IRS REVERSES ITSELF AND SAYS THAT MUTUAL LIFE INSURERS CANNOT USE A NEGATIVE DIFFERENTIAL EARNINGS RATE.

Notice 88-106

Announcement 88-47, 1988-12 I.R.B. 56, announced that the Internal Revenue Service had tentatively determined that the "recomputed differential earnings rate" for 1986 was negative 1.700 percent. The regulations under section 809 of the Internal Revenue Code will provide that the differential earnings rate and the recomputed differential earnings rate may not be a negative rate.

BACKGROUND

Section 809 of the Code provides that, in the case of any mutual life insurance company, the amount of the deduction allowable under section 808 for policyholder dividends shall be reduced (but not below zero) by the "differential earnings amount." Any excess of the "differential earnings amount" over the amount of the deduction allowable under section 808 shall be taken into account as a reduction in the closing balance of reserves under subsections (a) and (b) of section 807. The "differential earnings amount" for any taxable year is the amount equal to the product of (a) the life insurance company's average equity base for the taxable year multiplied by (b) the "differential earnings rate" for such taxable year. The "differential earnings rate" for the taxable year is the excess of (a) the "imputed earnings rate" for the taxable year over (b) the "average mutual earnings rate" for the second calendar year preceding the calendar year in which the taxable year begins. The "imputed earnings rate" for any taxable year is the amount that bears the same ratio to 16.5 percent as the "current stock earnings rate" for the taxable year bears to the "base period stock earnings rate."

Section 809(f) of the Code provides that, in the case of any mutual life insurance company, if the "recomputed differential earnings amount" for any taxable year exceeds the differential earnings amount for such taxable year, such excess shall be included in life insurance gross income for the succeeding taxable year. If the differential earnings amount for any taxable year exceeds the "recomputed differential earnings amount" for such taxable year, such excess shall be allowed as a life insurance deduction for the succeeding taxable year. The "recomputed differential earnings amount" for any taxable year is an amount calculated in the same manner as the differential earnings mount for such taxable year, except that the "average mutual earnings rate" for the calendar year in which the taxable year begins is substituted for the "average mutual earnings rate" for the second calendar year preceding the calendar year in which the taxable year begins.

REGULATIONS UNDER SECTION 809

The regulations under section 809 of the Code will provide that the differential earnings rate and the recomputed differential earnings rate may not be a negative rate. Thus, for any taxable year in which the average mutual earnings rate for the second preceding calendar year exceeds the imputed earnings rate, the differential earnings rate will be zero. Similarly, for any taxable year in which the average mutual earnings rate for the calendar year exceeds the imputed earnings rate, the recomputed differential earnings rate will be zero. See; Rev. Rul. 88-80 1988-40 I.R.B., for the differential earnings rate for 1987 and the recomputed differential earnings rate for 1986. Based on this Notice, the recomputed differential earnings rate for 1986 is zero.

ADMINISTRATIVE PRONOUNCEMENT

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.

DRAFTING INFORMATION

For further information regarding this Notice, please contact Katherine A. Hossofsky of the Corporation Tax Division at (202) 566- 4196 (not a toll-free call).