This document amends the Income Tax Regulations (26 CFR part 1) under section 141 to modify and clarify the standards for treating PILOTs as generally applicable taxes for purposes of the private security or payment test under section 141.

Final regulations under section 141 were published in the Federal Register on January 16, 1997 (T.D. 8712, 1997-1 C.B. 15 [62 FR 2275]) (1997 Regulations), to provide comprehensive guidance on most aspects of the private activity bond restrictions. On October 19, 2006, the IRS published a notice of proposed rulemaking in the Federal Register (REG-136806-06, 2006-2 C.B. 950 [71 FR 61693]) (Proposed Regulations) regarding the standards for treating PILOTs as generally applicable taxes for purposes of the private security or payment test under section 141. In the Proposed Regulations, the Treasury Department and the IRS solicited public comments and invited interested parties to a public hearing scheduled for February 13, 2007. On January 30, 2007, the Treasury Department and the IRS cancelled the public hearing because no requests to speak at the hearing were received, and published a notice of such cancellation in the Federal Register (Published in the IRB as Announcement 2007-19, 2007-7 I.R.B. 521 [72 FR 4220]).

The Treasury Department and the IRS received a number of written comments on the Proposed Regulations. After consideration of the written comments, the Proposed Regulations are adopted, with revisions, as final regulations by this Treasury decision (Final Regulations). The revisions are discussed in the preamble.

In general, interest on State and local governmental bonds is excludable from gross income under section 103 of the Code. Interest on a private activity bond, other than a qualified bond under section 141(e), is not excludable from gross income. Section 141(a) classifies a bond as a private activity bond if it is part of an issue that meets both the private business use test under section 141(b)(1) (private business use test) and the private security or payment test under section 141(b)(2) (private payment test). In addition, section 141(a) independently treats a bond as a private activity bond if it is part of an issue that meets the private loan test under section 141(c).

Section 141(b)(2) provides generally that an issue meets the private payment test if the payment of the debt service on more than 10 percent of the proceeds of such issue is (under the terms of such issue or any underlying arrangement) directly or indirectly (1) secured by any interest in property used or to be used for a private business use, or payments in respect of such property, or (2) to be derived from payments (whether or not to the issuer) in respect of property, or borrowed money, used or to be used for a private business use.

Sections 1.141-4(c) and 1.141-4(d) of the 1997 Regulations provide general rules for purposes of application of the private payment test. Private payments generally include any payments made, directly or indirectly, by any nongovernmental person that is a private business user of proceeds during a period of private business use and any payments made with respect to property financed with proceeds of an issue during a period of private business use, whether or not made by a private business user. In addition, private payments include property and payments in respect of property that are used or to be used for private business use to the extent that any interest in that property or payments serves as security for the payment of debt service on an issue.

Section 1.141-4(e) of the 1997 Regulations provides an exception to the otherwise broad scope of payments taken into account under the private payment test in the case of generally applicable taxes. Thus, §1.141-4(e)(1) provides that for purposes of the private security or payment test, generally applicable taxes are not taken into account (that is, are not payments from a nongovernmental person and are not payments in respect of property used for a private business use). In general, the purpose of the generally applicable taxes exception is to allow eligible tax payments made with respect to property or services to be used to pay debt service on an issue without causing private payments. For this purpose, §1.141-4(e)(2) of the 1997 Regulations defines a generally applicable tax to mean an enforced contribution exacted pursuant to legislative authority in the exercise of the taxing power that is imposed and collected for the purpose of raising revenue to be used for governmental purposes. To qualify as a generally applicable tax, a tax must have a uniform rate that is applied to all persons of the same classification in the appropriate jurisdiction, and the tax must have a generally applicable manner of determination and collection.

Section 1.141-4(e)(4)(i) provides that a tax does not have a generally applicable manner of determination and collection to the extent that one or more taxpayers make any impermissible agreements relating to the payment of those taxes. Section 1.141-4(e)(4)(ii) and (iii) of the 1997 Regulations set forth permissible and impermissible agreements for this purpose. An example of a permissible agreement that does not cause a tax to fail to have a generally applicable manner of determination and collection includes an agreement to reduce or limit the amount of taxes collected to further a bona fide governmental purpose. For example, an agreement to abate taxes to encourage a property owner to rehabilitate property in a distressed area is a permissible agreement.

Section 1.141-4(e)(3) of the 1997 Regulations provides that a payment does not qualify as a generally applicable tax if it is a special charge for a special privilege granted or service rendered. This provision further provides that special assessments paid by property owners benefiting from financed improvements are not generally applicable taxes. This provision includes an example that a tax or PILOT that is limited to the property or persons benefited by an improvement is not a generally applicable tax.

The Proposed Regulations generally did not address the special charge limitation on generally applicable taxes. Commentators suggested clarifying the scope of this special charge limitation and its application in the context of PILOTs.

The Final Regulations clarify and illustrate the scope of the special charge limitation on generally applicable taxes. The Final Regulations provide that a special charge includes a payment for a special privilege granted or regulatory function (for example, a license fee), a service rendered (for example, a sanitation services fee), a use of property (for example, rent), or a payment in the nature of a special assessment to finance capital improvements that is imposed on a limited class of persons based on benefits received from the capital improvements financed with the assessment. The Final Regulations illustrate that a special assessment to finance infrastructure improvements in a new industrial park (such as sidewalks, streets, streetlights, and utility infrastructure improvements) that is imposed on a limited class of persons composed of property owners within the industrial park who benefit from those improvements is a special charge. The Final Regulations also illustrate that, by contrast, an otherwise-qualified generally applicable tax (for example, a generally applicable ad valorem tax on all real property within a governmental taxing jurisdiction) or an eligible PILOT that is based on such a generally applicable tax is not treated as a special charge merely because the taxes or PILOTs received are used for governmental or public purposes in a manner that benefits particular property owners.

Section 1.141-4(e)(5) of the 1997 Regulations treats PILOTs as generally applicable taxes if: (1) The payments are commensurate with and not greater than the amounts imposed by the statute for a tax of general application; and (2) The payments are designated for a public purpose and are not special charges (as described in §1.141-4(e)(3)). Section 1.141-4(e)(5) of the 1997 Regulations further provides an example which states that a PILOT made in consideration for the use of property financed with tax-exempt bonds is treated as a special charge.

The Proposed Regulations proposed to clarify and to tighten the commensurate standard for PILOTs to better ensure a reasonably close relationship between eligible PILOTs and generally applicable taxes. In particular, the Proposed Regulations proposed to define the commensurate standard to provide generally that an eligible PILOT payment must represent a fixed percentage of, or reflect a fixed adjustment to, the amount of generally applicable taxes in each year, based on comparable current valuation assessments. Commentators suggested that the proposed commensurate standard was unduly restrictive and suggested allowing fixed-payment PILOTs. The Treasury Department and the IRS decline to adopt this suggestion to allow fixed-payment PILOTs. The Final Regulations generally continue the approach to the commensurate standard in the Proposed Regulations because the Treasury Department and the IRS continue to believe that this approach will better ensure a reasonably close relationship between eligible PILOTs and generally applicable taxes.

The Final Regulations refine the commensurate standard in certain technical respects in response to public comments. The Proposed Regulations proposed to permit only a single change in the measure of a PILOT in relation to an underlying generally applicable tax following completion of the development of the subject property. Commentators suggested allowing broader flexibility for phased adjustments to PILOTs during the development, construction, or initial start-up period of the property. The Final Regulations adopt this comment.

The Proposed Regulations also proposed to treat any payment based in any way on debt service on an issue as impermissible under the commensurate standard. Commentators suggested that this limitation is overly broad and could prohibit any use of PILOTs to pay debt service on an issue. The Final Regulations do not prohibit any use of PILOTs to pay debt service on an issue, but provide that a PILOT is not commensurate with a generally applicable tax if the PILOT is set at a fixed dollar amount (for example, fixed debt service on a bond issue) that cannot vary with changes in the level of the generally applicable tax on which it is based.

Section 1.141-4(e)(5) of the 1997 Regulations and the Proposed Regulations require designation of PILOTs for a “public purpose.” Section 1.141-4(e)(2) of the 1997 Regulations requires use of generally applicable taxes for “governmental purposes.” These references to the designation of PILOTs for a public purpose and to the use of generally applicable taxes for governmental purposes were intended to refer to the same standard. In this regard, longstanding Revenue Rulings on the definition of generally applicable taxes under section 164 on which the section 141 definition was based have consistently required the use of generally applicable taxes for “public or governmental purposes.” See, for example, Rev. Rul. 71-49, 1971-1 C.B. 103; Rev. Rul. 61-152, 1961-2 C.B. 42 (see §601.601(d)(2)(ii)(b)). To clarify the intended uniform standard for the use of generally applicable taxes and eligible PILOTs, the Final Regulations adopt consistent terminology to state this uniform standard.

The 1997 Regulations and the Proposed Regulations require “designation” of eligible PILOTs for public purposes. Commentators suggested clarifying this designation principle to require “application” of PILOTs for public purposes or to deem PILOTs as duly designated upon commingling with other governmental taxes or revenues. In response to this comment, the Final Regulations require use of an eligible PILOT for governmental or public purposes for which the underlying generally applicable tax on which it is based may be used.

The Proposed Regulations proposed to eliminate the example in the last sentence of §1.141-4(e)(5)(ii) of the 1997 Regulations, which illustrated that a PILOT made in consideration of the use of property financed with tax-exempt bonds is treated as a special charge. Most commentators supported this proposed change and one commentator objected to this proposed change. The Final Regulations remove this example, but address the issue raised in this example separately in clarifying guidance on the “special charge” limitation on generally applicable taxes under §1.141-4(e)(3). A payment made “in consideration for the use of property” is more properly characterized as rent or an installment sale payment for the use of property. The Final Regulations clarify that, among other special charges, a payment for the use of property (for example, rent) is treated as a special charge under §1.141-4(e)(3). Further, the reference to tax-exempt bond financing in the referenced example caused confusion because the presence or absence of tax-exempt bond financing properly is irrelevant to the determination of whether a payment, in substance, is in the nature of a special charge for the use of property or a generally applicable tax. The above-described revision with respect to the referenced example represents a technical clarification rather than a substantive change.

The Proposed Regulations were published on October 19, 2006, and were proposed to apply to bonds sold on or after February 16, 2007. This proposed effective date was intended to accommodate completion of bond issues for projects in progress under the 1997 Regulations. Commentators indicated that the proposed effective date of the Proposed Regulations was insufficient to accommodate completion of bond issues for projects substantially in progress. Commentators also requested transitional relief for refundings of bonds issued before the effective date of the Proposed Regulations.

The Final Regulations generally apply to bonds sold on or after October 24, 2008.

In response to public comments, the Final Regulations provide a transitional rule for refundings. Under this transitional rule, the 1997 Regulations may continue to be applied to certain refundings of bonds that were sold before the dates of applicability of the Final Regulations if they meet a prescribed weighted average maturity test set forth in the Final Regulations.

In addition, in response to public comments, the Final Regulations also provide a transitional rule for certain bonds for projects substantially in progress at the time of the promulgation of the Proposed Regulations. Under this transitional rule, the 1997 Regulations may continue to be applied to certain bonds issued within a prescribed time to finance certain projects that meet prescribed conditions set forth in the Final Regulations.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedures Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the proposed regulations preceding these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.141-0 is amended by adding a new entry for §1.141-15(k) to read as follows:

This document amends §1.1367-2 of the Income Tax Regulations (26 CFR part 1) regarding the definition of open account debt and adjustments in basis of indebtedness for shareholder advances and repayments on advances of open account debt.

Section 1367(a)(1) provides that the basis of each shareholder’s stock in an S corporation is increased by the shareholder’s pro rata share of the S corporation’s income (separately and nonseparately computed items of income) and the excess of the deductions for depletion over the basis of the property subject to depletion. Section 1367(a)(2) provides that the basis of each shareholder’s stock in the S corporation is decreased by the shareholder’s distributions not includible in income of the shareholder by reason of section 1368 (nontaxable distributions), and the shareholder’s pro rata share of the losses and deductions (separately and nonseparately computed losses), any expense of the corporation that is not deductible and not properly chargeable to capital account, and certain deductions for depletion for any oil and gas property held by the S corporation. Under section 1367(b)(2)(A), if for any taxable year the amounts specified in section 1367(a)(2) (other than distributions) exceed the amount which reduces the shareholder’s basis to zero, such excess losses and deductions shall be applied to reduce (but not below zero) the shareholder’s basis in any indebtedness of the S corporation to the shareholder. Section 1367(b)(2)(B) provides that if a shareholder’s basis in indebtedness is reduced for any taxable year, any net increase (the amount by which the items described in section 1367(a)(1) exceed the items described in section 1367(a)(2)) for any subsequent taxable year is applied to restore the reduction in basis in indebtedness before any of the excess is used to increase basis in stock.

On January 3, 1994, the Treasury Department and the IRS published final regulations under section 1367 of the Code (T.D. 8508, 1994-1 C.B. 219 [59 FR 12], amended on December 22, 1999 (T.D. 8852, 2000-1 C.B. 253 [64 FR 71641])). Those final regulations relate, in part, to adjustments to basis in both stock of shareholders and indebtedness of an S corporation to its shareholders. Section 1.1367-2 of the Income Tax Regulations provides specific rules for required adjustments (reductions and restorations) to basis in any indebtedness of an S corporation to a shareholder. Section 1.1367-2(a) also provides that for purposes of adjustments to basis of indebtedness to shareholders, shareholder advances not evidenced by separate written instruments and repayments on the advances (open account debt) are treated as a single indebtedness. The basis adjustment rules under the final regulations apply to all indebtedness of an S corporation to a shareholder, whether the indebtedness is evidenced by a written instrument or is open account debt. Taxpayers should also remember that all advances to an S corporation by a shareholder are subject to the general tax principles for debt, whether evidenced by a written instrument or not.

On August 25, 2005, the Tax Court issued its decision in Brooks v. Commissioner, TC Memo. 2005-204, involving open account debt. Under its interpretation of §1.1367-2, the court in Brooks held “that the basis of the open account indebtedness is properly computed by netting at the close of the year advances of open account debt during the year and repayments of open account debt during the year.” This allowed the taxpayer in Brooks to defer indefinitely the recognition of income on any repayment of his open account debt over the several years during which the taxpayer and the S corporation made advances and repayments, respectively.

On April 12, 2007, the Treasury Department and the IRS published a notice of proposed rulemaking and a notice of public hearing (REG-144859-04, 2007-20 I.R.B. 1245) in the Federal Register (72 FR 18417) proposing amendments to the regulations relating to the treatment of open account debt between S corporations and their shareholders. A public hearing on the proposed regulations was scheduled for July 31, 2007, but was cancelled because no one requested to speak. However, comments responding to the proposed regulations were received. After consideration of these comments, the proposed regulations are adopted as revised by this Treasury decision. These final regulations generally retain the provisions of the proposed regulations with the modifications discussed in the preamble.

All of the comments received in response to the proposed regulations suggested that the regulations were overly broad and should be withdrawn. Two commentators suggested that amending the regulations for open account debt is not an appropriate approach for the Treasury Department and the IRS to address concerns regarding transactions similar to that in Brooks. Instead, the commentators asserted, such concerns should be addressed through established judicial doctrines such as substance over form, business purpose, sham transaction, and economic substance. One commentator alternatively recommended a narrowly tailored anti-abuse rule targeting open account debt instead of broader rules that would apply to all such debt.

The Treasury Department and the IRS continue to believe that regulatory guidance on open account debt is necessary. The Treasury Department and the IRS believe that the treatment of open account debt as interpreted in Brooks permits tax consequences that are inconsistent with the original purpose of §1.1367-2 and is not conducive to sound tax administration. Neither established judicial doctrines alone nor a narrowly tailored anti-abuse rule suggested by the commentators would adequately address these concerns, though the Treasury Department and the IRS continue to recognize the applicability of the judicial doctrines in appropriate cases in addition to these final regulations.

The proposed regulations defined open account debt as shareholder advances not evidenced by separate written instruments for which the principal amount of the aggregate advances (net of repayments on advances) did not exceed $10,000 per shareholder at the close of any day during the S corporation’s taxable year. Shareholders were required to determine for open account debt purposes whether shareholder advances and repayments on the advances exceeded the $10,000 aggregate principal threshold on any day during the S corporation’s taxable year. To make such a determination, shareholders were required to maintain a “running balance” of shareholder advances and repayments on advances, and the outstanding principal amount of the open account debt. If the resulting aggregate principal of the running balance exceeded $10,000 at the close of any day during the S corporation’s taxable year, the entire principal amount of the indebtedness would no longer constitute open account debt effective at the close of that day.

Commentators suggested that the proposed regulations’ aggregate principal threshold of $10,000 was too low for most businesses. One commentator asserted that establishing any aggregate principal threshold dollar amount for open account debt in final regulations would be arbitrary and would impose a certain compliance burden on smaller businesses. However, that commentator also suggested that increasing the aggregate principal threshold dollar amount would mitigate the compliance burden. The commentators suggested that if the final regulations adopt any threshold dollar amount for open account debt, such a threshold amount should be increased to an amount ranging from $100,000 to $1 million.

After considering the comments on the aggregate principal threshold dollar amount, and on recognizing customary business practices as noted by the commentators, the Treasury Department and the IRS have concluded that the aggregate principal threshold dollar amount for open account debt should be increased and that other changes are necessary. Therefore, the final regulations adopt a $25,000 aggregate principal threshold amount per shareholder for open account debt. For example, an S corporation with ten shareholders could receive up to $250,000 of open account debt as long as no single shareholder advanced more than $25,000. The Treasury Department and the IRS believe that the $25,000 threshold, together with certain other changes noted below, balances concerns over deferral potential with normal business practices. Under the final regulations, for any particular shareholder advances and repayments on those advances for which, as of the specified determination date, the aggregate principal balance exceeds the $25,000 aggregate principal threshold amount will no longer constitute open account debt, but instead will be treated as debt evidenced by a separate written instrument subject to the basis adjustment and repayment accounting rules applicable to S corporation shareholder debt generally.

As noted in the preamble to the proposed regulations, the $10,000 aggregate principal threshold amount for open account debt for purposes of §1.1367-2 was modeled after section 7872(c)(3) and the de minimis exception for corporation-shareholder loans in §1.7872-9 of the proposed regulations. However, the Treasury Department and the IRS do not believe it is necessary that the threshold amount for open account debt be modeled after the rules under §1.7872-9 regarding corporate-shareholder loans. Nevertheless, despite the $25,000 threshold amount for open account debt in these final regulations, the provisions under section 7872 and related regulations for corporate-shareholder loans in excess of $10,000 separately apply to open account debt in excess of $10,000 for each advance if the corporation is not obligated to pay a market rate of interest on the advances.

The proposed regulations effectively required day-to-day monitoring of open account debt. For purposes of determining compliance with the aggregate principal threshold amount for open account debt, the shareholder was required to maintain a daily running balance of shareholder advances and repayments on such advances, and the outstanding principal amount of the open account debt. Some of the commentators suggested that the daily monitoring requirement would impose an unreasonable burden on shareholders and recommended that the running balance requirement be tested quarterly, annually or when the corporation maintains and updates its other books and records. One commentator described the practice by many closely held corporations of reconciling and accounting only once a year and noted that only then would such an S corporation and its shareholder(s) know what payments are legitimately charged to the corporation as opposed to those appropriately charged to the shareholder(s).

Another commentator suggested that with daily monitoring, a maximum threshold rule for open account debt is too harsh for shareholders insofar as it immediately changes the treatment of such debt the principal balance of which exceeds the threshold by a single cent on any day, resulting in a “cliff” effect. The commentator suggested that in order to mitigate this “cliff” effect, the final regulations should adopt a second prong to the aggregate principal threshold amount test so that advances would fail to meet the definition of open account debt only if both the aggregate principal of the running balance exceeded the applicable aggregate principal threshold dollar amount on any given day of the year and the balance at the end of the year exceeded the average of the daily balances throughout the year. The commentator provided examples of intended beneficiaries of such an “averaging” rule, for example, shareholders who need to advance their S corporation more funds on a short-time basis but end the year with an outstanding principal amount of the open account debt below the threshold level.

After careful consideration of these comments, the Treasury Department and the IRS have concluded that extending the period for which a shareholder determines whether shareholder advances and repayments exceed the aggregate principal threshold dollar amount for open account debt would reduce both the complexity of the regulations and any perceived burden on shareholders in making such determinations. In addition, such a modified rule should alleviate concerns over any potential “cliff” effect resulting from a day-to-day determination of threshold amount as required in the proposed regulations. The Treasury Department and the IRS also recognize that shareholder advances made to an S corporation and subsequently repaid during the same taxable year of the S corporation are not available for inclusion in the shareholder’s basis in the indebtedness for purposes of passing through additional losses to the shareholder at the end of the taxable year.

Therefore, the final regulations do not adopt a daily determination of whether shareholder advances and repayments on the advances exceed the $25,000 threshold amount. Instead, the final regulations provide that a determination of whether the threshold balance of $25,000 is exceeded will be made at the end of the taxable year of the S corporation. Under these final regulations, however, if open account debt is disposed of in whole or in part before the end of the S corporation’s taxable year, the determination of whether the advances and repayments have exceeded the designated aggregate principal threshold amount must be made immediately before the disposition of the debt during that taxable year. Moreover, if a shareholder with open account debt is no longer a shareholder at the end of the S corporation’s taxable year, the determination must be made immediately before the shareholder’s interest in the S corporation is terminated.

One of the commentators suggested that the final regulations address the issue of how to characterize any income or gain that is recognized upon repayment of both open account debt and indebtedness evidenced by a written instrument. While recognizing the commentators’ concerns, the Treasury Department and the IRS believe that the characterization issue is beyond the scope of these final regulations. However, the Treasury Department and the IRS intend to continue considering the characterization issue.

The effective date in the proposed regulations provided that the proposed rules for open account debt applied to any shareholder advances to the S corporation made on or after the date the regulations were published as final regulations and repayments on those advances by the S corporation. Thus, all open account debt (net of repayments) prior to the publication of the final regulation was outside the scope of the proposed regulations, irrespective of the outstanding principal amount.

One of the commentators believed that the effective date language in the proposed regulations was subject to two interpretations. Under the first interpretation, the rules under these final regulations (New Rules) would apply only to open account debt created on or after the effective date, that is, shareholder advances made on or after the effective date and repayments on those same advances. The rules under the prior final regulations (as contained in the 26 CFR edition revised April 1, 2007) (Old Rules) would apply to open account debt created before the effective date, that is, shareholder advances with respect to pre-effective date open account debt and repayments on those prior advances. Accordingly, a shareholder could have open account debt, subject to the Old Rules, and open account debt, subject to the New Rules, to which new shareholder advances and repayments on those advances could be made after the effective date.

Under the second interpretation, a shareholder could not make additional advances with respect to open account debt created before the effective date but could receive repayments on that debt under the Old Rules. Accordingly, the New Rules would apply to all shareholder advances on and after the effective date, as well as repayments on those advances, and the Old Rules would apply only to repayments on pre-effective date open account debt.

The Treasury Department and the IRS intend that the rules under these final regulations (New Rules) apply to any and all shareholder advances made on and after the effective date. The rules under these final regulations (New Rules) also apply to repayments on such advances. However, if a shareholder has open account debt (net of prior repayments in the taxable year) outstanding prior to the effective date of these final regulations, the rules under the prior final regulations (Old Rules) apply to any repayments on such pre-effective date open account debt. Accordingly, that pre-effective date open account debt will not be subject to any aggregate principal threshold dollar amount. The shareholder may not make additional advances with respect to the pre-effective date open account debt (because all shareholder advances made on or after the effective date of these final regulations constitute new open account debt subject to these final regulations).

For instance, assume that the effective date of these final regulations falls within the taxable year of shareholder A’s S corporation. Also assume that, at the beginning of the S corporation’s taxable year, A will have existing open account debt with an outstanding principal balance of $12,000. Assume further that A will make an additional advance of $3,000 to and will receive a $2,000 repayment from his S corporation prior to the effective date. Thus, as of the effective date, A will have existing open account debt with an outstanding principal balance of $13,000 (A would net the pre-effective date advance and repayment for the taxable year and combine that net advance of $1,000 with the $12,000 outstanding aggregate principal balance of the then existing open account debt). This $13,000 pre-effective date open account debt would not be subject to these final regulations and, thus, would not be subject to any aggregate principal threshold dollar amount and would be repaid under the rules of the prior final regulations. If, on or after the effective date of these final regulations, A were to both make an advance of $5,000 to his S corporation and receive a $1,000 repayment on that advance, the advance and repayment would constitute separate new open account debt subject to the rules under these final regulations.

Shareholders also have the option to apply these rules to shareholder advances to the S corporation and repayments on those advances by the S corporation made before the effective date of these regulations. Using the example above, A would have the option to net the $5,000 advance and $1,000 repayment.

The regulations apply to any and all shareholder advances to the S corporation made on or after October 20, 2008, and repayments on those advances by the S corporation.

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Because these regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking that preceded these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.1367-2 also issued under 26 U.S.C. 1367(b)(2).* * *

Par. 2. Section 1.1367-2 is amended as follows:

1. Paragraph (a) is revised.

2. Paragraphs (c)(2) and (d)(1) are revised.

3. Paragraph (d)(2) is redesignated as paragraph (d)(3) and new paragraph (d)(2) is added.

4. Paragraph (e) is amended by adding Examples 6, 7 and 8.

The revisions and additions read as follows:

The Newborns’ and Mothers’ Health Protection Act of 1996 (Newborns’ Act), Public Law 104-204, was enacted on September 26, 1996. The rules contained in this document implement changes made to the Employee Retirement Income Security Act of 1974 (ERISA) and the Public Health Service Act (PHS Act) made by the Newborns’ Act, and parallel changes to the Internal Revenue Code of 1986 (Code) enacted as part of the Taxpayer Relief Act of 1997 (TRA ’97). The Newborns’ Act was enacted to provide protections for mothers and their newborn children with regard to hospital lengths of stay following childbirth. Interim final rules implementing the group and individual market provisions of the Newborns’ Act were published in the Federal Register on October 27, 1998 (63 FR 57546) (the interim final rules).

These regulations being published today in the Federal Register finalize the interim final rules. The final regulations implementing the group market provisions of the Newborns’ Act are issued jointly by the Secretaries of the Treasury, Labor, and HHS.^[1] The individual market final regulations are issued solely by HHS.^[2]

Section 9811 of the Code, section 711 of ERISA, and sections 2704 and 2751 of the PHS Act (the Newborns’ Act provisions) provide a general rule under which a group health plan and a health insurance issuer may not restrict mothers’ and newborns’ benefits for a hospital length of stay in connection with childbirth to less than 48 hours following a vaginal delivery or 96 hours following a delivery by cesarean section. The interim final rule—

In general, these final regulations do not change the interim final rules. However, the text of these final regulations incorporates a clarifying statement from the preamble of the interim final rules that the definition of attending provider does not include a plan, hospital, managed care organization, or other issuer. The text also makes a small clarification with respect to state law applicability.

In addition, these final regulations make minor clarifications to the notice requirements for nonfederal governmental plans. The interim final rules specified that the notice of post-childbirth hospitalization benefits must be included in the plan document that described plan benefits to participants and beneficiaries. These final regulations specify that any notice a nonfederal governmental plan must provide under these regulations can be included either in the plan document that describes benefits, or in the type of document the plan generally uses to inform participants and beneficiaries of plan benefit changes. These final regulations also specify that any time a plan distributes one or both of these documents after providing the initial notice, the applicable statement must appear in one or both of these documents.

The interim final rules and these final regulations provide that when a delivery occurs in the hospital, the stay begins at the time of delivery (or, in the case of multiple births, at the time of the last delivery) rather than at the time of admission or onset of labor. Also, the interim final rules and these final regulations provide that when a delivery occurs outside of the hospital, the stay begins at the time the mother or newborn is admitted (rather than at the time of delivery).

Some comments expressed concern that this rule somehow required birthing centers or other non-hospital facilities to extend the right to stay to more than 24 hours. These comments noted that such extended stays may violate local regulations or otherwise conflict with the operations of such facilities. The statute and these final regulations do not require hospitals or other facilities to provide particular lengths of stay, but instead require group health plans and health insurance issuers to provide benefits for particular hospital lengths of stay.

A comment recommended that if a delivery was planned for outside of a hospital, any following admission in response to complications resulting from that delivery should be excluded from the provisions providing for particular lengths of stay. These final regulations do not distinguish between a delivery that was planned for outside of the hospital and other deliveries occurring outside of a hospital.

The mandatory coverage period provisions are not violated if the attending provider, in consultation with the mother, decides to discharge the mother or newborn earlier. Under the interim final rules and these final regulations, the attending provider is defined by a functional analysis of state licensure rules and the actual performance of care. Under this definition, the attending provider is restricted to an individual who is licensed under applicable state law to provide maternal or pediatric care and who is directly responsible for providing such care to a mother or newborn child. While the preamble to the interim final rules noted that this definition could include a nurse midwife or physician assistant, the regulation itself does not provide a list of titles or positions that qualify as attending providers.

Some comments requested that additional titles, such as pediatric nurse practitioners, or nurse practitioners, be specifically mentioned in the definition. While positions with these titles may meet the definition in many cases, as noted above, the language of the regulation takes a functional approach and does not provide a list of titles or positions that qualify as attending providers. This functional approach is more useful in addressing who the attending provider is on an ongoing basis, as specific position titles and responsibilities may vary from location to location as well as over time.

It was also suggested that the text of the final regulations incorporate a clarifying statement from the preamble of the interim final rules that the definition of attending provider does not include a plan, hospital, managed care organization, or other issuer. These final regulations adopt this suggestion.

Several comments addressed the provisions in the interim final rules that relate to the compensation of physicians and other attending providers. These provisions prohibit plans and issuers from penalizing attending providers who provide care in accordance with the regulations, and prohibit plans and issuers from inducing attending providers to provide care in a manner that is inconsistent with the regulations. At the same time, the statute specifies that plans and issuers are still free to negotiate with attending providers the level and type of compensation for care furnished in accordance with the regulations.

The comments requested greater specificity in the final regulations for distinguishing between the types of compensation arrangements that are permissible under the negotiation provision and those that are impermissible under the prohibitions against penalties and inducements. One comment suggested that it is clear that a bonus arrangement for obstetricians and gynecologists contingent on the percentage of discharges within 24 hours would not be permitted. The comment requested confirmation that arrangements with a more general focus would be permitted, such as a global payment for prenatal care and childbirth, or a bonus for a multi-specialty group including obstetricians and gynecologists based on the utilization for all patients served by the group. Another comment expressed a concern about whether capitated arrangements are consistent with the hospital length-of-stay requirements.

The Departments devoted considerable resources over a sustained period of time to develop rules that provide greater specificity for distinguishing between negotiated compensation arrangements that would give attending providers an incentive to deliver health care services efficiently and arrangements that could give providers an incentive to discharge patients in contravention of the statute and regulations. The great variety, complexity, and mutability of such arrangements^[3] would have required extensive rules that at best were likely to impose heavy administrative costs and yet were still of only marginal value in clarifying what arrangements would be permissible. For this reason, the rules on compensation arrangements for attending providers are adopted unchanged from the interim final rules.

The final regulations do not attempt to provide guidance on this issue through examples. Certainly the bonus arrangement described in one comment, based on the percentage of discharges within 24 hours, violates the prohibition against providing inducements for early discharge. Such an example is not included in the final regulations to avoid the inference that anything less blatant would be permissible. Examples of less blatant arrangements could be similarly misleading, whether the conclusion was that the arrangement was permissible or impermissible, since there are bound to be differences between arrangements that would have been described in the regulations and any actual arrangement for an attending provider, and in some cases even minor differences could change the result.

The interim final rules and these final regulations provide, under paragraph (a), that a group health plan or a health insurance issuer may not require a physician or other health care provider to obtain authorization from the plan or issuer to prescribe a hospital length of stay that is subject to the general rule.

Under paragraph (b) of the interim final rules and these final regulations, a plan or issuer may not restrict benefits for part of a stay that is subject to the general rule in a way that is less favorable than a prior portion of the stay. An example in the interim final rules and these final regulations illustrates that a plan or issuer is precluded from requiring a covered individual to obtain precertification for any portion of a hospital stay that is subject to the general rule if precertification is not required for any preceding portion of the stay. However, the interim final rules do not prevent a plan or issuer from requiring precertification for any portion of a stay after 48 hours (or 96 hours), or from requiring precertification for an entire stay.

Under paragraph (c) of the interim final rules and these final regulations, a plan or issuer may not increase an individual’s coinsurance for any later portion of a 48-hour (or 96-hour) hospital stay. An example in the interim final rules and these final regulations illustrates that plans and issuers may vary cost-sharing in certain circumstances, provided the cost-sharing rate is consistent throughout the 48-hour (or 96-hour) hospital length of stay.

One comment asked whether less favorable cost sharing for the 48-hour (or 96-hour) stay can be applied to covered individuals who fail to give advance notice or notice upon admission for the services or providers related to the stay, if such a penalty applies in other hospitalization situations. This issue was addressed in Example 2 of paragraph (c)(3) of the interim final rules. This example is repeated in the final regulations and illustrates that a plan may require advance notice for services or providers related to hospital length of stay in connection with childbirth, in order for a covered individual to obtain more favorable cost sharing under the plan or coverage. Such requirements may not be used to deny an individual benefits for any portion of the 48-hour (or 96-hour) stay based on a determination of medical necessity or appropriateness. Any variance in cost-sharing related to compliance with a plan’s or an issuer’s advance notice requirements must be applied consistently throughout the 48-hour (or 96-hour) stay. Under the principles set forth in the rule and illustrated in this example, a plan or issuer could generally apply less favorable cost sharing towards the hospital length of stay in connection with childbirth of an individual who failed to satisfy the plan’s advance notice requirements, to the extent permissible under the preexisting condition rules in 26 CFR 54.9801-3, 29 CFR 2590.701-3, and 45 CFR 146.111 and 148.120.^[4]

This section of the final regulations addresses the Newborns’ Act notice requirements under ERISA and the PHS Act. The interim final rules, and these final regulations, contain different notice provisions for ERISA-covered group health plans, nonfederal governmental plans, and health insurance issuers in the individual market. ERISA-covered group health plans are required to comply with the ERISA notice regulations, whether insured or self-insured. Nonfederal governmental plans and health insurance issuers in the individual market are required to comply with the PHS Act notice regulations. Because there are fundamental differences between the types of entities regulated under ERISA as compared to the PHS Act, and in the structure of the two acts, the notice requirements in the ERISA regulations and PHS Act regulations differ.

Notice Requirements under ERISA. The interim final rules and these final regulations require group health plans that are subject to ERISA to comply with summary plan description (SPD) disclosure requirements at 29 CFR 2520.102-3(u). The SPD rules generally require that participants and beneficiaries in a group health plan be furnished an SPD to apprise them of their rights and obligations. The rules also prescribe the content of the SPD and the manner and timing in which participants and beneficiaries are to be notified of any material modification to the terms of the plan or any change in the information required to be included in the SPD.

In November 2000, the Department of Labor finalized the SPD content regulation (65 FR 70241) requiring that all group health plans (including insured plans not subject to the federal Newborns’ Act) provide language in the SPD that describes the federal or state law requirements applicable to the plan or any health insurance coverage offered under the plan relating to hospital lengths of stay in connection with childbirth for the mother or newborn child. If federal law applies in some areas in which the plan operates and state law applies in other areas, the SPD should describe the different areas and the federal or state law requirements applicable in each. Model language for plans subject to the federal Newborns’ Act’s requirements is included in the SPD content regulation. This change became applicable as of the first day of the second plan year beginning on or after January 22, 2001.

Some comments asked for clarification about whether the notice can be provided through electronic media, as an alternative to traditional paper disclosure. Under ERISA, the notice can be provided through electronic media if the plan complies with ERISA’s electronic disclosure rules in 29 CFR 2520.104b-1.

Some comments requested that the rules require plans to provide information to patients and providers regarding who has legal oversight with respect to the Newborns’ Act and who to contact in the event of a violation. However, this concern is already addressed by current regulation. Under 29 CFR 2520.102-3(t)(1) of the SPD content rules, ERISA plans are required to provide a statement of ERISA rights in the SPD. Among other things, this provision requires ERISA-covered plans to provide information on the enforcement of a participant or beneficiary’s rights and who to contact if there are any questions about the plan.

Notice Requirements under the PHS Act. Nonfederal governmental plans. The Newborns’ Act requires nonfederal governmental plans to comply with the Newborns’ Act notice requirements under section 711(d) of ERISA as if section 711(d) applied to such plans.

The interim final rules and these final regulations require plans that are subject to the federal Newborns’ Act requirements to provide a notice with specific language describing the federal requirements. Under the interim final rules and these final regulations, if federal law applies in some areas in which the plan operates and state law applies in others, the plan must provide the appropriate notice to each participant and beneficiary who is covered by federal law.

Several comments on the interim final rules objected that specific language was required for the disclosure statement, and suggested that the regulation instead should have provided guidelines for plans to base their own language on (such as language that comports with the Department of Labor’s sample language). However, requiring specific language ensures the substantive adequacy of the notices. Additionally, because many plans presumably have already incorporated that mandatory language into their documents since the effective date of the interim final rules, continuing to require that language is the simplest approach.

As in the interim final rules, these final regulations require nonfederal governmental plans to provide notice not later than 60 days after the first day of the plan year following the effective date, regardless of whether the plan had already provided notice under the Department of Labor standards. This takes into account the fundamental differences between the nonfederal governmental plans regulated under the PHS Act and the types of entities regulated under ERISA. However, with respect to the requirement that notice be provided within that 60-day period, the final regulations include an exception for plans with regard to participants and beneficiaries for whom the plan has already provided notices in accordance with the interim final regulations that are consistent with these final regulations (such as self-insured nonfederal governmental plans that are subject to the federal Newborns’ Act requirements and that have already provided such notices).

Health insurance issuers in the individual market. The Newborns’ Act requires health insurance issuers in the individual market to comply with the Newborns’ Act notice requirements under section 711(d) of ERISA as if section 711(d) applied to such issuers. Thus, the interim final rules and these final regulations require individual market health insurance issuers that provide benefits for hospital lengths of stay in connection with childbirth to include, in the insurance contract, a rider, or equivalent amendment to the contract, specific language that notifies policyholders of their rights under the Newborns’ Act. The interim final rules and these final regulations also require such issuers to provide this notice not later than a specific time frame that is within a few months after the effective date of the regulations.

Several comments on the interim final rules objected that specific language was required for the disclosure statement and suggested instead there should be guidelines for issuers to base their own language on. However, requiring specific language ensures the substantive adequacy of the notices. Additionally, because issuers presumably have already incorporated that language into their documents since the effective date of the interim final rules, continuing to require that same language is the simplest approach.

These final regulations retain the notice exception in the interim final rules for issuers that are subject only to state insurance law requirements regarding hospital lengths of stay following childbirth.

The statute and the interim final rules include an exception to the Newborns’ Act requirements for health insurance coverage in certain states. Specifically, the Newborns’ Act and the interim final rules do not apply with respect to health insurance coverage if there is a state law that meets any of the criteria^[5] that follow:

Although this exception applies with respect to insured group health plans, it does not apply with respect to a group health plan to the extent the plan provides benefits for hospital lengths of stay in connection with childbirth other than through health insurance coverage. Accordingly, self-insured plans in all states generally are required to comply with the federal requirements (except those nonfederal governmental plans that have opted out of the PHS Act requirements).

These final regulations repeat the statute and the interim final rules with one clarification. With respect to the second criterion above (professional guidelines), the statute only addresses the period following a vaginal delivery or a caesarean section. Accordingly, although guidelines issued by professional medical associations such as the American College of Obstetricians and Gynecologists (ACOG) cover a spectrum of care both before and after childbirth, the only relevant guidelines for this purpose are those pertaining to care following childbirth. Therefore, the final rules include an express clarification that State law need only require coverage in accordance with professional guidelines that deal with care following childbirth. Guidelines relating to other issues are not relevant for this purpose.

One comment to the interim final rules supported the criteria used in those rules for determining whether the federal Newborns’ Act applies in a given state. However, another comment objected to the fact that issuers in states that have enacted one of the three types of state laws described in the federal Newborns’ Act would arguably be exempt from several of the federal Act’s requirements, such as the prohibitions on offering incentives to providers to induce them to provide care in a manner inconsistent with the Act. This comment asked us to reconsider whether the regulations should provide such a broad exception from the federal Act’s requirements in such states. The statutory language does not require state law to include all the federal provisions, such as the anti-incentive provisions, in order for health insurance coverage in that state to be excepted from the federal requirements. In light of this flexibility, these final regulations retain the exception from the interim final rules.

These final rules apply to group health plans, and health insurance issuers offering group health insurance coverage, for plan years beginning on or after January 1, 2009. The final rules for the individual market apply with respect to health insurance coverage offered, sold, issued, renewed, in effect, or operated in the individual market on or after January 1, 2009. Until the applicability date for this regulation, plans and issuers are required to continue to comply with the corresponding sections of the regulations previously published in the Federal Register (63 FR 57546) and other applicable regulations.

The Newborns’ Act provisions generally prohibit group health plans and group health insurance issuers from limiting hospital lengths of stay in connection with childbirth to less than 48 hours for vaginal deliveries and 96 hours for cesarean sections and from requiring a health care practitioner to obtain preauthorization for such stays. For insured coverage, the Newborns’ Act allows any state law, meeting one of three criteria, to take its place. The Departments have crafted these regulations to secure the Act’s protections in as economically efficient a manner as possible, and believe that the economic benefits of the regulations justify their costs.^[6]

The primary economic benefits associated with securing these minimum lengths of stay derive from the reduction in complications linked to premature discharge of mothers and newborns. Complications that are easily treated and readily identifiable, like excessive bleeding and infection in new mothers and dehydration and hyperbilirubinemia in their newborns, are common causes for readmission following a premature discharge. These complications and the subsequent readmissions are expensive and cause avoidable suffering for mothers and their newborns.

By eliminating the need to obtain preauthorization for affected stays, the Act provides affected individuals with increased access to the health care system. Increased access fosters timelier and fuller medical care, better health outcomes, and improved quality of life. This is especially true for certain individuals affected by the Newborns’ Act provisions. For example, lower-income individuals, when denied coverage for the full length of stay, are more likely to forego care for financial reasons. When adverse health outcomes result, costs for the individual and the plan are high. For these individuals especially, this requirement is more likely to mean receiving timely, quality postnatal care, and living healthier lives.

Any mandate to increase the richness of health benefits, however, adds to the cost of health coverage. Plans can mitigate costs by increasing cost-sharing or by reducing non-mandated benefits. This in turn shifts the economic burden of the regulation to plan participants, and may induce some employers and employees, as well as those in the individual insurance market, to drop coverage. The cost of enacting federal minimum stay regulation is estimated to fall between $139 and $279 million annually.^[7] However, as this constitutes a small fraction of one percent of total health care expenditures, it would most likely be a small, possibly negligible, factor in most employers’ decisions to offer health coverage and individuals’ decisions to enroll.

While the interim final regulations clarified several provisions within the statute, this action serves primarily to provide the certainty associated with a final rule for the regulated community, as well as update the cost of the regulation, adjusting for changes in the landscape of the community. Because these regulations are being published several years after the Newborns’ Act’s passage and minimal interpretation of the statutory language was required, the regulatory implementation costs should be negligible. Costs of the final regulation are detailed below in the section entitled “Unified Analysis of Costs and Benefits.” Benefits of the regulation are also discussed in that section at length, although because the benefits primarily involve quality of life improvements, the Departments have not attempted to quantify them. They do, however, believe them to be sufficiently large so as to justify the cost of the regulation.

Under Executive Order 12866, the Departments must determine whether a regulatory action is “significant” and therefore subject to the requirements of the Executive Order and subject to review by the Office of Management and Budget (OMB). Under section 3(f), the order defines a “significant regulatory action” as an action that is likely to result in a rule (1) having an annual effect on the economy of $100 million or more, or adversely and materially affecting a sector of the economy, productivity, competition, jobs, the environment, public health or safety, or state, local or tribal governments or communities (also referred to as “economically significant”); (2) creating serious inconsistency or otherwise interfering with an action taken or planned by another agency; (3) materially altering the budgetary impacts of entitlement grants, user fees, or loan programs or the rights and obligations of recipients thereof; or (4) raising novel legal or policy issues arising out of legal mandates, the President’s priorities, or the principles set forth in the Executive Order.

Pursuant to the terms of the Executive Order, it has been determined that this action is “economically significant” and is subject to OMB review under Section 3(f) of the Executive Order. Consistent with the Executive Order, the Departments have assessed the costs and benefits of this action. The Departments’ assessment, and the analysis underlying the assessment, is detailed below. The Departments performed a comprehensive, unified analysis to estimate the costs and benefits attributable to the regulations for purposes of compliance with Executive Order 12866, the Regulatory Flexibility Act, and the Paperwork Reduction Act.

These final regulations are needed to provide certainty for the affected community, as well as clarify the economic burden that the Newborns’ Act will place on health plans and their participants. The Departments believe that this regulation’s benefits will justify its costs. This belief is grounded in the assessment of costs and benefits that is summarized earlier and detailed below.

The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) (RFA) imposes certain requirements with respect to Federal rules that are subject to the notice and comment requirements of section 553(b) of the Administrative Procedure Act (5 U.S.C. 551 et seq.) and likely to have a significant economic impact on a substantial number of small entities. Unless an agency certifies that a final rule will not have a significant economic impact on a substantial number of small entities, section 604 of the RFA requires that the agency present a final regulatory flexibility analysis (FRFA) at the time of the publication of the notice of final rulemaking describing the impact of the rule on small entities. Small entities include small businesses, organizations, and governmental jurisdictions.

Because the 1998 rules were issued as interim final rules and not as a notice of proposed rulemaking, the RFA did not apply and the Departments were not required to either certify that the rule would not have a significant impact on a substantial number of small entities or conduct a regulatory flexibility analysis. The Departments nonetheless crafted those regulations in careful consideration of effects on small entities, and conducted an analysis of the likely impact of the rules on small entities. This analysis was detailed in the preamble to the interim final rule.

For purposes of this discussion, the Departments consider a small entity to be an employee benefit plan with fewer than 100 participants. Pursuant to the authority of section 104(a)(3) of ERISA, the Department of Labor has previously issued at 29 CFR 2520.104-20, 2520.104-21, 2520.104-41. 2520.104-46 and 2520.104b-10, certain simplified reporting provisions and limited exemptions from reporting and disclosure requirements for small plans, including unfunded or insured welfare plans covering fewer than 100 participants and which satisfy certain other requirements.

Further, while some small plans are maintained by large employers, most are maintained by small employers. Both small and large plans may enlist small third party service providers to perform administrative functions, but it is generally understood that third party service providers shift their costs to their plan clients in the form of fees. Thus, the Departments believe that assessing the impact of this final rule on small plans is an appropriate substitute for evaluating the effect on small entities. The definition of small entity considered appropriate for this purpose differs, however, from a definition of small business based on size standards promulgated by the Small Business Administration (SBA) (13 CFR 121.201) pursuant to the Small Business Act (5 U.S.C. 631 et seq.). The Department of Labor solicited comments on the use of this standard for evaluating the impact of the proposed regulations on small entities. No comments were received with respect to this standard.

The Departments believe that the final regulation will not have a significant economic impact on a substantial number of small entities. The direct costs of restricting short stay policies is estimated to fall between $15 million and $31 million for small plans which amount to a per-participant cost of between nine and nineteen dollars for those plans affected, or a small fraction of one percent of total small plan expenditures.^[8]

The Departments estimate that prior to the Act, 115,000 small plans with 1.6 million participants would have restricted lengths of stay in connection with childbirth or required preauthorization for such stays.^[9] While this represents just 5 percent of all small plans, the Departments believe it may represent a substantial number of small entities.

These rules contain no new information collection requirements that are subject to review and approval by OMB under the Paperwork Reduction Act of 1995 (Public Law 104-13, 44 U.S.C. Chapter 35). The Department of Labor reported the information collection burdens associated with the Newborns’ Act in the interim rules (Interim Rules Amending ERISA Disclosure Requirements for Group Health Plans) implementing section 711(d) of ERISA that were published in the Federal Register on April 8, 1997 (62 FR 16979). OMB approved the information collection under OMB Control Number 1210-0039, expiring on March 31, 2010.

These rules contain no new information collection requirements that are subject to review and approval by OMB under the Paperwork Reduction Act of 1995 (Public Law 104-13, 44 U.S.C. Chapter 35). HHS reported the information collection burdens associated with the Newborns’ Act in the interim rules (Information Collection Requirements Referenced in HIPAA for the Group Market, Supporting Regulations 45 CFR 146), published in the Federal Register on April 8, 1997. These collection requirements were approved under OMB Control Number 0938-0702, expiring on August 31, 2009.

Notwithstanding the determinations of the Departments of Labor and of Health and Human Services, for purposes of the Department of the Treasury it has been determined that this Treasury decision is not a significant regulatory action. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these Treasury regulations, and, because these regulations do not impose a collection of information on small entities, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

These regulations are subject to the Congressional Review Act provisions of the Small Business Regulatory Enforcement Fairness Act of 1996 (5 U.S.C. 801 et seq.) and have been transmitted to Congress and the Comptroller General for review. These regulations, however, are considered a “major rule,” as that term is defined in 5 U.S.C. 804, because they are likely to result in an annual effect on the economy of $100 million or more.

For purposes of the Unfunded Mandates Reform Act of 1995 (Public Law 104-4), as well as Executive Order 12875, these regulations do not include any federal mandate that may result in expenditures by state, local, or tribal governments,^[10] however, they include mandates which may impose an annual burden of $100 million or more on the private sector, updated annually for inflation. After applying the most current gross domestic product implicit price deflator in 2008, that threshold is approximately $130 million.

Executive Order 13132 outlines fundamental principles of federalism. It requires adherence to specific criteria by federal agencies in formulating and implementing policies that have “substantial direct effects” on the States, the relationship between the national government and States, or on the distribution of power and responsibilities among the various levels of government. Federal agencies promulgating regulations that have these federalism implications must consult with State and local officials, and describe the extent of their consultation and the nature of the concerns of State and local officials in the preamble to the regulation.

In the Departments’ view, these final regulations have federalism implications because they may have substantial direct effects on the States, the relationship between the national government and States, or on the distribution of power and responsibilities among the various levels of government. However, in the Departments’ view, the federalism implications of these final regulations are substantially mitigated because, with respect to health insurance issuers, all but one of the States have requirements that prescribe benefits for hospital lengths of stay in connection with childbirth that satisfy the Newborns’ Act hospital length of stay requirements.

In general, through section 514, ERISA supersedes State laws to the extent that they relate to any covered employee benefit plan, but preserves State laws that regulate insurance. At the same time, however, ERISA prohibits States from regulating a plan as an insurance company. HIPAA added a new section to ERISA (as well as to the PHS Act and the Code) narrowly preempting State requirements for issuers of group health insurance coverage.^[11] HIPAA’s conference report states that the conferees intended only the narrowest preemption of State laws with regard to health insurance issuers. H.R. Conf. Rep. No. 736, 104^th Cong. 2d Session 205 (1996).

The Newborns’ Act also added a new section to ERISA (and to the PHS Act and the Code) which provides that the federal requirements applicable to group health plans and health insurance issuers concerning hospital lengths of stay for mothers and newborns following childbirth do not apply if State law meets one or more of three specific criteria in the statute.^[12] The accompanying conference report states that it is the intent of the conferees that States may impose more favorable requirements for the treatment of maternity coverage under health insurance coverage than required by the Newborns’ Act. H.R. Conf. Rep. No. 104-812, 104^th Cong. 2d Session 88 (1996).

Guidance conveying the Newborns’ Act hospital length of stay requirements was published in the Federal Register on October 27, 1998 (63 FR 57546). These final regulations clarify and implement the statute’s minimum standards and do not significantly reduce the discretion given the States by the statute. Moreover, the Departments understand that all but one State have requirements that prescribe benefits for hospital lengths of stay in connection with childbirth that satisfy the Newborns’ Act requirements.

The Newborns’ Act modified HIPAA’s framework to provide that the States have primary responsibility for enforcement of the provisions of the Newborns’ Act as they pertain to issuers, but that the Secretary of Health and Human Services must enforce any provision that a State fails to substantially enforce. To date, CMS enforces the Newborns’ Act hospital length of stay requirements in only one State. When exercising its responsibility to enforce the Newborns’ Act provisions, CMS works cooperatively with the State for the purpose of addressing the State’s concerns and avoiding conflicts with the exercise of State authority. CMS has developed procedures to implement its enforcement responsibilities, and to afford the States the maximum opportunity to enforce the Newborns’ Act requirements in the first instance. CMS procedures address the handling of reports that States may not be enforcing the Newborns’ Act requirements, and the mechanism for allocating responsibility between the States and CMS. In compliance with Executive Order 13132’s requirement that agencies examine closely any policies that may have federalism implications or limit the policymaking discretion of the States, the Department of Labor and CMS have consulted and worked cooperatively with affected State and local officials.

For example, the Departments sought and received input from State insurance regulators and the National Association of Insurance Commissioners (NAIC). The NAIC is a non-profit corporation established by the insurance commissioners of the 50 States, the District of Columbia, and the four U.S. territories. In most States the insurance commissioner is appointed by the governor; in approximately 14 States, the insurance commissioner is an elected official. Among other activities, it provides a forum for the development of uniform policy when uniformity is appropriate. Its members meet, discuss and offer solutions to mutual problems. The NAIC sponsors quarterly meetings to provide a forum for the exchange of ideas and in-depth consideration of insurance issues by regulators, industry representatives and consumers. CMS and Department of Labor staff have consistently attended these quarterly meetings to listen to the views of the State insurance departments.

In addition, the Departments informally consulted with the NAIC in developing the interim final regulations. Through the NAIC, the Departments sought and received the input of State insurance departments regarding preemption of State laws, applicability of the Newborns’ Act provisions, and certain insurance industry definitions (e.g., attending provider). In general, these final regulations do not change the interim final rules. Significantly, the Departments received only eleven formal comment letters on the interim final regulation, none of which were from or on behalf of the NAIC or any of the States.

The Departments have also cooperated with the States in several ongoing outreach initiatives, through which information is shared among federal regulators, State regulators and the regulated community. In particular, the Department of Labor has established a Health Benefits Education Campaign with more than 70 partners, including CMS, NAIC and many business and consumer groups. CMS has sponsored conferences with the States — the Consumer Outreach and Advocacy conferences in March 1999 and June 2000, and the Implementation and Enforcement of HIPAA National State-Federal Conferences in August 1999, 2000, 2001, 2002, and 2003. Furthermore, both the Department of Labor and CMS websites offer links to important State websites and other resources, facilitating coordination between the State and federal regulators and the regulated community.

Throughout the process of developing these regulations, to the extent feasible within the specific preemption provisions of HIPAA and the Newborns’ Act, the Departments have attempted to balance the States’ interests in regulating health insurance issuers, and Congress’ intent to provide uniform minimum protections to consumers in every State. By doing so, it is the Departments’ view that they have complied with the requirements of Executive Order 13132.

Pursuant to the requirements set forth in Section 8(a) of Executive Order 13132, and by the signatures affixed to these final regulations, the Departments certify that the Employee Benefits Security Administration and the Centers for Medicare & Medicaid Services have complied with the requirements of Executive Order 13132 for the attached Final Regulations for Group Health Plans and Health Insurance Issuers Under the Newborns’ and Mothers’ Health Protection Act (RIN 1210-AA63 and RIN 0938-AI17), in a meaningful and timely manner.

The Newborns’ Act’s provisions generally prohibit group health plans and health insurance issuers from: 1) limiting hospital lengths of stay in connection with childbirth to less than 48 hours for vaginal deliveries and 96 hours for cesarean sections, and 2) requiring preauthorization for the 48/96 hour stays. The primary effect and intent of the provision is to reduce postpartum complications associated with premature discharge.

These regulations draw on the Departments’ authority to clarify and interpret the Newborns’ Act’s statutory provisions in order to secure the protections intended by Congress for newborns and mothers. The Departments crafted them to satisfy this mandate in as economically efficient a manner as possible, and believe that the economic benefits of the regulations justify their costs. This conclusion takes into account both the effect of the statute and the impact of the discretion exercised in the regulations.

This regulation is needed to clarify and interpret the Newborns’ Act provisions under section 711 of ERISA, sections 2704 and 2751 of the PHS Act, and section 9811 of the Internal Revenue Code and to ensure that group health plans and health insurance issuers subject to these rules do not impermissibly restrict benefits or require preauthorization for 48-hour or 96-hour hospital lengths of stay in connection with childbirth.

The Departments provide qualitative assessments of the nature of the costs and benefits that are expected to derive from the statutory provisions of the Newborns’ Act. In addition, the Departments provide summaries of any credible, empirical estimates of these effects that are available.

In order to determine how many plan participants could benefit from the Newborns’ Act provision, the Departments considered the estimated 2.8 million births in 2005 by women with private health insurance.^[13] Of these, approximately 55.0 percent are assumed to be normal, healthy deliveries, and therefore eligible for early discharge.^[14] Because legislation has been passed in every state but Wisconsin, the Departments limited their analysis to participants in self-insured group health plans throughout the country and all health plans within Wisconsin. Finally, because Health Maintenance Organizations (HMOs) have traditionally had more aggressive short-stay policies, the share of workers enrolled in HMOs versus commercial plans was taken into account as were the share of those plans with short-stay policies.^[15]

Based on these assumptions, approximately 328,000 births or roughly 22 percent of healthy births by privately insured women would be affected by the provision.^[16] If each woman then stayed the maximum period outlined in the statute, approximately 348,000 additional days of hospital care would be required.^[17] Assuming hospitals charge $800 per day for postpartum care, the annual cost of the provision would be $279 million: $1.7 million of which would be attributable to the individual market in Wisconsin; the remaining $276.9 million would be attributable to the group market in Wisconsin and self-funded plans throughout the country. However, because the statute does not require a 48 or 96-hour stay, but instead gives the decision-making authority to the attending physician in consultation with the mother, it is expected that not all of these births will result in additional hospital time. If only one-half of affected mothers had their stays extended by the full amount, the annual cost of the provision would be $139 million, less than $1 million of which would be attributable to the individual market of Wisconsin.^[18]

While the Departments estimate that the cost of the NMHPA is as much as $279 million annually, health plans are estimated to have spent more than $775 billion in 2007 to cover approximately 201.7 million privately insured individuals.^[19] Therefore, the upper estimate of the costs under the Newborns’ Act’s provisions represent a very small fraction of one percent of total health plan expenditures.

Moreover, the cost of this provision is likely to decline in the future, despite increases in overall health care spending. Since the statute was passed, there has been a significant increase in the number of cesarean births, compared to vaginal births. While traditionally cesarean births are associated with higher risk, an increasing number of women are now electing to have the procedure.^[20] Women who elect to have a cesarean would presumably have a lower risk than those for whom the procedure is required and therefore may not require the prescribed 96-hour recovery period detailed in the statute.^[21] If this trend continues, the burden of this statute should lessen.

The primary statutory economic benefits associated with the Newborns’ Act’s provisions derive from an increase in access to health plan coverage for postpartum care and monitoring of mothers and their newborns. Individuals without coverage for this care and monitoring are less likely to remain in the hospital for fear of incurring expenses that must be paid for ‘out-of-pocket.’ Lower-income individuals are more likely to forego care not covered by their insurance. Foregoing this care and monitoring increases the risk of adverse health outcomes, which in turn generates higher medical costs. Much of these costs may be shifted to public funding sources (and therefore to taxpayers) or to other payers.^[22]

Foregoing appropriate care can also negatively affect the quality of life. Improved access to health coverage for mothers and newborns will lead to more appropriate medical care and monitoring, better health outcomes, and improved quality of life.^[23] Denied coverage, individuals must choose whether to pay for the extra day(s) in the hospital and potentially suffer economic hardship or forego the care and monitoring, creating a risk of an adverse health outcome. Gaining coverage will sometimes mean receiving high quality care and living healthier lives.^[24]

The provisions of the Newborns’ Act and its regulation generally apply to both group health plans and health insurance issuers. While the costs of the Newborns’ Act are substantial, economic theory predicts that issuers will pass their costs of compliance back to plans, and that plans may shift some or all of issuers’ and their own costs of compliance to participants either through increases in premiums, increased cost-sharing, or reducing the richness of non-mandated health benefits.^[25]

While 74 million individuals are enrolled in group or private health plans, only 15 million individuals are enrolled in plans that had policies affected by the Newborns’ Act. Of these, only 328,000 individuals are expected to be annually directly impacted and receive additional coverage they were previously denied or restricted for 48 or 96-hour hospital stays following childbirth. Though these benefits are received by a small number of plan enrollees, the costs are distributed broadly among all plan participants. As a result, the cost of the Newborns’ Act per individual enrollee is expected to be minimal — between 9 and 19 dollars per person for those enrolled in affected plans.^[26] While it is possible that some enrollees on the margin will decline coverage in response to cost increases, the number of those acting in such a manner is expected to be negligible. As such, the benefits of this statute are believed to justify its costs.

The interim final rule clarified when a stay begins under the Newborns’ Act. Prior to this, private health plans could use the expectant mother’s admittance time to determine the required stay, an assumption that consistently reduced the number of women experiencing stays less than those prescribed by the statute by 5 percent.^[27] By clarifying this assumption in the interim final rule, the number of stays that would have been shorter than 48/96 hours increased by approximately 16,000 for all plans, and by approximately 2,000 for small plans. This in turn raised the direct costs to health plans by 5 percent (from $265 to $279 million for the upper bound for all plans and from $29 to $31 million for small plans). However, because it can take several hours for certain conditions to present themselves, such as jaundice and dehydration, the additional hours of hospital supervision — gained by generally not using an expectant mother’s admittance time as the start of a stay — can be critical. Therefore, the benefits of this clarification should justify this additional cost.

The regulation also defines that for births occurring outside of a hospital, stays begin once the mother or newborn is admitted as a hospital inpatient in connection with childbirth, as defined by the attending provider. The Departments lack any firm basis for quantifying the number of individuals likely to be affected by this provision, and therefore are unable to quantify the increase in costs and benefits. However, given the special and narrow circumstances to which this provision applies, costs and benefits are expected to be small.

The Department of the Treasury final rule is adopted pursuant to the authority contained in sections 7805 and 9833 of the Code (26 U.S.C. 7805, 9833).

The Department of Labor final rule is adopted pursuant to the authority contained in 29 U.S.C. 1027, 1059, 1135, 1161-1168, 1169, 1181-1183, 1181 note, 1185, 1185a, 1185b, 1191, 1191a, 1191b, and 1191c, sec. 101(g), Public Law 104-191, 110 Stat. 1936; sec. 401(b), Public Law 105-200, 112 Stat. 645 (42 U.S.C. 651 note); Secretary of Labor’s Order 1-2003, 68 FR 5374 (Feb. 3, 2003).

The Department of Heath and Human Services final rule is adopted pursuant to the authority contained in sections 2701 through 2763, 2791, and 2792 of the PHS Act (42 U.S.C. 300gg through 300gg-63, 300gg-91, and 300gg-92), as amended by Public Law 104-191, 110 Stat. 1936, Public Law 104-204, 110 Stat. 2935 and Public Law 105-277, 112 Stat. 2681-436.

In accordance with OMB Circular A-4 (available at http://www.whitehouse.gov/omb/circulars/a004/a-4.pdf), in the table below, we have prepared an accounting statement showing the classification of the expenditures associated with the provisions of this final rule. This table provides our best estimate for the annual costs associated with enacting the federal minimum stay final regulation.

* * * * *

Paragraph 1. The authority citation for part 54 is amended by adding an entry for §54.9811-1 in numerical order and by removing the entry for §54.9811-1T to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 54.9811-1 also issued under 26 U.S.C. 9833. * * *

Par. 2. Section 54.9801-1(a) is amended by removing the language “54.9811-1T” and adding “54.9811-1” in its place.

Par. 3. In §54.9801-2, the introductory paragraph before the definitions is amended by removing the language “54.9811-1T” and adding “54.9811-1” in its place.

Par. 4. Section 54.9811-1 is added to read as follows:

Par. 5. Section 54.9811-1T is removed.

Par. 6. Section 54.9831-1(b) is amended by removing the language “54.9811-1T” and adding “54.9811-1” in its place.

Approved September 23, 2008.

Transactions that are the same as, or substantially similar to, the transaction described in this notice are identified as transactions of interest for purposes of § 1.6011-4(b)(6) and §§ 6111 and 6112 effective October 31, 2008, the date this notice was released to the public. Persons entering into these transactions on or after November 2, 2006, must disclose the transaction as described in § 1.6011-4. Material advisors who make a tax statement on or after November 2, 2006, with respect to transactions entered into on or after November 2, 2006, have disclosure and list maintenance obligations under §§ 6111 and 6112. See § 1.6011-4(h) and §§ 301.6111-3(i) and 301.6112-1(g) of the Procedure and Administration Regulations.

Independent of their classification as transactions of interest, transactions that are the same as, or substantially similar to, the transaction described in this notice already may be subject to the requirements of §§ 6011, 6111, or 6112, or the regulations thereunder. When the IRS and Treasury Department have gathered enough information to make an informed decision as to whether this transaction is a tax avoidance type of transaction, the IRS and Treasury Department may take one or more actions, including removing the transaction from the transactions of interest category in published guidance, designating the transaction as a listed transaction, or providing a new category of reportable transaction.

Under § 1.6011-4(c)(3)(i)(E), each recipient of the term interest and Trust are participants in this transaction for each year in which their respective tax returns reflect tax consequences or a tax strategy described in this notice. Charity is not a participant if it sold or otherwise disposed of its interest in Trust on or prior to October 31, 2008. For interests sold or otherwise disposed of after October 31, 2008, under § 1.6011-4(c)(3)(i)(E), Charity is a participant for the first year for which Charity’s tax return reflects or is required to reflect the sale or other disposition of Charity’s interest in Trust. In general, Charity is required to report the sale or other disposition of its interest in Trust on its return for the year of the sale or other disposition. See § 6033 and § 1.6033-2(a)(ii). Therefore, in general, Charity will be a participant for the year in which charity sells or otherwise disposes of its interest in Trust.

See §1.6011-4(e) and § 301.6111-3(e).

The threshold amounts in § 301.6111-3(b)(3)(i)(B) are reduced to $5,000.

Persons required to disclose these transactions under § 1.6011-4 who fail to do so may be subject to the penalty under § 6707A. Persons required to disclose these transactions under § 6111 who fail to do so may be subject to the penalty under § 6707(a). Persons required to maintain lists of advisees under § 6112 who fail to do so (or who fail to provide such lists when requested by the IRS) may be subject to the penalty under § 6708(a). In addition, the IRS may impose other penalties on parties involved in these transactions or substantially similar transactions, including the accuracy-related penalty under § 6662 or § 6662A.