IRS guidance offers simplified method change for insurers
TAX ALERT |
The IRS released Rev. Proc. 2019-30, that provides a streamlined procedure for insurance companies to qualify for automatic method changes to conform with discounting rule changes introduced in recent tax legislation (commonly referred to as the Tax Cuts and Jobs Act, or TCJA). The new procedure is significant in that it does not require a Form 3115 and generally recognizes the adjustment to income over an eight-year period.
The IRS also released Rev. Proc. 2019-31, which introduces revised unpaid loss discount factors for the 2018 accident year and earlier, as well as setting discount factors for the 2019 accident year that must be used in taxable years ending on or after June 17, 2019. These discount factors are based on recently released final regulations for section 846, and the unpaid loss discount factors set by the new Rev. Proc. serve as salvage discount factors for use in computing estimated salvage recoverable under section 832(b), and discounted unpaid losses of life insurance companies under sections 805 and 807.
TCJA amended section 846, changing both the definition of ‘annual rate’ under section 846(c) and the computational rules for loss payment patterns under 846(d). Significantly, TCJA repealed the election in the former section 846(e), which let insurance companies use their own historical loss payment patterns. Instead, for tax years beginning after Dec. 31, 2017, insurance companies must use the pattern published by the secretary.
The transition rule requires that for the first taxable year beginning after Dec. 31, 2017, the unpaid losses at the end of the preceding taxable year are determined as if the amendments made by TCJA had applied to the unpaid losses in the preceding taxable year and by using the annual rate and loss payment patterns applicable to accident years ended with calendar year 2018. The resulting adjustment, if any, is included in the insurance company's gross income ratably over eight taxable years, beginning with the insurance company's first taxable year beginning after Dec. 31, 2017, and continuing through the seven succeeding taxable years. For subsequent taxable years, the amendments made by TCJA are applied with respect to unpaid losses for accident years ended with or before calendar year 2018 by using the annual rate and loss payment patterns applicable to accident years ended with calendar year 2018.
The IRS released proposed regulations to administer section 846 in November 2018, and released Rev. Proc. 2019-06 to prescribe unpaid loss discount factors for the 2018 accident year and earlier accident years. As part of Rev. Proc. 2019-06, IRS and Treasury announced that it would revise the unpaid loss discount factors as necessary after issuing final regulations. The IRS changed the discount rate used to discount loss reserves and produced factor (by accident year and line of business) which were published in Rev. Proc. 2019-06. Then Rev. Proc. 2019-31 was issued with updated the discount factors based on finalization of the ‘appropriate interest rate’ used to produce the discount factors.
Some companies had already filed their 2018 returns using the earlier discount rates, which resulted in more discount/smaller deductible tax reserves than what the new rates would generate.
Making the change
Section 2.02(1) of Rev. Proc. 2019-30 states that a change in method of discounting unpaid losses, estimated salvage recoverable, or unearned premiums attributable to title insurance to comply with the new section 846 rules is a change in method of accounting. Accordingly, such a change is subject to the requirements in section 446. However, Rev. Proc. 2019-30 waives the requirement to file a Form 3115 for changes made under Rev. Proc. 2019-30. Instead, the taxpayer may simply follow the reporting requirements of Rev. Proc. 2019-30 to recognize the adjustments to its income.
Rev. Proc. 2019-30 applies to any property and casualty insurance company that changes its method of accounting for discounting unpaid losses under section 846, discounting salvage recoverable under section 832, or both to comply with amended section 846, and to any life insurance company that changes its method of accounting for discounting unpaid losses to comply with amended section 846, provided the taxpayer (whether a life insurance company or property and casualty insurance company) is a calendar year taxpayer (including a calendar year taxpayer with a short taxable year beginning after Dec. 31, 2017, and ending before June 17, 2019) and satisfies the conditions set forth in section 3.01(1) or (2).
The discounted reserves at Dec. 31, 2017 were recalculated at Jan. 1, 2018 and the drop in the discounted reserve from Dec. 31, 2017 to Jan. 1, 2018 is generally included in income ratably over eight years starting in 2018. Now that there is less discount under the new factors, the eight year inclusion dollar amount is lower. Note that taxpayers are allowed to use either the final factors (i.e., Rev. Proc. 2019-31) or the preliminary factors (i.e., Rev. Proc. 2019-06) for tax year 2018 (see section 2.01(11) of Rev. Proc. 2019-31). Note that the eight year spread does not apply in all situations (e.g., for salvage, pursuant to section 6.02(1) (b)).
If a taxpayer decides to use the preliminary factors, the taxpayer must change the inclusion amount starting in 2019. Taxpayers should look to section 6 of Rev. Proc. 2019‑30 for the rules to calculate and implement the section 481(a) adjustment, based on each of the following categories of taxpayer:
Taxpayer using Revised Discount Factors in First TCJA Year
Taxpayer using Proposed Discount Factors in First TCJA Year and Revised Discount Factors in Second TCJA Year
Taxpayer using Revised Annual Rate in First TCJA Year
Taxpayer using Proposed Annual Rate in First TCJA Year and Revised Annual Rate in Second TCJA Year
TCJA’s amendments to section 846 will require some taxpayers to change their methods of accounting in their next filing period. Rev. Proc. 2019-31 provides new discount factors to discount loss reserves. Unlike most other method changes, the section 481(a) adjustment for this change is generally recognized over eight years. The procedures established in Rev. Proc. 2019-30 are the only procedures available for taxpayers making the change in taxable years beginning after Dec. 31, 2017 and ending on or before Dec. 31, 2019. Accordingly, taxpayers avoid the cost of filing a Form 3115, but must be careful to follow the rules of Rev. Proc. 2019-30 as there is no other allowable procedure.