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

• Author: Yin, Rachel

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...