On September 13, 2012, the United States Tax Court issued its much-anticipated opinion in Cigna Corp. v. Commissioner.1 In deciding the case, the court declined to rule on the issue of whether a life insurance company may compute tax reserves under § 8072 by retroactively applying National Association of Insurance Commissioners (NAIC) Actuarial Guideline XXXIV (AG 34) for minimum guaranteed death benefits (MGDB) in variable annuity contracts. The court’s conclusion was based, in large part, on the concession by the Internal Revenue Service (IRS) that the taxpayer’s tax reserves were calculated correctly for the relevant taxable year, and the IRS’s representation that it will not challenge taxpayers that used AG 34 to compute tax reserves for MGDB.
Sutherland Observation: Because the IRS has disputed whether AG 34 may be applied retroactively for purposes of calculating the tax reserves for insurance products other than those at issue in Cigna Corp., taxpayers may continue to face challenges in this area.
In Cigna Corp., the taxpayer had entered into reinsurance treaties prior to 1998 in order to reinsure certain MGDB (the Reinsurance Treaties). At the times that the taxpayer entered into the Reinsurance Treaties, there was no universally accepted method for computing statutory reserves for MGDB, and, as a result, life insurance companies generally computed their statutory reserves for MGDB under various standards imposed by state insurance regulators. On December 31, 1998, the NAIC sought to standardize these statutory reserve computations by promulgating AG 34. From 1999 to 2008, the taxpayer computed all of its statutory reserves for MGDB in accordance with AG 34, including the statutory reserves attributable to the Reinsurance Treaties, notwithstanding the fact that the taxpayer had entered into the Reinsurance Treaties before the promulgation of AG 34.
The IRS issued a notice of deficiency for the taxpayer’s 2004 taxable year, claiming that the taxpayer could not use AG 34 to compute the tax reserves attributable to the Reinsurance Treaties because the taxpayer had entered into those treaties before the promulgation of AG 34. However, before the case went to trial, the IRS conceded that the taxpayer’s tax reserve computations were correct. At trial, the only remaining dispute was whether, as a matter of law, the taxpayer could use AG 34 to compute the tax reserves attributable to the Reinsurance Treaties. In light of its concession, the IRS asked the Tax Court to enter judgment in the taxpayer’s favor. The taxpayer objected, arguing that the court should consider the remaining dispute based on the importance of the issue to the insurance industry.
Ultimately, the Tax Court declined to rule on the tax reserve issue because it concluded that its opinion would be advisory. In so concluding, the court reasoned that the “interests of justice” did not compel it to rule on the tax reserve issue because that issue was a discrete one involving a specific insurance product. The court also was not convinced that resolving the tax reserve issue would alleviate taxpayer uncertainty, especially considering that the IRS represented that it will not challenge taxpayers that used AG 34 to compute tax reserves for MGDB.
Sutherland Observation: The IRS sometimes has conceded issues before the Tax Court when a case presents bad facts for the IRS, but the IRS still believes that it is correct regarding the law. This may have been the case in Cigna Corp. However, the Tax Court has ignored an IRS concession when it believes that the interests of justice requires it to do so. See, e.g., North West Life Assurance Co. of Canada v. Commissioner, 107 T.C. 363 (1996).
While observers may be disappointed that the Tax Court did not address whether AG 34 may be applied retroactively for purposes of computing tax reserves under § 807, two circuit courts of appeals have recently outlined the circumstances under which NAIC guidance can be applied retroactively for tax reserve computation purposes. Specifically, in American Financial Group v. Commissioner,3 the Sixth Circuit held that taxpayers may apply actuarial guidelines retroactively for purposes of computing tax reserves under § 807 when the guidelines constitute clarifications rather than changes.4 Similarly, in State Farm Mutual Automobile Insurance Co. v. Commissioner,5 the Seventh Circuit held that a clarifying interpretation regarding statutory accounting practices could be applied retroactively in computing loss reserves under § 832. Thus, notwithstanding the holding in Cigna Corp., taxpayers can look to these other cases for guidance regarding the types of NAIC pronouncements that may be applied retroactively when computing tax reserves.