Authored by Carrie Small and Mike Gehr
In April 2017, the Trump administration outlined core principles of its tax reform proposal. Tax reform has been identified as a priority for the president, but there is much uncertainty on whether the administration and Congress will be able to get any type of tax reform legislation passed in the near future. Despite this timing uncertainty, a tax reform package including a tax rate reduction for many Americans and restructuring of business taxes is likely what the president and Congress will try to accomplish before midterm elections in November 2018.
Insurance company considerations
Corporate tax rate reduction
The business tax reform proposal includes a reduction in the corporate tax rate to 15 percent from 35 percent. If the corporate tax rate is reduced, there are some key considerations for insurance companies with respect to deferred tax assets and the impact on surplus. First, the beginning-of-year gross deferred tax assets will have to be revalued for financial statement purposes at the new tax rate on the effective date of enactment. This creates an immediate effect on the gross deferred tax asset, as the value will decline by the 20 percent rate change. The impact of the rate change runs through the effective tax rate, potentially creating large variances in a company’s rate from year to year.
Once the reduced adjusted gross deferred tax asset is calculated, insurance companies will also have to consider the changes in the admissibility calculation under Statement of Statutory Accounting Principles No. 101 in paragraphs 11.a., 11.b. and 11.c.
- 11.a: There will now be a disconnect in the tax rates used in the calculation of the reversing deferred tax assets (taxed at 15 percent) versus the calculation of the taxes available for recoupment (taxed at the higher rate prior to tax reform). Therefore, it is possible that admitted assets under paragraph 11.a. could decrease under tax reform if a company’s reversing deferred tax assets do not exceed taxes paid in the applicable carryback period.
- 11.b: Using the Realization Threshold Limitation Table and the “with and without” calculation to determine the tax savings of reversing temporary differences based on future taxable income under paragraph 11.b., the admissibility calculation will be limited by the 15 percent tax rate. However, as the reversing deferred tax assets will also be valued at the lower 15 percent tax rate, there should not be a significant change in the mechanical calculation of this paragraph in the admissibility calculation.
- 11.c: The reduction of the corporate tax rate to 15 percent from 35 percent should also not have much impact on the admissibility of adjusted gross deferred tax assets under paragraph 11.c. Reversing gross deferred tax liabilities calculated at the 15 percent rate can still be used to offset reversing gross deferred tax assets calculated at the 15 percent rate (after the application of paragraphs 11.a. and 11.b).
Ultimately, it is likely that insurance companies in a net deferred tax asset position may need to reduce their deferred tax asset resulting from the 20 percent rate decrease as well as potentially through changes in the admissibility calculation. Tax reform may create a long-term benefit for insurance companies, but a one-time negative surplus hit in the year of tax reform. Alternatively, a company in a net deferred tax liability position may be able to realize a favorable surplus adjustment as the future tax liability originally recorded may now be taxed at the lower tax rate.
Prior to enactment, deferring income or accelerating deductions where appropriate will allow for a company to take advantage of a future tax rate reduction. As the value of deferred tax assets decreases, companies may want to revisit the admissibility calculation if they currently have non-admitted deferred tax assets. This could involve capital and surplus planning to ensure the exDTA Authorized Control Level Risk-Based Capital percentage is appropriate to allow for a three-year projection of taxable income. Companies may also want to revisit reversal patterns of deferred tax assets to confirm that all reversals within the three-year period (assuming certain thresholds are met) are being adequately captured and utilized in the admissibility calculation.
For more information on this topic, or to learn how Baker Tilly insurance industry tax specialists can help, contact our team.
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