On July 30, 2012, the Commissioner of the IRS’s Large Business & International Division (LB&I) issued a Directive to LB&I examiners that resolves a very significant tax issue for the insurance industry. (LB&I- 4-0712-009) The Directive allows insurance companies to claim partial worthlessness tax deductions by adopting a Statement of Statutory Accounting Principle (SSAP) 43-R approach, provided that they make an adjustment to eliminate non-credit losses that they may have previously taken. Companies are allowed to adopt this safe harbor in any tax year 2009 through 2012. If a company does so, the Directive generally provides that LB&I examiners are not to challenge the company’s partial worthlessness deductions claimed in prior years for eligible securities covered by SSAP 43-R. Regular interests in Real Estate Mortgage Investment Conduits (REMICs) are the most common type of instrument subject to the Directive.
The Directive resulted from a collaborative process between an industry coalition and the IRS’s LB&I. In September 2010, the coalition filed a request for guidance under the Industry Issue Resolution program outlined in Revenue Procedure 2003-36, 2003-1 C.B. 859. By the time the coalition filed the request, the partial worthlessness issue had become the most commonly raised issue in insurance company examinations. Insurance companies relied on a conclusive presumption of tax worthlessness in Treasury Regulation § 1.166-2(d)(1) for regulated industries to support the write-downs. LB&I examiners disagreed and disallowed the deductions on failure-of-proof grounds, which could result in costly factual disputes and controversy because of the complex nature of REMICs and similar instruments. Fortunately, LB&I leadership recognized and acknowledged the potential strain on resources on both sides and agreed to a global resolution. It is anticipated that most insurers that hold impaired REMICs will adopt the Directive’s safe harbor and avoid a prolonged dispute with the IRS.