On Saturday, December 2, 2017, the U.S. Senate passed a comprehensive tax reform bill. Sidley's general tax reform update published December 4 can be found here. Below is a summary and comparison of certain insurance-specific provisions of the Senate Bill and of the competing bill passed by the House of Representatives in November. A House-Senate Conference Committee is expected to produce a compromise version later this month.
Life Company Tax Reserves
Life insurance companies compute tax reserves using the greater of net surrender value or the Federally Prescribed Reserve (subject to a statutory reserves cap).
House Bill 8% surtax (placeholder).
Tax reserves equal the greater of net surrender value or 92.87% of statutory reserves (subject to a statutory reserves cap).
Analysis: Senate Bill reflects a solution proposed by the life industry trade association, and strikes controversial current law concept of CRVM/CARVM "in effect on the issue date."
Life Reserves: Transition Rule Current Law N/A
8 year spread beginning 2018. Same as House.
Analysis: Tax reserves are restated as of 1/1/18. Note that if the restatement results in an increase, the increase is deductible over 8 years.
DAC Current Law
Insurance companies with premium income from "specified insurance contracts" (generally life and non-qualified annuity business) must defer over 120 months arbitrary amounts of otherwise deductible business expenses. The
8% surtax (placeholder).
Increases percentages to 2.1%, 2.46% and 9.24% respectively; extends amortization period to 180 months.
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three broad categories of specified insurance contracts subject to this requirement under current law are annuity (1.75% rate), group life (2.05% rate), and other specified contracts (e.g., individual life contracts)(7.7% rate).
Analysis: Senate Bill reflects a solution proposed by the life industry trade association. Existing DAC balances continue to be amortized on existing schedule.
DRD Current Law
Life insurance companies are required to reduce certain tax benefits (e.g., the DRD) to reflect the portion of dividends and tax-exempt interest that is used to fund tax-deductible reserves for obligations to policyholders. Current law employs a complex formula that computes the shares of net investment income that are attributable to the company and to the policyholders. The respective shares are computed separately for the company's general account and for each separate account. Longstanding IRS guidance relating to the separate account computation resulted in substantial amounts of DRD for companies holding dividend-paying stocks in support of variable contracts.
8% surtax (placeholder).
Fixes "company share"at 70%.
Analysis: Senate Bill reflects a solution proposed by the life industry trade association. Note that maintaining the current law AMT at a 20% AMT rate (i.e., equal to the regular corporate tax rate) would effectively eliminate the benefit of this deduction.
Changes to Life Reserves (807(f))
Changes in a life insurance company's basis for computing reserves are spread over ten years under Section 807(f).
Treat change like an accounting method change initiated by taxpayer with consent of IRS and apply section 481.
Senate Bill Same as House.
Analysis: Existing section 807(f) amounts continue to be taken into account over their remaining spread period under present law.
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P&C insurance companies are required to reduce losses incurred by 15% of (a) the company's taxexempt interest income, (b) the deductible portion of dividends received, and (c) the increase for the tax year in the cash value of life insurance, endowment, or annuity contracts that the company owns.
Increases 15% rate to 26.25%. With 20% tax rate, current law effective tax rate of 5.25% is preserved.
Increases rate to 26.25%, floating with future changes in the statutory corporate tax rate to maintain effective tax rate of 5.25%.
Analysis: Senate Bill provision on proration is generally supported by the P&C insurance trade associations.
Loss Reserve Discounting
Unpaid losses are discounted using an interest rate equal to a rolling average of the applicable federal mid-term interest rate and based on either the company's own loss payment patterns or an industry-wide average loss payment pattern published by Treasury. The Treasury published patterns generally assume payment over a period ending either three years, or ten years, after the accident year, except that for certain long-tail lines of business, the assumed loss payment pattern is extended to the accident year and the following 15 years.
Requires P&C insurance companies to use higher corporate bond yield curve to discount unpaid losses. Repeals company-specific loss payment patterns. Extends loss payment pattern period to 18 years for short-tail lines and 25 years for long-tail lines.
Same as House.
Special Estimated Tax Payments
For then-applicable accounting reasons, certain companies elected to forego loss reserve discounting but also had to forego any resulting timing benefit by making offsetting cash payments to the IRS styled special estimated tax payments.
House Bill Repealed.
Analysis: This provision is not viewed as controversial.
Senate Bill Same as House.
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Phase III Accounts Current Law
Taxable income of certain life insurance companies that was deferred under pre-1984 law continued to be deferred unless treated as distributed to shareholders.
Requires any life insurance company with a remaining policyholders surplus account balance to include such amount in income over an eight-year period.
Senate Bill Same as House.
Analysis: Most companies eliminated or reduced Phase III account balances during a tax holiday in effect during 2005-6. This provision is not viewed as controversial.
NOLs Current Law
Corporations may carry NOLs back two years and forward up to 20 years. Life insurance companies may carry NOLs back three years and forward up to 15 years.
For both life and non-life companies: eliminates carrybacks, perpetual carryovers, 90% use limitation, and inflation adjustment to carryovers.
Similar to the House Bill, with the following modifications: 90% use limitation drops to 80% beginning after 2022, no inflation adjustment to carryovers, and property and casualty insurance companies may carry NOLs back two years and forward up to 20 years to offset 100% of taxable income.
Analysis: Senate Bill recognizes P&C industry volatility due largely to natural disasters, and the resulting special importance of existing NOL rules.
Corporate AMT Current Law
Corporations must compute their income for purposes of both the regular income tax and the alternative minimum tax (AMT); tax liability is equal to the greater of 35% of taxable income or 20% of AMT income. If the latter is greater, the excess becomes a credit usable in any future year when the former is greater.
Repeals corporate AMT; corporations can continue to use AMT credits to offset regular income tax and can obtain refunds of unused AMT credits beginning after 2018.
Maintains corporate AMT.
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Analysis: Original version of Senate Bill repealed the corporate AMT (same as House Bill). However, a late manager's amendment to the Senate Bill retained both the corporate and individual AMT. This difference will be a point of focus during conference.
Affiliated Foreign Reinsurance Current Law
Outbound reinsurance premiums are fully deductible and are subject to a 1% federal excise tax (FET) on the gross reinsurance premium (subject to applicable treaty waivers).
20% excise tax on gross outbound payment unless foreign affiliate elects to pay US net income tax (subject to partial foreign tax credit) and branch profits tax on deemed profits from the transaction. Deemed profits determined without regard to interest income or expense. Provision applies to groups with annual average payments to foreign affiliates in excess of $100 million. No change to FET.
Minimum tax on US domestic taxpayers equal to 10% of modified taxable income, determined by adding back "base erosion tax benefits" from "base erosion payments" to foreign affiliates. Provision applies to groups with at least $500 million of average annual gross receipts and a "base erosion percentage" of at least 4 percent. No change to FET.
Analysis: Uncertain aspects of the proposals include (1) lack of exception for foreign affiliates engaged in a US business; (2) treatment of offsetting/related payments from foreign affiliates; (3) loss payments made to reimburse foreign companies that purchased coverage from a US affiliate; (4) continuing application of insurance premium excise tax; (5) application of rules to modco reinsurance arrangements.
CFCs: Downward Attribution Current Law
Section 958(b)(4) prohibits downward attribution of stock from a foreign person to a US person in applying constructive ownership rules for subpart F purposes.
Repeals Section 958(b)(4), therefore permitting downward attribution of stock from a foreign person to a US entity in which the foreign person owns an interest.
Same as House
Analysis: Provision will expand the circumstances in which a foreign corporation will be a CFC. For example, foreign subsidiaries in a foreign-parented group will in many cases be CFCs if the group includes any US subsidiaries, due to the downward attribution of their stock to such US subsidiaries.
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CFCs: 10% Shareholder by Value Current Law
"US Shareholder" is a person that owns (directly, indirectly or constructively) 10% or more of the voting power of a foreign corporation.
Expands definition to include a person that owns (directly, indirectly or constructively) 10% or more of the value of a foreign corporation.
Analysis: Provision would make obsolete certain common planning techniques used to avoid subpart F income inclusions (e.g., voting power cutbacks, nonvoting stock).
PFICs: Definition of "Active" Insurance Company
Exception to PFIC treatment for a foreign corporation that is predominantly engaged in the active conduct of an insurance business and would be taxed as an insurance company were it a U.S. corporation. Little guidance available regarding qualification for the exception.
Exception available only to companies with "applicable insurance liabilities" greater than 25% of total assets; term does not expressly include reserves for annuity contracts or unearned premium reserves. Exception also available to companies below the threshold under certain circumstances.
Legislative language same as House; explanation indicates that reserves for annuity contracts are intended to be included although this is not expressly reflected in statutory language.
Analysis: Ongoing lobbying is expected, focused on including unearned premium reserves in "insurance liabilities."
Taxable Year of Income Inclusion Current Law
A taxpayer generally is required to include an item of income no later than the time of its actual or constructive receipt, unless the item properly is accounted for in a different period under the taxpayer's method of accounting.
Accrual method taxpayers must take income into account no later than when the item of income is taken into account in an "applicable financial statement." Rule does not apply to "any item of gross income for which the taxpayer uses a special
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method of accounting" other than sections 12711288 relating to OID and market discount. An "applicable financial statement" means a financial statement prepared in accordance with GAAP, IFRS, or, if neither is applicable, a financial statement specified by Treasury.
Analysis: Summaries of the bill indicate that it was aimed at credit card interchange income earned by card issuers. The actual language of the bill is quite broadly written, however, and affects OID and market discount on bonds, and may sweep in aspects of the GAAP revenue recognition project that goes into effect in 2018. Under existing law, life insurance companies are subject to a "special method of accounting" for market discount under Section 811(b), but no similar treatment is available to P&C companies.
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