On Dec. 13, 2018, the IRS released Rev. Proc. 2019-10, which provides guidance to insurance companies seeking to change their basis of computing life insurance reserves under section 807. The guidance outlines procedures for insurance companies, both life insurance and nonlife insurance companies, to make an automatic method change by filing Form 3115 to comply with the revisions to section 807(f) under the tax law changes enacted as part of the Tax Cuts and Jobs Act (TCJA).
Background
Section 807 allows insurance companies to include certain increases or decreases in insurance reserves when calculating taxable income. An insurance company calculates its life insurance reserves by applying the tax reserve method applicable to each type of contract.
Prior to the passage of the TCJA, if insurance companies changed their basis of computing reserves they did so prospectively without requesting consent from the commissioner of the IRS, regardless of who initiated the change. A change in basis included the correction of actuarial errors, errors in judgement, or revisions to the assumptions used, including the consideration of later events. Taxpayers spread the difference in the amount of the reserve arising from a change in basis equally over 10 years, beginning with the year of change. Moreover, taxpayers were required to take both positive and negative adjustments over the 10-year period.
The TCJA revised the treatment for taxpayers making a change in the basis of calculating reserves, designating a change as a change in method of accounting, for taxable years beginning after Dec. 31, 2017. Accordingly, taxpayers must now follow the rules under section 481 for calculating adjustments for a change in a method of accounting attributable to contracts issued before the year of change and must request consent from the commissioner.
The TCJA also provides an additional new method for computing the amount of life insurance reserves under section 807(d). Under a transition rule, however, taxpayers changing to this new method of accounting must recognize the difference in the amount of the reserve arising from a change in basis attributable to contracts commencing prior to the enactment of the TCJA equally over 8 years.
Finally, taxpayers who changed their basis of computing reserves in tax years prior to Jan. 1, 2018, must continue to recognize the related adjustments over the 10-year period.
Rev. Proc. 2019-10
Rev. Proc. 2019-10 amends Rev. Proc. 2018-31 to add a new automatic method change under section 26.04 for taxpayers seeking to make a change in basis of computing reserves. Life insurance companies and nonlife insurance companies with life insurance reserves may now file Form 3115 and receive audit protection for taxable years prior to the year of change. While the taxpayer receives audit protection for prior years, the consent granted under this guidance is not a determination by the Commissioner that the new method is a permissible method and the IRS may adjust the year of change and future years if it determines an adjustment is necessary.
Under the new procedures, where an increase in the reserve under the taxpayer’s new method results in a negative adjustment, the taxpayer will recognize the negative adjustment in the year of change. Alternatively, a taxpayer will recognize any positive adjustment resulting from a decrease in the reserve equally over a four-year period, beginning with the year of change.
If a taxpayer makes multiple changes during the same taxable year for the same type of contract, the taxpayer should net the changes and treat them as a single negative or positive adjustment. However, where a taxpayer has multiple types of contracts, the taxpayer must calculate a separate adjustment for each contract type.
The revenue procedure waives the eligibility rules under section 5.01(1)(f) of Rev. Proc. 2015-13 for changes made within the last five taxable years. The designated accounting method change number for this change is “240.”
The revenue procedure also modifies Rev. Rul. 94-74 and Rev. Rul. 2002-6 to remove inconsistencies with the changes to section 807(f) under the TCJA.
Takeaways
Insurance companies seeking to change their basis for computing life insurance reserves may find the changes under the TCJA and this guidance favorable as negative adjustments may now be fully included in the year of change. This may have a significant impact compared with spreading the change over 10 years. However, for taxpayers required to make a positive adjustment, the four-year spread is likely less favorable. While the change in basis for reserves now requires additional steps to comply with the law, taxpayers enjoy audit protection where they did not previously. Taxpayers seeking to make a change for taxable years beginning after Dec. 31, 2017 should consult their tax advisors to ensure they correctly follow the new procedures in order to take advantage of the automatic procedures outlined in Rev. Proc. 2019-10.
