bkd national insurance services group. tax update thomas f. wheeland partner bkd national insurance...

BKD National Insurance Services Group

TAX UPDATEThomas F. WheelandPartner


AGENDA• Annual Statement Accounting vs. The Code• Policyholder Dividends• IRC §461 Rulings – Bonus Accruals• Loss Reserves• Research & Experimentation Credit• LB&I Directive on Partial Worthlessness• Tax Reform• Extender Provisions• Uncertain Tax Positions• Meals & Entertainment• Repair Regulations• Tax Exempt Interest – Non-Life Company Analysis• Q&A


ANNUAL STATEMENT ACCOUNTING VS. THE CODE

• State Farm case [110 AFTR 2d 2012-5778, 08/31/2012]– 7th Circuit decision involved punitive damages treated as part of loss reserves for SAP

purposes– Taxpayer relied upon annual statement treatment in claiming a deduction (on a

discounted basis) for estimated punitive damages– Court ruled in favor of IRS reasoning that the NAIC’s guidance only allowed for the

inclusion of compensatory damages in loss reserves and did not provide such guidance with regard to punitive damages

– Also addressed an AMT issue holding that the ACE adjustment should be made on a consolidated basis and then allocated to the life and non-life subgroups

• TAM 200939019 - IRS believes the inclusion of compensation related accruals (in this instance, retiree medical benefits) in LAE should not result in an immediate reserve deduction - §404 trumps §832


POLICYHOLDER DIVIDENDS• Mass Mutual case [109 AFTR 2d 2012-837, 01/30/2012]

– Court of Federal Claims decision involved a mutual life dividend guarantee, but is applicable to non-life dividends as well

– The court determined that the requirements of the “all events” test of §461 were met• The fact of the liability (although the identity of recipients was unknown) was established with reasonable

accuracy• Economic performance had occurred (the guaranteed amount was always paid out)• The taxpayer had elected the recurring item exception (an important finding was that the dividend was akin to a

rebate or refund)

• New York Life case [112 AFTR 2d 2013-5555, 08/01/2013]– Second Circuit decision involving January dividends (credited in preceding December) and a minimum

liability dividend (calculated as the lesser of the annual dividend or termination dividend)• January dividends credited in December did not meet “all events” test as policyholder could surrender the policy

with no right to the credited dividends • Minimum liability dividend failed to meet the “all events” test as well because insurer was under no contractual

or statutory obligation to pay a termination dividend when the policyholder surrendered policy

• PLR 200948042 – IRS ruled that insurer’s “practice” of paying January anniversary dividends did not trump the terms of

the policy– Taxpayer’s argument that it must pay either a termination or policyholder dividend was rejected as

well


IRC §461 RULINGS – BONUS ACCRUALS

• FAA 20134301F– Formula approved in year of accrual– Do not have to be an employee on date of payment to receive bonus– Failed on 3 counts:

• Company retained right after year end to modify or eliminate bonuses• Committee approval required after year end; role not merely ministerial• Subjective individual performance rating impacted bonus

• Rev. Rul. 2011-29– Must be employee on date of payment to receive bonus– The “fact of the liability” for bonuses established by resolution or objective formula– Amounts forfeited are re-distributed to other employees

• CCA 200949040– Must be employee on date of payment to receive bonus– Bonus plan whereby amounts forfeited would be paid to a charity– Different timing rules exist under §170 and §461; deduct in year of payment


LOSS RESERVES• Acuity Decision

– Taxpayer’s reserves found to be “fair and reasonable”– Diversified writer with increasing premiums and changes in product mix– Reserves developed by internal actuary and within outside actuary’s range– Outside actuary’s range was under 20% (14.6%)– Taxpayer’s conservative reserve assumptions (“implicit margin”) supported by actual loss

experience and exercise of professional judgment – Court cited State Farm and Sears in deferring to annual statement– Credentialed actuary employed multiple methods and complied with SSAP 55 and ASOPs– History of positive development not determinative– Utah Medical parallels where management chose reserves w/in range– Differentiated from Minnesota Lawyers where range was excessive– Court acknowledged that wider range appropriate for monoline companies


LOSS RESERVES• Coordinated Issue Paper (CIP) on Reserve Margins

– Reserves must be fair and reasonable and represent actual unpaid losses

– Additions must be based upon actual loss experience– Actuary’s opinion not entitled to any presumption or deference– Note: Effective January 21, 2014, all CIPs have been de-coordinated


RESEARCH & EXPERIMENTATION CREDIT EXAMPLE

• Assume consistent R&E spending of $2,000/year for the period 2012-2014 (base period) and 2015 (current period)

• Assume all costs are internal wages and credit eligible• Excess of current year ($2,000) over 50% of base period

($1,000) is $1,000• Credit is 14% ($140) and reduced credit (to account for the fact

that the amounts were already deducted under IRC §174) is 65% of $140

• Credit is $91 or 4.55% of eligible costs


LB&I DIRECTIVE ON PARTIAL WORTHLESSNESS

• IRC§166(a)(2) provides for a partial worthlessness deduction for debt

• SAP 43R impairments related to loan-backed or structured securities such as REMICs may be deductible for tax purposes as well under the charge-off conformity rule of the directive

• 2012 is the last year to which the directive applies• The position still has technical support


TAX REFORM• Reduce top corporate tax rate (25%, 28%)• Repeal AMT and revise NOL rules• Eliminates exclusion of performance-based compensation from §162(m)• Life reserves – increase in discount rate to compute tax reserves• Non-life reserves – increase in rate, loss payment pattern lengthening, no company election• Increase in DAC percentages• Change in proration rules• Repeal of §833 (BCBS entities)• Removes benefits for small life and non-life insurers • Limits COLI interest expense exception to 20% owners for new contracts• Repeal of §847 – Special Estimated Tax Payments• International provisions


EXTENDER PROVISIONS

• 50% Bonus Depreciation• Section 179 Expensing• R&E Credit• All Extended Through 12/31/14


UNCERTAIN TAX POSITIONS• New SSAP 101 UTP standard may require companies to establish tax contingencies

for the first time• Like the GAAP standard, the new SAP standard requires companies to analyze tax

positions by employing a “more likely than not” threshold• Only applies to federal and foreign income tax positions• Assumes a review by the relevant taxing authority with full knowledge of facts• Exception for temporary differences• SAP only filers should carefully apply SSAP 101’s regime to minimize tax

contingencies and avoid the need to disclose on Schedule UTP


MEALS & ENTERTAINMENT

• Revised §274 regulations• Provides guidance as to who will be subject to 50% disallowance• If employer has a reimbursement or expense allowance arrangement:

– Limitation applies to employee if reimbursement is treated as compensation; applies to employer if not treated as such

• Can be subject to written agreement between independent contractors and clients/customers– If no written agreement, limitation applies to independent contractor to extent

he/she does not “account” for expenses; otherwise, applies to client/customer


REPAIR REGULATIONS

• Generally effective for tax years beginning on or after January 1, 2014• Companies can early adopt in years beginning on or after January 1, 2012• Incidental materials and supplies can be deducted in the tax year their cost

is paid• Non-incidental materials can be deducted under the de minimis expensing

rule ($5,000 per invoice)• Final companion regulations governing general asset accounts and

disposition of depreciable property expected soon


TAX EXEMPT INTEREST – NON-LIFE COMPANY ANALYSIS

• Regular tax and alternative minimum tax break-even analysis– Assume taxable income is $1,000,000 before tax-exempt interest deduction– Regular tax rate is 35%; AMT rate is 20%; no state taxes– Tax-exempt interest (net of proration) is $(500,000)– Regular taxable income is $500,000 and tax is $175,000– AMTI = $500,000+[$500,000*75%] = $875,000 and tax is $175,000– Break-even level in example is $(588,235) of tax exempt interest net of $88,235 of

proration• After-tax yield comparison (35% federal tax rate; no state tax)

– A 5% taxable bond has an after-tax yield of 3.25%– A 5% tax-exempt bond has a 4.7375% after-tax yield– A 3.43% tax-exempt bond has an after-tax yield of 3.25%


TAX PROVISION EXAMPLE - FACTS• Pre-Tax Income of $10,000,000• Permanent Differences of $(1,000,000) - $(350,000) Tax Effected • Temporary Differences (I/S Items) of $3,000,000 - $1,050,000 Tax Effected • Increase in Nonadmitted Receivables of $400,000 - $140,000 Tax Effected• Increase in Unrealized Gains of $1,400,000 – $490,000 Tax Effected• Deferred Tax Assets BOY

EOY– Income Statement Items (at 35%) $3,500,000 $ 4,550,000

DTA– Nonadmitted Assets (at 35%) $1,050,000 $ 1,190,000

DTA– Unrealized Gains (at 35%) $ (700,000)

$(1,190,000) DTL– Gross DTA

$3,850,000 $ 4,550,000 DTA– Nonadmitted DTA $ (850,000) $

(550,000) Assumed– Admitted DTA $3,000,000

$ 4,000,000 DTA


TAX PROVISION EXAMPLE – CURRENT AND DEFERRED PROVISIONS

• Taxable Income $12,000,000• Tax Rate 35%• Current Tax Expense $4,200,000

42.0%

• Change in DT $(1,000,000) (A)Benefit• Change in Nonadmitted (300,000) (B)Benefit• Change in Unrealized Gains 490,000 (C)Charge• Change in DTA [(A)-(B)-(C)] $(1,190,000) Benefit

(11.9)%

• Total Taxes (SAP FN) $ 3,010,000 30.1%

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TAX PROVISION EXAMPLE

• Effective Tax Rate 30.1%• Impact of Nonadmitted Assets 1.4%

• Effective Tax Rate (P&L Related) 31.5%

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PLEASE COMPLETE THE SESSION EVALUATION FORM

21 // experience

clarityBKD National Insurance Services Group

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THANK YOU!Thomas F. Wheeland, [email protected]


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