The new health care law and the Medicare Part D retiree drug subsidy.

On March 23, 2010, President Obama signed the Patient Protection

and Affordable Care Act. (1) On March 30, 2010, he signed the Health

Care and Education Reconciliation Act of 2010, (2) a bill to make

changes to the Patient Protection and Affordable Care Act. These two

acts are the primary vehicles of health care reform.

Within weeks after the laws were passed, some companies that

provide employees with health care in retirement announced noncash

one-time accounting charges resulting from changes to how Medicare

subsidies will be taxed (see Exhibit 1). However, some companies that

receive the Medicare Part D retiree drug subsidy have not yet taken a

charge because the legislation is new and subject to changes.

Exhibit 1: Companies taking accounting charges

Company Q1 2010 impact

AT&T $995 million

Verizon Communications Inc. $962 million

Deere & Co. $130 million

Prudential Financial $94 million

Caterpillar $90 million

3M $84 million

Alcoa $79 million

AK Steel Corp. $25 million

Valero Energy $16 million

Source: Companies’ first quarter Forms 10-Q.

A company that provides employees with health care coverage in

retirement is required under accounting standards applicable in the

United States to recognize the liability for this retirement benefit

during the employees’ active service periods. These accounting

standards require the company to estimate the cost of providing health

care coverage from the time an active employee retires until that

employee’s death. The company recognizes this estimated cost over

the period that the employee provides service to it. For each period

that the company reports results, it includes an expense for this

obligation and recognizes the anticipated tax benefits associated with

paying the health care costs sometime in the future. Under current tax

law, companies can receive a 28% tax-free subsidy under Sec. 139A when

paying for prescription drug coverage, up to $1,330 per year per

retiree. When companies spend the tax-free federal subsidy on benefits,

the federal subsidy does not reduce an employer’s income tax

deduction for the costs of providing such prescription drug plans nor is

it subject to income tax individually.

The health care legislation eliminates this favorable tax treatment

for the drug subsidies. Under the law, beginning in 2013, a

company’s tax deduction for covered retiree prescription drug

expenses will be reduced to the extent these expenses are reimbursed

under the retiree drug subsidy program. Thus, the subsidy payments will

be treated like most other payments that are excludible from income.

Impact in Year 2010

Although this change in the tax treatment of retiree drug subsidies

is not effective until 2013, under applicable U.S. accounting standards

the deferred tax asset that accumulated as retirement health care costs

were recognized in operating results will need to be reduced in the

period that the law is enacted, even though the changes are not

effective until future periods. This will be a one-time charge to the

income statement. A portion of the accumulated actuarial gains or losses

caused by the retiree drug subsidy will be recorded in accumulated other

comprehensive income. Exhibit 2 explains the origin of this one-time

charge incurred by companies that receive the federal subsidy without

considering the effect of the accumulated actuarial gains or losses.

Exhibit 2: Example of origin of one-time charge

Current law New law Decrease in


tax asset

and net

income due

to change

OPEB * a $1,000,000 $1,000,000


without subsidy

Subsidy (28%) b $ 280,000 $ 280,000

Benefit c = a-b $ 720,000 $ 720,000

obligation with


Deductible a $1,000,000 $ 720,000 c



Assumed tax d 35% 35%


Deferred tax a x d $ 350,000 $ 252,000 c x d $98,000


* Other post-employment benefit (OPEB) obligation includes a liability

for both the prescription drug benefit and other benefits.

Exhibit 2 assumes there are no other benefits.

The income statement impact is the tax treatment of the difference

in the retirement benefit obligation for prescription drug coverage with

and without the tax-free subsidy. Companies will record the difference

as a discrete event in the interim period, which for most companies (3)

is the period ending on or after March 30, 2010. For companies that have

a valuation allowance against their deferred tax assets, the new law

will have no impact on their financial statements.

Impact in Year 2013

Beginning in 2013, an employer’s income tax deduction for the

costs of providing Medicare Part D equivalent prescription drug benefits

to retirees will be reduced by the amount of the federal subsidy. The

government offered the subsidies so that more companies would continue

to offer coverage to retirees and keep them off government-funded

Medicare Part D. Many observers have commented that this could

significantly increase government health care costs because companies

may be compelled to drop or curtail current benefit levels.

(1) Patient Protection and Affordable Care Act, P.L. 111-148.

(2) Health Care and Education Reconciliation Act of 2010, P.L.


(3) Due to the difference in the enactment dates of the Patient

Protection and Affordable Care Act (March 23, 2010) and the Health Care

and Education Reconciliation Act (March 30, 2010), companies with

periods ending between the two dates technically are required to report

the change in two periods. However, the SEC has indicated that it will

not object to registrant companies with period end dates falling between

March 23 and March 30 to report the change in the period ending on or

after March 23, 2010 (FASB Accounting Standards Update No. 2010-12,

Accounting for Certain Tax Effects of the 2010 Health Care Reform Acts,

adding ASC [paragraph]740-10-S99-4, SEC Staff Announcement,

“Accounting for the Health Care and Education Reconciliation Act of

2010 and the Patient Protection and Affordable Care Act” (April



Rachel Yin is a senior manager with Amper, Politziner & Mattia,

LLP, in Edison, NJ. For more information about this article, contact Ms.

Yin at yin@amper.com.

By: Rachel Yin, CPA

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