the measurement date in any earlier taxable year, 
there is no increase in the account balance for that later taxable 
year.
    (C) Certain account balance adjustments. For purposes of 
determining the account balance on a measurement date under paragraph 
(d)(3)(ii)(B) of this section, the account balance is adjusted as 
provided in this paragraph (d)(3)(ii)(C).
    (1) In-service payments. If an in-service payment is made from the 
account of an applicable individual under an account balance plan in 
any taxable year of a covered health insurance provider, then the rules 
of this paragraph (d)(3)(ii)(C)(1) apply.
    (i) Solely for purposes of determining the increase in the 
applicable individual's account balance as of the measurement date in 
the payment year (and not for purposes of attributing any amount that 
becomes otherwise deductible in any later taxable year), the account 
balance as of the measurement date for that taxable year is increased 
by the amount of all in-service payments made from the plan during that 
taxable year.
    (ii) For purposes of attributing any amount that becomes otherwise 
deductible under the plan in any taxable year after the payment year of 
the in-service payment--
    (A) the account balance as of the measurement date in each taxable 
year that ends before the taxable year to which the in-service payment 
is attributed pursuant to this paragraph (d)(3)(ii) is reduced by the 
sum of the amount of the in-service payment that is attributed to that 
taxable year and the amount of the in-service payment that is 
attributed to each taxable year that ends before that taxable year, if 
any, and
    (B) to the extent that the in-service payment includes an amount 
that was deductible by the covered health insurance provider in a 
previous taxable year and, therefore, was previously attributable to 
services performed by the applicable individual in one or more taxable 
years of the covered health insurance provider (for example, because 
the amount was made available in a previous taxable year but was not 
paid at that time), the account balance as of the measurement date for 
each taxable year that ends before the taxable year to which the in-
service payment is attributed pursuant to this paragraph (d)(3)(ii) is 
reduced by the sum of the amount of the in-service payment previously 
attributable to that taxable year and the amount of the in-service 
payment previously attributable to each taxable year that ends before 
that taxable year, if any.
    (2) Certain increases after ceasing to be a service provider. Any 
addition (other than income or earnings) to an account balance plan 
made in a taxable year that begins after an applicable individual 
ceases to be a service provider (and that ends before the applicable 
individual becomes a service provider again, if applicable) is added to 
the account balance of the applicable individual as of the measurement 
date of the first preceding taxable year in which the applicable 
individual was a service provider.
    (3) Account balance adjustments for grandfathered amounts. If a 
covered health insurance provider uses the principal additions method 
for determining grandfathered amounts for an applicable individual 
under paragraph (h) of this section, then, for purposes of determining 
the increase in the applicable individual's account balance, the 
account balance as of any measurement date is reduced by the amount of 
any grandfathered amounts otherwise included in the account balance.
    (D) Transition rule for amounts attributed before the applicability 
date of the final regulations. Amounts that become otherwise deductible 
in taxable years beginning before September 23, 2014 may be attributed 
to services performed in taxable years of a covered health insurance 
provider under the rules set forth in the proposed regulations. If a 
covered health insurance provider attributes an amount paid to an 
applicable individual pursuant to a method permitted under the proposed 
regulations and then chooses to use the account balance ratio method to 
attribute amounts that subsequently become otherwise deductible with 
respect to that applicable individual, then, for purposes of applying 
the account balance ratio method to attribute any amount that becomes 
otherwise deductible under the plan after the taxable year in which the 
last payment was made that was attributed pursuant to the proposed 
regulations, the account balance as of the measurement date for each 
taxable year that ends before the taxable year in which the last 
payment that was attributed pursuant to the proposed regulations is 
reduced by the sum of the amount previously attributed to that taxable 
year under the proposed regulations and the amount previously 
attributable to each taxable year that ends prior to that taxable year 
under the proposed regulations, if any.
    (iii) Principal additions method--(A) In general. Under this 
method, remuneration that becomes otherwise deductible under an account 
balance plan during a payment year must be attributed to services 
performed by the applicable individual in the taxable year of the 
covered health insurance provider during which the applicable 
individual was a service provider and in which the principal addition 
to which the amount relates is credited under the plan (determined in 
accordance with paragraph (d)(3)(iii)(B) and (C) of this section). An 
amount relates to a principal addition if the amount is a payment of 
the principal addition or earnings on the principal addition, based on 
a separate accounting of these amounts. The principal additions method 
described in this paragraph may be used to attribute amounts that 
become otherwise deductible under an account balance plan only if the 
covered health insurance provider separately accounts for each 
principal addition to the plan (and any earnings thereon) and traces 
each amount that becomes otherwise deductible under the plan to a 
principal addition made in a taxable year of the covered health 
insurance provider.
    (B) Principal addition--(1) For purposes of this paragraph 
(d)(3)(iii), the excess (if any) of the sum of the account balance of 
an applicable individual in an account balance plan as of the last day 
of a taxable year and any payments made during the taxable year over 
the account balance as of the last day of the immediately preceding 
taxable year, that is not due to earnings or losses (as described in 
paragraph (d)(3)(iii)(C) of this section), is treated as a principal 
addition that is credited to the plan in that taxable year if the 
applicable individual was a service provider during that taxable year. 
If the applicable individual was not a service provider during that 
taxable year, the excess described in the preceding sentence is treated 
as a principal addition that is credited to the plan in accordance with 
paragraph (d)(3)(iii)(B)(2) of this section.
    (2) Principal additions after termination of employment. Any 
principal addition to an account balance plan made in a taxable year 
that begins after an applicable individual ceases to

[[Page 56911]]

be a service provider (and that ends before the applicable individual 
becomes a service provider again, if applicable) is treated as a 
principal addition that is credited in the first preceding taxable year 
in which the applicable individual was a service provider.
    (C) Earnings. Whether remuneration constitutes earnings on a 
principal addition is determined under the principles defining income 
attributable to an amount taken into account under Sec.  31.3121(v)(2)-
1(d)(2). Therefore, for an account balance plan, earnings on an amount 
deferred generally include an amount credited on behalf of an 
applicable individual under the terms of the arrangement that reflects 
a rate of return that does not exceed either the rate of return on a 
predetermined actual investment (as defined in Sec.  31.3121(v)(2)-
1(d)(2)(i)(B)), or, if the income does not reflect the rate of return 
on a predetermined actual investment, a rate of return that reflects a 
reasonable rate of interest (as defined in Sec.  31.3121(v)(2)-
1(d)(2)(i)(C)). For purposes of this paragraph (d)(3)(iii), the use of 
a rate of return that is not based on a predetermined actual investment 
or a reasonable rate of interest generally will result in the treatment 
of some or all of the remuneration as a principal addition that is 
attributable to services performed by an applicable individual in a 
taxable year of a covered health insurance provider in accordance with 
this paragraph (d)(3)(iii) of this section.
    (4) Nonaccount balance plans--(i) In general. When remuneration for 
services performed by an applicable individual for a covered health 
insurance provider becomes otherwise deductible under a plan described 
in Sec.  1.409A-1(c)(2)(i)(C) (a nonaccount balance plan), that 
remuneration must be attributed to services performed by the applicable 
individual in a taxable year of the covered health insurance provider 
in accordance with the attribution method described in either paragraph 
(d)(4)(ii) or (d)(4)(iii) of this section. However, except as provided 
in paragraphs (d)(4)(ii)(D) and (d)(4)(iii)(D) and (f)(3) of this 
section, the covered health insurance provider and all members of its 
aggregated group must apply the same attribution method under this 
paragraph (d)(4) consistently for all taxable years beginning after 
September 23, 2014 for all amounts that become deductible under all 
nonaccount balance plans.
    (ii) Present value ratio attribution method--(A) In general. Under 
this method, remuneration for services performed by an applicable 
individual for a covered health insurance provider that becomes 
otherwise deductible under a nonaccount balance plan must be attributed 
to services performed by the applicable individual in each taxable year 
of the covered health insurance provider ending with or before the 
payment year during which the applicable individual was a service 
provider for which the present value of the future payment(s) to be 
made to or on behalf of the applicable individual under the plan 
increased (determined in accordance with paragraph (d)(3)(ii)(B) and 
(C) of this section). The amount attributed to each such taxable year 
is equal to the amount of remuneration that becomes otherwise 
deductible under the plan multiplied by a fraction, the numerator of 
which is the increase in the present value of the future payment(s) to 
which the applicable individual has a legally binding right under the 
plan for the taxable year, and the denominator of which is the sum of 
all such increases for all taxable years during which the applicable 
individual was a service provider. Thus, remuneration that becomes 
otherwise deductible under a plan is attributed to a taxable year of 
the covered health insurance provider in proportion to the increase in 
the present value of the future payment(s) under the plan for that 
taxable year.
    (B) Increase in present value of future payments. For purposes of 
this paragraph (d)(4)(ii), for a taxable year of a covered health 
insurance provider, an increase in the present value of the future 
payment(s) to which an applicable individual has a legally binding 
right under a nonaccount balance plan occurs if the present value of 
the future payment(s) as of the measurement date in the taxable year is 
greater than the present value of the future payment(s) as of the 
measurement date in every earlier taxable year. In that case, the 
amount of the increase for that taxable year is equal to the excess of 
the present value of the future payment(s) to which the applicable 
individual has a legally binding right under the plan as of the 
measurement date for that taxable year over the greatest present value 
of the future payment(s) to which the applicable individual had a 
legally binding right under the plan as of the measurement date in 
every earlier taxable year. If the present value of the future 
payment(s) as of a measurement date in a taxable year is less than or 
equal to the present value of the future payment(s) as of the 
measurement date in any earlier taxable year, then there is no increase 
in the present value of the future payment(s) to which the applicable 
individual has a legally binding right under the plan for that later 
taxable year. For purposes of determining the increase (or decrease) in 
the present value of a future payment(s) under a nonaccount balance 
plan, the rules of Sec.  31.3121(v)(2)-1(c)(2) apply (including the 
requirement that reasonable actuarial assumptions and methods be used).
    (C) Certain present value adjustments. For purposes of determining 
the present value of the future payment(s) to which an applicable 
individual has a legally binding right to receive as of a measurement 
date under paragraph (d)(4)(ii)(B) of this section, the present value 
is adjusted as provided in this paragraph (d)(3)(iii)(C).
    (1) In-service payments. If an in-service payment is made to or on 
behalf of an applicable individual under a nonaccount balance plan in 
any taxable year of a covered health insurance provider, then the rules 
of this paragraph (d)(3)(iii)(C)(1) apply.
    (i) Solely for purposes of determining the increase in the present 
value of the future payment(s) under the plan for the payment year (and 
not for purposes of attributing any amount that becomes otherwise 
deductible in any later taxable year), the present value of the future 
payment(s) under the plan as of the measurement date in the payment 
year is increased by the amount of any reduction in the present value 
of the future payment(s) resulting from the in-service payment made 
from the plan during that taxable year.
    (ii) For purposes of attributing any amount that becomes otherwise 
deductible under the plan in any taxable year after the payment year of 
the in-service payment, the present value of the future payment(s) as 
of the measurement date for each taxable year that ends before the 
payment year is reduced by the present value of the future payment to 
which the applicable individual had a legally binding right to be paid 
on the date of the in-service payment (determined as of the measurement 
date based upon all of the applicable factors under the plan as of the 
measurement date, such as compensation and years of service on that 
date).
    (2) Increases in the present value of future payments after ceasing 
to be a service provider. Any increase in the present value of the 
future payment(s) under a plan in a taxable year that begins after an 
applicable individual ceases to be a service provider (and that ends 
before the applicable individual becomes a service provider again, if 
applicable) that is not due merely to the passage of time or a change 
in the

[[Page 56912]]

reasonable actuarial assumptions used to determine the present value of 
the future payment(s) is added to the present value of the future 
payment(s) for the applicable individual as of the measurement date of 
the most recent preceding taxable year in which the applicable 
individual was a service provider.
    (D) Transition rule for amounts attributed before the effective 
date of the final regulations. Amounts that become otherwise deductible 
in taxable years beginning before September 23, 2014 may be attributed 
under the rules set forth in the proposed regulations. If a covered 
health insurance provider attributes an amount paid to an applicable 
individual pursuant to the proposed regulations and then chooses to use 
the present value ratio method to attribute amounts that subsequently 
become otherwise deductible with respect to that applicable individual, 
then, for purposes of applying the present value ratio method to 
attribute any amount that becomes otherwise deductible under the plan 
in any taxable year after the taxable year in which the last payment 
was made that was attributed pursuant to the proposed regulations, the 
present value of the future payment(s) as of the measurement date for 
each taxable year that ends before the taxable year in which the last 
payment that was attributed pursuant to the proposed regulations is 
reduced by the present value of each future payment to which the 
applicable individual had a legally binding right to be paid that was 
attributed pursuant to the proposed regulations (determined as of the 
measurement date based upon all of the applicable factors under the 
plan as of the measurement date, such as compensation and years of 
service on that date), with no adjustment for an amount that became 
otherwise deductible, but was not paid.
    (iii) Formula benefit ratio method--(A) In general. Under this 
method, remuneration that becomes otherwise deductible under a 
nonaccount balance plan on a date (referred to for these purposes as 
the date of payment) must be attributed to services performed by the 
applicable individual in each taxable year of the covered health 
insurance provider ending with or before the payment year during which 
the applicable individual was a service provider and for which the 
formula benefit of the applicable individual under the plan increased 
(determined in accordance with paragraph (d)(3)(iii)(B), (C) and (D) of 
this section). The amount attributed to each such taxable year is equal 
to the amount of remuneration that becomes otherwise deductible under 
the plan on the date of payment multiplied by a fraction, the numerator 
of which is the increase in the applicable individual's formula benefit 
under the plan for the taxable year and the denominator of which is the 
sum of all such increases for all taxable years during which the 
applicable individual was a service provider (which will generally be 
the amount that becomes otherwise deductible under the plan on the date 
of payment). Thus, remuneration that becomes otherwise deductible under 
a plan is attributed to a taxable year of the covered health insurance 
provider in proportion to the increase in the applicable individual's 
formula benefit under the plan in that taxable year.
    (B) Formula benefit. For purposes of this paragraph (d)(4)(iii), an 
applicable individual's formula benefit as of any date is the benefit 
(or portion thereof) to which the applicable individual has a legally 
binding right under a nonaccount balance plan as of that date 
determined based upon all of the applicable factors under the plan (for 
example, compensation and years of service as of that date), 
disregarding any substantial risk of forfeiture and assuming that the 
applicable individual meets any applicable eligibility requirements for 
the benefit as of that date. For this purpose, the formula benefit is 
expressed in the form that it has become otherwise deductible. For 
example, if an applicable individual's benefit under a plan is paid in 
the form of a single lump sum, then the applicable individual's formula 
benefit under the plan is expressed in the form of a single lump sum 
for all purposes under this paragraph (d)(4)(iii). If the amount that 
becomes otherwise deductible is payable in more than one form of 
payment (for example, 50 percent of the benefit is paid in the form of 
a lump sum and 50 percent is paid in the form of a life annuity), then 
each separate form of payment is treated as a separate formula benefit 
to which this paragraph (d)(4)(iii) is applied separately.
    (C) Increase in formula benefit. For purposes of this paragraph 
(d)(4)(iii), an increase in an applicable individual's formula benefit 
under a nonaccount balance plan occurs for a taxable year of a covered 
health insurance provider if the formula benefit as of the measurement 
date in that taxable year is greater than the formula benefit as of the 
measurement date in every earlier taxable year. In that case, the 
amount of the increase for that taxable year is equal to excess of the 
formula benefit as of the measurement date in that taxable year over 
the greatest formula benefit as of any measurement date in any earlier 
taxable year. If the applicable individual's formula benefit as of a 
measurement date in a taxable year is less than or equal to the 
applicable individual's formula benefit as of the measurement date in 
any earlier taxable year, there is no increase in the formula benefit 
to which the applicable individual has a legally binding right under 
the plan for that later taxable year.
    (D) Certain adjustments. For purposes of determining the increase 
in the formula benefit as of a date of payment under paragraph 
(d)(4)(iii)(C) of this section, the rules of this paragraph 
(d)(3)(iii)(D) apply--
    (1) Attribution to payment year. Solely for purposes of attributing 
a payment under this paragraph (d)(4)(iii) (including an in-service 
payment), the date of payment is substituted for the measurement date 
in the payment year to determine whether an increase in the formula 
benefit occurs in the payment year and the amount of any such increase.
    (2) Amounts not paid. If an amount becomes otherwise deductible 
under a nonaccount balance plan, but is not paid, the formula benefit 
for that amount must be determined using the form in which it will be 
paid, if that form is known, or any form in which it may be paid, if 
the actual form of payment is unknown.
    (3) Increases in the formula benefit after ceasing to be a service 
provider. Any increase in the formula benefit with respect to an 
applicable individual resulting from a legally binding right arising in 
a taxable year that begins after the applicable individual ceases to be 
a service provider (and that ends before the applicable individual 
becomes a service provider again, if applicable) is added to the 
formula benefit with respect to the applicable individual as of the 
measurement date of the first preceding taxable year in which the 
applicable individual was a service provider. However, any increase in 
the formula benefit resulting from a legally binding right arising in a 
taxable year that begins before the applicable individual ceases to be 
a service provider is added to the formula benefit with respect to the 
applicable individual as of the measurement date of the taxable year in 
which the legally binding right arises, even if the increase is not 
reflected until after the applicable individual ceases to be a service 
provider (such as in the case of a cost of living adjustment).
    (5) Equity-based remuneration--(i) Stock options and stock 
appreciation

[[Page 56913]]

rights--(A) In general. Except as provided in paragraph (d)(5)(i)(B) of 
this section, remuneration resulting from the exercise of a stock 
option (including compensation income arising at the time of a 
disqualifying disposition of an incentive stock option described in 
section 422 or an option under an employee stock purchase plan 
described in section 423) or a stock appreciation right (SAR) is 
attributable to services performed by an applicable individual for a 
covered health insurance provider on a daily pro rata basis over the 
period beginning on the date of grant (within the meaning of Sec.  
1.409A-1(b)(5)(vi)(B)) of the stock option or SAR and ending on the 
date that the stock option or SAR is exercised, excluding any days on 
which the applicable individual is not a service provider.
    (B) Stock options or SARs subject to a substantial risk of 
forfeiture. If a stock option or SAR is subject to a substantial risk 
of forfeiture, a covered health insurance provider may attribute 
remuneration resulting from the exercise of the stock option or SAR to 
services performed by an applicable individual in a taxable year on a 
daily pro rata basis over the period beginning on the date of grant 
(within the meaning of Sec.  1.409A-1(b)(5)(vi)(B)) of the stock option 
or SAR and ending on the first date that the stock option or SAR is no 
longer subject to a substantial risk of forfeiture, but only if the 
covered health insurance provider uses this attribution method 
consistently for all stock options or SARs exercised in taxable years 
of a covered health insurance provider beginning after September 23, 
2014, except as provided in paragraph (f)(3) of this section.
    (ii) Restricted stock. Remuneration resulting from restricted 
stock, for which an election under section 83(b) has not been made, 
that becomes substantially vested or transferred is attributed on a 
daily pro rata basis to services performed by an applicable individual 
for a covered health insurance provider over the period, excluding any 
days on which the applicable individual is not a service provider, 
beginning on the date the applicable individual obtains a legally 
binding right to the restricted stock and ending on the earliest of--
    (A) The date the restricted stock becomes substantially vested, or
    (B) The date the restricted stock is transferred by the applicable 
individual.
    (iii) Restricted stock units. Remuneration resulting from a 
restricted stock unit (RSU) is attributed on a daily pro rata basis to 
services performed by an applicable individual for a covered health 
insurance provider over the period beginning on the date the applicable 
individual obtains a legally binding right to the RSU and ending on the 
date the remuneration is paid or made available, excluding any days on 
which the applicable individual is not a service provider.
    (iv) Partnership interests and other equity. [Reserved]
    (6) Involuntary separation pay. Involuntary separation pay is 
attributable to services performed by an applicable individual for a 
covered health insurance provider in the taxable year in which the 
involuntary separation from service occurs. Alternatively, the covered 
health insurance provider may attribute involuntary separation pay to 
services performed by an applicable individual on a daily pro rata 
basis beginning on the date that the applicable individual obtains a 
legally binding right to the involuntary separation pay and ending on 
the date of the involuntary separation from service. Involuntary 
separation pay to different individuals may be attributed using 
different methods; however, if involuntary separation payments are made 
to the same individual over multiple taxable years, all the payments 
must be attributed using the same method. For purposes of this section, 
the term involuntary separation pay means remuneration to which an 
applicable individual has a right to payment solely as a result of the 
individual's involuntary separation from service (within the meaning of 
Sec.  1.409A-1(n)). To the extent that involuntary separation pay is 
attributed to services performed in two or more taxable years of a 
covered health insurance provider as permitted under this paragraph, 
any amount of involuntary separation pay that is paid or made available 
must be attributed to services performed in all of those taxable years 
in the same proportion that the total involuntary separation pay is 
attributed to taxable years of the covered health insurance provider.
    (7) Reimbursements. Remuneration that is provided in the form of a 
reimbursement or benefit provided in-kind (other than cash) is 
attributable to services performed by an applicable individual in the 
taxable year of a covered health insurance provider in which the 
applicable individual makes a payment for which the applicable 
individual has a right to reimbursement or receives an in-kind benefit, 
except that remuneration provided in the form of a reimbursement or in-
kind benefit during a taxable year of a covered health insurance 
provider in which an applicable individual is not a service provider is 
attributable to services performed in the most recent preceding taxable 
year of the covered health insurance provider in which the applicable 
individual is a service provider.
    (8) Split-dollar life insurance. Remuneration resulting from a 
split-dollar life insurance arrangement (as defined in Sec.  1.61-
22(b)) under which an applicable individual has a legally binding right 
to economic benefits described in Sec.  1.61-22(d)(2)(ii) (policy cash 
value to which the non-owner has current access within the meaning of 
Sec.  1.61-22(d)(4)(ii)) or Sec.  1.61-22(d)(2)(iii) (any other 
economic benefits provided to the non-owner) is attributable to 
services performed in the taxable year of the covered health insurance 
provider in which the legally binding right arises. Split-dollar life 
insurance arrangements under which payments are treated as split-dollar 
loans under Sec.  1.7872-15 generally will not give rise to DDR within 
the meaning of paragraph (b)(11) of this section, although they may 
give rise to AIR. However, in certain situations, this type of 
arrangement may give rise to DDR for purposes of section 162(m)(6), for 
example, if amounts due on a split-dollar loan are waived, cancelled, 
or forgiven.
    (9) Examples. The following examples illustrate the principles of 
paragraphs (d)(1) through (8) of this section. For purposes of these 
examples, each corporation has a taxable year that is the calendar year 
and is a covered health insurance provider for all relevant taxable 
years, DDR is otherwise deductible in the taxable year in which it is 
paid, and amounts payable under nonaccount balance plans are not 
forfeitable upon the death of the applicable individual. For purposes 
of these examples, the interest rates used in these examples are 
assumed to be reasonable.

    Example 1 (Account balance plan--account balance ratio method 
with earnings and a single payment). (i) B is an applicable 
individual of corporation Y for all relevant taxable years. On 
January 1, 2016, B begins participating in a nonqualified deferred 
compensation plan of Y that is an account balance plan. Under the 
terms of the plan, all amounts are fully vested at all times, and Y 
will pay B's entire account balance on January 1, 2019. B's account 
earns five percent interest per year, compounded annually. Y credits 
$10,000 to B under the plan annually on January 1 for three years 
beginning on January 1, 2016. Thus, B's account balance is $10,500 
($10,000 + ($10,000 x 5%)) on December 31, 2016; $21,525 ($10,500 + 
$10,000 + ($20,500 x 5%)) on December 31, 2017; and $33,101 ($21,525 
+ $10,000 + ($31,525 x 5%)) on December 31, 2018. On January 1, 
2019, Y

[[Page 56914]]

pays B $33,101, the entire account balance. Y attributes payments 
under its account balance plans using the account balance ratio 
method described in paragraph (d)(3)(i) of this section.
    (ii) The increase in B's account balance during 2016 is $10,500 
($10,500 - zero); the increase in B's account balance for 2017 is 
$11,025 ($21,525 - $10,500); and the increase in B's account balance 
for 2018 is $11,576 ($33,101 - $21,525). The sum of all the 
increases is $33,101 ($10,500 + $11,025 + $11,576). Accordingly, for 
Y's 2016 taxable year, the attribution fraction is .3172 ($10,500/
$33,101); for Y's 2017 taxable year, the attribution fraction is 
.3331 ($11,025/$33,101); and for Y's 2018 taxable year, the 
attribution fraction is .3497 ($11,576/$33,101).
    (iii) With respect to the $33,301 payment made on January 1, 
2019, $10,500 ($33,101 x .3172) of DDR is attributable to services 
performed by B in Y's 2016 taxable year; $11,026 ($33,101 x .3331) 
of DDR is attributable to services performed by B in Y's 2017 
taxable year; and $11,575 ($33,101 x .3497) of DDR is attributable 
to services performed by B in Y's 2018 taxable year.

    Example 2 (Account balance plan--principal additions method with 
earnings and a single payment. (i) The facts are the same as in 
Example 1, except that Y attributes remuneration using the principal 
additions method described in paragraph (d)(3)(ii) of this section.
    (ii) The $10,000 principal addition made on January 1, 2016 and 
$1,576 of earnings thereon (interest on the 2016 $10,000 principal 
addition at five percent for three years compounded annually) are 
attributable to services performed by B in Y's 2016 taxable year; 
the principal addition of $10,000 on January 1, 2017 and $1,025 of 
earnings thereon (interest on the 2017 $10,000 principal addition at 
five percent for two years compounded annually) are attributable to 
services performed by B in Y's 2017 taxable year; and the principal 
addition of $10,000 to B's account on January 1, 2018 and $500 of 
earnings thereon (interest on the 2018 $10,000 principal addition at 
five percent for one year compounded annually) are attributable to 
services performed by B in Y's 2018 taxable year. Accordingly, with 
respect to the $33,301 payment made on January 1, 2019, $11,576 
($10,000 + $1,576) is attributable to services performed by B in Y's 
2016 taxable year; $11,025 ($10,000 + $1,025) is attributable to 
services performed in Y's 2017 taxable year; and $10,500 ($10,000 + 
$500) is attributable to services performed by B in Y's 2018 taxable 
year.

    Example 3 (Account balance plan--account balance ratio method 
with earnings and losses). (i) J is an applicable individual of 
corporation Z for all relevant taxable years. On January 1, 2016, J 
begins participating in a nonqualified deferred compensation plan of 
Z that is an account balance plan. Under the terms of the plan, all 
amounts are fully vested at all times, and Z will pay J's entire 
account balance on January 1, 2019. Z credits $10,000 to J under the 
plan on January 1, 2016 and January 1, 2018. Earnings under the 
terms of the plan are based on a predetermined actual investment (as 
defined in Sec.  31.3121(v)(2)-1(e)(2)(i)(B)), which results in J's 
account balance increasing by five percent in the 2016 taxable year, 
decreasing by five percent in the 2017 taxable year, and increasing 
again by five percent in the 2018 taxable year. Therefore, on 
December 31, 2016, J's account balance is $10,500 ($10,000 + 
($10,000 x 5%)); on December 31, 2017, J's account balance is $9,975 
($10,500 - ($10,500 x 5%)); and on December 31, 2018, J's account 
balance is $20,974 ($9,975 + $10,000 + ($19,975 x 5%)). On January 
1, 2019, Z pays J the entire account balance of $20,974.
    (ii) The increase in J's account balance for 2016 is $10,500 
($10,500 - zero); the increase in J's account balance for 2017 is 
zero (because J's account balance decreased by $525 ($9,975 - 
$10,500)); the increase in J's account balance for 2018 is $10,474 
($20,974 - $10,500, which is the highest account balance in any 
prior taxable year). The sum of all the increases is $20,974 
($10,500 + $10,474). Thus, for Z's 2016 taxable year the attribution 
fraction is .5006 ($10,500/$20,974); for Z's 2017 taxable year the 
attribution fraction is zero because there was a decrease in the 
account balance for the year; and for Z's 2018 taxable year the 
attribution fraction is .4994 ($10,474/$20,974).
    (iii) Accordingly, with respect to the $20,974 payment made on 
January 1, 2019, $10,499 ($20,974 x .5006) of DDR is attributable to 
services performed by J in Z's 2016 taxable year, and $10,474 
($20,973.75 x .4994) of DDR is attributable to services performed by 
J in Z's 2018 taxable year. No amount is attributable to services 
performed by J in Z's 2017 taxable year because there was no 
increase in the account balance for that taxable year.
    Example 4 (Account balance plan--principal additions method with 
earnings and losses). (i) The facts are the same as in Example 3, 
except that Z attributes remuneration using the principal additions 
method described in paragraph (d)(3)(ii) of this section.
    (ii) The $10,000 principal addition made on January 1, 2016 and 
the $474 of net earnings thereon ($500 of earnings for 2016, $525 of 
losses for 2017, and $499 of earnings for 2018) are attributable to 
services performed by J in Z's 2016 taxable year; and the $10,000 
principal addition made on January 1, 2018 and the $500 of earnings 
thereon are attributable to services performed by J in Z's 2018 
taxable year. Accordingly, with respect to the $20,974 payment made 
on January 1, 2019, $10,474 ($10,000 + $474) of DDR is attributable 
to services performed by J in Z's 2016 taxable year, and $10,500 
($10,000 + $500) of DDR is attributable to services performed by J 
in Z's 2018 taxable year.
    Example 5 (Account balance plan--account balance ratio method 
with losses and an in-service payment). (i) N is an applicable 
individual of corporation M for all relevant taxable years. On 
January 1, 2016, N begins participating in a nonqualified deferred 
compensation plan sponsored by M that is an account balance plan. 
Under the plan, all amounts are fully vested at all times. The 
balances in N's account are $110,000 on December 31, 2016; $90,000 
on December 31, 2017; $250,000 on December 31, 2018; and $240,000 on 
December 31, 2019. N ceases providing services to N on December 31, 
2019. In accordance with the plan terms, M pays to N $10,000 on 
September 30, 2017, $150,000 on January 1, 2021, and $100,000 on 
January 1, 2022. M attributes payments under its account balance 
plans using the account balance ratio method described in paragraph 
(d)(3)(i) of this section.
    (ii) For purposes of attributing the $10,000 payment made on 
September 30, 2017 to taxable years, the increase in N's account 
balance for 2016 is $110,000 ($110,000 - zero). N's account balance 
for 2017 is treated as $100,000 ($90,000 + $10,000 payment on 
September 30, 2017), but, because the account balance of $100,000 is 
less than the account balance in an earlier year, the increase in 
N's account balance for 2017 is zero. The sum of all the increases 
in N's account balance is $110,000 ($110,000 + $0). Thus, the 
attribution fraction for 2016 is 1 ($110,000/$110,000), and the 
attribution fraction for 2017 is zero ($0/$110,000). Accordingly, 
with respect to the $10,000 payment made on September 30, 2017, the 
entire $10,000 is attributable to services performed by N in M's 
2016 taxable year, and no amount is attributable to services 
performed by N in M's 2017 taxable year.
    (iii) After attributing the September 30, 2017 payment of 
$10,000 to 2016, N's account balance for 2016 is treated as being 
$100,000 ($110,000 - $10,000), and the increase for 2016 is likewise 
treated as $100,000; N's account balance for 2017 decreased; the 
increase in N's account balance for 2018 is $150,000 ($250,000 - 
$100,000); and N's account balance for 2018 decreased. The sum of 
all the increases is $250,000 ($100,000 + $150,000). Thus, the 
attribution fraction for 2016 is .40 ($100,000/$250,000); the 
attribution fraction for 2017 is zero ($0/$250,000); the attribution 
fraction for 2018 is .60 ($150,000/$250,000); and the attribution 
fraction for 2019 is zero ($0/$250,000).
    (iv) Accordingly, with respect to the $150,000 payment made on 
January 1, 2021, $60,000 ($150,000 x .40) is attributable to 
services performed by N in M's 2016 taxable year, and $90,000 
($150,000 x .60) is attributable to services performed by N in M's 
2018 taxable year. With respect to the $100,000 payment made on 
January 1, 2022, $40,000 ($100,000 x .40) is attributable to 
services performed by N in M's 2016 taxable year, and $60,000 
($100,000 x .60) is attributable to services performed by N in M's 
2018 taxable year. No amount is attributable to services performed 
by N in M's 2017 and 2019 taxable years.
    Example 6 (Account balance plan--principal additions method with 
multiple payments). (i) O is an applicable individual of corporation 
L for all relevant taxable years. On January 1, 2016, O begins 
participating in a nonqualified deferred compensation plan sponsored 
by L that is an account balance plan. Under the plan, all amounts 
are fully vested at all times. L credits principal additions to O's 
account each year, and

[[Page 56915]]

credits earnings based on a predetermined actual investment within 
the meaning of Sec.  31.3121(v)(2)-1(d)(2)(i)(B). L makes principal 
additions of $90,000 on June 30, 2016; $140,000 on June 30, 2017; 
and $180,000 on June 30, 2018. The predetermined actual investment 
earns five percent for 2016, seven percent for 2017; eight percent 
for 2018; and nine percent for 2019. Thus, as of December 31, 2018, 
the earnings with respect to the $90,000 principal addition made on 
June 30, 2016 are $16,605, for a total of $106,605; and the earnings 
with respect to the $140,000 principal addition made on June 30, 
2017 are $16,492, for a total of $156,492. As of January 1, 2020, 
the earnings with respect to the $180,000 principal addition made on 
June 30, 2018 are $24,048, for a total of $204,048. Under the terms 
of the plan, the principal addition (and earnings thereon) made on 
June 30, 2016 and June 30, 2017 are payable on December 31, 2018, 
and the principal addition (and earnings thereon) made on June 30, 
2018 is payable on January 1, 2020. On December 31, 2018, L pays O 
$263,097 in accordance with the plan terms. On January 1, 2020, L 
pays O the remaining account balance of $204,048 in accordance with 
the plan terms.
    (ii) The $263,097 payment made on December 31, 2018 is 
attributed to services performed by O in the 2016 and 2017 taxable 
years. Of the $263,097 payment, $106,605 is attributable to services 
performed by O in L's 2016 taxable year because this amount 
represents the $90,000 principal addition made on June 30, 2016 and 
earnings thereon. The remaining $156,492 is attributable to services 
performed by O in L's 2017 taxable year because this amount 
represents the $140,000 principal addition made on June 30, 2017 and 
earnings thereon. The $204,048 payment made on January 1, 2020 is 
attributable to services performed by O in L's 2018 taxable year 
because this amount represents the $180,000 principal addition made 
on June 30, 2018 and earnings thereon.
    Example 7 (Account balance plan--account balance ratio method 
with an employer contribution after the applicable individual ceases 
to be a service provider).  (i) A is an applicable individual of 
corporation Z for all relevant taxable years. On January 1, 2016, A 
begins participating in a nonqualified deferred compensation plan of 
Z that is an account balance plan. Under the terms of the plan, all 
amounts are fully vested at all times. The balances in A's account 
(including employer contributions and earnings) are $20,000 on 
December 31, 2016, and $60,000 on December 31, 2017. On December 31, 
2017, A ceases providing services to Z. On January 1, 2019, Z makes 
a discretionary contribution of $30,000 to A's account balance plan. 
On December 31, 2019, in accordance with the plan terms, Z pays 
$120,000 to A, which is N's entire account balance. Z attributes 
payments under its account balance plans using the account balance 
ratio method described in paragraph (d)(3)(i) of this section.
    (ii) The increase in A's account balance for 2016 is $20,000; 
the increase in A's account balance for 2017 is $40,000. The 
discretionary contribution made on January 1, 2019 of $30,000 is 
added to the account balance for 2017. Thus, the discretionary 
contribution of $30,000 on January 1, 2019, is treated as increasing 
A's account balance for 2017 by $30,000. The increase in A's account 
balance for 2016 is $20,000, and the increase in A's account balance 
for 2017 is $70,000 ($40,000 + $30,000). The sum of all the 
increases is $90,000 ($20,000+$70,000).
    (iii) Thus, the attribution fraction for 2016 is .2222 ($20,000/
$90,000); and the attribution fraction for 2017 is .7778 ($70,000/
$90,000). Accordingly, with respect to the $120,000 payment made on 
January 1, 2019, $26,664 ($120,000 x .2222) is attributable to 
services performed by A in Z's 2016 taxable year, and $93,336 
($120,000 x .7778) is attributable to services performed by A in Z's 
2017 taxable year.
    Example 8 (Account balance plan--principal additions method with 
a principal addition after the applicable individual ceases to be a 
service provider). (i) C is an applicable individual of corporation 
X for all relevant taxable years. On January 1, 2016, C begins 
participating in a nonqualified deferred compensation plan of X that 
is an account balance plan. Earnings under the terms of the plan are 
based on a predetermined actual investment (as defined in Sec.  
31.3121(v)(2)-1(e)(2)(i)(B)). Under the terms of the plan, all 
amounts are fully vested at all times. X credits a $10,000 principal 
addition to C under the plan on April 1, 2016, and a $20,000 
principal addition to C on April 1, 2017. C ceases providing 
services to X on December 31, 2017. On January 1, 2019, X credits 
$30,000 to C's account in recognition of C's past services. The 
$10,000 principal addition made on April 1, 2016 increases to 
$15,000 as of December 31, 2019, as a result of earnings. The 
$20,000 principal addition made on April 1, 2017, increases to 
$28,000 as of December 31, 2019 as a result of earnings. The January 
1, 2019, contribution of $30,000 increases to $33,000 as of December 
31, 2019, as a result of earnings. On December 31, 2019, in 
accordance with the plan terms, X pays C's entire account balance of 
$76,000. X attributes payments under its account balance plans using 
the principal additions method described in paragraph (d)(3)(ii) of 
this section.
    (ii) When the $76,000 payment is made to C on December 31, 2019, 
the remuneration becomes attributable to service performed by C in 
prior taxable years. The $10,000 principal addition in 2016 plus 
earnings thereon of $5,000 are attributable to services performed by 
C in X's 2016 taxable year, and the $20,000 principal addition in 
2017 (plus earnings thereon of $8,000) are attributable to services 
performed by C in X's 2017 taxable year. The principal addition of 
$30,000 plus earnings thereon of $3,000 ($33,000) are also 
attributable to services performed by C in X's 2017 taxable year. 
Thus, $16,500 of the $33,000 is attributed to services performed by 
C in X's 2017 taxable year.
    (iii) Accordingly, with respect to the $76,000 payment by X to C 
on December 31, 2019, $15,000 ($10,000 + $5,000) is attributed to 
services performed by C in X's 2016 taxable year, and $61,000 
($20,000 + $8,000 + $33,000) is attributed to services performed by 
C in X's 2017 taxable year.
    Example 9 (Nonaccount balance plan--present value ratio method 
with a single payment). (i) C is an applicable individual of 
corporation X for all relevant taxable years. On January 1, 2015, X 
grants C a vested right to a $100,000 payment on January 1, 2020. C 
ceases providing services on December 31, 2019. The payment of 
$100,000 is made on January 1, 2020. X determines the present value 
of the payment using an interest rate of five percent for all years.
    (ii) The present value of $100,000 payable on January 1, 2020, 
determined using a five percent interest rate, is $82,270 as of 
December 31, 2015; $86,384 as of December 31, 2016; $90,703 as of 
December 31, 2017; $95,238 as of December 31, 2018, and $100,000 as 
of December 31, 2019. Accordingly, $82,270 is the amount of the 
increase in the present value of the future payment of $100,000 for 
X's 2015 taxable year ($82,270 - $0); $4,114 ($86,384 - $82,270) is 
the increase in the present value of the future payment for X's 2016 
taxable year; $4,319 ($90,703 - $86,384) is the increase in the 
present value of the future payment for X's 2017 taxable year; 
$4,535 ($95,238 - $90,703) is the increase in the present value of 
the future payment for X's 2018 taxable year; and $4,762 ($100,000 - 
$95,238) is the increase in the present value of the future payment 
for X's 2019 taxable year. The sum of all the increases is $100,000 
($82,270 + $4,114 + $4,319 + $4,535 + $4,762). Thus, the attribution 
fraction for 2015 is .8227 ($82,270/$100,000); the attribution 
fraction for 2016 is .0411 ($4,114/$100,000); the attribution 
fraction for 2017 is .0432 ($4,319/$100,000); the attribution 
fraction for 2018 is .0454 ($4,535/$100,000); and the attribution 
fraction for 2019 is .0476 ($4,762/$100,000).
    (iii) The $100,000 payment made on January 1, 2020 is multiplied 
by the attribution fraction for each taxable year, and the result is 
the amount that is attributable to service performed by C for that 
taxable year. Accordingly, $82,270 ($100,000 x .8227) is 
attributable to services performed by C in X's 2015 taxable year; 
$4,114 ($100,000 x .0411) is attributable to services performed by C 
in X's 2016 taxable year; $4,319 ($100,000 x .0432) is attributable 
to services performed by C in X's 2017 taxable year; $4,535 
($100,000 x .0454) is attributable to services performed by C in X's 
2018 taxable year; and $4,762 ($100,000 x .0476) is attributable to 
services performed by C in X's 2019 taxable year.
    Example 10. (Nonaccount balance plan--present value ratio method 
with an in-service payment). (i) The facts are the same as Example 
9, except that X grants C a vested right to a $40,000 payment on 
June 30, 2018 and a vested right to a $60,000 payment on January 1, 
2020.
    (ii) The present value of the future payments ($40,000 payable 
on June 30, 2018 and $60,000 payable on January 1, 2020), determined 
using a five percent interest rate, is $84,758 as of December 31, 
2015; $88,996 as of December 31, 2016; $93,446 as of December 31, 
2017; and $57,143 as of December 31, 2018. However, for purposes of 
determining the increase in the present value of the future payments 
during 2018 (the year

[[Page 56916]]

of the in-service payment), $57,143 must be increased by $40,000, 
the amount of the in-service payment, resulting in a present value 
of future payments as of December 31, 2018, of $97,143 solely for 
purposes of attributing the $40,000 in-service payment. Accordingly, 
$84,758 is the amount of the increase in the present value of the 
future payments for X's 2015 taxable year, $4,238 ($88,896 - 
$84,758) is the increase in the present value of the future payments 
for X's 2016 taxable year, $4,450 ($93,446 - $88,996) is the 
increase in the present value of the future payments for X's 2017 
taxable year, and $3,697 ($97,143 - $93,446) is the increase in the 
present value of the future payments for X's 2018 taxable year. The 
sum of all the increases is $97,143 ($84,758 + $4,238 + $4,450 + 
$3,697). Thus, the attribution fraction for 2015 is .8725 ($84,758/
$97,143); the attribution fraction for 2016 is .0436 ($4,238/
$97,143); the attribution fraction for 2017 is .0458 ($4,450/
$97,143); and the attribution fraction for 2018 is .0381 ($3,697/
$97,143).
    (iii) Accordingly, with respect to the $40,000 payment made on 
June 30, 2018, $34,900 ($40,000 x .8725) is attributable to services 
performed by C in X's 2015 taxable year; $1,744 ($40,000 x .0436) is 
attributable to services performed by C in X's 2016 taxable year; 
$1,832 ($40,000 x .0458) is attributable to services performed by C 
in X's 2017 taxable year; and $1,524 ($40,000 x .0381) is 
attributable to services performed by C in X's 2018 taxable year.
    (iv) For purposes of attributing the $60,000 payment made on 
January 1, 2020, the present value of the future payments for each 
taxable year that ends prior to the taxable year in which the 
$40,000 in-service payment is paid is reduced by the present value 
of the future payment to which the applicable individual had a 
legally binding right to be paid on the date the $40,000 in-service 
is paid (based on the applicable factors and plan provisions as of 
the measurement date in each such taxable year). The present value 
of that future payment is $35,396 as of December 31, 2015; $37,166 
as of December 31, 2016; and $39,024 as of December 31, 2017. 
Therefore, for purposes of attributing the $60,000 payment on 
January 1, 2020, the present value of future payments as of December 
31, 2015, is $49,362 ($84,758 - $35,396); the present value of 
future payments as of December 31, 2016, is $51,830 ($88,996 - 
$37,166); the present value of future payments as of December 31, 
2017, is $54,422 ($93,446 - $39,024). The present value of future 
payments as of December 31, 2018, is $57,143. Accordingly, $49,362 
is the increase in the present value of the future payment of 
$60,000 for X's 2015 taxable year; $2,468 ($51,830 - $49,362) is the 
increase in the present value of the future payment for X's 2016 
taxable year; $2,592 ($54,422 - $51,830) is the increase in the 
future value of the payment for X's 2017 taxable year; $2,721 
($57,143 - $54,422) is the increase in the future value of the 
payments for X's 2018 taxable year; and $2,857 ($60,000 - $57,143) 
is the increase in the future value of the payment for X's 2019 
taxable year. The sum of all the increases is $60,000 ($49,362 + 
$2,468 + $2,592 + $2,721 + $2,857). Thus, the attribution fraction 
for 2015 is .8227 ($49,362/$60,000); the attribution fraction for 
2016 is .0411 ($2,468/$60,000); the attribution fraction for 2017 is 
.0432 ($2,592/$60,000); the attribution fraction for 2018 is .0454 
($2,721/$60,000); and the attribution fraction for 2019 is .0476 
($2,857/$60,000).
    (v) Accordingly, with respect to the $60,000 payment made on 
January 1, 2020, $49,362 ($60,000 x .8227) is attributable to 
services performed by C in X's 2015 taxable year; $2,468 ($60,000 x 
.0411) is attributable to services performed by C in X's 2016 
taxable year; $2,592($60,000 x .0432) is attributable to services 
performed by C in X's 2017 taxable year; $2,721 ($60,000 x .0454) is 
attributable to services performed by C in X's 2018 taxable year; 
and $2,857 ($60,000 x .0476) is attributable to services performed 
by C in X's 2019 taxable year.
    Example 11 (Nonaccount balance plan--formula benefit ratio 
method with losses and multiple payments). (i) D is an applicable 
individual of W for all relevant taxable years. D becomes a 
participant in a nonaccount balance plan sponsored by R on January 
1, 2018. The plan provides W with the vested right to receive a five 
annual installments each equal to $20,000 times the full years of 
service that D completes. The first payment is to be made on the 
later of December 31, 2027, or on the December 31 of the first year 
in which D is no longer a service provider. D has a break in service 
in 2020 and does not accrue an additional benefit during 2020. D 
ceases to be a service provider on December 31, 2022, after having 
completed four years of service, entitling D to five annual payments 
equal to $80,000 per year commencing on December 31, 2027. W 
determines the present value of amounts to be paid under the plan 
using an interest rate of five percent for 2018 and 2019, and seven 
percent for 2021, 2022, and 2023. W uses the formula benefit ratio 
method described in paragraph (d)(4)(ii) of this section.
    (ii) Under the plan formula, in 2018, E accrued the right to a 
$20,000 annual payment for five years, and E accrued an additional 
$20,000 in annual payments in 2019, 2021, and 2022, resulting in the 
right to receive an annual payment of $80,000 commencing on December 
31, 2027. Thus, the attribution fraction is .25 for 2018 ($20,000/
$80,000), .25 for 2019 ($20,000/$80,000), .25 for 2021 ($20,000/
$80,000), and .25 for 2022 ($20,000/$80,000). The attribution 
fraction for 2020 is zero because no additional formula benefit 
accrued during that year.
    (iii) The attribution fraction for each disqualified taxable 
year is multiplied by each payment and the result is attributed to 
that taxable year. Accordingly, with respect to each $80,000 
payment, $20,000 ($80,000 x .25) is attributable to services 
performed by D in W's 2018 taxable year; $20,000 ($80,000 x .25) is 
attributable to services performed by D in W's 2019 taxable year; 
$20,000 ($80,000 x .25) is attributable to services performed by D 
in W's 2021 taxable year; and $20,000 ($80,000 x .25) is 
attributable to services performed by D in W's 2022 taxable year. No 
amount is attributable to services performed by D in W's 2020 
taxable year.
    Example 12 (Stock option). (i) E is an applicable individual of 
corporation V for all relevant taxable years. On January 1, 2016, V 
grants E an option to purchase 100 shares of V common stock at an 
exercise price of $50 per share (the fair market value of V common 
stock on the date of grant). The stock option is not subject to a 
substantial risk of forfeiture. On December 31, 2017, E ceases to be 
a service provider of V or any member of V's aggregated group. On 
January 1, 2019, E resumes providing services for V and again 
becomes both a service provider and an applicable individual of V. 
On December 31, 2020, when the fair market value of V common stock 
is $196 per share, E exercises the stock option. The remuneration 
resulting from the stock option exercise is $14,600 (($196 -- $50) x 
100).
    (ii) The $14,600 is attributed pro rata over the 1,460 days from 
January 1, 2016 to December 31, 2017 and from January 1, 2019 to 
December 31, 2020 (365 days per year for the 2016, 2017, 2019, and 
2020 taxable years), so that $10 ($14,600 divided by 1,460) is 
attributed to each calendar day in this period, and $3,650 (365 days 
x $10) of remuneration is attributed to services performed by E in 
each of V's 2016, 2017, 2019, and 2020 taxable years.
    Example 13 (Stock option subject to a substantial risk of 
forfeiture). (i) The facts are the same as Example 14, except that 
the stock option is subject to a substantial risk of forfeiture that 
lapses on December 31, 2017, and is not transferable until that 
date, and V chooses to attribute remuneration resulting from the 
exercise of stock options that are subject to a substantial risk of 
forfeiture over the period beginning on the date of grant and ending 
on the date the substantial risk of forfeiture lapses, as permitted 
under paragraph (d)(5)(i)(B) of this section.
    (ii) The $14,600 is attributed pro rata over the 730 days from 
January 1, 2016 to December 31, 2017 (365 days per year for the 2016 
and 2017 taxable years), so that $20 ($14,600 divided by 730) is 
attributed to each calendar day in this period, and $7,300 (365 days 
x $20) is attributed to services performed by E in each of V's 2016 
and 2017 taxable years.
    Example 14 (Restricted stock). (i) F is an applicable individual 
of corporation U for all relevant taxable years. On January 1, 2017, 
U grants to F 1000 shares of restricted U common stock. Under the 
terms of the grant, the shares will be forfeited if F voluntarily 
terminates employment before December 31, 2019 (so that the shares 
are subject to a substantial risk of forfeiture through that date) 
and are nontransferable until the substantial risk of forfeiture 
lapses. F does not make an election under section 83(b) and 
continues in employment with U through December 31, 2019, at which 
time F's rights in the stock become substantially vested within the 
meaning of Sec.  1.83-3(b) and the fair market value of a share of 
the stock is $109.50. The remuneration resulting from the vesting of 
the restricted stock is $109,500 ($109.50 x 1000).
    (ii) The $109,500 of remuneration is attributed to services 
performed by F over the 1,095 days between January 1, 2017 and 
December 31, 2019 (365 days per year for the

[[Page 56917]]

2017, 2018, and 2019 taxable years), so that $100 ($109,500 divided 
by 1,095) is attributed to each calendar day in this period, and 
remuneration of $36,500 (365 days x $100) is attributed to services 
performed by F in each of U's 2017, 2018, and 2019 taxable years.
    Example 15 (RSUs). (i) G is an applicable individual of 
corporation T for all relevant taxable years. On January 1, 2018, T 
grants to G 1000 RSUs. Under the terms of the grant, T will pay G an 
amount on December 31, 2020 equal to the fair market value of 1000 
shares of T common stock on that date, but only if G continues to 
provide substantial services to T (so that the RSU is subject to a 
substantial risk of forfeiture) through December 31, 2020. G remains 
employed by T through December 31, 2020, at which time the fair 
market value of a share of the stock is $219, and T pays G $219,000 
($219 x 1000).
    (ii) The $219,000 in remuneration is attributed to services 
performed by G over the 1,095 days beginning on January 1, 2018 and 
ending on December 31, 2020 (365 days per year for the 2018, 2019, 
and 2020 taxable years), so that $200 ($219,000/1,095) is attributed 
to each calendar day in this period, and $73,000 (365 days x $200) 
is attributed to service performed by G in each of T's 2018, 2019, 
and 2020 taxable years.
    Example 16 (Involuntary separation pay). (i) H is an applicable 
individual of corporation S. On January 1, 2015, H and S enter into 
an employment contract providing that S will make two payments of 
$150,000 each to H if H has an involuntary separation from service. 
Under the terms of the contract, the first payment is due on January 
1 following the involuntary separation from service, and the second 
payment is due on January 1 of the following year. On December 31, 
2016, H has an involuntary separation from service. S pays H 
$150,000 on January 1, 2017 and $150,000 on January 1, 2018.
    (ii) Pursuant to paragraph (d)(6) of this section, involuntary 
separation pay may be attributed to services performed by H in the 
taxable year of S in which the involuntary separation from service 
occurs. Alternatively, involuntary separation pay may be attributed 
to services performed by H on a daily pro rata basis beginning on 
the date H obtains a legally binding right to the involuntary 
separation pay and ending on the date of the involuntary separation 
from service. The entire $300,000 amount, including both $150,000 
payments, must be attributed using the same method. Therefore, the 
entire $300,000 amount (comprised of two $150,000 payments) may be 
attributed to services performed by H in S's 2016 taxable year, 
which is the taxable year in which the involuntary separation from 
service occurs. Alternatively, each $150,000 payment may be 
attributed on a daily pro rata basis to the period beginning on 
January 1, 2015 and ending December 31, 2016, so that $410.96 
(($150,000 x 2)/(365 x 2)) is attributed to each day of S's 2015 and 
2016 taxable years. Accordingly, $150,000 is attributed to services 
performed by H in each of S's 2015 and 2016 taxable years.
    Example 17 (Reimbursement after termination of services). (i) I 
is an applicable individual of corporation R. On January 1, 2018, I 
enters into an agreement with R under which R will reimburse I's 
country club dues for two years following I's separation from 
service. On December 31, 2020, I ceases to be a service provider of 
R. I pays $50,000 in country club dues on January 1, 2021 and 
$50,000 on January 2, 2022. Pursuant to the agreement, R reimburses 
I $50,000 for the country club dues in 2021 and $50,000 in 2022.
    (ii) $100,000 is attributed to services performed in R's 2020 
taxable year, the taxable year in which I ceases to be a service 
provider.
    (10) Certain remuneration subject to a substantial risk of 
forfeiture. If remuneration is attributable in accordance with 
paragraphs (d)(2) (legally binding right), (d)(3) (account balance 
plan), or (d)(4) (nonaccount balance plan) of this section to services 
performed in a period that includes two or more taxable years of a 
covered health insurance provider during which the remuneration is 
subject to a substantial risk of forfeiture, that remuneration must be 
attributed using a two-step process. First, the remuneration must be 
attributed to the taxable years of the covered health insurance 
provider in accordance with paragraph (d)(2), (3), or (4) of this 
section, as applicable. Second, the remuneration attributed to the 
period during which the remuneration is subject to a substantial risk 
of forfeiture (the vesting period) must be reattributed on a daily pro 
rata basis over that period beginning on the date that the applicable 
individual obtains a legally binding right to the remuneration and 
ending on the date that the substantial risk of forfeiture lapses. If a 
vesting period begins on a day other than the first day of a covered 
health insurance provider's taxable year or ends on a day other than 
the last day of the covered health insurance provider's taxable year, 
the remuneration attributable to that taxable year under the first step 
of the attribution process is divided between the portion of the 
taxable year that includes the vesting period and the portion of the 
taxable year that does not include the vesting period. The amount 
attributed to the portion of the taxable year that includes the vesting 
period is equal to the total amount of remuneration that would be 
attributable to the taxable year under the first step of the 
attribution process, multiplied by a fraction, the numerator of which 
is the number of days during the taxable year that the amount is 
subject to a substantial risk of forfeiture and the denominator of 
which is the number of days in such taxable year. The remaining amount 
is attributed to the portion of the taxable year that does not include 
the vesting period and, therefore, is not reattributed under the second 
step of the attribution process.
    (11) Example. The following example illustrates the principles of 
paragraph (d)(10) of this section. For purposes of this example, the 
corporation has a taxable year that is the calendar year and is a 
covered health insurance provider for all relevant taxable years, DDR 
is otherwise deductible in the taxable year in which it is paid, and 
amounts payable under nonaccount balance plans are not forfeitable upon 
the death of the applicable individual.

    Example (Account balance plan subject to a substantial risk of 
forfeiture using the principal additions method). (i) J is an 
applicable individual of corporation Q for all relevant taxable 
years. On January 1, 2016, J begins participating in a nonqualified 
deferred compensation plan that is an account balance plan. Under 
the terms of the plan, Q will pay J's account balance on January 1, 
2021, but only if J continues to provide substantial services to Q 
through December 31, 2018 (so that the amount credited to J's 
account is subject to a substantial risk of forfeiture through that 
date). Q credits $10,000 to J's account annually for five years on 
January 1 of each year beginning on January 1, 2016. The account 
earns interest at a fixed rate of five percent per year, compounded 
annually, which solely for the purposes of this example, is assumed 
to be a reasonable rate of interest. Q attributes increases in 
account balances under the plan using the principal additions method 
described in paragraph (d)(3)(ii) of this section.
    (ii) Earnings on a principal addition are attributed to the same 
disqualified taxable year of Q to which the principal addition is 
attributed; therefore, the amount initially attributable to Q's 2016 
taxable year is $12,763 (the $10,000 principal addition in 2016 at 
five percent interest for five years); the amount initially 
attributable to Q's 2017 taxable year is $12,155 (the $10,000 
principal addition in 2017 at five percent interest for four years); 
the amount initially attributable to Q's 2018 taxable year is 
$11,576 (the $10,000 principal addition in 2018 at five percent 
interest for three years); the amount attributable to Q's 2019 
taxable year is $11,025 (the $10,000 principal addition in 2019 at 
five percent interest for two years); and the amount attributable to 
Q's 2020 taxable year is $10,500 (the $10,000 principal addition in 
2020 at five percent interest for one year).
    (iii) Remuneration that is attributable to two or more taxable 
years of Q during which it is subject to a substantial risk of 
forfeiture must be reattributed on a daily pro rata basis to the 
period beginning on the date that J obtains a legally binding right 
to the remuneration and ending on the date that the substantial risk 
of forfeiture lapses. Therefore, $36,494 ($12,763 + $12,155 + 
$11,576) is reattributed on a daily pro rata basis over the period 
beginning on January 1, 2016, and ending on December 31, 2018. Thus, 
$12,165 is attributed to services

[[Page 56918]]

performed by J in each of Q's 2016, 2017, and 2018 taxable years.

    (e) Application of the deduction limitation-(1) Application to 
aggregate amounts. The $500,000 deduction limitation is applied to the 
aggregate amount of AIR and DDR attributable to services performed by 
an applicable individual in a disqualified taxable year. The aggregate 
amount of AIR and DDR attributable to services performed by an 
applicable individual in a disqualified taxable year that exceeds the 
$500,000 deduction limit is not allowed as a deduction in any taxable 
year. Therefore, for example, if an applicable individual has more than 
$500,000 of AIR attributable to services performed for a covered health 
insurance provider in a disqualified taxable year, the amount of that 
AIR that exceeds $500,000 is not deductible in any taxable year, and no 
DDR attributable to services performed by the applicable individual in 
that disqualified taxable year is deductible in any taxable year. 
However, if an applicable individual has AIR for a disqualified taxable 
year that is $500,000 or less and DDR attributable to services 
performed in the same disqualified taxable year that, when combined 
with the AIR for the year, exceeds $500,000, all of the AIR is 
deductible in that disqualified taxable year, but the amount of DDR 
attributable to that taxable year that is deductible in future taxable 
years is limited to an amount equal to $500,000 less the amount of the 
AIR for that taxable year.
    (2) Order of application and calculation of deduction limitation-
(i) In general. The deduction limitation with respect to any applicable 
individual for any disqualified taxable year is applied to AIR and DDR 
attributable to services performed by that applicable individual in 
that disqualified taxable year at the time that the remuneration 
becomes otherwise deductible, and each time the deduction limitation is 
applied to an amount that is otherwise deductible, the deduction limit 
is reduced (but not below zero) by the amount against which it is 
applied. Accordingly, the deduction limitation is applied first to an 
applicable individual's AIR attributable to services performed in a 
disqualified taxable year and is reduced (but not below zero) by the 
amount of the AIR to which the deduction limit is applied. If the 
applicable individual also has an amount of DDR attributable to 
services performed in that disqualified taxable year that becomes 
otherwise deductible in a subsequent taxable year, the deduction limit, 
as reduced, is applied to that amount of DDR in the first taxable in 
which the DDR becomes otherwise deductible. The deduction limit is then 
further reduced (but not below zero) by the amount of the DDR to which 
the deduction limit is applied. If the applicable individual has an 
additional amount of DDR attributable to services performed in the 
original disqualified taxable year that becomes otherwise deductible in 
a subsequent taxable year, the deduction limit, as further reduced, is 
applied to that amount of DDR in the taxable year in which it is 
otherwise deductible. This process continues for future taxable years 
in which DDR attributable to services performed by the applicable 
individual in the original disqualified taxable year is otherwise 
deductible. No deduction is allowed in any taxable year for any AIR or 
DDR attributable to services performed by an applicable individual in a 
disqualified taxable year for the excess of those amounts over the 
deduction limit (as reduced, if applicable) for that disqualified 
taxable year at the time the deduction limitation is applied to the 
remuneration.
    (ii) Application to payments--(A) In general. Any payment of 
remuneration may include amounts that are attributable to services 
performed by an applicable individual in one or more taxable years of a 
covered health insurance provider pursuant to paragraphs (d)(2) through 
(11) of this section. In that case, a separate deduction limitation 
applies to each portion of the payment that is attributed to services 
performed in a different disqualified taxable year. Any portion of a 
payment that is attributed to a taxable year that is a disqualified 
taxable year is deductible only to the extent that it does not exceed 
the deduction limit that applies with respect to the applicable 
individual for that disqualified taxable year, as reduced by the 
amount, if any, of AIR and DDR attributable to services performed in 
that disqualified taxable year that was deductible in an earlier 
taxable year.
    (3) Examples. The following examples illustrate the rules of 
paragraphs (e)(1) and (2) of this section. For purposes of these 
examples, each corporation has a taxable year that is the calendar year 
and is a covered health insurance provider for all relevant taxable 
years; DDR is otherwise deductible in the taxable year in which it is 
paid; and amounts payable under nonaccount balance plans are not 
forfeitable upon the death of the applicable individual.

    Example 1 (Lump-sum payment of DDR attributable to a single 
taxable year).  (i) L is an applicable individual of corporation O. 
During O's 2015 taxable year, O pays L $550,000 in salary, which is 
AIR, and grants L a right to $50,000 of DDR payable upon L's 
separation from service from O. L has a separation from service in 
2020, at which time O pays L the $50,000 of DDR attributable to 
services performed by L in O's 2015 taxable year.
    (ii) The $500,000 deduction limitation for 2015 is applied first 
to L's $550,000 of AIR for 2015. Because the $550,000 of AIR in 2015 
is greater than the deduction limit, O may deduct only $500,000 of 
the AIR for 2015, and $50,000 of the $550,000 of AIR is not 
deductible for any taxable year. The deduction limit for 
remuneration attributable to services provided by L in O's 2015 
taxable year is then reduced to zero. Because the $50,000 in DDR 
attributable to services performed by L in 2015 exceeds the reduced 
deduction limit of zero, that $50,000 is not deductible for any 
taxable year.
    Example 2 (Installment payments of DDR attributable to a single 
taxable year).  (i) M is an applicable individual of corporation N. 
During N's 2016 taxable year, N pays M $300,000 in salary, which is 
AIR, and grants M a right to $220,000 of DDR payable on a fixed 
schedule beginning upon M's separation from service. The $220,000 is 
attributable to services provided by M in N's 2016 taxable year. M 
ceases providing services on December 31, 2016. In 2020, N pays M 
$120,000 of DDR that is attributable to services performed in N's 
2016 taxable year. In 2021, N pays M the remaining $100,000 of DDR 
attributable to services performed by M in N's 2016 taxable year.
    (ii) The $500,000 deduction limitation for 2016 is applied first 
to M's $300,000 of AIR for 2016. Because the deduction limit is 
greater than the AIR, N may deduct the entire $300,000 of AIR paid 
in 2016. The $500,000 deduction limit is then reduced to $200,000 
because the limitation is reduced by the amount of AIR ($500,000 - 
$300,000). The reduced deduction limit is then applied to M's 
$120,000 of DDR attributable to services performed by M in N's 2016 
taxable year that is paid in 2020. Because the reduced deduction 
limit of $200,000 is greater than the $120,000 of DDR, N may deduct 
the entire $120,000 of DDR paid in 2020. The $200,000 deduction 
limit is reduced to $80,000 by the $120,000 in DDR because the limit 
is reduced by the amount of DDR to which the deduction limit applied 
($200,000 - $120,000). The reduced deduction limit of $80,000 is 
then applied to the remaining $100,000 payment of DDR attributable 
to services performed by M in N's 2016 taxable year. Because the 
$100,000 payment by N for 2021 exceeds the reduced deduction limit 
of $80,000, N may deduct only $80,000 of the payment for the 2021 
taxable year, and $20,000 of the $100,000 payment is not deductible 
by N for any taxable year.
    Example 3 (Lump-sum payment attributable to multiple years from 
an account balance plan using the account balance ratio method). (i) 
N is an applicable individual of corporation M for all relevant 
taxable years. On January 1, 2015, N begins participating in a 
nonqualified deferred compensation plan sponsored by M that is an 
account balance plan. Under the plan, all amounts are fully vested 
at all times. The balances in N's account (including earnings)

[[Page 56919]]

are $50,000 on December 31, 2015, $100,000 on December 31, 2016, and 
$200,000 on December 31, 2017. N's AIR from M is $425,000 for 2015, 
$450,000 for 2016, and $500,000 for 2017. On January 1, 2018, in 
accordance with the plan terms, M pays $200,000 to N, which is a 
payment of N's entire account balance under the plan. M uses the 
account balance ratio method to attribute amounts to services 
performed in taxable years.
    (ii) To determine the extent to which M is entitled to a 
deduction for any portion of the $200,000 payment under the plan, 
the payment must first be attributed to services performed by N in 
M's taxable years in accordance with the attribution rules set forth 
in paragraph (d) of this section. The increase in N's account 
balance during 2015 is $50,000 ($50,000 - zero); the increase in N's 
account balance for 2016 is $50,000 ($100,000 - $50,000); and the 
increase in N's account balance for 2017 is $100,000 ($200,000 - 
$100,000). The sum of all the increases is $200,000 ($50,000 + 
$50,000 + $100,000). Accordingly, for N's 2015 taxable year, the 
attribution fraction is .25 ($50,000/$200,000); for N's 2016, 
taxable year, the attribution fraction is .25 ($50,000/$200,000); 
and for N's 2017 taxable year, the attribution fraction is .50 
($100,000/$200,000).
    (iii) With respect to the $200,000 payment made on January 1, 
2018, $50,000 ($200,000 x .25) of DDR is attributable to services 
performed by N in M's 2015 taxable year; $50,000 ($200,000 x .25) of 
DDR is attributable to services performed by N in M's 2016 taxable 
year; and $100,000 ($200,000 x .50) of DDR is attributable to 
services performed by N in M's 2017 taxable year.
    (iv) The $500,000 deduction limitation for 2015 is applied first 
to N's $425,000 of AIR for 2015. Because the deduction limit is 
greater than the AIR, M may deduct the entire $425,000 of AIR paid 
in 2015. The $500,000 deduction limit is then reduced to $75,000 by 
the amount of AIR against which it is applied ($500,000 - $425,000). 
The reduced deduction limit is then applied to N's $50,000 of DDR 
attributable to services performed by N in M's 2015 taxable year 
that is paid in 2018. Because $50,000 does not exceed the reduced 
deduction limit of $75,000, all $50,000 of the DDR attributable to 
services performed by N in M's 2015 taxable year is deductible for 
2018, the year of payment. The deduction limit for remuneration 
attributable to services performed by N in 2015 is then reduced to 
$25,000 ($75,000 - $50,000), and this reduced limit is applied to 
any future payment of DDR attributable to services performed by N in 
2015. With respect to M's 2016 taxable year, the $500,000 deduction 
limit for 2016 is applied first to N's $450,000 of AIR for 2016. 
Because the deduction limit is greater than the AIR, M may deduct 
the entire $450,000 of AIR paid in 2016. The $500,000 deduction 
limit is then reduced to $50,000 by the AIR ($500,000 - $450,000). 
The reduced deduction limit is then applied to N's $50,000 of DDR 
attributable to services performed by N in M's 2016 taxable year 
that is paid in 2018. Because $50,000 does not exceed the reduced 
deduction limit of $50,000, all $50,000 of the DDR attributed to M's 
2016 taxable year is deductible for 2018, the year of payment. The 
deduction limit for remuneration attributable to services performed 
by N in 2016 is then reduced to zero, and this reduced limit is 
applied to any future payment of DDR attributable to services 
performed by N in 2016. With respect to M's 2017 taxable year, the 
$500,000 deduction limit for 2017 is applied first to N's $500,000 
of AIR for 2017. Because the deduction limit is not greater than the 
AIR, M may deduct the entire $500,000 of AIR paid in 2017. The 
$500,000 deduction limit is then reduced to zero by the amount of 
the AIR against which it is applied ($500,000 - $500,000). The 
reduced deduction limit is applied to N's $100,000 of DDR 
attributable to services performed by N in M's 2017 taxable year 
that is paid in 2018. Because $100,000 exceeds the reduced deduction 
limit of zero, the $100,000 of the DDR attributed to services 
performed by N in M's 2017 taxable year is not deductible for the 
year of payment (or any other taxable year). As a result, $100,000 
of the $200,000 payment ($50,000 + $50,000 + $0) is deductible by M 
for M's 2018 taxable year, and the remaining $100,000 is not 
deductible by M for any taxable year.
    Example 4 (Installment payments and in-service payment 
attributable to multiple taxable years from an account balance plan 
using the account balance ratio method). (i) O is an applicable 
individual of corporation L for all relevant taxable years. On 
January 1, 2016, O begins participating in a nonqualified deferred 
compensation plan sponsored by L that is an account balance plan. 
Under the plan, all amounts are fully vested at all times. L makes 
contributions to O's account each year and credits earnings based on 
a predetermined actual investment within the meaning of Sec.  
31.3121(v)(2)-1(d)(2)(i)(B). The closing balances in O's account 
(including contributions, earnings, and distributions made during 
the year) are $100,000 on December 31, 2016, $250,000 on December 
31, 2017, and $50,000 on December 31, 2018. O's AIR from L is 
$500,000 for 2016, $300,000 for 2017, and $450,000 for 2018. On 
December 31, 2018, L pays O $400,000 in accordance with the plan 
terms. On December 31, 2019, O's account balance is $200,000, 
reflecting additional credits of $125,000 made during the year and 
earnings on the account. O's AIR from L is $200,000 for 2019. O 
ceases providing services to L on December 31, 2019. On January 1, 
2020, L pays O $200,000 in accordance with the plan terms. L uses 
the account balance ratio method to attribute amounts to services 
performed in taxable years.
    (ii) To determine the extent to which L is entitled to a 
deduction for any portion of either of the payments under the plan, 
O's payments under the plan must first be attributed to services 
performed by O in L's taxable years in accordance with the 
attribution rules set forth in paragraph (d) of this section. For 
purposes of attributing the $400,000 payment made on December 31, 
2018 to a taxable year, the increase in O's account balance during 
2016 is $100,000 ($100,000 - zero); the increase in O's account 
balance for 2017 is $150,000 ($250,000 - $100,000); and the increase 
in O's account balance for 2018 is $200,000 ($50,000 - $250,000 + 
$400,000 (payment on December 31, 2018)). The sum of all the 
increases is $450,000 ($100,000 + $150,000 + $200,000). Thus, for 
L's 2016 taxable year, the attribution fraction is .2222 ($100,000/
$450,000); for L's 2017 taxable year, the attribution fraction is 
.3333 ($150,000/$450,000); and for L's 2018 taxable year, the 
attribution fraction is .4444 ($200,000/$450,000). Accordingly, with 
respect to the $400,000 payment made on December 31, 2019, $88,889 
($400,000 x .2222) is attributable to services performed by O in L's 
2016 taxable year; $133,333 ($400,000 x .3333) is attributable to 
services performed by O in L's 2017 taxable year; and $177,778 
($400,000 x .4444) is attributable to services performed by O in L's 
2018 taxable year.
    (iii) The portion of the $400,000 payment attributed to services 
performed in a disqualified taxable year under paragraph (d) of this 
section that exceeds the deduction limit for that disqualified 
taxable year, as reduced through the date of payment, is not 
deductible in any taxable year. The $500,000 deduction limit for 
2016 is applied first to O's $500,000 of AIR for 2016. Because the 
deduction limit is equal to the $500,000 of AIR, L may deduct the 
entire $500,000 of AIR paid in 2016. The $500,000 deduction limit is 
then reduced to zero by the amount of the AIR ($500,000 - $500,000). 
The reduced deduction limit is applied to O's $88,889 of DDR 
attributable to services performed by O in L's 2016 taxable year 
that is paid in 2018. Because $88,889 exceeds the reduced deduction 
limit of zero, the $88,889 of DDR attributed to 2016 is not 
deductible for L's 2018 taxable year or any other taxable year. With 
respect to L's 2017 taxable year, the $500,000 deduction limitation 
for 2017 is applied first to O's $300,000 of AIR for 2017. Because 
the $500,000 deduction limit is greater than the $300,000 of AIR, L 
may deduct the entire $300,000 of AIR paid in 2017. The $500,000 
deduction limit is reduced to $200,000 by the amount of the AIR 
($500,000 - $300,000). The reduced deduction limit is then applied 
to O's $133,333 of DDR attributable to services performed by O in 
L's 2017 taxable year that is paid in 2018. Because $133,333 does 
not exceed that reduced deduction limit of $200,000, the $133,333 is 
deductible for 2018. The deduction limit for remuneration 
attributable to services performed by O in 2017 is then reduced to 
$66,667 ($200,000 - $133,333), and this reduced limit is applied to 
any future payment of DDR attributable to services performed by O in 
2017. With respect to L's 2018 taxable year, the $500,000 deduction 
limit for 2018 is applied first to O's $450,000 of AIR for 2018. 
Because the deduction limit is greater than the AIR, L may deduct 
the entire $450,000 of AIR paid in 2017. The $500,000 deduction 
limit is reduced to $50,000 by the amount of the AIR ($500,000 - 
$450,000). The reduced deduction limit is applied to O's $177,778 
attributable to services performed by O in L's 2018 taxable year 
that is paid in 2018. Because the $177,778 exceeds the reduced 
deduction limit of $50,000, $50,000 of DDR

[[Page 56920]]

is deductible for L's 2018 taxable year, and $127,778 of the 
$177,778 is not deductible for L's 2018 taxable year or any other 
taxable year. As a result, $183,333 of the $400,000 payment ($0 + 
$133,333 + $50,000) is deductible by L for L's 2018 taxable year, 
and the remaining $216,667 is not deductible by L for any taxable 
year.
    (iv) For purposes of attributing amounts paid or made available 
from the plan in future taxable years, the following adjustments are 
made to O's account balances to reflect the in-service payment of 
$400,000 in 2018. O's account balance as of December 31, 2016 is 
reduced by the $88,889 attributable to 2016; and for 2017 is reduced 
by the sum of the $133,333 attributable to 2017 and the $88,889 
attributable to 2016. Therefore, after attributing the $400,000 
payment, O's adjusted closing account balance as of December 31, 
2016, is $11,111 ($100,000 - $88,889), and as of December 31, 2017, 
is $27,778 ($250,000 - $133,333 - $88,889).
    (v) For purposes of attributing the $200,000 payment made on 
January 1, 2020, to services performed in the taxable years of S, 
the increase in O's account balance during 2016 is $11,111 ($11,111 
- $0); the increase in O's account balance for 2017 is $16,667 
($27,778 - $11,111); the increase in O's account balance for 2018 is 
$22,222 ($50,000 - $27,778), and the increase in O's account balance 
for 2019 is $150,000 ($200,000 - $50,000). The sum of all such 
increases is $200,000 ($11,111 + $16,667 + $22,222 + $150,000). 
Thus, for O's 2016 taxable year, the attribution fraction is .0556 
($11,111/$200,000); for O's 2017, taxable year, the attribution 
fraction is .0833 ($16,667/$200,000); for O's 2018 taxable year, the 
attribution fraction is .1111 ($22,222/$200,000); for O's 2019 
taxable year, the attribution fraction is .7500 ($150,000/$200,000). 
Accordingly, with respect to the $200,000 payment made on January 1, 
2020, $11,111 ($200,000 x .0556) of DDR is attributable to services 
performed by O in L's 2016 taxable year; $16,667 ($200,000 x .0833) 
of DDR is attributable to services performed by O in L's 2017 
taxable year; $22,222 ($200,000 x .1111) of DDR is attributable to 
services performed by O in L's 2018 taxable year; and $150,000 
($200,000 x .7500) of DDR is attributable to services performed by O 
in L's 2019 taxable year.
    (vi) The portion of the DDR attributed to a disqualified taxable 
year under paragraph (d) of this section that exceeds the deduction 
limit for that disqualified taxable year, as reduced, is not 
deductible for any taxable year. For L's 2016 taxable year, the 
deduction limit is reduced to zero by the $500,000 of AIR for that 
year. Because $11,111 exceeds the reduced deduction limit of zero, 
$11,111 of the DDR is not deductible for L's 2020 taxable year or 
any other taxable year. For L's 2017 taxable year, the deduction 
limit is reduced to $200,000 by the $300,000 of AIR for that year 
and further reduced to $66,667 by the $133,333 of DDR previously 
attributed to 2017. Because $16,667 does not exceed the $66,667 
deduction limit, the $16,667 of DDR is deductible for L's 2020 
taxable year, the year of payment. The deduction limit for 
remuneration attributable to services performed by O in 2017 is then 
reduced to $50,000 ($66,667 - $16,667), and this reduced limit is 
applied to any future payment attributable to services performed by 
O in 2017. For L's 2018 taxable year, the deduction limit is reduced 
to zero by the $450,000 of AIR for that year and the $50,000 of DDR 
previously attributed to 2018. Because $22,222 exceeds the reduced 
deduction limit of zero for 2018, the $22,222 of DDR is not 
deductible for L's 2020 taxable year or any other taxable year. For 
L's 2019 taxable year, the $500,000 deduction limit for 2019 is 
applied first to O's $200,000 of AIR for 2019. Because the deduction 
limit is greater than the AIR, L may deduct the entire $200,000 of 
AIR paid in 2019. The $500,000 deduction limit is reduced to 
$300,000 by the amount of the AIR ($500,000 - $200,000). The reduced 
deduction limit is applied to O's $150,000 of DDR attributable to 
services performed by O in L's 2019 taxable year that is paid in 
2020. Because $150,000 does not exceed the $300,000 limit, the 
$150,000 of DDR is deductible for L's 2020 taxable year, the year of 
payment. The deduction limit for remuneration attributable to 
services performed by O in 2019 is then reduced to $150,000 
($500,000 - $200,000 - $150,000), and this reduced limit is applied 
to any future payment attributable to services performed by O in 
2019. As a result, $166,667 of the $200,000 payment ($0 + $16,667 + 
$0 + $150,000) is deductible by L for L's 2020 taxable year, the 
year of payment, and the remaining $33,333 is not deductible by L 
for any taxable year.
    Example 5 (Installment payments and in-service payment 
attributable to multiple taxable years from an account balance plan 
using the principal additions method). (i) The facts are the same as 
set forth in Example 4, paragraph (i), except that L uses the 
principal additions method for attributing remuneration from an 
account balance plan; principal additions under the plan are 
$100,000 in 2016, $125,000 in 2017, $150,000 in 2018, and $125,000 
in 2019; as of the December 31, 2018 initial date of payment, 
earnings on the 2016, 2017, and 2018 principal additions are 
$40,000, $30,000, and $5,000 respectively. Under the terms of the 
plan, the $400,000 payment made on December 31, 2018, is from 
principal additions in 2016, 2017, and 2018, and earnings thereon, 
and the $200,000 payment made on January 1, 2020, is from principal 
additions in 2018 and 2019, and earnings thereon.
    (ii) To determine the extent to which L is entitled to a 
deduction for any portion of either payment under the plan, the 
payments to O under the plan must first be attributed to services 
performed by O in F's taxable years in accordance with the 
attribution rules set forth in paragraph (d) of this section. Under 
the rules in paragraph (d)(3)(ii) of this section, the $400,000 
payment on January 1, 2019, is attributed to services performed by O 
in the taxable year to which the payment relates under the terms of 
the plan. DDR including principal additions and earnings thereon are 
attributed to services performed by O in a taxable year of L when 
the $400,000 payment is made to O on December 31, 2018. Under the 
terms of the plan, the $400,000 payment made on December 31, 2018 is 
attributed to services performed by O in L's 2016 taxable year in 
the amount of $140,000, and is attributed to services performed by O 
in L's 2017 taxable year in the amount of $155,000, and the 
remaining $105,000 ($400,000 - $140,000 - $155,000) is attributed to 
services performed by O in L's 2018 taxable year.
    (iii) The portion of the DDR attributable to services performed 
in a disqualified taxable year under paragraph (d) of this section 
that exceeds the deduction limit for that disqualified taxable year, 
as reduced, is not deductible for any taxable year. The $500,000 
deduction limitation for 2016 is applied first to O's $500,000 of 
AIR for 2016. Because the deduction limit is equal to the $500,000 
of AIR, L may deduct the entire $500,000 of AIR paid in 2016. The 
$500,000 deduction limit is then reduced to zero by the amount of 
the AIR ($500,000 - $500,000). The reduced deduction limit is 
applied to O's $140,000 of DDR attributable to services performed by 
O in L's 2016 taxable year that is paid in 2018. Because $140,000 
exceeds the reduced deduction limit of zero, the $140,000 is not 
deductible for L's 2018 taxable year (the year of payment), or any 
other taxable year. For L's 2017 taxable year, the $500,000 
deduction limit for 2017 is applied first to O's $300,000 of AIR for 
2017. Because the deduction limit is greater than the AIR, L may 
deduct the entire $300,000 of AIR paid in 2017. The $500,000 
deduction limit is then reduced to $200,000 by the amount of the AIR 
($500,000 - $300,000). The reduced deduction limit is applied to O's 
$155,000 of DDR attributable to services performed by O in L's 2017 
taxable year that is paid in 2018. Because $155,000 does not exceed 
the reduced deduction limit of $200,000, the $155,000 payment is 
deductible for 2018. For L's 2018 taxable year, the $500,000 
deduction limitation for 2018 is applied first to O's $450,000 of 
AIR for 2018. Because the deduction limit is greater than the AIR, L 
may deduct the entire $450,000 of AIR paid in 2018. The $500,000 
deduction limit is then reduced to $50,000 by the amount of the AIR 
($500,000 - $450,000). The reduced deduction limit is applied to O's 
$105,000 of DDR attributable to services performed by O in L's 2018 
taxable year that is paid in 2018. Because $105,000 exceeds the 
reduced deduction limit of $50,000, $55,000 of the $105,000 
attributable to L's 2018 taxable year is not deductible for 2018 
(the year of payment), or any other taxable year. As a result, 
$205,000 of the $400,000 payment ($0 + $155,000 + $50,000) is 
deductible by L for L's 2018 taxable year (the year of payment) and 
the remaining $195,000 is not deductible by L for any taxable year.
    (iv) Earnings through January 1, 2020 on the principal addition 
for L's 2018 taxable year ($50,000) that was not paid as part of the 
December 31, 2018 payment are $5,000. Earnings through January 1, 
2020 on the $125,000 credited to O's account on January 1, 2019 are 
$20,000. On December 31, 2018, after the $400,000 payment is applied 
to 2016, 2017, and 2018, the account balance for 2016 and 2017 is 
reduced to zero, and the account balance for 2018 is reduced to 
$50,000 ($150,000 + $5,000 (earnings) -

[[Page 56921]]

$105,000). Under the terms of the plan, the $200,000 payment made on 
January 1, 2020, is attributable to services performed by O in L's 
2018 and 2019 taxable years. Therefore, the $200,000 payment on 
January 1, 2020 is attributed to services performed by O in L's 
taxable years as follows: $55,000 ($50,000 + $5,000) to 2018 and 
$145,000 ($125,000 + $20,000) to 2019.
    (v) The portion of the DDR attributed to a disqualified taxable 
year under paragraph (d) of this section that exceeds the deduction 
limit for that disqualified taxable year, as reduced, is not 
deductible for any taxable year. For L's 2018 taxable year, the 
deduction limit is reduced to zero by the $450,000 of AIR for that 
year and the payment of $50,000 of DDR attributable to that year. 
Because $55,000 exceeds the reduced deduction limit of zero, the 
$55,000 is not deductible for 2020, the year of payment (or any 
other taxable year). With respect to L's 2019 taxable year, the 
$500,000 deduction limit for 2019 is applied first to O's $200,000 
of AIR for 2019. Because the deduction limit is greater than the 
AIR, L may deduct the entire $200,000 of AIR paid in 2019. The 
$500,000 deduction limit is then reduced to $300,000 by the amount 
of the AIR ($500,000 - $200,000). The reduced deduction limit is 
applied to O's $145,000 of DDR attributable to services performed by 
O in L's 2019 taxable year that is paid in 2020. Because $145,000 
does not exceed the $300,000 reduced limit, the $145,000 is 
deductible for 2020 (the year of payment). As a result, $145,000 of 
the $200,000 payment ($0 + $145,000) is deductible for L's 2020 
taxable year, and the remaining $55,000 is not deductible by L for 
any taxable year.

    (4) Application of deduction limitation to aggregated groups of 
covered health insurance providers--(i) In general. The total combined 
deduction for AIR and DDR attributable to services performed by an 
applicable individual in a disqualified taxable year allowed for all 
members of an aggregated group that are covered health insurance 
providers for any taxable year is limited to $500,000. Therefore, if 
two or more members of an aggregated group that are covered health 
insurance providers may otherwise deduct AIR or DDR attributable to 
services performed by an applicable individual in a disqualified 
taxable year, the AIR and DDR otherwise deductible by all members of 
the aggregated group is combined, and the deduction limitation is 
applied to the total amount.
    (ii) Proration of deduction limitation. If the total amount of AIR 
or DDR attributable to services performed by an applicable individual 
in a disqualified taxable year that is otherwise deductible by two or 
more members of an aggregated group in any taxable year exceeds the 
$500,000 deduction limit (as reduced by previously deductible AIR or 
DDR, if applicable), the deduction limit is prorated based on the AIR 
or DDR otherwise deductible by the members of the aggregated group in 
the taxable year and allocated to each member of the aggregated group. 
The deduction limit allocated to each member of the aggregated group is 
determined by multiplying the deduction limit for the disqualified 
taxable year (as previously reduced, if applicable) by a fraction, the 
numerator of which is the AIR or DDR otherwise deductible by that 
member in that taxable year that is attributable to services performed 
by the applicable individual in the disqualified taxable year, and the 
denominator of which is the total AIR or DDR otherwise deductible by 
all members of the aggregated group in that taxable year that is 
attributable to services performed by the applicable individual in the 
disqualified taxable year. The amount of AIR or DDR otherwise 
deductible by a member of the aggregated group in excess of the portion 
of the deduction limit allocated to that member is not deductible in 
any taxable year. If a covered health insurance provider is a member of 
more than one aggregated group, the deduction limit for that covered 
health insurance provider under section 162(m)(6) may in no event 
exceed $500,000 for AIR and DDR attributable to services performed by 
an applicable individual in a disqualified taxable year.
    (5) Examples. The following examples illustrate the rules of 
paragraph (e)(4) of this section. For purposes of these examples, each 
corporation has a taxable year that is the calendar year and is a 
covered health insurance provider for all relevant taxable years, and 
DDR is otherwise deductible by the covered health insurance provider in 
the taxable year in which it is paid.

    Example 1.  (i) Corporations I, J, and K are members of the same 
aggregated group under paragraph (b)(3) of this section. At separate 
times during 2016, C is an employee of, and performs services for, 
I, J, and K. C's total AIR for 2016 is $1,500,000, which consists of 
$750,000 of AIR for services performed to K; $450,000 of AIR for 
services provided to J; and $300,000 of AIR for services to I.
    (ii) Because I, J, and K are members of the same aggregated 
group, the AIR otherwise deductible by them is aggregated for 
purposes of applying the deduction limitation. Further, because the 
aggregate AIR otherwise deductible by I, J, and K for 2016 exceeds 
the deduction limitation for C for that taxable year, the deduction 
limit is prorated and allocated to the members of the aggregated 
group in proportion to the AIR otherwise deductible by each member 
of the aggregated group for that taxable year. Therefore, the 
deduction limit that applies to the AIR otherwise deductible by K is 
$250,000 ($500,000 x ($750,000/$1,500,000)); the deduction limit 
that applies to the AIR otherwise deductible by J is $150,000 
($500,000 x ($450,000/$1,500,000)); and the deduction limit that 
applies to AIR otherwise deductible by I is $100,000 ($500,000 x 
($300,000/$1,500,000)). For the 2016 taxable year, K may not deduct 
$500,000 of the $750,000 of AIR paid to C ($750,000 - $250,000); J 
may not deduct $300,000 of the $450,000 of AIR paid to C ($450,000 - 
$150,000); and I may not deduct $200,000 of the $300,000 of AIR paid 
to C ($300,000 - $100,000).
    Example 2.  (i) The facts are the same as Example 1, except that 
C's total AIR for 2016 is $400,000, which consists of $75,000 for 
services provided to K; $150,000 for services provided to J; and 
$175,000 for services provided to I. In addition, C becomes entitled 
to $60,000 of DDR attributable to services provided to K in 2016, 
which is payable (and paid) on April 1, 2018, and $75,000 of DDR 
attributable to services provided to J in 2016, which is payable 
(and paid) on April 1, 2019.
    (ii) Because C's total AIR of $400,000 for 2016 for services 
provided to K, J, and I do not exceed the $500,000 limitation, K, J, 
and I may deduct $75,000, $150,000, and $175,000, respectively, for 
2016. The deduction limit is then reduced to $100,000 by the total 
AIR deductible by all members of the aggregated group ($500,000 - 
$400,000). The deduction limit, as reduced, is then applied to any 
DDR attributable to services provided by C in 2016 in the first 
subsequent taxable year that DDR becomes deductible. The first year 
that DDR for 2016 becomes deductible is 2018, due to the $60,000 
payment made on April 1, 2018. Because the $60,000 of DDR otherwise 
deductible by K does not exceed the 2016 $100,000 deduction limit, K 
may deduct the entire $60,000 for its 2018 taxable year. The 
$100,000 deduction limit is then reduced by the $60,000 of DDR 
deductible by K for 2018, and the reduced deduction limit of $40,000 
($100,000 - $60,000) is applied to the $75,000 of DDR that is 
otherwise deductible for 2019. Because the DDR of $75,000 otherwise 
deductible by J exceeds the reduced deduction limit of $40,000, J 
may deduct only $40,000, and the remaining $35,000 ($75,000 - 
$40,000) is not deductible by J for that taxable year or any other 
taxable year.
    Example 3. (i) The facts are the same as Example 2, except that 
C's DDR of $75,000 attributable to services performed by C in J's 
2016 taxable year is payable (and paid) on July 1, 2018.
    (ii) The results are the same as Example 2, except that the 
reduced deduction limit of $100,000 is prorated between K and J in 
proportion to the DDR otherwise deductible by them for 2018. 
Accordingly, $44,444 of the remaining deduction limit is allocated 
to K ($100,000 x ($60,000/$135,000)), and $55,556 of the remaining 
deduction limit is allocated to J ($100,000 x ($75,000/$135,000)). 
Because the $60,000 of DDR otherwise deductible by K exceeds the 
$44,444 deduction limit applied to that remuneration, K may deduct 
only $44,444 of the $60,000 payment, and $15,556 may not be deducted 
by K for the 2018 taxable year or any other taxable year. Similarly, 
because the $75,000 of DDR otherwise deductible by

[[Page 56922]]

J exceeds the $55,556 deduction limit applied to that remuneration, 
J may deduct only $55,556 of the $75,000 payment, and $19,444 may 
not be deducted by J for that taxable year or any other taxable 
year.

    (f) Corporate transactions--(1) Treatment as a covered health 
insurance provider in connection with a corporate transaction. Except 
as otherwise provided in this paragraph (f), a person that participates 
in a corporate transaction is a covered health insurance provider for 
the taxable year in which the corporate transaction occurs (and any 
other taxable year) if it would otherwise be a covered health insurance 
provider under paragraph (b)(4) of this section for that taxable year. 
For example, if a member of an aggregated group that did not previously 
include a health insurance issuer purchases a health insurance issuer 
that is a covered health insurance provider (so that the health 
insurance issuer becomes a member of the aggregated group), each member 
of the acquiring aggregated group will be a covered health insurance 
provider for its full taxable year in which the corporate transaction 
occurs and each subsequent taxable year in which the health insurance 
issuer continues to be a member of the group, if it would otherwise be 
a covered health insurance provider under paragraph (b)(4), except as 
otherwise provided in this paragraph (f). For purposes of this section, 
the term corporate transaction means a merger, acquisition or 
disposition of assets or stock, reorganization, consolidation, 
separation, or any other transaction resulting in a change in the 
composition of an aggregated group.
    (2) Transition period relief for a person becoming a covered health 
insurance provider solely as a result of a corporate transaction--(i) 
In general. Except as provided in paragraph (f)(2)(ii) of this section, 
a person that is not a covered health insurance provider before a 
corporate transaction, but would (except for application of this 
paragraph (f)(2)(i)) become a covered health insurance provider solely 
because it becomes a member of an aggregated group with another person 
that is a health insurance issuer as a result of the corporate 
transaction, is not a covered health insurance provider subject to the 
deduction limitation of section 162(m)(6) for the taxable year of that 
person in which the corporate transaction occurs (the transition period 
relief).
    (ii) Certain applicable individuals. The transition period relief 
described in paragraph (f)(2)(i) of this section does not apply with 
respect to the remuneration of any individual who is an applicable 
individual of a person that would have been a covered health insurance 
provider for the taxable year in which the corporate transaction 
occurred without regard to the occurrence of the corporate transaction 
(for example, the applicable individuals of a health insurance issuer 
and the members of its affiliated group that were covered health 
insurance issuers before the occurrence of a corporate transaction). 
This exception to the transition period relief applies even with 
respect to remuneration attributable to services performed by the 
applicable individual for a person that is eligible for the transition 
period relief described in paragraph (f)(1)(ii)(A) of this section. 
Accordingly, each member of an acquiring aggregated group that would 
become a covered health insurance provider solely as a result of a 
corporate transaction, but is not a covered health insurance provider 
under the transition period relief described in paragraph (f)(1)(ii)(A) 
of this section, is subject to the deduction limitation of section 
162(m)(6) for its taxable year in which the corporate transaction 
occurs with respect to AIR and DDR attributable to services performed 
by any individual who is an applicable individual of the acquired 
health insurance issuer and any member of its aggregated group that 
would have been a covered health insurance provider in the taxable year 
in which the corporate transaction occurred, even if the corporate 
transaction had not occurred.
    (3) Transition relief from the attribution consistency 
requirements--(i) In general. Paragraphs (d)(3)(i), (d)(4)(i) and 
(d)(5)(i)(B) of this section require a covered health insurance 
provider and all members of its aggregated group to use the same method 
for attributing remuneration to services performed by applicable 
individuals consistently for all taxable years (attribution consistency 
requirements). As a result of a corporate transaction, however, a 
covered health insurance provider that uses an attribution method for 
its account balance plans, nonaccount balance plans, or stock options 
or SARs may become a member of an aggregated group with another covered 
health insurance provider that uses a different attribution method for 
those types of plans or arrangements. In that case, neither member of 
the aggregated group will be treated as violating the attribution 
consistency requirements merely because it uses an attribution method 
that is different from the attribution method used by another member of 
its aggregated group to attribute remuneration that becomes otherwise 
deductible in the taxable year in which the corporate transaction 
occurs. However, the attribution consistency requirements apply with 
respect to remuneration that becomes otherwise deductible in all 
subsequent taxable years. Following the date of the corporate 
transaction, any member of the aggregated group may change the 
attribution method that it used before the date of the corporate 
transaction to attribute remuneration under its account balance plans, 
nonaccount balance plans, or stock options or SARs to make its method 
consistent with the method used by any other member of the aggregated 
group. Notwithstanding the foregoing, the Secretary may subject this 
change in attribution method to limitations, or may otherwise modify 
the attribution consistency requirements, pursuant to a notice, revenue 
ruling, or other guidance of general applicability published in the 
Internal Revenue Bulletin.
    (ii) Exception for certain applicable individuals. Notwithstanding 
the transition relief described in paragraphs (f)(2)(A) of this 
section, if a covered health insurance provider has attributed 
remuneration under a method described in paragraphs (d)(3), (d)(4), or 
(d)(5) of this section with respect to an applicable individual before 
a corporate transaction, the covered health insurance provider must 
continue at all times to use that attribution method for all other 
remuneration that becomes otherwise deductible under the same type of 
plan (that is, an account balance plan, a nonaccount balance plan, or a 
stock option or SAR) to which the applicable individual has a legally 
binding right as of the corporate transaction.
    (4) Deduction limitation not prorated for short taxable years. If a 
corporate transaction results in a short taxable year for a covered 
health insurance provider, the $500,000 deduction limit for the short 
taxable year is neither prorated nor reduced. For example, if a 
corporate transaction results in a short taxable year of three months, 
the deduction limit under section 162(m)(6) for that short taxable year 
is $500,000 (and is not reduced to $125,000).
    (5) Effect of a corporate transaction on the application of the de 
minimis exception. If a person becomes or ceases to be a member of an 
aggregated group, only the premiums and gross revenues of that person 
for the portion of its taxable year during which it is a member of the 
aggregated group are taken into account for purposes of

[[Page 56923]]

determining whether the de minimis exception applies.
    (6) Examples. The following examples illustrate the principles of 
this paragraph (f). For purposes of these examples, each corporation 
has a taxable year that is the calendar year unless stated otherwise, 
and none of the corporations qualify for the de minimis exception under 
paragraph (b)(4)(v) of this section.

    Example 1.  (i) Corporation J merges with and into corporation H 
on June 30, 2015, such that H is the surviving entity. As a result 
of the merger, J's taxable year ends on June 30, 2015. For its 
taxable year ending June 30, 2015, J is a health insurance issuer 
that is a covered health insurance provider. For all taxable years 
before the taxable year of the merger, H is not a covered health 
insurance provider.
    (ii) Corporation J is a covered health insurance provider for 
its short taxable year ending June 30, 2015. As a result of the 
merger, H becomes a covered health insurance provider for its 2015 
taxable year, but Corporation H is not a covered health insurance 
provider for its 2015 taxable year by reason of the transition 
period relief in paragraph (f)(1)(ii)(A) of this section. However, 
applicable individuals of J continue to be subject to the deduction 
limit under section 162(m)(6) for amounts that become otherwise 
deductible in the 2015 taxable year and DDR that is attributable to 
services performed by applicable individuals of J, and H is a 
covered health insurance provider for all subsequent taxable years 
for which it is a covered health insurance provider under paragraph 
(b)(4) of this section.
    Example 2.  (i) On January 1, 2016, corporations D, E, and F are 
members of a controlled group within the meaning of section 414(b). 
F is a health insurance issuer that is a covered health insurance 
provider under paragraph (b)(4)(i)(A) of this section. D and E are 
not health insurance issuers (but are covered health insurance 
providers pursuant to paragraphs (b)(4)(i)(C) and (D) of this 
section). D is the parent entity of the DEF aggregated group. F's 
taxable year ends on September 30. P is an applicable individual of 
F for all taxable years. On May 1, 2016, a controlled group within 
the meaning of section 414(b) consisting of corporations C and B 
purchases all of the stock of corporation F, resulting in a 
controlled group within the meaning of section 414(b) consisting of 
corporations C, B, and F. The amount of premiums received by F from 
providing minimum essential coverage during the portion of its 
taxable year when it was a member of the DEF aggregated group 
constitute more than two percent of the gross revenues of the 
aggregated group for the taxable year of D (the parent entity) 
ending on December 31, 2016, and the taxable years of E and F ending 
with or within D's taxable year (December 31, 2016 and May 1, 2016 
respectively). C and B are not health insurance issuers. C is the 
parent entity of the CBF aggregated group. The CBF aggregated group 
is also a consolidated group within the meaning of Sec.  1.1502-
1(h). Thus, F's taxable year ends on May 1, 2016 by reason of Sec.  
1.1502-76(b)(1)(ii)(A)(1), and F becomes part of the CBF 
consolidated group for the taxable year ending December 31, 2016.
    (ii) D and E are covered health insurance providers for the 
taxable year ending December 31, 2016, and the de minimis exception 
does not apply because the amount of premiums received by F from 
providing minimum essential coverage during the short taxable year 
that it was a member of the DEF aggregated group are more than two 
percent of the gross revenues of the aggregated group for the 
taxable years during which the members would otherwise be a covered 
health insurance providers under paragraph (b)(4)(i) of this 
section. Accordingly, D and E are subject to the deduction 
limitation under section 162(m)(6) for their taxable years ending 
December 31, 2016. C and B are not covered health insurance 
providers for their taxable year ending December 31, 2016, by reason 
of the transition period relief of paragraph (f)(1)(ii)(A) of this 
section.
    (iii) As a result of leaving the aggregated group, F has a new 
taxable year beginning on May 2, 2016 and ending on December 31, 
2016. F is a covered health insurance provider within the meaning of 
paragraph (b)(4) of this section for its new taxable year ending on 
December 31, 2016 (even though C and B are not covered health 
insurance providers for their taxable years ending December 31, 
2016) unless the CBF aggregated group qualifies for the de minimis 
exception for that taxable year.
    (iv) P is an applicable individual whose remuneration from F is 
subject to the deduction limitation under section 162(m)(6) for F's 
short taxable year ending May 1, 2016 and F's taxable year ending 
December 31, 2016. In addition, any remuneration provided to P by C 
or B at any time for services provided by P from May 1, 2016 to 
December 31, 2016 is also subject to the deduction limitation under 
section 162(m)(6), even though C and B are not covered health 
insurance providers for their taxable years ending December 31, 2016 
by reason of the transition period relief of paragraph (f)(1)(ii)(A) 
of this section. Remuneration to which P had the legally binding 
right on or before the date of the transaction is subject to the 
deduction limitation when that remuneration becomes otherwise 
deductible.
    Example 3. (i) The same facts as Example 2, except that E is a 
health insurance issuer that is a covered health insurance provider 
under paragraph (b)(4) of this section and thus receives premiums 
from providing minimum essential coverage (instead of F), and F is 
not a health insurance issuer.
    (ii) F is a covered health insurance provider for its short 
taxable year ending May 1, 2016. However, because F is not a health 
insurance issuer that is a covered health insurance provider and 
there are no other health insurance issuers in the BCF aggregated 
group, F is not a covered health insurance provider for its short, 
post-acquisition taxable year ending December 31, 2016.
    (iii) With respect to P, remuneration to which P had the legally 
binding right on or before the date of the transaction is subject to 
the deduction limitation. However, remuneration to which P obtains 
the legally binding right after the date of the corporate 
transaction is not subject to the deduction limitation.
    Example 4. (i) Corporations N, O, and P are members of an 
aggregated group as described in paragraph (b)(2) of this section. N 
is a health insurance issuer that is a covered health insurance 
provider pursuant to paragraph (b)(4)(i)(A) of this section, but 
neither O nor P is a health insurance issuer. P is the parent entity 
of the aggregated group. On April 1, 2016, O ceases to be a member 
of the NOP aggregated group as the result of a corporate 
transaction. O's taxable year does not end as a result of the 
corporate transaction.
    (ii) Because O was a member of the NOP aggregated group during a 
portion of its taxable year, O is a covered health insurance 
provider for its taxable year ending December 31, 2016.
    Example 5. (i) Corporations V, W, and X are members of an 
aggregated group as described in paragraph (b)(2) of this section. V 
is a health insurance issuer that is a covered health insurance 
provider pursuant to paragraph (b)(4)(i)(A) of this section, but 
neither W nor X is a health insurance issuer. W is the parent entity 
of the aggregated group. V's taxable year ends on December 31; W's 
taxable year ends on June 30; and X's taxable year ends on September 
30. For its taxable year ending June 30, 2017, W has $100x in gross 
revenue. For its taxable year ending September 30, 2016, X has $60x 
in gross revenue. For its taxable year ending December 31, 2016, V 
receives $4x of premiums from providing minimum essential coverage 
and has no other revenue. As of September 30, 2016, V ceases to be a 
member of the VWX aggregated group. V's taxable year does not end on 
September 30, 2016 as a result of the transaction. Of the $4x that 
that V receives for providing minimum essential coverage during its 
taxable year ending December 31, 2016, $3x is received during the 
period from January 1, 2016 through September 30, 2016. As a result 
of the corporate transaction, V's taxable year ends on September 30, 
2016. The de minimis exception of paragraph (b)(4)(v)(A) of this 
section did not apply to the members of the VWX aggregated group for 
their immediately preceding taxable years ending December 31, 2015, 
June 30, 2016, and September 30, 2015, respectively.
    (ii) For purposes of applying the de minimis exception to an 
aggregated group for a taxable year during which a person leaves or 
joins the aggregated group, only the premiums and revenues of the 
person for the portion of its taxable year during which it was a 
member of the aggregated group are taken into account. The premiums 
from providing minimum essential coverage received by the VWX 
aggregated group for W's taxable year ending June 30, 2017 are $3x. 
The revenues of the V, W, and X aggregated group for W's taxable 
year ending June 30, 2017 are $163x. Accordingly, the premiums 
received by the members of the aggregated group from providing 
minimum essential coverage are less than two percent of the gross 
revenues of the aggregated group

[[Page 56924]]

($3x is less than $3.26x (two percent of $163x)). Therefore, V, W 
and X are not covered health insurance providers for their taxable 
years ending December 31, 2016, June 30, 2017, and September 30, 
2016, respectively.

    Example 6.  (i) The facts are the same as Example 5, except that 
F received $4x of premiums during the period from January 1, 2016 to 
September 30, 2016, and the members of the VWX aggregated group were 
not covered health insurance providers for their taxable years 
ending December 31, 2015, June 30, 2016, and September 30, 2015, 
respectively (their immediately preceding taxable years) solely by 
reason of the de minimis exception of paragraph (b)(4)(v)(A) of this 
section.
    (ii) The premiums from providing minimum essential coverage 
received by the VWX aggregated group for W's taxable year ending 
June 30, 2017 are $4x. The revenues of the VWX aggregated group for 
W's taxable year ending June 30, 2017 are $164x. Accordingly, the 
premiums received by the members of the aggregated group from 
providing minimum essential coverage are greater than two percent of 
the gross revenues of the aggregated group ($4x is greater than 
$3.28x (two percent of $164x)). Therefore, V, W, and X do not 
qualify for the de minimis exception for their taxable years ending 
December 31, 2016, June 30, 2017, and September 30, 2016, 
respectively. However, V, W, and X are not covered health insurance 
providers for these taxable years by reason of the de minimis 
exception one year transition period described in paragraph 
(b)(4)(v)(B) of this section.

    Example 7.  (i) Corporation N is a health insurance issuer that 
is a covered health insurance provider. Corporation O is also a 
health insurance issuer that is a covered health insurance provider. 
Both N and O have taxable years ending December 31. N uses the 
account balance ratio method to attribute remuneration that becomes 
otherwise deductible under its account balance plans. O uses the 
principal additions method to attribute amounts that become 
otherwise deductible under its account balance plans. On June 30, 
2016, O purchases all of the stock of N.
    (ii) For the taxable year of N and O ending December 31, 2016, N 
may continue to attribute amounts that become deductible under its 
account balance plans using the account balance ratio method, and O 
can continue to attribute amounts that become otherwise deductible 
under its account balance plan using the principal additions method, 
even though they are members of the same aggregated group, pursuant 
to the transition period relief described in paragraph (f)(2) of 
this section. In all subsequent taxable years, N and O must use the 
same method to attribute amounts that become otherwise deductible 
under their account balance plans. Either N or O may change the 
method that it uses to attribute amounts under its account balance 
plans to be consistent with the attribution method used by the 
other.

    Example 8.  (i) The facts are the same as Example 7. In 
addition, B is an applicable individual of N before the corporate 
transaction and is a participant in an account balance plan of N. On 
December 31, 2015, N made a payment to B, and N used the account 
balance ratio method described in paragraph (d)(3)(ii) of this 
section to attribute the payment to services performed by B in 
taxable years of N.
    (ii) Because N used the account balance ratio method described 
in paragraph (d)(3)(ii) of this section to attribute an amount that 
became otherwise deductible under the plan before the corporate 
transaction, N must continue to use the account balance ratio method 
for attributing amounts to which B had a legally binding right as of 
the corporate transaction, whenever those amounts become otherwise 
deductible.

    (g) Coordination--(1) Coordination with section 162(m)(1). If 
section 162(m)(1) and section 162(m)(6) both otherwise would apply with 
respect to the remuneration of an applicable individual, the deduction 
limitation under section 162(m)(6) applies without regard to section 
162(m)(1). For example, if an applicable individual is both a covered 
employee of a publicly held corporation (see sections 162(m)(2) and 
(3); Sec.  1.162-27) and an applicable individual within the meaning of 
paragraph (b)(7) of this section, remuneration earned by the applicable 
individual that is attributable to a disqualified taxable year of a 
covered health insurance provider is subject to the $500,000 deduction 
limitation under section 162(m)(6) with respect to such disqualified 
taxable year, without regard to section 162(m)(1).
    (2) Coordination with disallowed excess parachute payments--(i) In 
general. The $500,000 deduction limitation of section 162(m)(6) is 
reduced (but not below zero) by the amount (if any) that would have 
been included in the AIR or DDR of the applicable individual for a 
taxable year but for the deduction for the AIR or DDR being disallowed 
by reason of section 280G.
    (ii) Example. The following example illustrates the rule of this 
paragraph (g)(2).

    Example.  Corporation A, a covered health insurance provider, 
pays $750,000 of AIR to P, an applicable individual, during A's 
disqualified taxable year ending December 31, 2016. Of the $750,000, 
$300,000 is an excess parachute payment as defined in section 
280G(b)(1), the deduction for which is disallowed by reason of that 
section. The excess parachute payment reduces the $500,000 deduction 
limit to $200,000 ($500,000 - $300,000). Therefore, A may deduct 
only $200,000 of the $750,000 in AIR, and $250,000 of the payment is 
not deductible by reason of section 162(m)(6).

    (h) Grandfathered amounts attributable to services performed in 
taxable years beginning before January 1, 2010--(1) In general. The 
section 162(m)(6) deduction limitation does not apply to remuneration 
attributable to services performed in taxable years of a covered health 
insurance provider beginning before January 1, 2010 (grandfathered 
amounts). For purposes of this paragraph (h), whether remuneration is 
attributable to services performed in a taxable year beginning before 
January 1, 2010, is determined by applying an attribution method 
described in paragraph (h)(2) of this section.
    (2) Identification of services performed in taxable years beginning 
before January 1, 2010--(i) In general. DDR described in paragraphs 
(d)(2) (legally binding right), (d)(3) (account balance plans), (d)(4) 
(nonaccount balance plans), (d)(6) (involuntary separation pay), (d)(7) 
(reimbursements), and (d)(8) (split dollar life insurance) of this 
section is attributable to services performed in a taxable year 
beginning before January 1, 2010 if it is attributable to services 
performed before that date under the rules of these paragraphs, without 
regard to whether that remuneration is subject to a substantial risk of 
forfeiture on or after that date. Notwithstanding the requirement under 
paragraph (d)(3)(i) of this section that a covered health insurance 
provider must use the same attribution method for its account balance 
plans for all taxable years, a covered health insurance provider that 
uses the account balance ratio method described in paragraph (d)(3)(i) 
of this section to attribute remuneration to services performed in 
taxable years beginning after December 31, 2009 may use the principal 
additions method described in paragraph (d)(3)(ii) of this section to 
attribute remuneration under an account balance plan to services 
performed in a taxable year beginning before January 1, 2010 for 
purposes of determining grandfathered amounts under the plan. (See 
paragraph (d)(3)(ii)(C)(3) of this section for required account balance 
adjustments if a covered health insurance provider generally uses the 
account balance ratio method to attribute amounts otherwise deductible 
under its account balance plans but uses the principal additions method 
to attribute remuneration to services performed in taxable years 
beginning before January 1, 2010.)
    (ii) Equity-based remuneration. For purposes of this section, all 
remuneration resulting from a stock option, stock appreciation right, 
restricted stock, or restricted stock unit

[[Page 56925]]

and the right to any associated dividends or dividend equivalents 
(together, referred to as equity-based remuneration) granted before the 
first day of the taxable year of the covered health insurance provider 
beginning on or after January 1, 2010, is attributable to services 
performed in taxable years beginning before January 1, 2010, regardless 
of the date on which the equity-based remuneration is exercised (in the 
case of a stock option or SAR), the date on which the amounts due under 
the equity-based remuneration are paid or includible in income, or 
whether the equity-based remuneration is subject to a substantial risk 
of forfeiture on or after the first day of the taxable year of the 
covered health insurance provider beginning on or after January 1, 
2010. For example, appreciation in the value of restricted shares 
granted before the first day of the taxable year beginning on or after 
January 1, 2010 is treated as remuneration that is attributable to 
services performed in taxable years beginning before January 1, 2010, 
regardless of whether the shares are vested at that time.
    (i) Transition rules for certain DDR--(1) Transition rule for DDR 
attributable to services performed in taxable years of the covered 
health insurance provider beginning after December 31, 2009 and before 
January 1, 2013. The deduction limitation under section 162(m)(6) 
applies to DDR attributable to services performed in a disqualified 
taxable year of a covered health insurance provider beginning after 
December 31, 2009 and before January 1, 2013, only if that remuneration 
is otherwise deductible in a disqualified taxable year of the covered 
health insurance provider beginning after December 31, 2012. However, 
if the deduction limitation applies to DDR attributable to services 
performed by an applicable individual in a disqualified taxable year of 
a covered health insurance provider beginning after December 31, 2009 
and before January 1, 2013, the deduction limitation is calculated as 
if it had been applied to the applicable individual's AIR and DDR 
deductible in those taxable years.
    (2) Examples. The following examples illustrate the principles of 
this paragraph (i). For purposes of these examples, each corporation 
has a taxable year that is the calendar year, and DDR is otherwise 
deductible by the covered health insurance provider in the taxable year 
in which it is paid.

    Example 1.  (i) Q is an applicable individual of corporation Z. 
Z's 2010, 2011, and 2012 taxable years are disqualified taxable 
years. Z's 2013, 2014, and 2015 taxable years are not disqualified 
taxable years. However, Z's 2016 taxable year and all subsequent 
taxable years are disqualified taxable years. Q receives $200,000 of 
AIR from Z for 2012, and becomes entitled to $800,000 of DDR that is 
attributable to services performed by Q in 2012. Z pays Q $350,000 
of the DDR in 2015, and the remaining $450,000 of the DDR in 2016. 
These payments are otherwise deductible by Z in 2015 and 2016, 
respectively.
    (ii) DDR attributable to services performed by Q in Z's 2010, 
2011, and 2012 taxable years that is otherwise deductible in Z's 
2013, 2014, or 2015 taxable years is not subject to the deduction 
limitation under section 162(m)(6) by reason of the transition rule 
under paragraph (i)(1) of this section. However, DDR attributable to 
services performed in Z's 2010, 2011, and 2012 taxable years that is 
otherwise deductible in a later taxable year that is a disqualified 
taxable year (in this case, Z's 2016 and subsequent taxable years) 
is subject to the deduction limitation under section 162(m)(6). 
Accordingly, the deduction limitation with respect to AIR and DDR 
attributable to services performed by Q in 2012 is determined by 
reducing the $500,000 deduction limit by the $200,000 of AIR paid to 
Q by Z for 2012 ($500,000 - $200,000). Under the transition rule of 
paragraph (i)(1) of this section, no portion of the reduced 
deduction limit of $300,000 for the 2012 taxable year is applied 
against the $350,000 payment made in 2015, and accordingly, the 
deduction limit is not reduced by the amount of that payment. The 
reduced deduction limit is then applied to Q's $450,000 of DDR 
attributable to services performed by Q in 2012 that is paid to Q 
and becomes otherwise deductible in 2016. Because the reduced 
deduction limit of $300,000 is less than the $450,000 otherwise 
deductible by Z in 2016, Z may deduct only $300,000 of the DDR, and 
$150,000 of the $450,000 payment is not deductible by Z in that 
taxable year or any taxable year.

    Example 2.  (i) R is an applicable individual of corporation Y, 
which is a covered health insurance provider for all relevant 
taxable years. During 2010, Y pays R $400,000 in salary and grants R 
a right to $200,000 in DDR payable on a fixed schedule in 2011, 
2012, and 2013. Pursuant to the fixed schedule, Y pays R $50,000 of 
DDR in 2011, $50,000 of DDR in 2012, and the remaining $100,000 of 
DDR in 2013.
    (ii) Because the deduction limitation for DDR under section 
162(m)(6)(A)(ii) is effective for DDR that is attributable to 
services performed by an applicable individual during any 
disqualified taxable year beginning after December 31, 2009 that 
would otherwise be deductible in a taxable year beginning after 
December 31, 2012, only the DDR paid by Y in 2013 is subject to the 
deduction limitation. However, the limitation is applied as if 
section 162(m)(6) and paragraph (c)(2) of this section were 
effective for taxable years beginning after December 31, 2009 and 
before January 1, 2013. Accordingly, the deduction limitation with 
respect to remuneration for services performed by R in 2010 is 
determined by reducing the $500,000 deduction limit by the $400,000 
of AIR paid to R for 2010 ($500,000 -$400,000). The reduced 
deduction limit of $100,000 is further reduced to zero by the 
$50,000 of DDR attributable to services performed by R in Y's 2010 
taxable year that is deductible in each of 2011 and 2012 (($100,000 
- $50,000 - $50,000). Because the deduction limit is reduced to 
zero, none of the $100,000 of DDR attributable to services performed 
by R in Y's 2010 taxable year and paid to R in 2013 is deductible.

    (j) Effective/applicability dates. These regulations are effective 
on September 23, 2014. The regulations apply to taxable years beginning 
on or after September 23, 2014.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: September 15, 2014.
 Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2014-22317 Filed 9-18-14; 4:15 pm]
BILLING CODE 4830-01-P