Congress and the White House are pushing for tax reform to be signed into law before the end of 2017. The House and Senate bills both include tax law changes that would deeply affect many insurance companies. In general, the proposed tax provisions would become effective for taxable years beginning after 2017. Contained in the bills are general business provisions, including the reduction of the corporate tax rate.
Insurance Tax Provisions
Property and Casualty
In the proposed legislation, the insurance tax provisions for property and casualty (P&C) insurance would:
- Increase the fixed 15 percent proration reduction in the reserve deduction to a fixed 26.25 percent reduction in the reserve deduction, which would preserve the current effective tax rates on reductions in the unpaid loss deduction.
- Require P&C insurance companies to use the corporate bond yield curve, which typically would be a higher rate than what is used currently, in order to discount unpaid loss reserves under IRC Section 846. This change would result in larger tax discounting relative to the undiscounted unpaid loss values that currently reduce loss reserve deductions.
- Apply the special rule that extends the loss payment pattern period for all “long-tail lines” to all lines of business.
- Repeal the election to use company-specific, rather than industrywide, historical loss payment patterns. The Senate proposal does not include this change to current law on unpaid loss discounting.
- Repeal the deduction and special estimated tax payment rules for companies electing to deduct the difference between reserves computed on a discounted basis and the amount computed on an undiscounted basis.
- Preserve the current law for P&C net operating losses (NOLs), which would allow such NOLs to be carried back two years and carried forward 20 years to offset 100 percent of taxable income in applicable years. This preservation appears only in the Senate version of the bill.
Under the proposed legislation, tax provisions for life insurance would:
- Provide for an 8 percent surcharge on life insurance company taxable income as a placeholder for revenue generation until subsequent legislation is provided. The Senate proposal does not provide for a surcharge on life insurance company taxable income.
- Preserve current law treatment of deferred acquisition costs, life insurance reserves, and proration. The Senate proposal increases the deferred acquisition expense capitalization percentages to 3.17 percent for annuity contracts, 3.72 percent for group life, and 13.97 percent for all other contracts. It also lengthens the amortization period from a 120-month to a 600-month period.
- Repeal the small life insurance company deduction for taxable years beginning after Dec. 31, 2017.
- Adjust the 10-year spread for changes in computing life insurance company reserves under IRC Section 807(f) to be consistent with IRS accounting change methodologies over a four-year period.
- Modify the NOL deduction of life insurance companies by adopting the general corporation rules under Section 172, as discussed in the important general business provisions of the bills.
The legislation as proposed would:
- Impose a new excise tax on amounts paid or incurred by a domestic corporation to foreign affiliates that are members of the same international financial reporting group. The rate of the proposed excise tax would equal the highest corporate tax rate, effectively denying the benefit of the deduction from the domestic company, unless the foreign recipient elects to treat the payment as effectively connected income with a U.S. trade or business. An offsetting 80 percent foreign tax credit against foreign taxes paid would be applied against effectively connected income from corporate affiliates subject to the 20 percent corporate income tax.
- Exempt insurance companies that satisfy the new definition of a qualified insurance corporation from the passive foreign investment company (PFIC) rules. A qualified insurance company is required to maintain insurance liabilities that constitute more than 25 percent of its total assets.
- The House proposal would provide potential relief to foreign corporations that cannot satisfy the 25 percent test by allowing the U.S. person who owns the stock of the foreign corporation to elect to treat the insurance company as a qualifying insurance company. This designation is allowable only if the foreign company’s applicable liabilities equal 10 percent of its assets; if the company is predominately engaged in an insurance business; and if the failure to satisfy the 25 percent test is solely due to run-off or rating-related circumstances. The Senate currently has a similar proposal in its bill.
Change Is Coming
If enacted, the changes discussed here would affect insurance companies of all sizes from both a financial statement and tax return perspective. Stay tuned for more information to help understand the changes and any potential impact they may have on operations.