Authored by Michael Gehr
In the early hours of Dec. 2, 2017, the Senate passed its version of the Tax Cuts and Jobs Act (TCJA). This tax reform bill, while having many similarities to the House’s version, has some significant differences. The two bills now sit with the conference committee where the members will work to reconcile the differences. After a majority of the conference committee members agree on a final version, the House and Senate will vote on the bill before it is sent to the president for signature. It is anticipated this process could be completed before the Christmas holiday with the first conference committee meeting expected on, or around, Dec. 13, 2017. After this meeting, there may be some clarity around the direction of the final bill.
The following is a summary of the major insurance provisions included in both TCJA bills. Except as noted below, these provisions would generally be effective for tax years beginning after 2017.
Corporate tax rate
Both the House and the Senate bills propose a 20 percent corporate tax rate. However, the House has an effective date beginning in 2018; whereas, the Senate bill would begin in 2019. Corporate alternative minimum tax (AMT) would be repealed under the House version, but the 20 percent AMT rate would remain under the Senate plan.
Net operating losses
Under the House plan, operating loss deductions (OLD) would conform to section 172 net operating losses (NOL) that are applicable to general corporations. However, general NOL rules would also change to allow for no carry-back potential and an indefinite carry-forward subject to an annual limit up to 90 percent of taxable income.
The Senate plan is in line with the House plan except that the carry forward limit is reduced to 80 percent of taxable income beginning in 2023.
Under the House plan, net operating losses would have no carry-back potential and an indefinite carry-forward subject to an annual limit up to 90 percent of taxable income.
The Senate plan, however, preserves the current law for property and casualty insurers allowing for a two-year carry-back and 20-year carry forward up to 100 percent of taxable income.
Small life insurance company deduction
Both the House and the Senate plans would repeal this tax subsidy for the insurance industry that is not available to other similar sized small businesses. This repeal essentially eliminates a 60 percent deduction on the first $3 million of life insurance related taxable income (phasing out after $3 million) that was otherwise allowable for a small life insurance company.
Computation of life insurance tax reserves
Under the House plan, there is no specific provision with respect to the computation of life insurance tax reserves. However, there is a placeholder provision intended to preserve the current tax treatment of deferred acquisition costs, life insurance company reserves, and proration. The placeholder provision also includes an 8 percent surtax on life insurance company income.
Under the Senate plan, life insurance tax reserves would be calculated by including the greater of the net surrender value of such contract or 92.87 percent of the reserve determined under the tax rules. However, the tax reserves may not exceed the statutory reserve with respect to the contract as calculated for regulatory reporting.
Adjustment for change in computing life reserves
Similar for both the House and the Senate plans, this provision would repeal the section 807(f) 10-year period for adjustments to take into account changes in a life insurance company’s basis for computing reserves. Instead, the general rule for making tax accounting method adjustments would apply to changes in computing reserves by life insurance companies (generally a four-year spread).
Repeal special rule for distributions to shareholders from pre-1984 policyholders’ surplus accounts
Both the House and the Senate plans would repeal the rules for policyholders’ surplus accounts and any remaining balances would be subject to tax, payable in eight annual installments.
Modify proration rules for property and casualty insurance companies
Both the House and the Senate plans would increase the percent reduction in the reserve deduction for property and casualty (P&C) insurance companies from 15 percent to 26.25 percent. However, the Senate plan would take effect in 2019 when corporate tax rates are scheduled to be reduced to 20 percent. This change would keep the reduction in the reserve deduction consistent with current law by adjusting the rate proportionately to the decrease in the corporate tax rate.
Modify discounting rules for property and casualty insurance companies
Under the House plan, P&C insurance companies would use the corporate bond yield curve (as specified by the U.S. Department of the Treasury) to discount the amount of unpaid losses rather than mid-term applicable Federal rates. In addition, the special rule that extends the loss payment pattern period for long-tail lines of business would be applied similarly to all lines of business. The provision also would repeal the election to use company-specific, rather than industry-wide, historical loss payment patterns. There would be a transition rule that would spread adjustments relating to pre-effective date losses and expenses over such tax year and the succeeding seven tax years.
Under the Senate plan, there is no similar or specific provision with respect to modifying the discounting rules for P&C insurance companies.
Repeal of special estimated tax payments
Both House and Senate provisions would repeal the elective deduction and related special estimated tax payment rules under section 847. Under current law, insurance companies may elect to claim a deduction equal to the difference between the amount of reserves computed on a discounted basis and the amount computed on an undiscounted basis. Companies that make this election are required to make a special estimated tax payment equal to the tax benefit attributable to the deduction.
Capitalize certain policy acquisition expenses (DAC)
Under the House plan, the current tax treatment of deferred acquisition costs would remain unchanged. However, see above discussion regarding the placeholder provision in the House legislation.
The Senate proposal would lengthen the amortization period for specified policy acquisition expenses from 10 years to 15 years. It would increase the specified percentage companies use to calculate policy acquisition costs. These would change from 1.75 percent to 2.1 percent for annuity contracts, from 2.05 percent to 2.46 percent for group life insurance contracts, and from 7.70 percent to 9.24 percent for all other specified insurance contracts.
In addition to the provisions mentioned above, there are a few international provisions that could have a significant impact on insurance companies.
General base erosion
Under the House plan, domestic corporations would be subject to a 20 percent excise tax on specified payments to a foreign affiliate that is part of the same international financial reporting group, but only if the specified payments total at least $100 million annually, using a three year average. Specified amounts would include reinsurance premiums, and other deductible amounts or amounts includible in cost of goods sold. A foreign company could elect to treat the specified amount as effectively connected to a U.S. trade or business, in which case the 20 percent excise tax would not apply and a limited amount of foreign tax credit would be provided.
The Senate proposal does not include the excise tax, but instead would impose a ‘base erosion and anti-abuse’ tax on certain ‘base erosion payments’ paid to foreign affiliated companies. Companies subject to the tax would pay the excess of tax computed at a 10 percent rate on an expanded definition of taxable income that adds back the base eroding payment to regular taxable income (but not reduced by NOLs) over their regular tax liability reduced by certain credits. The tax would not apply to companies with ‘base erosion tax benefits’ less than four percent of total deductions of the taxpayer. No effectively connected income election would be available under this provision, unlike under the House bill.
Both the House and the Senate proposal would apply to affiliated reinsurance payments, with the understanding that calculations are based on “gross” reinsured premiums. The insurance industry is currently lobbying for the calculations to be based on “net” reinsurance.
Restriction on insurance business exception to passive foreign investment company (PFIC) rules
For both the House and the Senate plan, the PFIC exception for insurance companies would be amended to apply only if the foreign corporation would be taxed as an insurance company were it a U.S. corporation and if loss and loss adjustment expenses, unearned premiums and certain reserves constitute more than 25 percent of the foreign corporation’s total assets (or 10 percent if the corporation is predominantly engaged in an insurance business and the reason for the percentage falling below 25 percent is solely due to temporary circumstances).
For more information on the tax reform proposals, or to learn how Baker Tilly’s specialized insurance tax team can help, contact our team.