Luckily for them, health systems have savvy tax experts recommending maneuvers that will reduce their exposure to the new tax. Even then, systems must tread carefully to ensure they're staying within the law.
The first step many health systems took shortly after Congress passed the tax law was to rush through hefty compensation payouts at the end of 2017 that would have otherwise been subject to the tax this year.
"Everyone that I've spoken to wanted to take advantage of the opportunity to accelerate to avoid any excise tax," said Tom Flannery, a senior client partner with the healthcare consultancy at Korn Ferry. He wouldn't name specific clients.
Flannery said he expects 2017 health system financial disclosures will show higher executive compensation, followed by lower compensation in 2018 and 2019, after which pay will likely climb back up.
The move appears to be allowable under the new law, and fits with the goal of any prudent board: to minimize non-healthcare-related payments, Flannery said.
"If you had the opportunity to avoid paying a tax, would you do it?" he asked.
In some cases, systems accelerated seven-figure deferred compensation packages that had accrued over a number of years, Mancino said. He also wouldn't name specific clients, but said such accelerations should have buy-in from both the companies and the affected employees.
Section 409A of the Internal Revenue Code is designed to prevent artificial acceleration of deferred compensation agreements. Health systems would have needed to use specific exceptions to that section in order to use the accelerations legally, Mancino said.
Some health systems are also getting around the excise tax by replacing traditional deferred compensation packages with what are known as split dollar loan arrangements. Under such arrangements, employers make substantial loans to executives that go toward their life insurance premiums. Loans are not considered wages, and are thus not subject to the excise tax.
Split dollar loan arrangements then allow those executives to, upon retirement, borrow accumulated, non-taxable cash from those life insurance companies every year. The cash borrowing has to be done within prescribed limits so that the employer and the executives' beneficiaries are paid the full benefits under the life insurance policy upon the executive's death, Mancino said.
Those arrangements are a "win-win" for employees and employers alike, Mancino said, with employees getting the same economic benefit from the loans as they would under deferred compensation.
"This becomes a very, very attractive option," Mancino said.
Major health systems like Kaiser Permanente, Sutter Health, SSM Health, Dignity Health and Baylor Scott & White Health said they aren't using either tactic.
"We plan to administer our total rewards package as it exists today and continue to abide by all appropriate tax reporting guidelines," Sutter spokeswoman Karen Garner wrote in an email.
Congress has asked the IRS to write rules preventing not-for-profit organizations from avoiding the excise tax by letting people perform services other than as employees, or by paying people through pass-through entities such as partnerships, limited liability companies or S corporations, Mancino said.
He said health systems have for years classified medical directors as independent contractors rather than employees, which tends to be a front-burner issue in hospital audits. Mancino said he expects the IRS will determine that performing services through a limited liability company will be subject to the excise tax if the compensation for those services exceeds $1 million.
"There's a lot of techniques that are in use today that will probably be scrutinized if it appears they are being used in an abusive fashion," he said.
There are a number of unresolved questions surrounding the new law that the IRS is expected to clarify when it issues proposed regulations at the end of the month. For example, the law includes an exemption for providing medical care, which raises the question of whether physician compensation that exceeds $1 million would be subject to the tax, especially if a portion of their time is spent on administrative duties.
"The question is, would those administrative duties related to medical services be deductible or not?" Flannery pondered. "There is a level of uncertainty around some of these issues."
