n-10-79.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Modification of Section 833 Treatment of Certain Health Organizations

Notice 2010-79

SECTION 1. PURPOSE
.01 This notice alerts taxpayers to an amendment made to § 833 of the Internal
Revenue Code (Code) by the Patient Protection and Affordable Care Act (H.R. 3590,
P.L. 111-148) (the “Affordable Care Act”). Section 833 provides special rules for certain
Blue Cross and Blue Shield organizations, and certain other organizations. Effective for
taxable years beginning after December 31, 2009, the amendment adds new
§ 833(c)(5), which limits the application of § 833 to otherwise-qualifying taxpayers with a
medical loss ratio that is not less than 85 percent.
.02 This notice also provides interim guidance to taxpayers on the interpretation
and application of § 833(c)(5). The Affordable Care Act was enacted on March 23,
2010, adding § 833(c)(5) with retroactive effect for taxable years beginning after
December 31, 2009. The Treasury Department and the Internal Revenue Service
(Service) are engaged in developing detailed guidance for this provision. That guidance
must also take into account other closely related guidance that the Department of
Health and Human Services (HHS) has just published. To allow affected taxpayers to

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comply with the mid-year change in law while detailed guidance is under development,
the Treasury Department and the Service are providing interim guidance on the
operation of § 833(c)(5) for the first taxable year beginning after December 1, 2009.
SECTION 2. BACKGROUND
.01 An insurance company other than a life insurance company is subject to tax
under § 831.
.02 Section 831(c) provides that for purposes of § 831, the term “insurance
company” has the meaning given to such term by § 816(a). Section 816(a) provides the
term “insurance company” means any company more than half of the business of which
during the taxable year is the issuing of insurance or annuity contracts or the reinsuring
of risks underwritten by insurance companies.
.03 Section 832(a) provides that, for an insurance company subject to the tax
imposed by § 831, the term “taxable income” means the company's gross income as
defined in § 832(b)(1) less the deductions authorized in § 832(c). Under § 832(b)(1),
gross income includes underwriting income.
.04 Section 832(b)(3) defines underwriting income as the premiums earned on
insurance contracts during the taxable year less losses incurred and expenses incurred.
.05 Section 832(b)(4) defines the term "premiums earned on insurance contracts
during the taxable year" as the gross premiums written on insurance contracts during
the taxable year, less return premiums and premiums paid for reinsurance. The result
so obtained is further adjusted by adding 80 percent of the unearned premiums on
outstanding business at the end of the preceding taxable year and deducting 80 percent

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of the unearned premiums on outstanding business at the end of the taxable year.
.06 Section 833 provides special rules for existing Blue Cross or Blue Shield
organizations and other organizations that meet the requirements of § 833(c)(3)--
(a) Section 833(a)(1) states that such an organization is subject to tax in the
same manner as if it were a stock insurance company;
(b) Section 833(a)(2) allows a special deduction for such an organization,
determined under § 833(b), which is the excess (if any) of (i) 25 percent of the sum of
the claims incurred during the taxable year, liabilities incurred during the taxable year
under cost-plus contracts, and expenses incurred during the taxable year in connection
with the administration, adjustment, or settlement of claims or in connection with the
administration of cost-plus contracts, over (ii) the adjusted surplus as of the beginning of
the taxable year; and
(c) Section 833(a)(3) provides that the 20 percent reduction of unearned
premiums set forth in § 832(b)(4) does not apply to such an organization.
.07 Section 9016 of the Affordable Care Act added § 833(c)(5) to the Code,
effective for taxable years beginning after December 31, 2009. Section 833(c)(5)
provides that § 833 does not apply to an otherwise-eligible organization unless the
organization's medical loss ratio, as defined, during the taxable year is not less than 85
percent. For this purpose, an organization's medical loss ratio is equal to the amount
expended on reimbursement for clinical services provided to enrollees under its policies
during the taxable year (as reported under § 2718 of the Public Health Service Act)
("Section 833 MLR Numerator") divided by the organization's total premium revenue

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("Section 833 MLR Denominator").
.08 Section 2718 of the Public Health Service Act (the “PHS Act”) was added by
§ 1001 and amended by § 10101 of the Affordable Care Act, and was incorporated into
the Code by § 9815(a)(1). Section 2718(a) of the PHS Act requires a health insurance
issuer to submit an annual report to the Secretary of HHS concerning the ratio of the
incurred loss (or incurred claims) plus the loss adjustment expenses (or change in
contract reserves) to earned premiums. The report must include the percentage of total
premium revenue, after accounting for collections or receipts for risk adjustment and
risk corridors and payments of reinsurance, that the issuer expends (a) on
reimbursement for clinical services provided to enrollees; (b) for activities that improve
health care quality; and (c) on all other non-claims costs.
.09 Section 2718(b) of the PHS Act requires that a health insurance issuer,
beginning not later than January 1, 2011, provide a rebate to each enrollee, on a pro
rata basis, if the ratio of (a) the amount of premium revenue expended on
reimbursement for clinical services and for activities that improve health care quality to
(b) the total amount of premium revenue (excluding Federal and State taxes and
licensing or regulatory fees and after accounting for payments or receipts for risk
adjustment, risk corridors and reinsurance) is less than a prescribed percentage.
.10 Section 2718(c) of the PHS Act directs the National Association of Insurance
Commissioners (NAIC) to establish uniform definitions of the activities required to be
reported to the Department of HHS under § 2718(a), and standardized methodologies
for calculating measures of these activities, not later than December 31, 2010, and

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subject to the certification of the Secretary of HHS. On November 22, 2010, the
Department of HHS filed with the Federal Register, for publication December 1, 2010,
interim final regulations implementing § 2718. See
http://www.ofr.gov/OFRUpload/OFRData/2010-29596_PI.pdf.
SECTION 3. INTERIM GUIDANCE FOR 2010
.01 The Treasury Department and the Service are aware that because
§ 833(c)(5) applies to taxable years beginning after December 31, 2009 (including the
period in 2010 before enactment of the Affordable Care Act), the implementation of
§ 833(c)(5) presents issues for the first taxable year beginning after December 31,
2009. Moreover, because § 833(c)(5) references § 2718 of the PHS Act, the Treasury
Department and the Service, and taxpayers, will need to consider the effect, if any, of
the recently-published guidance under § 2718 on issues that arise under § 833(c)(5).
Finally, the Treasury Department and the Service anticipate issuing further guidance on
§ 833(c)(5). Accordingly, this Section 3 provides interim guidance that taxpayers may
rely on solely for the first taxable year beginning after December 31, 2009.
Computation of MLR Numerator for Purposes of § 833(c)(5)

.02 For purposes of determining whether a taxpayer's percentage of total
premium revenue expended on reimbursement for clinical services provided to
enrollees is not less than 85 percent (and thus satisfies the requirement of § 833(c)(5)),
taxpayers must use the definition of "reimbursement for clinical services provided to
enrollees" that is set forth in HHS interim final regulations.
.03 For purposes of determining whether the 85-percent requirement of

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§ 833(c)(5) is satisfied, the Service will not challenge the inclusion of "amounts
expended for activities that improve health care quality" as defined in HHS interim final
regulations.
Consequences of Nonapplication of § 833 by Reason of § 833(c)(5)

.04 Section 833(c)(5) provides that § 833 does not apply to an organization
unless the organization's percentage of total premium revenue expended on
reimbursement for clinical services provided to enrollees is not less than 85 percent.
Accordingly, the consequences for an organization for which this amount is less than 85
percent are as follows:
(a) The organization is not taxable as a stock insurance company by reason of
§ 833(a)(1) (but may be taxable as an insurance company if it otherwise meets the
requirements of § 831(c));
(b) The organization is not allowed the special deduction set forth in § 833(b);
and
(c) The organization takes into account 80 percent, rather than 100 percent, of its
unearned premiums for purposes of computing premiums earned on insurance
contracts during the taxable year under § 832(b)(4).
.05 Notwithstanding Section 3.04(a) of this Notice and solely for the first taxable
year beginning after December 31, 2009, the Service will not treat a taxpayer as losing
its status as a stock insurance company by reason of § 833(c)(5) provided the following
conditions are met--
(a) the taxpayer was described in § 833(c) in the immediately preceding taxable

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year;
(b) the taxpayer would have been taxed as a stock insurance company for the
current taxable year but for the enactment of § 833(c)(5); and
(c) the taxpayer would have met the requirements of § 831(c) to be taxed as an
insurance company for the current taxable year but for its activities in the administration,
adjustment or settlement of claims under cost-plus or administrative services-only
contracts.
Changes in Accounting Method

.06 Section 446(e) of the Code states that, except as otherwise provided, a
taxpayer that changes a method of accounting on the basis of which it regularly
computes income in keeping its books must secure consent before computing taxable
income under a new method. Section 1.446-1(e)(3)(i) of the Income Tax Regulations
requires that, except as provided under the authority of § 1.446-1(e)(3)(ii), to secure the
Commissioner’s consent to change its method of accounting, a taxpayer must file a
Form 3115, Application for Change in Accounting Method, during the taxable year in
which the taxpayer desires to make the proposed change.
.07 Rev. Proc. 97-27, 1997-1 C.B. 680, as amplified and modified by
Rev. Proc.
2002-19, 2002-1 C.B. 696, as amplified and clarified by
Rev. Proc. 2002-54, 2002-2
C.B. 432, as modified by
Rev. Proc. 2007-67, 2007-2 C.B. 1072, and as clarified and
modified by Rev. Proc. 2009-39, 2009-2 C.B. 371, provides the general procedures for
obtaining the advance consent of the Commissioner to change a method of accounting.
See also Rev. Proc. 2010-1, 2010-1 I.R.B. 1 (or any successor).

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.08 The application of § 833 in a taxable year followed by nonapplication of that
provision in the subsequent taxable year (or vice versa) may result in one or more
changes in accounting method. For example, accounting for 100 percent of unearned
premiums under § 833(a)(3) in one year, but only 80 percent of unearned premiums
under § 832(b)(4) in the next year, is a change in method of accounting. Likewise, the
loss (or recovery) of insurance company status may implicate a number of changes in
methods of accounting because some methods of accounting are available only to
insurance companies under Subchapter L. The special deduction allowed under §
833(a)(2) and § 833(b) is not, however, a method of accounting.
.09 A taxpayer that is required to change one or more methods of accounting by
reason of the application or nonapplication of § 833 must secure consent for these
changes under the advance consent procedures of Rev. Proc. 97-27. These
accounting method changes are not within the scope of Rev. Proc. 2008-52, 2008-2
C.B. 587, as amplified, clarified, and modified by
Rev. Proc. 2009-39.
SECTION 4. PROCEDURAL INFORMATION AND RELIANCE ON INTERIM
GUIDANCE
This notice serves as an “administrative pronouncement” as that term is used in
§ 1.6662-4(d)(3)(iii) of the Income Tax Regulations and may be relied upon to the same
extent as a revenue ruling or revenue procedure. If, and to the extent, future published
guidance differs from the interim guidance in this notice, the different provisions of that
future guidance will be applied without adverse retroactive effect.
SECTION 5. REQUEST FOR COMMENTS

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.01 The Treasury Department and the Service request comments on the
following:
(a) What guidance, if any, will taxpayers need under § 833(c)(5) for years after
the transition year that is addressed in Section 3 of this Notice?
(b) Is more specific guidance needed on accounting method issues that arise
when a taxpayer loses its status as an insurance company?
(c) Will guidance be needed in the future on the appropriate Subchapter L
treatment of rebates that are paid under § 2718 of the PHS Act?
(d) The Treasury Department and the Service recognize that medical loss ratios
are computed under § 2718 of the PHS Act, as well as under § 833(c)(5). Comments
are requested on how guidance could coordinate the medical loss ratio computation
under § 2718 of the PHS Act with the medical loss ratio computation under § 833(c)(5).
.02 Comments should be submitted in writing on or before March 7, 2011 and
should contain reference to this Notice 2010-79. Comments may be submitted to
CC:PA:LPD:PR (Notice 2010-79), Room 5203, Internal Revenue Service, P.O. Box
7604, Ben Franklin Station, Washington, DC 20044. Alternatively, taxpayers may
submit comments electronically to Notice.Comments@irscounsel.treas.gov.
Please
include “Notice 2010-79” in the subject line of any electronic communications.
.03 Submissions may be hand-delivered Monday through Friday between the
hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2010-79), Courier’s Desk, Internal
Revenue Service, 1111 Constitution Ave., NW, Washington, DC 20224. All comments
will be available for public inspection and copying.

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DRAFTING INFORMATION
The principal author of this notice is Rebecca L. Baxter of the Office of Associate
Chief Counsel (Financial Institutions & Products (CC:FIP:B04)). For further information
regarding this notice contact Ms. Baxter on (202) 622-7117 (not a toll-free call).