- Tax Cuts and Jobs Bill Update, November 14: Major Insurance Industry Changes
- November 20, 2017 | Authors: Susan E. Seabrook; Thomas A. Gick; William J. Walderman; Michael R. Miles; Carol P. Tello; Mary E. Monahan; Dennis L. Allen
- Law Firms: Eversheds Sutherland (US) LLP - Washington Office ; Eversheds Sutherland (US) LLP - New York Office; Eversheds Sutherland (US) LLP - Washington Office
As noted in a previous Eversheds Sutherland Legal Alert, on November 2, the House Ways and Means Committee released the “Tax Cuts and Jobs Act” (H.R. 1) (the House Bill). An amended version of the House Bill (the Ways and Means Markup) was reported out of the Ways and Means Committee on November 10. On November 9, the Joint Committee on Taxation issued a description of the Senate version of the “Tax Cuts and Jobs Act” (the Senate Bill). The Senate is not expected to release actual bill language prior to the Markup by the Senate Finance Committee. Instead, the Markup will be based on the Joint Committee’s description.
Like the House Bill, the Senate Bill would reduce the corporate tax rate to 20%, but, unlike the House Bill, only beginning in 2019. It also would make changes to a number of insurance-specific provisions and includes certain international provisions that could have significant impacts on insurance companies.
Senator Tim Scott has introduced an amendment to the Senate Bill (the Scott Amendment) which would:
- For contracts described under section 807(c)(1),1 apply a 5% “haircut” to reserves for those contracts reported in the National Association of Insurance Commissioners annual statement subject to a cash value/deposit floor determined on a seriatim basis (no deduction for asset adequacy or deficiency reserves would be allowed);
- Impose a single rate of 70% for determining the company share in both the separate and general account of life insurance companies; and
- Extend the amortization period for deferred acquisition costs from 10 years to 15 years, maintain the three product categories, and modify the rates by increasing the capitalization rates 20% for new premiums.
At this time, the Scott Amendment has not been incorporated into the Senate Bill.
What follows is a side-by-side comparison of provisions in the House Bill and the Senate Bill (without taking into account the Scott Amendment) of particular interest to the insurance industry.Life Insurance Company Provisions
Changes to Life Insurance Tax Reserves
The Ways and Means Markup,
consistent with Chairman Brady’s second amendment to the House Bill, does not include a provision in the original House Bill that would have eliminated the longstanding “federally prescribed reserve” and substituted a reserve calculation equal to certain statutory reserve amounts less a 24.5% “haircut.” For this purpose, deficiency reserves, asset adequacy reserves, unearned premium reserves, and any other amount not constituting reserves for future unaccrued claims would have been excluded from the statutory reserves.
The Senate Bill would not make any changes to the calculation of life insurance tax reserves.
Change to Policy Acquisition Expense Rules
The Ways and Means Markup,
consistent with Chairman Brady’s second amendment to the House Bill, does not include a provision in the original House Bill that would have significantly increased the percentages of policy acquisition expenses (DAC) that must be deferred and amortized over 10 years under section 848.
Under the House Bill, the three categories of insurance contracts to which DAC currently applies (annuity contracts, group life insurance contracts, and other) would have been reduced to two categories (group contracts and other). For group contracts (whether group life, annuity, or non-cancellable accident and health contracts), the percentage of premium taken into account in computing DAC would have increased to 4%, and for all other contracts (i.e., all individual contracts), the percentage would have increased to 11%. The greatest increase would have been for individual annuity contracts, which would have increased from the current 1.75% rate for annuity contracts to the 11% rate for all individual contracts.
The Senate Bill would retain the three existing categories of contracts to which DAC applies, but would increase the percentage of premium taken into account in computing DAC to 3.17% for annuity contracts, to 3.72% for group life insurance contracts, and to 13.97% for all other specified insurance contracts. In addition, the Senate Bill would increase the DAC amortization period from 10 years to 50 years. The Senate provision would be effective for taxable years beginning after 2017.
Changes to Life Insurance Company Proration Rules
The Ways and Means Markup, consistent with Chairman Brady’s second amendment to the House Bill, does not include a provision in the original House Bill that would have amended section 812(a) to define the company’s share of an insurance company’s net investment income as 40% and the policyholder’s share as 60%. This “proration” rule would have been relevant for determining a life insurance company’s dividends-received deduction net increase or net decrease in reserves.
The Senate Bill would not make any changes to the life insurance company proration rules.
Surtax on Life Insurance Company Taxable Income
The House Ways and Means Markup includes a provision that would impose a tax on a life insurance company’s taxable income in addition to the tax imposed on such income at the regular corporate tax rate. The additional tax would be equal to 8% of the life insurance company’s taxable income. This surtax was added in Chairman Brady’s second amendment to the House Bill and, reportedly, is a “placeholder” in lieu of the changes to the life insurance tax reserve calculations, the policy acquisition expense rules, and the life insurance company proration rules discussed above. However, because the surtax is described as a “placeholder,” the House could insist in a Senate/House Conference on changing the 8%-rate or making other modifications to the reserve, DAC, or proration rules.
The Senate Bill would not impose a surtax on life insurance companies.
Change to NOL Carryforward and Carryback Periods for Life Insurance Companies
The House Bill would repeal the special carryback (three years) and carryforward (15 years plus an additional three years for a new company) provisions applicable to life insurance company net operating losses (NOLs) and would conform the treatment of life insurance companies’ NOLs to the general treatment of NOLs applicable to other companies. Under the House Bill, the general rule for NOLs would be amended to limit a company’s NOL deduction to 90% of taxable income (determined without regard to the deduction) and to adjust carryovers to other years to take into account this limitation. In addition, NOLs could be carried forward indefinitely with an inflation adjustment, but could not be carried back. The provision would be effective for losses arising in taxable years after 2017.
The Senate Bill also would limit a company’s NOL to 90% of taxable income and would make the same changes to NOL carryforward and carryback periods for life insurance companies as would the House Bill. The effective date would be the same as under the House Bill.
Repeal of Small Life Insurance Company Deduction
The House Bill would repeal section 806, which provides a deduction of up to $1.8 million to small life insurance companies (with assets of less than $500 million as determined on a controlled group basis). Section 806 permits a life insurance company to deduct 60% of its first $3 million of life insurance-related income, phasing out for companies with income between $3 million and $15 million. The repeal would be effective for taxable years beginning after 2017.
The Senate Bill also would repeal the small life insurance company deduction for taxable years beginning after 2017.
Repeal of 10-Year Spread for Changes in Basis for Computing Reserves and Application of the General Change in Accounting Method Spread Period
Under section 807, a life insurance company that changes the basis for computing its reserves generally takes into account over 10 years any resulting reserve adjustment (regardless of whether the adjustment reduces or increases taxable income). The House Bill would amend section 807 to repeal the 10-year spread period and in its place would apply the general income adjustment rules applicable to changes in methods of accounting. As a result, a change in basis for computing reserves that reduces taxable income generally would be taken into account in the taxable year of the change, and adjustments that increase taxable income generally would be taken into account over four taxable years, beginning with the taxable year in which the change occurs. The provision would be effective for taxable years beginning after 2017.
The Senate Bill also would replace the 10-year spread period for taking into account a life insurance company’s change in basis for computing reserves with general adjustment rules applicable to changes in methods of accounting. The effective date would be the same as the House Bill.
Repeal of Rules for Pre-1984 Policyholders Surplus Accounts
The policyholders surplus account rules in section 815 are a vestige of the old three-phase tax system applicable to life insurance companies in the Internal Revenue Code of 1959. Under those rules, certain operating income of life insurance companies was credited to a policyholders surplus account and subject to tax only when treated as distributed. Although the three-phase tax system was eliminated by the Deficit Reduction Act of 1984, companies were permitted to continue to defer amounts in their policyholders surplus accounts until distributed to policyholders. Under the House Bill, remaining policyholders surplus accounts would be treated as distributed and subject to tax over an eight-year period. The provision would be effective for taxable years beginning after 2017.
The Senate Bill also would repeal the policyholders surplus account rules for years after 2017 and would impose tax on any remaining policyholders surplus account balances equally over eight years.
New Reporting Rules for Life Settlement Transactions and Related Changes to Basis and Transfer-for-Value Rules
The House Bill would not impose any new reporting rules for life settlement transactions or make any change to basis and transfer-for-value rules.
The Senate Bill would impose new reporting requirements with respect to reportable sales of existing life insurance contracts. Specifically, a buyer of a previously-issued life insurance contract that does not have a substantial family, business, or financial relationship with the insured would be required to report to the Internal Revenue Service (IRS), to the insurance company that issued the contract, and to the seller the following: (i) certain identifying information about the buyer and any other persons that receive payments in the transaction, (ii) the date of the transaction, and (iii) the amount of each payment. The provision also would impose reporting requirements on an insurance company when it receives notice of a reportable sale of one of its in-force policies or when it makes a payment of a death benefit following a reportable policy sale. The reporting rules would apply to reportable policy sales occurring and reportable death benefits paid after 2017.
In addition, the Senate Bill would provide that the basis of a life insurance or annuity contract would not be reduced by the cost of insurance. This provision would reverse the IRS’s published position that the cost of insurance is deducted from the basis of a life insurance or annuity contract. Other than the basis adjustment, the Senate Bill generally follows the IRS’s position in Rev. Rul. 2009-13 and Rev. Rul. 2009-14. The basis provision would apply to transactions entered into after August 26, 2009.
The current transfer-for-value rules limit the amount of a death benefit payment that may be excluded from the recipient’s income if the policy with respect to which the payment is made previously was transferred for valuable consideration. Certain transfers are excluded from the limitation, including transfers giving rise to carry-over basis in the life insurance contract and transfers to a partner of an insured or to a partnership or corporation in which the insured has an interest. The Senate Bill would prevent the transfer-for-value exclusions from applying to a transfer in a reportable policy sale. The modification to the transfer-for-value exclusions would apply to transfers occurring after 2017.