Part III. Administrative, Procedural, and Miscellaneous

Application of Market Reform and other Provisions of the Affordable Care Act to HRAs, Health FSAs, and Certain other Employer Healthcare Arrangements

Notice 2013–54

I. PURPOSE AND OVERVIEW

This notice provides guidance on the application of certain provisions of the Affordable Care Act ¹ to the following types of arrangements: (1) health reimbursement arrangements (HRAs), including HRAs integrated with a group health plan; (2) group health plans under which an employer reimburses an employee for some or all of the premium expenses incurred for an individual health insurance policy, such as a reimbursement arrangement described in Revenue Ruling 61–146, 1961–2 C.B. 25, or arrangements under which the employer uses its funds to directly pay the premium for an individual health insurance policy covering the employee (collectively, an employer payment plan); and (3) certain health flexible spending arrangements (health FSAs). This notice also provides guidance on section 125(f)(3) of the Internal Revenue Code (Code) and on employee assistance programs or EAPs.

The Departments of the Treasury (Treasury Department), Health and Human Services (HHS), and Labor (DOL) (collectively, the Departments) are continuing to work together to develop coordinated regulations and other administrative guidance to assist stakeholders with implementation of the Affordable Care Act. The guidance in this notice is being issued in substantially identical form by DOL, and guidance is being issued by HHS to reflect that HHS concurs in the application of the laws under its jurisdiction as set forth in this notice.

II. BACKGROUND

A. Health Reimbursement Arrangements

An HRA is an arrangement that is funded solely by an employer and that reimburses an employee for medical care expenses (as defined under Code § 213(d)) incurred by the employee, or his spouse, dependents, and any children who, as of the end of the taxable year, have not attained age 27, up to a maximum dollar amount for a coverage period. IRS Notice 2002–45, 2002–02 C.B. 93; Revenue Ruling 2002–41, 2002–2 C.B. 75. This reimbursement is excludable from the employee’s income. Amounts that remain at the end of the year generally can be used to reimburse expenses incurred in later years. HRAs generally are considered to be group health plans within the meaning of Code § 9832(a), § 733(a) of the Employee Retirement Income Security Act of 1974 (ERISA), and § 2791(a) of the Public Health Service Act (PHS Act) and are subject to the rules applicable to group health plans.

B. Employer Payment Plans

Revenue Ruling 61–146 holds that if an employer reimburses an employee’s substantiated premiums for non-employer sponsored hospital and medical insurance, the payments are excluded from the employee’s gross income under Code § 106. This exclusion also applies if the employer pays the premiums directly to the insurance company. An employer payment plan, as the term is used in this notice, does not include an employer-sponsored arrangement under which an employee may choose either cash or an after-tax amount to be applied toward health coverage. Individual employers may establish payroll practices of forwarding post-tax employee wages to a health insurance issuer at the direction of an employee without establishing a group health plan, if the standards of the DOL’s regulation at 29 C.F.R. § 2510.3–1(j) are met.

C. Health Flexible Spending Arrangements (Health FSAs)

In general, a health FSA is a benefit designed to reimburse employees for medical care expenses (as defined in Code § 213(d), other than premiums) incurred by the employee, or the employee’s spouse, dependents, and any children who, as of the end of the taxable year, have not attained age 27. See Employee Benefits—Cafeteria Plans, 72 Fed. Reg. 43938, 43957 (August 6, 2007) (proposed regulations; to be codified, in part, once final, at 26 C.F.R. § 1.125–5); Code §§ 105(b) and 106(f). Contributions to a health FSA offered through a cafeteria plan satisfying the requirements of Code § 125 (a Code § 125 plan) do not result in gross income to the employee. Code § 125(a). While employees electing coverage under a health FSA typically also elect to enter into a salary reduction agreement, employers may provide additional health FSA benefits in excess of the salary reduction amount. See Employee Benefits—Cafeteria Plans, 72 Fed. Reg. 43938, 43955–43957 (August 6, 2007) (proposed regulations; to be codified, in part, once final, at 26 C.F.R. §§ 1.125–1(r), 1.125–5(b)). For plan years beginning after December 31, 2012, the amount of the salary reduction is limited by Code § 125(i) to $2,500 (indexed annually for plan years beginning after December 31, 2013). See IRS Notice 2012–40, 2012–26 I.R.B. 1046, for more information about the application of the limitation. Additional employer contributions are not limited by Code § 125(i).

The Code, ERISA, and the PHS Act impose various requirements on group health plans, but certain of these requirements do not apply to a group health plan in relation to its provision of excepted benefits. Code § 9831(b), ERISA § 732(b), PHS Act §§ 2722(b) and 2763. Although a health FSA is a group health plan within the meaning of Code § 9832(a), ERISA § 733(a), and PHS Act § 2791(a), a health FSA may be considered to provide only excepted benefits if other group health plan coverage not limited to excepted

1 The “Affordable Care Act” refers to the Patient Protection and Affordable Care Act (enacted March 23, 2010, Pub. L. No. 111–148) (ACA), as amended by the Health Care and Education Reconciliation Act of 2010 (enacted March 30, 2010, Pub. L. No. 111–152), and as further amended by the Department of Defense and Full-Year Continuing Appropriations Act, 2011 (enacted April 15, 2011, Pub. L. No. 112–10).

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benefits is made available for the year to employees by the employer, but only if the arrangement is structured so that the maximum benefit payable to any participant cannot exceed two times the participant’s salary reduction election for the arrangement for the year (or, if greater, cannot exceed $500 plus the amount of the participant’s salary reduction election). 26 C.F.R. § 54.9831–1(c)(3)(v), 29 C.F.R. § 2590.732(c)(3)(v), and 45 C.F.R. § 146.145(c)(3)(v).

D. Affordable Care Act Guidance

1. Market Reforms — In General

The Affordable Care Act contains certain market reforms that apply to group health plans (the market reforms). ² In accordance with Code § 9831(a)(2) and ERISA § 732(a), the market reforms do not apply to a group health plan that has fewer than two participants who are current employees on the first day of the plan year, and, in accordance with Code § 9831(b), ERISA § 732(b), and PHS Act §§ 2722(b) and 2763, the market reforms also do not apply to a group health plan in relation to its provision of excepted benefits described in Code § 9832(c), ERISA § 733(c) and PHS Act § 2791(c). ³ Excepted benefits include, among other things, accident-only coverage, disability income, certain limited-scope dental and vision benefits, certain long-term care benefits, and certain health FSAs.

The market reforms specifically addressed in this notice are: ⁴

(a) PHS Act § 2711 which provides that a group health plan (or a health insurance issuer offering group health insurance coverage) may not establish any annual limit on the dollar amount of benefits for any individual—this rule does not prevent a group health plan, or a health insurance is

suer offering group health insurance coverage, from placing an annual limit, with respect to any individual, on specific covered benefits that are not essential health benefits ⁵ to the extent that such limits are otherwise permitted under applicable law (the annual dollar limit prohibition); and

(b) PHS Act § 2713 which requires non-grandfathered group health plans (or health insurance issuers offering group health insurance plans) to provide certain preventive services without imposing any cost-sharing requirements for these services (the preventive services requirements).

2. Prior Guidance on the Application of the Market Reforms to HRAs

The preamble to the interim final regulations implementing the annual dollar limit prohibition states that if an HRA is integrated with other coverage as part of a group health plan and the other coverage alone would comply with the annual dollar limit prohibition, the fact that benefits under the HRA by itself are limited does not fail to comply with the annual dollar limit prohibition because the combined benefit satisfies the requirements. Further, the preamble states that in the case of a standalone HRA that is limited to retirees, the exemption from the requirements of the Code and ERISA relating to the Affordable Care Act for plans with fewer than two current employees means that the retiree-only HRA is not subject to the annual dollar limit prohibition. 75 Fed. Reg. 37188, 37190–37191 (June 28, 2010). On January 24, 2013, the Departments issued FAQs that address the application of the annual dollar limit prohibition to certain HRA arrangements (HRA FAQs). ⁶ In the HRA FAQs, the Departments state that an HRA is not integrated with primary health coverage offered by an employer

unless, under the terms of the HRA, the HRA is available only to employees who are covered by primary group health plan coverage that is provided by the employer and that meets the annual dollar limit prohibition. Further, the HRA FAQs indicate that the Departments intend to issue guidance providing that:

(a) for purposes of the annual dollar limit prohibition, an employer-sponsored HRA cannot be integrated with individual market coverage or with individual policies provided under an employer payment plan, and, therefore, an HRA used to purchase coverage on the individual market under these arrangements will fail to comply with the annual dollar limit prohibition; and

(b) an employer-sponsored HRA may be treated as integrated with other coverage only if the employee receiving the HRA is actually enrolled in the coverage, and any HRA that credits additional amounts to an individual, when the individual is not enrolled in primary coverage meeting the annual dollar limit prohibition provided by the employer, will fail to comply with the annual dollar limit prohibition. The HRA FAQs also state that the Departments anticipate that future guidance will provide that, whether or not an HRA is integrated with other group health plan coverage, unused amounts credited before January 1, 2014 consisting of amounts credited before January 1, 2013, and amounts that are credited in 2013 under the terms of an HRA as in effect on January 1, 2013, may be used after December 31, 2013 to reimburse medical expenses in accordance with those terms without causing the HRA to fail to comply with the annual dollar limit prohibition. If the HRA terms in effect on January 1, 2013 did not prescribe a set amount or amounts to be credited during 2013 or the timing for

2 Section 1001 of the ACA added new PHS Act §§ 2711–2719. Section 1563 of the ACA (as amended by ACA § 10107(b)) added Code § 9815(a) and ERISA § 715(a) to incorporate the provisions of part A of title XXVII of the PHS Act into the Code and ERISA, and to make them applicable to group health plans and health insurance issuers providing health insurance coverage in connection with group health plans. The PHS Act sections incorporated by these references are sections 2701 through 2728. Accordingly, these referenced PHS Act sections ( i.e., the market reforms) are subject to shared interpretive jurisdiction by the Departments.

3 See the preamble to the Interim Final Rules for Group Health Plans and Health Insurance Coverage Relating to Status as a Grandfathered Health Plan Under the Patient Protection and Affordable Care Act, 75 Fed. Reg. 34538, 34539 (June 17, 2010). See also Affordable Care Act Implementation FAQs Part III, Question 1, available at http://www.dol.gov/ebsa/faqs/faq- aca3.html and at http://www.cms.gov/CCIIO/Resources/Fact-Sheets-and-FAQs/aca_implementation_faqs3.html.

4 The Departments previously addressed HRAs and the requirements under PHS Act § 2715 (summary of benefits and coverage and uniform glossary). See 77 Fed. Reg. 8668, 8670–8671 (February 14, 2012); see also Affordable Care Act Implementation FAQs Part VIII, Question 6, available at http://www.dol.gov/ebsa/faqs/faq-aca8.html and at http://www.cms.gov/CCIIO/Resources/Fact-Sheets-and-FAQs/aca_implementation_faqs8.html and see page 1 of the Instruction Guide for Group Coverage, available at http://www.dol.gov/ebsa/pdf/SBCInstructionsGroup.pdf.

5 See ACA § 1302(b) for the definition of “essential health benefits”.

6 See Affordable Care Act Implementation FAQs Part XI, available at http://www.dol.gov/ebsa/faqs/faq-aca11.html and at http://www.cms.gov/CCIIO/Resources/Fact-Sheets-and- FAQs/aca_implementation_faqs11.html.

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burses employees for an employee’s substantiated individual insurance policy premiums must satisfy the market reforms for group health plans. However the employer payment plan will fail to comply with the annual dollar limit prohibition because (1) an employer payment plan is considered to impose an annual limit up to the cost of the individual market coverage purchased through the arrangement, and (2) an employer payment plan cannot be integrated with any individual health insurance policy purchased under the arrangement. Question 2 : How do the preventive services requirements apply to an HRA that is integrated with a group health plan? Answer 2 : Similar to the analysis of the annual dollar limit prohibition, an HRA that is integrated with a group health plan will comply with the preventive services requirements if the group health plan with which the HRA is integrated complies with the preventive services requirements. Question 3 : The HRA FAQs provide that an employer-sponsored HRA cannot be integrated with individual market coverage, and, therefore, an HRA used to purchase coverage on the individual market will fail to comply with the annual dollar limit prohibition. May a group health plan, including an HRA, used to purchase coverage on the individual market be integrated with that individual market coverage for purposes of the preventive services requirements? Answer 3 : No. A group health plan, including an HRA, used to purchase coverage on the individual market is not integrated with that individual market coverage for purposes of the preventive services requirements. For example, a group health plan, such as an employer payment plan, that reimburses employees for an employee’s substantiated individual insurance policy premiums must satisfy the market reforms for group health plans. However, the employer payment plan will fail to comply with the preventive services requirements because (1) an employer payment plan does not provide preventive services without cost-sharing in all instances, and (2) an employer payment plan cannot be integrated with any individual health insurance policy purchased under the arrangement. Question 4 : Under what circumstances will an HRA be integrated with another

crediting such amounts, then the amounts credited may not exceed those credited for 2012 and may not be credited at a faster rate than the rate that applied during 2012.

3. Prior Guidance on the Application of the Market Reforms to Health FSAs

Under the interim final rules implementing the annual dollar limit prohibition, a health FSA, as defined in Code § 106(c)(2), is not subject to the annual dollar limit prohibition. See 26 C.F.R. § 54.9815–2711T(a)(2)(ii), 29 C.F.R. § 2590.715–2711(a)(2)(ii), and 45 C.F.R. § 147.126(a)(2)(ii). See Q&A 8 of this notice limiting the exemption from the annual dollar limit prohibition to a health FSA that is offered through a Code § 125 plan.

4. Prior Guidance on the Application of Code §§ 36B and 5000A

Section 36B of the Code allows a premium tax credit to certain taxpayers who enroll (or whose family members enroll) in a qualified health plan (QHP) through an Affordable Insurance Exchange (referred to in this notice as an Exchange, and also referred to in other published guidance as a Marketplace). The credit subsidizes a portion of the premiums for the QHP. In general, the premium tax credit may not subsidize coverage for an individual who is eligible for other minimum essential coverage. If the minimum essential coverage is eligible employer-sponsored coverage, however, an individual is treated as eligible for that coverage only if the coverage is affordable and provides minimum value or if the individual enrolls in the coverage.

Coverage provided through Code § 125 plans, employer payment plans, health FSAs, and HRAs are eligible employer-sponsored plans and, therefore, are minimum essential coverage, unless the coverage consists solely of excepted benefits. See Code § 5000A(f)(2) and Treas. Reg. § 1.5000A–2, 78 Fed. Reg. 53646, 53658 (August 30, 2013). Amounts newly made available for the current plan year under an HRA that is integrated with an eligible employer-sponsored plan and that an employee may use to pay premiums are counted for purposes of determining affordability of an eligible employer-sponsored plan under Code

§ 36B. See Minimum Value of Eligible Employer-Sponsored Plans and Other Rules Regarding the Health Insurance Premium Tax Credit, 78 Fed. Reg. 25909, 25914 (May 3, 2013) (proposed regulations; to be codified, in part, once final, at 26 C.F.R. § 1.36B–2(c)(3)(v)(A)(5)). Amounts newly made available for the current plan year under an HRA that is integrated with an eligible employer-sponsored plan are counted toward the plan’s minimum value percentage for that plan year if the amounts may be used only to reduce cost-sharing for covered medical expenses and the amount counted for this purpose is the amount of expected spending for health care costs in a benefit year. See Minimum Value of Eligible Employer-Sponsored Plans and Other Rules Regarding the Health Insurance Premium Tax Credit, 78 Fed. Reg. 25909, 25916 (May 3, 2013) (proposed regulations; to be codified, in part, once final, at 26 C.F.R. § 1.36B–6(c)(4), (c)(5)). See Q&A 11 of this notice for more explanation of the application of these rules to HRAs and other arrangements.

III. GUIDANCE

A. Guidance on HRAs and Certain other Employer Healthcare Arrangements, Health FSAs, and Employee Assistance Programs or EAPs Under the Joint Jurisdiction of the Departments

1. Application of the Market Reform Provisions to HRAs and Certain other Employer Healthcare Arrangements

Question 1 : The HRA FAQs provide that an employer-sponsored HRA cannot be integrated with individual market coverage, and, therefore, an HRA used to purchase coverage on the individual market will fail to comply with the annual dollar limit prohibition. May other types of group health plans used to purchase coverage on the individual market be integrated with that individual market coverage for purposes of the annual dollar limit prohibition? Answer 1 : No. A group health plan, including an HRA, used to purchase coverage on the individual market is not integrated with that individual market coverage for purposes of the annual dollar limit prohibition. For example, a group health plan, such as an employer payment plan, that reim

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ductibles, and premiums under Employer A’s group health plan or other non-HRA group coverage (as applicable), as well as medical care (as defined under Code § 213(d)) that does not constitute essential health benefits. Under the terms of Employer A’s HRA, an employee is permitted to permanently opt out of and waive future reimbursements from the HRA both upon termination of employment and at least annually.

Employer A employs Employee X. Employee X chooses to enroll in non-HRA group coverage sponsored by Employer B, the employer of Employee X’s spouse, instead of enrolling in Employer A’s group health plan. Employer A and Employer B are not treated as a single employer under Code § 414(b), (c), (m), or (o). Employee X attests to Employer A that he is covered by Employer B’s non-HRA group coverage. When seeking reimbursement under Employer A’s HRA, Employee X attests that the expense for which he seeks reimbursement is a co-payment, co-insurance, deductible, or premium under Employer B’s non-HRA group coverage or medical care (as defined under Code § 213(d)) that is not an essential health benefit.

Conclusion . Employer A’s HRA is integrated with Employer B’s non-HRA group coverage for purposes of the annual dollar limit prohibition and the preventive services requirements.

Example (Integration Method: Minimum Value Required)

Facts . Employer A sponsors a group health plan that provides minimum value and an HRA for its employees. Employer A’s HRA is available only to employees who are either enrolled in its group health plan or in non-HRA MV group coverage through a family member. Under the terms of Employer A’s HRA, an employee is permitted to permanently opt out of and waive future reimbursements from the HRA both upon termination of employment and at least annually.

Employer A employs Employee X. Employee X chooses to enroll in non-HRA MV group coverage sponsored by Employer B, the employer of Employee X’s spouse, instead of enrolling in Employer A’s group health plan. Employer A and Employer B are not treated as a single employer under Code § 414(b), (c), (m), or

group health plan for purposes of the annual dollar limit prohibition and the preventive services requirements? Answer 4 : An HRA will be integrated with a group health plan for purposes of the annual dollar limit prohibition and the preventive services requirements if it meets the requirements under either of the integration methods described below. Pursuant to this notice, under both methods, integration does not require that the HRA and the coverage with which it is integrated share the same plan sponsor, the same plan document or governing instruments, or file a single Form 5500, if applicable.

Integration Method: Minimum Value Not Required

An HRA is integrated with another group health plan for purposes of the annual dollar limit prohibition and the preventive services requirements if (1) the employer offers a group health plan (other than the HRA) to the employee that does not consist solely of excepted benefits; (2) the employee receiving the HRA is actually enrolled in a group health plan (other than the HRA) that does not consist solely of excepted benefits, regardless of whether the employer sponsors the plan (non-HRA group coverage); (3) the HRA is available only to employees who are enrolled in non-HRA group coverage, regardless of whether the employer sponsors the non-HRA group coverage (for example, the HRA may be offered only to employees who do not enroll in the employer’s group health plan but are enrolled in other non-HRA group coverage, such as a plan maintained by the employer of the employee’s spouse); (4) the HRA is limited to reimbursement of one or more of the following—co-payments, co-insurance, deductibles, and premiums under the non-HRA group coverage, as well as medical care (as defined under Code § 213(d)) that does not constitute essential health benefits; and (5) under the terms of the HRA, an employee (or former employee) is permitted to permanently opt out of and waive future reimbursements from the HRA at least annually and, upon termination of employment, either the remaining amounts in the HRA are forfeited or the employee is permitted to permanently opt out of and waive fu

ture reimbursements from the HRA. This opt-out feature is required because the benefits provided by the HRA generally will constitute minimum essential coverage under Code § 5000A (see Q&A 10 of this notice) and will therefore preclude the individual from claiming a Code § 36B premium tax credit.

Integration Method: Minimum Value Required

Alternatively, an HRA that is not limited with respect to reimbursements as required under the integration method expressed above is integrated with a group health plan for purposes of the annual dollar limit prohibition and the preventive services requirements if (1) the employer offers a group health plan to the employee that provides minimum value pursuant to Code § 36B(c)(2)(C)(ii); (2) the employee receiving the HRA is actually enrolled in a group health plan that provides minimum value pursuant to Code § 36B(c)(2)(C)(ii), regardless of whether the employer sponsors the plan (non-HRA MV group coverage); (3) the HRA is available only to employees who are actually enrolled in non-HRA MV group coverage, regardless of whether the employer sponsors the nonHRA MV group coverage (for example, the HRA may be offered only to employees who do not enroll in the employer’s group health plan but are enrolled in other non-HRA MV group coverage, such as a plan maintained by an employer of the employee’s spouse); and (4) under the terms of the HRA, an employee (or former employee) is permitted to permanently opt out of and waive future reimbursements from the HRA at least annually, and, upon termination of employment, either the remaining amounts in the HRA are forfeited or the employee is permitted to permanently opt out of and waive future reimbursements from the HRA.

Example (Integration Method: Minimum Value Not Required)

Facts . Employer A sponsors a group health plan and an HRA for its employees. Employer A’s HRA is available only to employees who are either enrolled in its group health plan or in non-HRA group coverage through a family member. Employer A’s HRA is limited to reimbursement of co-payments, co-insurance, de

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(o). Employee X attests to Employer A that he is covered by Employer B’s nonHRA MV group coverage and that the coverage provides minimum value.

Conclusion . Employer A’s HRA is integrated with Employer B’s non-HRA MV group coverage for purposes of the annual dollar limit prohibition and the preventive services requirements. Question 5 : May an employee who is covered by both an HRA and a group health plan with which the HRA is integrated, and who then ceases to be covered under the group health plan that is integrated with the HRA, be permitted to use the amounts remaining in the HRA? Answer 5 : Whether or not an HRA is integrated with other group health plan coverage, unused amounts that were credited to an HRA while the HRA was integrated with other group health plan coverage may be used to reimburse medical expenses in accordance with the terms of the HRA after an employee ceases to be covered by other integrated group health plan coverage without causing the HRA to fail to comply with the market reforms. Note that coverage provided through an HRA, other than coverage consisting solely of excepted benefits, is an eligible employersponsored plan and, therefore, minimum essential coverage under Code § 5000A. Question 6 : Does an HRA impose an annual limit in violation of the annual dollar limit prohibition if the group health plan with which an HRA is integrated does not cover a category of essential health benefits and the HRA is available to cover that category of essential health benefits (but limits the coverage to the HRA’s maximum benefit)? Answer 6 : In general, an HRA integrated with a group health plan imposes an annual limit in violation of the annual dollar limit prohibition if the group health plan with which the HRA is integrated does not cover a category of essential health benefits and the HRA is available to cover that category of essential health benefits and limits the coverage to the HRA’s maximum benefit. This situation should not arise for

a group health plan funded through nongrandfathered health insurance coverage in the small group market, as small group market plans must cover all categories of essential health benefits, with the exception of pediatric dental benefits, if pediatric dental benefits are available through a stand-alone dental plan offered in accordance with 45 C.F.R. § 155.1065. ⁷ However, under the integration method available for plans that provide minimum value described under Q&A 4 of this notice, if a group health plan provides minimum value under Code § 36B(c)(2)(C)(ii), an HRA integrated with that group health plan will not be treated as imposing an annual limit in violation of the annual dollar limit prohibition, even if that group health plan does not cover a category of essential health benefits and the HRA is available to cover that category of essential health benefits and limits the coverage to the HRA’s maximum benefit.

2. Application of the Market Reforms to Certain Health FSAs

Question 7 : How do the market reforms apply to a health FSA that does not qualify as excepted benefits? Answer 7 : The market reforms do not apply to a group health plan in relation to its provision of benefits that are excepted benefits. Health FSAs are group health plans but will be considered to provide only excepted benefits if the employer also makes available group health plan coverage that is not limited to excepted benefits and the health FSA is structured so that the maximum benefit payable to any participant cannot exceed two times the participant’s salary reduction election for the health FSA for the year (or, if greater, cannot exceed $500 plus the amount of the participant’s salary reduction election). ⁸ See 26 C.F.R. § 54.9831–1(c)(3)(v), 29 C.F.R. § 2590.732(c)(3)(v), and 45 C.F.R. § 146.145(c)(3)(v). Therefore, a health FSA that is considered to provide only excepted benefits is not subject to the market reforms.

If an employer provides a health FSA that does not qualify as excepted benefits, the health FSA generally is subject to the market reforms, including the preventive services requirements. Because a health FSA that is not excepted benefits is not integrated with a group health plan, it will fail to meet the preventive services requirements. ⁹ The Departments understand that questions have arisen as to whether HRAs that are not integrated with a group health plan may be treated as a health FSA as defined in Code § 106(c)(2). Notice 2002–45, 2002–02 C.B. 93, states that, assuming that the maximum amount of reimbursement which is reasonably available to a participant under an HRA is not substantially in excess of the value of coverage under the HRA, an HRA is a health FSA as defined in Code § 106(c)(2). This statement was intended to clarify the rules limiting the payment of long-term care expenses by health FSAs. The Departments are also considering whether an HRA may be treated as a health FSA for purposes of the exclusion from the annual dollar limit prohibition. In any event, the treatment of an HRA as a health FSA that is not excepted benefits would not exempt the HRA from compliance with the other market reforms, including the preventive services requirements, which the HRA would fail to meet because the HRA would not be integrated with a group health plan. This analysis applies even if an HRA reimburses only premiums. Question 8 : The interim final regulations regarding the annual dollar limit prohibition contain an exemption for health FSAs (as defined in Code § 106(c)(2)). See 26 C.F.R. § 54.9815–2711T(a)(2)(ii), 29 C.F.R. § 2590.715–2711(a)(2)(ii), and 45 C.F.R. § 147.126(a)(2)(ii). Does this exemption apply to a health FSA that is not offered through a Code § 125 plan? Answer 8 : No. The Departments intended for this exemption from the annual dollar limit prohibition to apply only to a health FSA that is offered through a Code § 125 plan and thus subject to a separate annual

7 Small group market plans will not be considered to fail to meet qualified health plan certification standards based solely on the fact that they exclude coverage of pediatric dental benefits that are otherwise required under ACA § 1302(b)(1)(J) where a stand-alone dental plan is also available. See ACA § 1302(b)(4)(F) and Question 5, CMS QHP Dental Frequently Asked Questions, May 31, 2013, https://www.regtap.info/uploads/library/PM_QHP_DentalFAQsV2_5cr_060313.pdf.

8 An HRA is paid for solely by the employer and not provided pursuant to salary reduction election or otherwise under a Code § 125 plan. IRS Notice 2002–45, 2002–02 C.B. 93.

9 Under the interim final rules implementing the annual dollar limit prohibition, a health FSA is not subject to the annual dollar limit prohibition, regardless of whether the health FSA is considered to provide only excepted benefits. See 26 C.F.R. § 54.9815–2711T(a)(2)(ii), 29 C.F.R. § 2590.715–2711(a)(2)(ii), and 45 C.F.R. § 147.126(a)(2)(ii). See Q&A 8 of this notice regarding the restriction of the exemption from the annual dollar limit prohibition to a health FSA that is offered through a Code § 125 plan.

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limitation under Code § 125(i). There is no similar limitation on a health FSA that is not part of a Code § 125 plan, and thus no basis to imply that it is not subject to the annual dollar limit prohibition. To clarify this issue, the Departments intend to amend the annual dollar limit prohibition regulations to conform to this Q&A 8 retroactively applicable as of September 13, 2013. As a result, a health FSA that is not offered through a Code § 125 plan is subject to the annual dollar limit prohibition and will fail to comply with the annual dollar limit prohibition.

3. Guidance on Employee Assistance Programs

Question 9 : Are benefits under an employee assistance program or EAP considered to be excepted benefits? Answer 9 : The Departments intend to amend 26 C.F.R. § 54.9831–1(c), 29 C.F.R. § 2590.732(c), and 45 C.F.R. § 146.145(c) to provide that benefits under an employee assistance program or EAP are considered to be excepted benefits, but only if the program does not provide significant benefits in the nature of medical care or treatment. Excepted benefits are not subject to the market reforms and are not minimum essential coverage under Code § 5000A. Until rulemaking is finalized, through at least 2014, the Departments will consider an employee assistance program or EAP to constitute excepted benefits only if the employee assistance program or EAP does not provide significant benefits in the nature of medical care or treatment. For this purpose, employers may use a reasonable, good faith interpretation of whether an employee assistance program or EAP provides significant benefits in the nature of medical care or treatment.

B. Guidance Under the Sole Jurisdiction of the Treasury Department and the IRS on HRAs and Code § 125 Plans

Question 10 : Is an HRA that has fewer than two participants who are current employees on the first day of the plan year (for example, a retiree-only HRA) minimum essential coverage for purposes of Code §§ 5000A and 36B?

Answer 10 : Yes. The Treasury Department and the IRS understand that some employers are considering making amounts available under standalone retiree-only HRAs to retired employees so that the employer would be able to reimburse medical expenses, including the purchase of an individual health insurance policy. For this purpose, the standalone HRA would constitute an eligible employer-sponsored plan under Code § 5000A(f)(2), and therefore the coverage would constitute minimum essential coverage under Code § 5000A, for a month in which funds are retained in the HRA (including amounts retained in the HRA during periods of time after the employer has ceased making contributions). As a result, a retiree covered by a standalone HRA for any month will not be eligible for a Code § 36B premium tax credit for that month. Note that unlike other HRAs, the market reforms generally do not apply to a retiree-only HRA and therefore would not impact an employer’s choice to offer a retiree-only HRA. ¹⁰ Question 11 : How are amounts newly made available under an HRA treated for purposes of Code § 36B? Answer 11 : An individual is not eligible for individual coverage subsidized by the Code § 36B premium tax credit if the individual is eligible for employer-sponsored coverage that is affordable (premiums for self-only coverage do not exceed 9.5 percent of household income) and that provides minimum value (the plan’s share of costs is at least 60 percent). If an employer offers an employee both a primary eligible employer-sponsored plan and an HRA that would be integrated with the primary plan if the employee enrolled in the plan, amounts newly made available for the current plan year under the HRA may be considered in determining whether the arrangement satisfies either the affordability requirement or the minimum value requirement, but not both. Amounts newly made available for the current plan year under the HRA that an employee may use only to reduce cost-sharing for covered medical expenses under the primary employer-sponsored plan count only toward the minimum value requirement. See Minimum Value of Eligible Em

ployer-Sponsored Plans and Other Rules Regarding the Health Insurance Premium Tax Credit, 78 Fed. Reg. 25909, 25916 (May 3, 2013) (proposed regulations, to be codified, in part, once final, at 26 C.F.R. § 1.36B–6(c)(4), (c)(5)). Amounts newly made available for the current plan year under the HRA that an employee may use to pay premiums or to pay both premiums and cost-sharing under the primary employer-sponsored plan count only toward the affordability requirement. See Minimum Value of Eligible Employer-Sponsored Plans and Other Rules Regarding the Health Insurance Premium Tax Credit, 78 Fed. Reg. 25909, 25914 (May 3, 2013) (proposed regulations; to be codified, in part, once final, at 26 C.F.R. § 1.36B–2(c)(3)(v)(A)(5)). Even if an HRA is integrated with a plan offered by another employer for purposes of the annual dollar limit prohibition and the preventive services requirements (see Q&A 4 of this notice), the HRA does not count toward the affordability or minimum value requirement of the plan offered by the other employer. Additionally, if an employer offers an HRA on the condition that the employee does not enroll in nonHRA coverage offered by the employer and instead enrolls in non-HRA coverage from a different source, the HRA does not count in determining whether the employer’s non-HRA coverage satisfies either the affordability or minimum value requirement. For purposes of the Code § 36B premium tax credit, the requirements of affordability and minimum value do not apply if an employee enrolls in any employer-sponsored minimum essential coverage, including coverage provided through a Code § 125 plan, an employer payment plan, a health FSA, or an HRA, but only if the coverage offered does not consist solely of excepted benefits. See 26 C.F.R. § 1.36B–2(c)(3)(vii). If an employee enrolls in any employer-sponsored minimum essential coverage, the employee is ineligible for individual coverage subsidized by the Code § 36B premium tax credit. Question 12 : Section 125(f)(3) of the Code, effective for taxable years beginning after December 31, 2013, provides that the term “qualified benefit” does not

10 See the preamble to the Interim Final Rules for Group Health Plans and Health Insurance Coverage Relating to Status as a Grandfathered Health Plan Under the Patient Protection and Affordable Care Act, 75 Fed. Reg. 34538, 34539 (June 17, 2010).

2013–40 I.R.B. 292 September 30, 2013

include any QHP (as defined in ACA § 1301(a)) offered through an Exchange. ¹¹ This prohibits an employer from providing a QHP offered through an Exchange as a benefit under the employer’s Code § 125 plan. Some states have already established Exchanges and employers in those states may have Code § 125 plan provisions that allow employees to enroll in health coverage through the Exchange as a benefit under a Code § 125 plan. If the employer’s Code § 125 plan operates on a plan year other than a calendar year, may the employer continue to provide the Exchange coverage through a Code § 125 plan after December 31, 2013? Answer 12 : For Code § 125 plans that as of September 13, 2013 operate on a plan year other than a calendar year, the restriction under Code § 125(f)(3) will not apply before the first plan year of the Code § 125 plan that begins after December 31, 2013. Thus, for the remainder of a plan year beginning in 2013, a QHP provided through an Exchange as a benefit under a Code § 125 plan will not result in all benefits provided under the Code § 125 plan being taxable. However, individuals may not claim a Code § 36B premium tax credit for any month in which the individual was covered by a QHP provided through an Exchange as a benefit under a Code § 125 plan.

IV. APPLICABILITY DATE AND RELIANCE PERIOD

This notice applies for plan years beginning on and after January 1, 2014, but taxpayers may apply the guidance provided in this notice for all prior periods. If legislative action by any State, local, or Indian tribal government entity is necessary to modify the terms of a pre-existing HRA, a health FSA that does not qualify as excepted benefits, an employer payment plan, or other similar arrangement, sponsored by any State, local, or Indian tribal government entity, as an employer, to avoid a failure to comply with the market reforms (including action to terminate such arrangement) and such action may only be taken by a State, local, or Indian tribal government entity legislative body, the applicability date of the portions of this notice under which such arrangement

would otherwise fail to comply with the market reforms is extended to the later of (1) January 1, 2014, or (2) the first day of the first plan year following the first close of a regular legislative session of the applicable legislative body after September 13, 2013.

V. FOR FURTHER INFORMATION

The Departments have coordinated on the guidance and other information contained in this notice. The guidance in this notice is being issued in substantially identical form by DOL, and guidance is being issued by HHS to reflect that HHS concurs in the application of the laws under its jurisdiction as set forth in this notice. Questions concerning the information contained in this notice may be directed to the IRS at 202–927–9639, the DOL’s Office of Health Plan Standards and Compliance Assistance at 202–693–8335, or HHS at 410–786–1565. Additional information for employers regarding the Affordable Care Act is available at www.health- care.gov, www.dol.gov/ebsa/healthreform, and at www.business.usa.gov .

Preventive Health Services Required under Public Health Service Act Section 2713 and Preventive Care for Purposes of Health Savings Accounts

Notice 2013–57

PURPOSE

This notice clarifies that a health plan will not fail to qualify as a high deductible health plan (HDHP) under section 223(c)(2) of the Internal Revenue Code (Code) merely because it provides without a deductible the preventive health services required under section 2713 of the Public Health Service Act (PHS Act) to be provided by a group health plan or a health insurance issuer offering group or individual health insurance coverage.

BACKGROUND

Section 223 of the Code permits eligible individuals to establish Health Savings

Accounts (HSAs). Among the requirements for an individual to qualify as an eligible individual under section 223(c)(1) (and thus to be eligible to make, or for the individual’s employer to make on their behalf, tax-favored contributions to a HSA) is that the individual be covered under a HDHP and have no disqualifying health coverage. A HDHP is a health plan that satisfies certain requirements with respect to minimum deductibles and maximum out-of-pocket expenses.

Generally, under section 223(c)(2)(A), a HDHP may not provide benefits for any year until the minimum deductible for that year is satisfied. However, section 223(c)(2)(C) provides a safe harbor for the absence of a deductible for preventive care. Section 223(c)(2)(C) states that “[a] plan shall not fail to be treated as a high deductible health plan by reason of failing to have a deductible for preventive care (within the meaning of section 1871 of the Social Security Act, except as otherwise provided by the Secretary).” A HDHP may therefore provide preventive care benefits without a deductible or, subject to any applicable constraints under section 2713 of the PHS Act, with a deductible below the minimum annual deductible otherwise required by section 223(c)(2)(A).

Notice 2004–23 (2004–15 I.R.B. 725), and Q&A 26 and 27 of Notice 2004–50 (2005–33 I.R.B. 196) provide guidance on preventive care benefits allowed to be provided by a HDHP without satisfying the minimum deductible requirement of section 223(c)(2)(A).

Section 1001 of the Affordable Care Act added section 2713 to the PHS Act, requiring group health plans and health insurance issuers offering group and individual health insurance coverage to provide benefits for certain preventive health services without imposing cost-sharing requirements. (42 U.S.C. 300gg–13). The Affordable Care Act also added section 715(a)(1) to the Employee Retirement Income Security Act of 1974 (ERISA) and section 9815(a)(1) to the Code to incorporate the provisions of part A of title XXVII of the PHS Act, including section 2713, into ERISA and the Code. Guidance under section 2713 of the PHS Act is published jointly by the Treasury Department

11 This rule does not apply with respect to any employee if the employee’s employer is a qualified employer (as defined in ACA § 1312(f)(2)) offering the employee the opportunity to enroll through an Exchange in a qualified health plan in a group market. See Code § 125(f)(3)(B).

September 30, 2013 293 2013–40 I.R.B.

and IRS and the Departments of Labor and Health and Human Services.

Temporary regulations issued by the Treasury Department and IRS implementing the requirements of section 2713 of the PHS Act under § 54.9815–2713T (and parallel regulations issued by the Departments of Labor and HHS) were published in the Federal Register on July 19, 2010 (75 FR 41726), later supplemented by regulations published in the Federal Register on August 3, 2011 (76 FR 46621), February 15, 2012 (77 FR 8725), March 21, 2012 (77 FR 16501) and February 6, 2013 (78 FR 8456). See also Q&A–8 of FAQ Part II (October 8, 2010) and Q&A–1 of FAQ Part V (December 22, 2010), both available at http://www.dol.gov/ebsa/healthreform/.

GUIDANCE

Under this notice, preventive care for purposes of section 223(c)(2)(C) of the Code is anything that is preventive care under Notice 2004–23 and Notice 2004–50 without regard to whether it would constitute preventive care for purposes of section 2713 of the PHS Act. Preventive care for purposes of section 223(c)(2)(C) also includes services required to be provided as preventive health services by a group health plan or a health insurance issuer offering group or individual health insurance coverage under section 2713 of the PHS Act and regulations and other administrative guidance issued thereunder. Accordingly, a health plan will not fail to qualify as an HDHP under section 223(c)(2) of the Code merely because it provides without a deductible the preventive care health services required under section 2713 of the PHS Act to be provided by a group health plan or a health insurance issuer offering group or individual health insurance coverage.

EFFECT ON OTHER DOCUMENTS

This notice generally provides that any goods or services that constitute preventive care under the guidance in Notice 2004–23 and Notice 2004–50 will continue to be treated as preventive care for purposes of section 223 and clarifies that any preventive services under section 2713 of the PHS Act will also be treated as preventive care under section 223.

DRAFTING INFORMATION

The principal author of this notice is Karen Levin of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Governmental Entities), though other Treasury Department and IRS officials participated in its development. For further information on the provisions of this notice, contact Karen Levin at (202) 927–9639 (not a toll-free number.)

Update for Weighted Average Interest Rates, Yield Curves, and Segment Rates

Notice 2013–58

This notice provides guidance on the corporate bond monthly yield curve (and the corresponding spot segment rates), and the 24-month average segment rates under § 430(h)(2) of the Internal Revenue Code. In addition, this notice provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008, the 30-year Treasury weighted average rate under § 431(c)(6)(E)(ii)(I), and the minimum present value segment rates under § 417(e)(3)(D) as in effect for plan years beginning after 2007. These rates reflect certain changes implemented by the Moving Ahead for Progress in the 21st Century Act, Public Law 112–141 (MAP–21). MAP–21 provides that for purposes of § 430(h)(2), the segment rates are limited by the applicable maximum percentage or the applicable minimum percentage based on the average of segment rates over a 25 year period.

YIELD CURVE AND SEGMENT RATES

Generally, except for certain plans under sections 104 and 105 of the Pension Protection Act of 2006, § 430 of the Code specifies the minimum funding requirements that apply to single employer plans pursuant to § 412. Section 430(h)(2) specifies the interest rates that must be used to determine a plan’s target normal cost and funding target. Under this provision, present value is generally

determined using three 24-month average interest rates (“segment rates”), each of which applies to cash flows during specified periods. To the extent provided under § 430(h)(2)(C)(iv), these segment rates are adjusted by the applicable percentage of the 25-year average segment rates for the period ending September 30 of the year preceding the calendar year in which the plan year begins. However, an election may be made under § 430(h)(2)(D)(ii) to use the monthly yield curve in place of the segment rates.

Notice 2007–81, 2007–44 I.R.B. 899, provides guidelines for determining the monthly corporate bond yield curve, and the 24-month average corporate bond segment rates used to compute the target normal cost and the funding target. Pursuant to Notice 2007–81, the monthly corporate bond yield curve derived from August 2013 data is in Table I at the end of this notice. The spot first, second, and third segment rates for the month of August 2013 are, respectively, 1.36, 4.60, and 5.58. For plan years beginning on or after January 1, 2012, the 24-month average segment rates determined under § 430(h)(2)(C)(iv) must be adjusted by the applicable percentage of the corresponding 25-year average segment rates. The 25-year average segment rates for plan years beginning in 2012 and for plan years beginning in 2013 were published in Notice 2012–55, 2012–36 I.R.B. 332 and Notice 2013–11, 2013–11 I.R.B. 610, respectively. For plan years beginning in 2014, based on the segment rates applicable for October 1988 to September 2013, the 25-year averages for the period ending September 30, 2013, of the first, second, and third segment rates are 5.54, 7.02, and 7.77 percent, respectively. For plan years beginning in 2014, the applicable minimum and maximum percentages are 80 percent and 120 percent. The 24-month average corporate bond segment rates applicable for September 2013 without adjustment, and the adjusted 24-month average segment rates taking into account the applicable percentages of the corresponding 25-year average segment rates, are as follows:

2013–40 I.R.B. 294 September 30, 2013

has determined this rate as the average of the daily determinations of yield on the 30-year Treasury bond maturing in May 2043 determined each day through August 7, 2013, and the yield on the 30-year Treasury bond maturing in August 2043 determined each day for the balance of the month. The following rates were determined for plan years beginning in the month shown below.

30-YEAR TREASURY SECURITIES INTEREST RATES

Generally for plan years beginning after 2007, § 431 specifies the minimum funding requirements that apply to multiemployer plans pursuant to § 412. Section 431(c)(6)(B) specifies a minimum amount for the full-funding limitation described in section 431(c)(6)(A), based on the plan’s current liability. Section 431(c)(6)(E)(ii)(I) provides that the inter

For Plan Years

est rate used to calculate current liability for this purpose must be no more than 5 percent above and no more than 10 percent below the weighted average of the rates of interest on 30-year Treasury securities during the four-year period ending on the last day before the beginning of the plan year. Notice 88–73, 1988–2 C.B. 383, provides guidelines for determining the weighted average interest rate. The rate of interest on 30-year Treasury securities for August 2013 is 3.76 percent. The Service

30-Year Treasury Weighted

Beginning in Permissible Range

Month Year

Average 90% to 105%

September 2013 3.43 3.09 3.61

rates determined for August 2013 are as follows:

Third Segment

MINIMUM PRESENT VALUE SEGMENT RATES

In general, the applicable interest rates under § 417(e)(3)(D) are segment rates

First Segment

computed without regard to a 24-month average. Notice 2007–81 provides guidelines for determining the minimum present value segment rates. Pursuant to that notice, the minimum present value segment

Second Segment

1.36 4.60 5.58

DRAFTING INFORMATION

The principal author of this notice is Tony Montanaro of the Employee Plans,

Tax Exempt and Government Entities Division. Mr. Montanaro may be e-mailed at RetirementPlanQuestions@irs.gov .

September 30, 2013 295 2013–40 I.R.B.

Table I

Monthly Yield Curve for August 2013

Derived from August 2013 Data

Maturity Yield Maturity Yield Maturity Yield Maturity Yield Maturity Yield

2013–40 I.R.B. 296 September 30, 2013

Application of Section 179(f) for Qualified Real Property

Notice 2013–59

I. PURPOSE

This notice provides guidance with respect to issues related to the enactment of § 315(d) of the American Taxpayer Relief Act of 2012, Pub. L. No. 112–240, 126 Stat. 2313 (January 2, 2013) (ATRA), which extended the application of § 179(f) of the Internal Revenue Code from any taxable year beginning in 2010 or 2011 to any taxable year beginning in 2010, 2011, 2012, or 2013. For these years, § 179(f) expands the definition of property qualifying for § 179 to include qualified real property (as defined in § 179(f)(1) and (2)). This notice also provides allocation methodologies for determining the portion of the gain that is attributable to § 1245 property upon the sale or other disposition of qualified real property.

II. BACKGROUND

(1) In general . Section 179(a) allows a taxpayer to elect to treat the cost (or a portion of the cost) of any § 179 property as an expense for the taxable year in which the taxpayer places the property in service. Section 179(b)(1) and section 179(b)(2) prescribe a dollar limitation on the aggregate cost of § 179 property that can be treated as an expense under § 179(a). The dollar limitation is the amount under § 179(b)(1) (the § 179(b)(1) limitation), reduced (but not below zero) by the amount by which the cost of § 179 property placed in service during the taxable year exceeds the amount under § 179(b)(2) (the § 179(b)(2) limitation). Prior to the enactment of ATRA, the § 179(b)(1) limitation was $500,000 for taxable years beginning in 2010 and 2011, $125,000 for taxable years beginning in 2012, and $25,000 for taxable years beginning after 2012. The § 179(b)(2) limitation was $2,000,000 for taxable years beginning in 2010 and 2011, $500,000 for taxable years beginning in 2012, and $200,000 for taxable years beginning after 2012. ATRA changed the limitations for taxable years beginning in 2012 or 2013 to $500,000 under § 179(b)(1) and $2,000,000 under § 179(b)(2).

Section 179(b)(3)(A) provides that a taxpayer’s § 179 deduction for any taxable year, after application of the § 179(b)(1) and (2) limitations, is limited to the taxpayer’s taxable income for that taxable year that is derived from the taxpayer’s active conduct of any trade or business during that taxable year (“taxable income limitation”). Section 179(b)(3)(B) provides that the amount of any cost of § 179 property elected to be expensed in a taxable year that is disallowed as a § 179 deduction under the taxable income limitation may be carried forward for an unlimited number of years (“carryover of disallowed deduction”) and may be deducted under § 179(a) in a future taxable year subject to the same limitations.

Section 179(d)(1) defines § 179 property as meaning § 1245 property (as defined in § 1245(a)(3)) that is: (1) tangible property to which § 168 applies and that is acquired by purchase (as defined in § 179(d)(2) and § 1.179–4(c) of the Income Tax Regulations) for use in the active conduct of a trade or business; or (2) computer software described in § 179(d)(1)(A)(ii) and that is acquired by purchase for use in the active conduct of a trade or business. Section 179 property does not include any property described in § 50(b) or air conditioning or heating units.

(2) Qualified real property . If a taxpayer elects to apply § 179(f), § 179 property also includes qualified real property. Prior to the enactment of ATRA, § 179(f) applied to qualified real property placed in service in any taxable year beginning in 2010 or 2011. ATRA extended the application of § 179(f) to qualified real property placed in service in any taxable year beginning in 2010, 2011, 2012, or 2013. Qualified real property means property that is: (1) of a character subject to an allowance for depreciation; (2) acquired by purchase (as defined in §§ 179(d)(2) and 1.179–4(c)) for use in the taxpayer’s active conduct of a trade or business; (3) not described in § 50(b); and (4) not air conditioning or heating units. In addition, qualified real property must be § 1250 property that is: (1) qualified leasehold improvement property as defined in §§ 168(e)(6), 168(k)(3), and 1.168(k)–1(c); (2) certain qualified restaurant property as defined in § 168(e)(7); or (3) qualified retail improvement property as defined in § 168(e)(8).

For purposes of applying the § 179(b)(1) limitation ($500,000) for any taxable year beginning in 2010, 2011, 2012, or 2013, § 179(f)(3) provides that not more than $250,000 of the aggregate cost (as defined in §§ 179(d)(3) and 1.179–4(d)) of § 179 property that is treated as an expense under § 179(a) for the taxable year can be attributable to qualified real property. Thus, the maximum amount of qualified real property that may be expensed under § 179(a) for any taxable year beginning in 2010, 2011, 2012, or 2013 is $250,000. Prior to the enactment of ATRA, § 179(f)(4) provided that, notwithstanding § 179(b)(3)(B), a taxpayer that elected to apply § 179(f) and elected to expense under § 179(a) the cost (or a portion of the cost) of qualified real property placed in service during any taxable year beginning in 2010 or 2011 could not carryover to any taxable year beginning after 2011 the amount of any cost of such property that was disallowed as a § 179 deduction under the taxable income limitation of § 179(b)(3)(A). To the extent any disallowed § 179 deduction attributable to qualified real property for any taxable year beginning in 2010 (the 2010 disallowed § 179 deduction) was not used in any taxable year beginning in 2011, that amount was treated as not being subject to a § 179 election and instead was treated as property placed in service on the first day of the taxpayer’s last taxable year beginning in 2011 for purposes of computing depreciation. Similarly, to the extent any disallowed § 179 deduction attributable to qualified real property for any taxable year beginning in 2011 (the 2011 disallowed § 179 deduction) was not used in the taxpayer’s last taxable year beginning in 2011, that amount was treated as not being subject to a § 179 election and instead was treated as property placed in service on the first day of the taxpayer’s last taxable year beginning in 2011 for purposes of computing depreciation.

ATRA amended § 179(f)(4) to provide that, notwithstanding § 179(b)(3)(B), the amount of any cost of qualified real property elected to be expensed under § 179(a) for any taxable year beginning in 2010, 2011, 2012, or 2013 that is disallowed as a § 179 deduction under the taxable income limitation of § 179(b)(3)(A) cannot be carried over to a taxable year begin

September 30, 2013 297 2013–40 I.R.B.

ments to taxable income or the tax liability (for example, the amount of depreciation allowed or allowable in the last taxable year beginning in 2011 for the amount of the 2010 disallowed § 179 deduction or the 2011 disallowed § 179 deduction). Such collateral adjustments also must be made on amended Federal tax returns for any affected succeeding taxable years. The amended returns for the taxpayer’s last taxable year beginning in 2011 and for any affected succeeding taxable years must be filed within the time prescribed by law for filing an amended return for such taxable years.

V. ALLOCATION OF CARRYOVER DISALLOWED AMOUNT

(1) Section 179 property is only quali- fied real property . If a taxpayer elects to expense under § 179(a) only qualified real property for any taxable year beginning in 2010, 2011, 2012, or 2013 and some or all of the cost of that qualified real property is disallowed as a § 179 deduction under the taxable income limitation for that taxable year, the aggregate amount of the carryover of disallowed deduction for that taxable year is attributed entirely to the qualified real property.

(2) Section 179 property includes quali- fied real property and other properties . If a taxpayer elects to expense under § 179(a) qualified real property and other types of § 179 property for any taxable year beginning in 2010, 2011, 2012, or 2013 and some or all of the cost of the § 179 property (including the qualified real property) is disallowed as a § 179 deduction under the taxable income limitation for that taxable year, the aggregate amount of the carryover of disallowed deduction for that taxable year must be allocated pro rata between the qualified real property and the other types of § 179 property. Pursuant to § 179(f)(4)(D), the aggregate amount of the carryover of disallowed deduction for the taxable year that is allocated to the qualified real property is determined by multiplying the aggregate amount of the carryover of disallowed deduction for the taxable year by a percentage that equals:

(a) the aggregate amount attributable to qualified real property placed in service during such taxable year, increased by the portion of any amount carried over to such taxable year from a prior taxable year

ning after 2013. To the extent that any § 179 deduction attributable to qualified real property is not allowed to be carried over to a taxable year beginning after 2013, that amount is to be treated as an amount for which an election under § 179 was not made and that amount is treated as property placed in service on the first day of the taxpayer’s last taxable year beginning in 2013 for purposes of computing depreciation.

The amendments made by the ATRA are effective retroactively to taxable years beginning after December 31, 2011.

A deduction under § 179 is treated as an amortization deduction for purposes of the recapture rules that apply to dispositions of certain depreciable property. In general, § 1245(a)(1) provides that upon a disposition of § 1245 property, the amount by which the lower of (1) the recomputed basis of the property (as defined in § 1245(a)(2)), or (2) the amount realized on a sale, exchange, or involuntary conversion of the property (or the fair market value of the property on any other disposition), exceeds the adjusted basis of the property is treated as ordinary income. This gain must be recognized notwithstanding any other provision of the Code. For purposes of this notice, the term “total amount realized” refers to the amount realized on a sale, exchange, or involuntary conversion of the property, or the fair market value of the property on any other disposition, as applicable.

Pursuant to § 1245(a)(3)(C), the term “§ 1245 property” includes property that is or has been property of a character subject to the allowance for depreciation provided in § 167 and that is so much of any real property (other than property described in § 1245(a)(3)(B)) that has an adjusted basis in which there are reflected adjustments for amortization under § 179.

III. ELECTION TO APPLY § 179(f) TO QUALIFIED REAL PROPERTY

A taxpayer may elect to apply § 179(f) and elect to expense under § 179(a) the cost (or a portion of the cost) of qualified real property placed in service by the taxpayer during any taxable year beginning in 2010, 2011, 2012, or 2013 by filing an original or amended Federal tax return for that taxable year in accordance with procedures similar to those in § 1.179–5(c)(2)

and section 7 of Rev. Proc. 2008–54, 2008–2 C.B. 722, 725. If a taxpayer elects or elected to apply § 179(f) and elects or elected to expense under § 179(a) a portion of the cost of qualified real property placed in service by the taxpayer during any taxable year beginning in 2010, 2011, 2012, or 2013, the taxpayer is permitted to increase the portion of the cost of such property expensed under § 179(a) by filing an amended Federal tax return for that taxable year. Any such increase in the amount expensed under § 179 is not deemed to be a revocation of the prior election for that taxable year.

IV. CARROVER OF 2010 OR 2011 DISALLOWED § 179 DEDUCTION FOR QUALIFIED REAL PROPERTY

The Treasury Department and the Internal Revenue Service (Service) recognize that a taxpayer that treated the amount of a 2010 disallowed § 179 deduction or a 2011 disallowed § 179 deduction as property placed in service on the first day of the taxpayer’s last taxable year beginning in 2011 may want to carryover that amount to any taxable year beginning in 2012 or 2013 in accordance with § 179(f)(4) (as amended by ATRA). Accordingly, a taxpayer that treated the amount of a 2010 disallowed § 179 deduction or a 2011 disallowed § 179 deduction as property placed in service on the first day of the taxpayer’s last taxable year beginning in 2011 may either (1) continue that treatment, or (2) if the period of limitations for assessment under § 6501(a) is open, amend its Federal tax return for the last taxable year beginning in 2011 to carryover the 2010 disallowed § 179 deduction or the 2011 disallowed § 179 deduction to any taxable year beginning in 2012 or 2013. However, if the taxpayer’s last taxable year beginning in 2011 is open under the period of limitations for assessment under § 6501(a) and an affected succeeding taxable year is closed under the period of limitations for assessment under § 6501(a), the taxpayer must continue to treat the amount of a 2010 disallowed § 179 deduction or a 2011 disallowed § 179 deduction as property placed in service on the first day of the taxpayer’s last taxable year beginning in 2011.

The amended Federal tax return for the taxpayer’s last taxable year beginning in 2011 must include any collateral adjust

2013–40 I.R.B. 298 September 30, 2013

which is attributable to qualified real property, divided by

(b) the total amount of § 179 property placed in service during such taxable year, increased by the aggregate amount carried over to such taxable year from any prior taxable year.

(3) Examples . (a) Example 1 — Disallowed § 179 deduction and allocation of the carryover of disallowed deduction to

qualified real property . During 2012, Company Y, a calendar year taxpayer, purchased and placed in service equipment that costs $100,000 and is § 179 property, and qualified real property that costs $200,000. For 2012, Company Y did not have any other asset purchases and did not have any carryover of disallowed deduction from prior taxable years, and has a taxable income limitation of $180,000. For 2012, Company Y elected to apply § 179(f) and elected under § 179(a) to expense the entire cost of the equipment and the entire cost of the qualified real prop

erty. Because of the taxable income limitation, the maximum § 179 deduction Company Y can claim for 2012 is $180,000. As a result, Company Y has a $120,000 carryover of disallowed deduction to 2013. This $120,000 carryover amount is allocated pro rata between the qualified real property and equipment placed in service by Company Y during 2012. Thus, $80,000 of the carryover amount is allocated to the qualified real property and $40,000 of the carryover amount is allocated to the equipment.

2012 § 179 Carryover Amount $120,000 Allocation Ratio ($200,000 QRP / $300,000 Total § 179 Property) 66.67% Carryover Amount Allocated to Qualified Real Property $80,000

2012 § 179 Carryover Amount $120,000 Allocation Ratio ($100,000 Equipment / $300,000 Total § 179 Property) 33.33% Carryover Amount Allocated to Equipment $40,000

(i) Pro rata allocation methodology . Under the pro rata allocation methodology, the taxpayer allocates pro rata the total amount realized ( e.g., sales price) upon a sale or other disposition of qualified real property between the § 1245 property and the § 1250 property. The total amount realized that is allocated to the § 1245 property is determined by multiplying the total amount realized by the percentage that equals the amount that is treated as § 1245 property (as determined under paragraph VI(2)(a) of this notice), divided by the total unadjusted basis of the qualified real property. The remaining amount of the total amount realized is allocated to the § 1250 property.

Next, the taxpayer will determine the portion of the gain that is attributable to the § 1245 property. The gain attributable to the § 1245 property equals the total amount realized that is allocated to the § 1245 property (as determined under the preceding paragraph) less the adjusted basis of the amount that is treated as § 1245 property (as determined under paragraph VI(2)(a) of this notice). The remaining amount of the gain or loss is attributable to the § 1250 property.

Finally, the taxpayer will determine whether all or a portion of the gain that is attributable to the § 1245 property (as determined under the preceding paragraph) is treated as ordinary income under § 1245(a). Except as provided in § 1245(b), the amount treated as ordinary income under § 1245(a) is equal to the lower of (1) the recomputed basis of the § 1245 property, or (2) the total amount realized that is allocated to the

(b) Example 2 — Treatment of the carryover of disallowed deduction attributable to qualified real property in a taxable year beginning after 2013 . The facts are the same as in Example 1 . In 2013, Company Y did not have any asset purchases and did not have any taxable income. As a result, no portion of the $80,000 carryover of disallowed deduction from 2012 that is attributable to the qualified real property can be used by Company Y in its 2013 taxable year. Because disallowed § 179 deductions relating to qualified real property cannot be carried over to taxable years beginning after December 31, 2013, no portion of the $80,000 carryover of disallowed deduction from 2012 that is attributable to the qualified real property can be carried over to 2014 pursuant to § 179(f)(4)(A). Accordingly, Company Y is treated as if the § 179 election made in 2012 to expense $80,000 of the cost of the qualified real property placed in service in 2012 had not been made. The $80,000 cost of the qualified real property is treated as placed in service by Company Y on January 1, 2013 (the first day of Company Y’s last taxable year beginning in 2013) for purposes of computing depreciation. The $40,000 carryover of disallowed deduction from 2012 that is allocated to the equipment is carried over to 2014 under § 179(b)(3)(B).

VI. DISPOSITION AND OTHER TRANSFERS OF QUALIFIED REAL PROPERTY

(1) In general . Upon a sale or other disposition of qualified real property in a taxable year beginning in 2010, 2011, 2012, or 2013, or a transfer of qualified real property in a taxable year beginning in 2010, 2011, 2012, or 2013 in a transaction in which gain or loss is not recognized in whole or in part (including transfers at death), immediately before the disposition or transfer, the adjusted basis of the qualified real property is increased by the amount of any outstanding carryover of disallowed deduction attributable to that

property. Thus, the carryover of the disallowed deduction cannot be deducted by the transferor or the transferee of the qualified real property. See § 1.179–3(f). However, the preceding two sentences of this paragraph VI(1) do not apply to a sale or other disposition of qualified real property, or a transfer of qualified real property in a transaction in which gain or loss is not recognized in whole or in part (including transfers at death), in the taxpayer’s last taxable year beginning in 2013 or any subsequent taxable year.

(2) Applicability of § 1245 and § 1250 . (a) Amounts treated as §§ 1245 and 1250 property . To the extent the unadjusted basis of the qualified real property is reduced by the § 179 deduction (after the application of paragraph VI(1) of this notice), the amount of that reduction is treated as § 1245 property. See § 1245(a)(3)(C). The remaining unadjusted basis of the qualified real property is treated as § 1250 property.

(b) Allocation methodologies for deter- mining § 1245 recapture . A taxpayer may use any reasonable allocation methodology for determining the portion of the gain that is attributable to § 1245 property upon the sale or other disposition of qualified real property. Below are two examples of reasonable allocation methodologies. The Service will not challenge any other reasonable methodology used by a taxpayer for determining the portion of gain that is attributable to the § 1245 property upon the sale or other disposition of qualified real property. The two reasonable allocation methodologies operate as follows:

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§ 1245 property (as determined under the first paragraph of the pro rata allocation methodology), less the adjusted basis of the § 1245 property.

(ii) Gain allocation methodology . Under the gain allocation methodology, the taxpayer allocates the gain from the sale or other disposition of qualified real property between the § 1245 property and the § 1250 property. The gain that is allocated to the § 1245 property is equal to the lower of (A) the amount of the gain, or (B) the amount of the unadjusted basis of the qualified real property that is treated as § 1245 property (as determined under paragraph VI(2)(a) of this notice). All of the gain that is allocated to the § 1245 property is treated as ordinary income under § 1245(a). The remaining amount of the gain is allocated to the § 1250 property.

(3) Examples . (a) Example 1 — Sale of qualified real property in 2014 that had a 2012 unused carryover of disal- lowed deduction . During April 2012, Company Y purchased for $20,000 and placed in service qualified leasehold improvement property that is qualified real property (“2012 qualified real property”). For 2012, Company Y did not have any other asset purchases and did not have any carryover of disallowed deduction from prior taxable years, and has a taxable income limitation of $12,000. For 2012, Company Y elected to apply § 179(f) and elected under § 179(a) to expense the entire cost of the 2012 qualified real property. Because of the taxable income limitation, the maximum § 179 deduction Company Y claimed for 2012 is $12,000. As a result, Company Y has an $8,000 carryover of disallowed deduction to 2013. Pursuant to § 179(f)(4)(D), this $8,000 carryover amount is allocated entirely to the 2012 qualified real property. As a result of the § 179 election to expense the entire cost of the 2012 qualified real property, Company Y’s adjusted basis in the 2012 qualified real property on December 31, 2012, was zero.

In 2013, Company Y did not have any asset purchases and did not have any taxable income. As a result, the $8,000 carryover of disallowed deduction from 2012 that is attributable to the 2012 qualified real property cannot be used by Company Y in its 2013 taxable year. Because disallowed § 179 deductions relating to qualified real property cannot be carried over to taxable years beginning after December 31, 2013, the $8,000 cannot be carried over to 2014. Accordingly, Company Y is treated as if it did not make the § 179 election in 2012 to expense $8,000 of the $20,000 cost of the 2012 qualified real property. The $8,000 of the $20,000 cost of the 2012 qualified real property is treated as placed in service by Company Y on January 1, 2013, for purposes of computing depreciation (the first day of Company Y’s last taxable year beginning in 2013). See § 179(f)(4)(C).

Under § 168 Company Y depreciated its qualified leasehold improvement property placed in service in 2013 using the optional depreciation table that corresponds with the general depreciation system, the straight-line method of depreciation, a 15-year

recovery period, and the half-year convention. Company Y also elected not to deduct the 50 percent additional first-year depreciation deduction provided by § 168(k) for any property placed in service during 2013. In December 2014, Company Y sells the 2012 qualified real property to an unrelated party for $15,000. The adjusted basis of this property for purposes of determining gain or loss is $7,467 (unadjusted basis of $20,000, less § 179 deduction of $12,000, less depreciation allowed and allowable of $533 for 2013 and 2014. The gain from the sale of the 2012 qualified real property is $7,533 (sales price of $15,000 less adjusted basis of $7,467).

(i) Pro rata allocation methodology . Company Y uses the pro rata allocation methodology provided in paragraph VI(2)(b)(i) of this notice. Pursuant to § 1245(a)(3)(C) and paragraph VI(2)(a) of this notice, $12,000 of the unadjusted basis of the 2012 qualified real property is treated as § 1245 property (the § 179 deduction of $12,000 claimed on the unadjusted basis of $20,000). This § 1245 property has an adjusted basis of zero as of the date of the sale and, pursuant to § 1245(a)(2), a recomputed basis of $12,000 (adjusted basis of $0 plus § 179 deduction of $12,000). The remaining unadjusted basis of $8,000 is treated as § 1250 property, which has an adjusted basis of $7,467, as of the date of the sale.

Under the pro rata allocation methodology, Company Y allocates pro rata the sales price of $15,000 between the § 1245 property and § 1250 property. Thus, $9,000 of the $15,000 sales price is allocated to the § 1245 property ($15,000 sales price multiplied by ($12,000 that is treated as § 1245 property divided by the $20,000 total unadjusted basis of the 2012 qualified real property)) and $6,000 of the $15,000 sales price is allocated to the § 1250 property.

As a result, of the total gain of $7,533, a gain of $9,000 is attributable to the § 1245 property ($9,000 sales price attributable to the § 1245 property less a zero adjusted basis for this § 1245 property) and a loss of $1,467 is attributable to the § 1250 property ($6,000 sales price attributable to the § 1250 property less the $7,467 adjusted basis for this § 1250 property). All of the $9,000 gain attributable to the § 1245 property is treated as ordinary income under § 1245. The loss of $1,467 attributable to the § 1250 property is subject to § 1231.

(ii) Gain allocation methodology . Company Y uses the gain allocation methodology provided in paragraph VI(2)(b)(ii) of this notice. Under the gain allocation methodology, Company Y allocates the gain of $7,533 from the sale of the 2012 qualified real property between § 1245 property and § 1250 property. The gain that is allocated to the § 1245 property is equal to the lower of (A) the amount of the gain of $7,533, or (B) $12,000, which is the amount of the unadjusted basis of the 2012 qualified real property that is treated as § 1245 property (the § 179 deduction of $12,000 claimed on the unadjusted basis of $20,000). Thus, all of the gain of $7,533 is allocated to the § 1245 property and is treated as ordinary income under § 1245(a). None of the gain is allocated to the § 1250 property.

(b) Example 2 — Sale of qualified real property in 2014 that had a 2012 unused carryover of disal- lowed deduction . The facts are the same as in Ex- ample 1, except that in December 2014, Company Y sells the 2012 qualified real property to an unrelated party for $25,000. The adjusted basis of this prop

erty for purposes of determining gain or loss is $7,467 (unadjusted basis of $20,000, less § 179 deduction of $12,000, less depreciation allowed and allowable of $533 for 2013 and 2014). The gain from the sale of the 2012 qualified real property is $17,533 (sales price of $25,000 less adjusted basis of $7,467).

(i) Pro rata allocation methodology . Company Y uses the pro rata allocation methodology provided in paragraph VI(2)(b)(i) of this notice. Pursuant to § 1245(a)(3)(C) and paragraph VI(2)(a) of this notice, $12,000 of the unadjusted basis of the 2012 qualified real property is treated as § 1245 property (the § 179 deduction of $12,000 claimed on the unadjusted basis of $20,000). This § 1245 property has an adjusted basis of zero as of the date of the sale and, pursuant to § 1245(a)(2), a recomputed basis of $12,000 (adjusted basis of $0 plus § 179 deduction of $12,000). The remaining unadjusted basis of $8,000 is treated as § 1250 property, which has an adjusted basis of $7,467, as of the date of the sale.

Under the pro rata allocation methodology, Company Y allocates pro rata the sales price of $25,000 between the § 1245 property and § 1250 property. Thus, $15,000 of the $25,000 sales price is allocated to the § 1245 property ($25,000 sales price multiplied by ($12,000 that is treated as § 1245 property divided by the $20,000 total unadjusted basis of the 2012 qualified real property)) and $10,000 of the $25,000 sales price is allocated to the § 1250 property.

As a result, of the total gain of $17,533, a gain of $15,000 is attributable to the § 1245 property ($15,000 sales price attributable to the § 1245 property less a zero adjusted basis for this § 1245 property) and a gain of $2,533 is attributable to the § 1250 property ($10,000 sales price attributable to the § 1250 property less the $7,467 adjusted basis for this § 1250 property). Of the $15,000 gain attributable to the § 1245 property, $12,000 is treated as ordinary income under § 1245 and $3,000 is subject to § 1231. Because Company Y depreciated the amount that is treated as § 1250 property ($8,000) using the straight-line method of depreciation, § 1250 recapture does not apply and all of the $2,533 gain attributable to the § 1250 property is subject to § 1231.

(ii) Gain allocation methodology . Company Y uses the gain allocation methodology provided in paragraph VI(2)(b)(ii) of this notice. Under the gain allocation methodology, Company Y allocates the gain of $17,533 from the sale of the 2012 qualified real property between § 1245 property and § 1250 property. The gain that is allocated to the § 1245 property is equal to the lower of (A) the amount of the gain of $17,533, or (B) $12,000, which is the amount of the unadjusted basis of the 2012 qualified real property that is treated as § 1245 property (the § 179 deduction of $12,000 claimed on the unadjusted basis of $20,000). Thus, of the total gain of $17,533, a gain of $12,000 is allocated to the § 1245 property and a gain of $5,533 is allocated to the § 1250 property.

All of the $12,000 gain attributable to the § 1245 property is treated as ordinary income under § 1245. Because Company Y depreciated the amount that is treated as § 1250 property ($8,000) using the straightline method of depreciation, § 1250 recapture does not apply and all of the $5,533 gain attributable to the § 1250 property is subject to § 1231.

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VII. DRAFTING INFORMATION

The principal author of this notice is Winston H. Douglas of the Office of

Associate Chief Counsel (Income Tax & Accounting). For further information regarding this revenue procedure, contact

Mr. Douglas on (202) 622–4930 (not a toll free call).

September 30, 2013 301 2013–40 I.R.B.