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Insurance Tax Developments in 2020: A Year of Change After Change

Posted on May 31, 2021

Pam Olson is a consultant to PwC and was a member of Tax Analysts’ board of directors. She is a retired principal who previously was the Washington National Tax Services (WNTS) leader and a deputy U.S. tax leader with PwC. All other authors are with PwC. Julie Goosman is a partner and the global and U.S. insurance tax leader; Mark Smith is a WNTS managing director; Larry Campbell is a WNTS managing director; Josie Lowman is a tax managing director; Surjya Mitra is a WNTS managing director; Chris Riffle is a tax director; Karl Russo is a WNTS director; Morgan Siepel is a tax senior manager; and Christine Watson is a tax partner.

In this article, the authors review last year’s corporate tax developments as they affect insurance companies.

The views expressed herein are solely those of the authors and do not necessarily reflect those of PwC. All errors and views are those of the authors and should not be ascribed to PwC or any other person.

Copyright 2021 PwC.
All rights reserved.

From the beginning of the Trump administration, it was apparent that the theme for the next four years would be change. Early in 2017, the administration kicked off that agenda with a series of executive orders establishing its philosophy and framework for providing regulatory guidance. Among other things, that framework resulted in a new and more robust review process for IRS and Treasury guidance and a commitment to eliminating obsolete or unnecessary regulations.

After Congress enacted the landmark Tax Cuts and Jobs Act in 2017, the IRS and Treasury prioritized the most important guidance needed under the new legislation, an initiative largely completed by January 20, 2021. By itself, the 2020 guidance under the TCJA would qualify the year as one of dramatic change. Regulations interpreting the base erosion and antiabuse tax addressed many issues of importance to both corporate taxpayers in general and insurance companies (in particular, their accounting for offshore reinsurance transactions).

Domestically, regulations on life insurance reserves and changes in basis for computing reserves updated the rules for both TCJA provisions and the nontax regulation of life insurers. Also, regulations addressing net operating losses of nonlife insurance companies and other corporate taxpayers memorialized the manner of applying significant TCJA amendments to the treatment of those losses.

Legislation and regulatory guidance in response to the COVID-19 pandemic were impactful to insurers and included a number of provisions of general application that were particularly important to some insurers, such as modified rules for NOLs (which themselves had been amended only two years earlier) and modernized interest rates used to test whether policies qualify as life insurance contracts. Each of these changes alone was significant.

Finally, the tax administrative impacts of the pandemic were as important to insurers as the formal legislation and guidance from the IRS and Treasury. Extensions of time to file returns and to pay tax, mechanics for filing tax returns (and for such simple items as powers of attorney), and the logistics for an IRS examination all were altered dramatically as a result of the pandemic. Further, the management of primarily remote workforces for both insurance companies and their advisers raised new technical questions of nexus and “doing business,” particularly for foreign and state and local tax authorities.

Observation: The continuing pandemic and new Biden administration promise yet more adaptations both to the Internal Revenue Code and related guidance, and to how companies do business and the IRS operates. Benjamin Franklin famously observed that “in this world, nothing is certain except death and taxes.” If he had been living in 2020, he might well have added “change.”

I. Legislative and Election Observations

A. Overview of Legislative Activity

At the start of 2020, many political commentators expected that divided control of Congress and a focus on the 2020 federal elections would result in limited tax legislation. Instead, continuing responses to the pandemic dominated the tax legislative agenda for the Trump administration and Congress. In March 2020 alone, Congress enacted three COVID-19 relief measures: the $8.3 billion Coronavirus Preparedness and Response Supplemental Appropriations Act,1 the $192 billion Families First Coronavirus Response Act,2 and the $2 trillion Coronavirus Aid, Relief, and Economic Security Act.3 In December 2020 Congress approved the $2.4 trillion Consolidated Appropriations Act, 20214 (Appropriations Act), to fund the federal government through the end of the fiscal year, provide further COVID-19 economic relief, and extend some expiring tax provisions. The latter two bills were arguably the most significant.

1. CARES Act

The CARES Act in particular featured significant tax measures, including (1) a five-year NOL carryback provision; (2) a temporary section 163(j) change increasing the 30 percent interest deduction limitation to 50 percent for 2019 and 2020; (3) a delay in the payment of some employer payroll taxes; and (4) a temporary employee retention credit. Additional CARES Act measures included the Paycheck Protection Program to provide loans and grants to eligible businesses, and a temporary expansion of unemployment benefits to help individuals who ended up out of work. The CARES Act also included several technical corrections to the TCJA, including a clarification regarding the treatment of excess business losses that are carried forward and treated as part of the taxpayer’s NOLs. Congress enacted additional legislation in April and June 2020 with supplemental funding for the PPP and other COVID-19 relief measures.

In addition to these general provisions, the CARES Act included several provisions of particular interest to the insurance industry. For example, a high-deductible health plan can temporarily cover telehealth services without a deductible, and an otherwise eligible individual may contribute to a health savings account despite receiving coverage for telehealth services before satisfying the high-deductible health plan deductible. This relief applies to services provided on or after January 1, 2020, regarding plan years beginning on or before December 31, 2021.

The CARES Act permanently expands the definition of qualified medical expenses for tax-advantaged health accounts (HSAs, Archer medical savings accounts, health flexible spending accounts, and health reimbursement arrangements) to include menstrual care products and over-the-counter products. The CARES Act also allowed, in full, credits for prior-year corporate alternative minimum taxes, a relief provision of particular importance to some Blue Cross Blue Shield and similar organizations.

2. Appropriations Act

In late December 2020, following months of extended debate, Congress approved the Appropriations Act, funding the federal government through the end of its 2021 fiscal year, providing further COVID-19 economic relief, and extending some expiring tax provisions.

This year-end legislation provided roughly $900 billion in COVID-19 relief funding for programs including PPP loans, a second round of direct payments to eligible individuals, unemployment assistance, and additional tax relief measures. These additional measures included an expansion of the employee retention credit, enhanced charitable contribution deductions, and a temporary full deduction for business expenses for food and beverages provided by a restaurant.

The legislation included a significant “tax extender” package that renewed for at least 12 months all but a few tax provisions that had been scheduled to expire on December 31, including the credit for health insurance costs of eligible individuals. Some provisions were made permanent and others extended for up to five years. Permanent provisions included a deduction for specific energy-efficient commercial building expenses and reduced craft beverage excise taxes. The look-through rule for payments between related controlled foreign corporations, the new markets tax credit, and the work opportunity tax credit are among the provisions extended through 2025.

The Appropriations Act modified the definition of a life insurance contract for federal income tax purposes. The purpose of the definition generally is to limit the investment orientation of a contract that receives favorable treatment for earnings on its cash value. For contracts issued after December 31, 2020, the legislation updates the interest rates used in the actuarial tests that are part of that definition to account for periods of low interest rates.

To qualify as an insurance contract, a contract must meet one of two alternative actuarial tests that limit the amount of funding (cash value or premiums) under the contract: the cash value accumulation test (CVAT) or the guideline premium limitation (GPL). Under prior law, there was a 4 percent floor on the interest rate for the CVAT and a 6 percent floor for the GPL. The legislation replaces the CVAT’s 4 percent floor with a rate equal to the least of (1) 4 percent, (2) the valuation interest rate prescribed by the National Association of Insurance Commissioners (NAIC) for life insurance contracts with a guaranteed duration of more than 20 years, or (3) a 60-month average of the midterm applicable federal rate.

The new GPL floor is 2 percentage points higher than the rate for the CVAT, preserving the prior-law rate differential between the two tests. The rates are redetermined only in an adjustment year (that is, the calendar year after the calendar year that includes the effective date of a change in the prescribed valuation interest rate described earlier). A transition rule provides that the minimum rate is 2 percent for the CVAT and 4 percent for the GPL from January 1, 2021, until the end of the first adjustment year that begins after December 31, 2021.

Because the actuarial tests involve present-value calculations, the use of lower interest rates permit higher cash value (or premiums, depending on the test) than had been permitted under prior law in a low-interest-rate environment. When the valuation interest rate and the applicable federal rate are above 4 percent, the tests will apply as they did under prior law.

B. 2020 Federal Election Results

The results of the 2020 federal elections — including the Georgia Senate runoff in January 2021 — significantly increased the prospects for a change of direction in federal tax policy, as well as further action on COVID-19 relief. A key factor for legislation in 2021 is that control of the White House and Congress provides an opportunity for Democrats to use the budget reconciliation process to advance President Biden’s tax proposals in 2021 with only Democratic votes.

Following his election, Biden said that his first priority would be additional COVID-19 relief legislation. As demonstrated by the enactment in March of the $1.9 trillion COVID-19 relief package (the American Rescue Plan Act of 2021 (ARPA))5 with only Democratic votes, the president and Democratic leaders can enact major fiscal policy legislation over Republican opposition through the reconciliation process.

Biden in late March proposed a $2.3 trillion American Jobs Plan focused on infrastructure and other spending initiatives, which would be partially funded by business tax increases like those outlined in the Made in America Tax Plan. Key business tax proposals include increasing the U.S. corporate tax rate to 28 percent, imposing a 15 percent minimum tax on companies’ global book income, and doubling the current minimum tax on profits earned by foreign subsidiaries of U.S. firms from 10.5 percent to 21 percent.

In late April, Biden called on Congress to enact a $1.8 trillion American Families Plan to be paid for by tax increases on higher-income individuals. Key spending provisions in this proposal include education funding, child care assistance programs, and a “national comprehensive paid family and medical leave program.” Tax relief provisions for individuals and families would extend ARPA child tax credit increases through 2025 and permanently make the child tax credit fully refundable; make permanent the ARPA earned income tax credit expansion for childless workers; extend expanded Affordable Care Act tax credits that were provided as part of the ARPA; and permanently increase tax credits to support families with child care needs for children under age 13. Some offsetting provisions include increasing the top individual income tax rate from 37 percent to 39.6 percent; taxing investment income at the same rate as ordinary income for individuals with income above $1 million; limiting the ability of individuals to use the current “step-up in basis at death” rule; and broadening application of the 3.8 percent net investment income tax.

Observation: The need for Biden to gain the near-unanimous support of House Democrats and all 50 Democratic senators to pass legislation under the reconciliation process is expected to limit the scope of any tax increase legislation. For example, Sen. Joe Manchin, D-W.Va., has said that he would only support increasing the corporate tax rate to 25 percent. Other moderate House and Senate Democrats are expected to have similar reservations about some of the president’s proposed tax increases.

Democratic control of both the White House and Congress also raises questions about how specific TCJA provisions that are subject to change under current law may be addressed. While TCJA provisions affecting individuals are not slated to expire until the end of 2025, other changes are scheduled to take effect earlier. For example, new rules are scheduled to take effect in 2022, requiring capitalization of research expenditures and further limiting interest deductions by denying an addback for depreciation and amortization.

C. BEPS 2.0

Negotiations over changes proposed by the OECD to long-standing international tax rules have carried forward into 2021. While most financial services activities — including insurance activities — may be excluded from the scope of the profit reallocation mechanism in pillar 1 of the BEPS 2.0 initiative, many other industry players likely will need to contend with the pillar 1 provisions. Regardless of whether the OECD negotiations result in consensus on changes to the international tax rules, globally engaged businesses face the risk of greater cross-border tax controversy.

Pillar 2 takes a global approach to base erosion and profit shifting, featuring an income inclusion rule (that is, generally a foreign minimum tax), as well as other supporting rules that act as a backstop to the income inclusion rule — including an undertaxed payments rule. These rules require a determination of whether the entities in a group have effective tax rates above a specific minimum threshold.

Observation: Insurers have raised concerns about how the effective tax rate is proposed to be computed and about the potential exposure to double taxation even in the absence of base erosion. What’s more, fundamental questions remain relating to the design of a minimum tax system, including differences among tax bases, use of current versus deferred tax accounting, timing differences that are unique to the industry (such as those related to reserves and acquisition expenses), carryforwards of credits and losses, statutory versus financial statements as a starting point in the calculations, competing regimes, and whether the U.S. global intangible low-taxed income rules may be treated as a qualifying regime.

Observation: Biden has proposed new and related tax changes in the Made in America Tax Plan. Notably, he has proposed to increase the GILTI rate to 21 percent, coupled with related foreign tax credits on a per-country basis. He also has proposed to replace the BEAT with SHIELD (stopping harmful inversions and ending low-tax developments) to deny deductions for cross-border payments to affiliates with a low effective tax rate.

II. Regulatory and Other Guidance

A. TCJA Guidance — Final Push

Before 2020, the IRS and Treasury had been striving to complete the most significant guidance under the TCJA by the end of the president’s fourth year in office. Early in the year, the government signaled its goal to complete those projects by October 2020. The last item of particular importance to many insurers — the passive foreign investment company regulations — appeared in the Federal Register in January.

1. Life Insurance Reserves

a. Determination of life insurance reserves

In April 2020 the IRS published proposed regulations (REG-132529-17) to implement TCJA changes related to the determination of tax-deductible life insurance reserves. In October 2020 the IRS finalized those regulations (T.D. 9911) with modest changes in response to comments.

The TCJA amended section 807(d), which provides rules for computing tax-deductible life insurance reserves of an insurance company. As amended, the provision now generally applies a factor of 92.81 percent to reserves (other than asset adequacy or deficiency reserves) determined using a regulatorily prescribed method as of the date the reserves are determined. The deductible reserve must be at least the net surrender value of the contract (the floor), but no more than the reserves held for the contract on the NAIC annual statement. Special rules apply to reserves for variable life insurance or annuity contracts. The amendments greatly simplify the rules for computing reserves and accommodate changes in the rules for computing statutory reserves, including principle-based reserve methods.

Most significantly, the final regulations reinforce the requirement that deductible life insurance reserves do not include any asset adequacy reserve (AAR). The regulations explain that an AAR is an additional reserve based on the analysis of the adequacy of reserves that otherwise would be established under NAIC-prescribed methods, and includes “any similar reserve.” Although the label placed on a reserve is not determinative, the regulations provide that an AAR includes a reserve that would have been established as an AAR under part 30 of the NAIC Valuation Manual (VM-30) as it existed on the date the TCJA was enacted.

Observation: Presumably, any changes to VM-30 after December 22, 2017, would need to be evaluated to determine whether they affect the federal income tax analysis.

The final regulations address other issues as well. In particular, the regulations:

  • amend the definition of life insurance reserves in existing regulations to make clear that factors other than interest rates and mortality tables may be considered;

  • state that a change in basis for computing reserves is a change in accounting method that is subject to section 446(e) and reg. section 1.446-1(e), and thus requires IRS consent;6

  • state that the IRS may require life insurance reserve reporting as required by TCJA amendments to the IRC;7

  • ask for comments on including annual statements with the filed return;8 and

  • obsolete and conform prior guidance.

    A significant portion of the proposed regulations was devoted to obsoleting prior guidance and updating other guidance to take into account changes that resulted from the TCJA. The final regulations generally adopt these changes as proposed. In particular, the Treasury decision that includes the final regulations obsoletes 14 revenue rulings that were identified for obsolescence in the April 2 notice of proposed rulemaking. The final regulations also either amend or remove several regulations that the IRS previously promulgated under the 1984 act and, in some cases, the 1959 act. These changes affect regulations under sections 338, 381, 801, 806, 809, 810, 817A, 818, 848, and 9100. Most of the changes are ministerial and drew little comment.

The April proposed regulations requested comments on the determination of reserves for a foreign-issued contract that fails the tax law’s distribution requirements to qualify as an annuity, the diversification requirements to qualify as variable life insurance and annuity contracts, and the actuarial requirements to qualify as a life insurance contract.

Observation: Commentators argued that a U.S. reinsurer of foreign-issued contracts should be allowed to compute its deductible life insurance reserves as if the contracts complied with U.S. tax rules, provided reasonable safeguards are met. The IRS declined to address the issue in the final regulations, explaining that it is complex and requires further study, and noting that the IRS “will continue to carefully consider these comments.”

b. Changes in basis for computing reserves

The TCJA also amended section 807(f) to require that adjustments resulting from a change in basis for computing reserves “be taken into account under section 481 as adjustments attributable to a change in method of accounting initiated by the taxpayer and made with the consent of the Secretary.” Previously, these amounts were spread over a 10-year period.

In addition to providing guidance under section 807(f) in the regulations, the IRS published Rev. Rul. 2020-19, 2020-40 IRB 611, to update its guidance on what constitutes a change in basis for computing reserves. In particular, prior guidance was in need of updating to account for:

  • changes in actuarial rules for determining statutory reserves, such as the adoption of the NAIC Valuation Manual and adoption of principle-based reserve methods;

  • TCJA amendments to the rules for determining tax reserves; and

  • TCJA amendments to section 807(f) to treat changes in basis more like changes in method of accounting under prior law.

Observation: As a technical matter, the ruling does not change the standard for what constitutes a change in basis. Under prior IRS guidance,9 changes in basis are analyzed as a subset of changes in accounting method. The situations addressed in the ruling are drawn largely from prior IRS guidance, and take into account formal comments by the industry.

Broadly, tax reserve changes that result from changes in statutory reserve guidance, or that are needed to comply with the tax law, are changes in basis. Changes that instead are inherently part of a method that already is used, or that result from changes in facts, are not changes in basis. The IRS historically has viewed changes in basis broadly. They remain automatic changes under IRS guidance and now include audit protection.10

2. Sales of Life Insurance Contracts

The TCJA included significant changes to the federal income tax treatment of sales of life insurance contracts (life settlement transactions). In particular, the TCJA amended section 101(a) to prevent exceptions to the “transfer for value” rule from applying to a reportable policy sale and added section 6050Y to require reporting on such a sale. The IRS and Treasury published final regulations in 201911 to address these provisions and to explain what constitutes a reportable policy sale subject to the new requirements.

In 2020 the IRS addressed another TCJA provision related to sales of life insurance contracts. Rev. Rul. 2020-5, 2020-9 IRB 454, concludes that the seller of a life insurance contract is not required to reduce the adjusted basis in the contract for the cost of insurance previously incurred. In two prior rulings — Rev. Rul. 2009-13, 2009-21 IRB 1029, and Rev. Rul. 2009-14, 2009-21 IRB 1031 — the IRS concluded that section 1016 required such a reduction. That conclusion led to more than a decade of controversy. The TCJA resolved that controversy by clarifying that no such reduction applies. Rev. Rul. 2020-5 republishes the facts and most of the analysis in these two previous rulings, but updates the basis conclusion to be consistent with the TCJA.

3. NOLs

Amendments to sections 172 and 810 under the TCJA materially affected the use of NOLs arising in tax years beginning after December 31, 2017 (post-2017 NOLs).

Significant changes included:

  • providing that a life insurance company taxable loss determined under Part I of subchapter L generates an NOL subject to rules under section 172; and

  • limiting a taxpayer’s ability to use post-2017 NOLs to 80 percent of life insurance company and non-insurance company taxable income for tax years beginning after December 31, 2020.12

While the changes to the NOL use rules appeared relatively straightforward for single-entity taxpayers, consolidated groups initially were left to interpret these changes based on historical consolidated return guidance related to NOLs. However, in October 2020 the IRS finalized proposed regulations to address the use of consolidated tax attributes,13 reflecting statutory amendments to section 172 under the TCJA. Also, conforming changes were made to reg. section 1.1502-47, addressing the use of tax attributes regarding a life-nonlife consolidated return.

a. 80 percent limitation on NOL utilization

The final regulations include rules for implementing the 80 percent limitation within a consolidated group and for determining the amount of consolidated group NOLs that may be carried forward for future use. The final regulations achieve this by creating two groups within the consolidated group — (1) the nonlife group for nonlife insurance companies and (2) all other members.

The consolidated group’s deduction for post-2017 NOLs is limited to the lesser of (1) the aggregate amount of post-2017 NOLs carried to the year or (2) 80 percent of the excess (if any) of the group’s consolidated taxable income (CTI) (computed without regard to any deductions under sections 172, 199A, and 250) over the aggregate amount of pre-2018 NOLs carried to the year. Thus, the amount allowed as a deduction for a particular consolidated return year beginning after December 31, 2020, equals the sum of (1) pre-2018 NOLs carried to that year and (2) post-2017 NOLs carried to that year after applying the 80 percent limitation.

If a group consists solely of members other than nonlife insurance companies during a consolidated return year beginning after December 31, 2020, the post-2017 consolidated NOL deduction limitation for the group for that year is determined by applying the 80 percent limitation to all of the group’s CTI for that year. In contrast, if a group consists solely of nonlife insurance companies during a consolidated return year beginning after December 31, 2020, the post-2017 consolidated NOL deduction limitation for the group for that year simply equals the group’s CTI less the aggregate amount of pre-2018 NOLs carried to that year.

A specific computation is required if a consolidated group consists of both nonlife insurance companies and other members in a consolidated return year beginning after December 31, 2020. In that case, the post-2017 consolidated NOL deduction limitation for the group would equal the sum of the following two amounts:

  • The first amount relates to the income of those members that are not nonlife insurance companies (residual income pool). This amount equals the lesser of (1) the aggregate amount of post-2017 NOLs carried to that year or (2) 80 percent of the excess of the group’s CTI for that year (determined without regard to income, gain, deduction, or loss of members that are nonlife insurance companies, and without regard to any deductions under sections 172, 199A, and 250) over the aggregate amount of pre-2018 NOLs carried to that year and allocated to the positive net income of members other than nonlife insurance companies.

  • The second amount relates to the income of those members that are nonlife insurance companies (nonlife income pool). This amount equals 100 percent of the group’s CTI for the year (determined without regard to any income, gain, deduction, or loss of members that are not nonlife insurance companies) less the aggregate amount of pre-2018 NOLs carried to that year and allocated to the positive net income of nonlife insurance company members.

For purposes of computing the foregoing amounts, pre-2018 NOLs are allocated pro rata between the two types of income pools in the group. This allocation is based on the relative amounts of positive net income in each pool in the particular consolidated return year.

b. Life insurance company members

For consolidated groups that include life insurance company members, life and nonlife subgroup calculation rules still apply. The final regulations merely create one more subcategory of losses to track, and clarify that the 80 percent limitation on taxable income of other members is determined without regard to life insurance member items.

Life insurance company taxable income that is offset by nonlife subgroup losses is limited to 35 percent of the life subgroup income or 35 percent of the nonlife loss, and may be further limited to 80 percent of life insurance company taxable income.

c. Dual consolidated losses

The final regulations also clarify that when applying separate return limitation year rules to the use of dual consolidated losses, the 80 percent limitation does not apply.

4. International Provisions

Significant insurance-relevant guidance continued to be issued in 2020 interpreting the TCJA’s international provisions. In particular, the IRS and Treasury issued regulations on PFICs, the BEAT, GILTI, the section 250 deduction, FTCs, and the section 163(j) interest expense deduction limitation, each with implications for insurance companies.

a. PFICs

New final (T.D. 9936) and proposed (REG-111950-20) regulations published in January provide guidance on the insurance exception and other issues relating to PFICs.

Taxpayer-favorable developments include a more flexible affiliation standard for testing whether sufficient insurance activities are conducted and exclusion of investment activity from the active conduct test.

Other developments include stricter requirements for financial statements that may be relied upon in determining whether the PFIC insurance exception applies, stricter requirements for reserve liabilities to be treated as applicable insurance liabilities, and certain modifications to the qualified domestic insurance company rules.

The IRS and Treasury requested comments regarding newly proposed rules on the active conduct test and the measurement of applicable insurance liabilities, among other things.

The final PFIC regulations generally apply to tax years of shareholders beginning on or after January 14, 2021. The proposed PFIC regulations generally are effective for tax years of shareholders beginning on or after the date of the filing of those rules as final in the Federal Register.

b. BEAT

BEAT regulations published in October 2020 finalized proposed regulations published in late 2019.14 The final regulations retain the basic approach and structure of the proposed regulations, including a rule that allows taxpayers to waive deductions for all purposes of the IRC. Important for the insurance industry is the treatment of reinsurance premiums paid as deductions for purposes of the election.

Observation: Before the release of the final BEAT regulations, it was unclear whether those payments would be eligible for the waiver, as they generally are treated as reductions to gross income rather than as deductions under subchapter L.

The final BEAT regulations were effective on December 8, 2020 (60 days after the date of publication in the Federal Register), but they contain rules for retroactive application.

c. GILTI

Final regulations published in July 2020 implement a high-tax exclusion for GILTI.15 The final GILTI regulations retain the general approach of applying the high-tax exclusion on a CFC groupwide basis, but vary from prior proposed regulations in some aspects — particularly regarding the use of the tested unit standard (rather than the qualified business unit standard) and the ability to elect the high-tax exclusion annually (including for prior years on an amended return, with some restrictions).

Observation: The complex tested unit calculations take into account disregarded transactions, as well as whether a tested unit’s gross income is subject to tax in more than one jurisdiction. As a result, the statutory income tax rate in the foreign country may not be indicative of whether income is subject to a sufficiently high tax rate. Accordingly, taxpayers should model the application of these rules to determine eligibility.

Also, proposed regulations were issued that generally would conform the high-tax exception under the subpart F regime with the high-tax exclusion under the GILTI regime (thus departing from the manner in which the subpart F high-tax exception is applied in some key respects) and adopt a single election under section 954(b)(4) for purposes of both subpart F income and tested income.16

Observation: Generally left unresolved are some challenges commonly encountered by insurance companies in applying the effective tax rate test in the high-tax exclusion for GILTI, including tax base and timing differences, and distortions resulting from mismatches between U.S. and foreign tax years.

d. Section 250 deduction

Final regulations under section 250 published in July 2020 withdrew an ordering rule related to the application of multiple provisions that depend on taxable income, including those related to NOLs under section 172, the interest expense limitation under section 163(j), and the section 250 deduction for GILTI and foreign-derived intangible income.17

The IRS and Treasury indicated that they are studying the interaction of these taxable-income-dependent provisions in the context of life-nonlife consolidated groups and would provide further insurance-specific guidance.

e. FTCs

Final FTC regulations published in November 2020 contain several updates relevant to the insurance industry, including rules related to prior-year foreign tax redeterminations under section 905(c) and updated rules on the treatment of stewardship expenses.18 The latter are applicable to tax years beginning after December 31, 2019, representing a delayed effective date from the 2019 proposed regulations. The final regulations provide taxpayers with an additional transition year to file required notifications regarding foreign tax redeterminations for tax years ending on or after December 16, 2019, and before November 12, 2020.

Also, new proposed regulations published in November 2020 include revised section 818(f) expense allocation rules, providing for allocation and apportionment on a subgroup basis, with an irrevocable election to allocate those expenses on a separate-company basis.19

The new proposed regulations also address the treatment of financial services groups and respond to taxpayer requests to revert to the general approach of existing regulations, with some changes. Specifically, the new rules would lower the threshold of active financing income an entity must earn to be considered a financial services entity from more than 80 percent to more than 70 percent; provide that active financing income generally must be earned from customers or other counterparties that are not related parties; and impose a cap on the amount of an insurance company’s income from investments that may be treated as active financing income.

f. Section 163(j) interest expense deduction limitation

Although final regulations were published in September 202020 and January,21 many insurance groups will not encounter the interest expense deduction limitation under section 163(j) because they generally earn substantial interest income. For those that do, updates in the final regulations include a more flexible CFC grouping rule and the elimination of the financial services subgroup for CFC groups, which is welcome news to many of these same insurance groups. Finally, a safe harbor election was added for CFC groups to apply section 163(j) on an aggregate basis, simplifying reporting obligations.

B. Other Developments

Apart from guidance under the TCJA, one of the more impactful pieces of guidance for insurers in 2020 was in regulations under the CARES Act NOL provisions. Although these regulations were important to all taxpayers and industries, they were especially relevant to insurers because of the different treatment of nonlife insurance companies and other taxpayers under the TCJA. Insurers otherwise were monitoring administrative developments in the IRS Large Business and International Division and anticipating how the IRS might focus its attention on the priority guidance plan.

1. CARES Act Guidance on NOLs

The CARES Act included modifications to the rules for NOL carrybacks to allow for expanded realization of NOLs (and the restoration of operating loss deductions for specific loss carrybacks). New final22 and temporary23 regulations issued in the latter part of 2020 address specific rules for both life and nonlife insurers that may allow some companies to reclaim taxes paid in prior years.

The TCJA limited the deduction under section 172 for NOLs that arise after 2017 to 80 percent of taxable income, and generally did not allow NOLs to be carried back to prior tax years (although they could be carried forward indefinitely). Insurance companies other than life insurance companies were permitted to carry back those losses two years and forward 20 years, without the limitation related to 80 percent of taxable income. Life insurance company losses arising before 2018 generally could be carried back three years and forward 15 years.

The CARES Act modifies the treatment of NOLs arising in tax years 2018, 2019, and 2020. Specifically, for tax years during this period and beginning before 2021, taxpayers must carry back NOLs (but not capital losses) to the prior five tax years, unless they elect to forgo the carryback. Also, the 80 percent taxable income limitation does not apply to losses arising in tax years 2018, 2019, and 2020. Effectively, this delays the 80 percent taxable income limitation until 2021 and temporarily extends the carryback period to five years (although the CARES Act provides that NOL carrybacks cannot be used against section 965 inclusions).

The new provisions allow nonlife companies to carry back NOLs in a similar manner — that is, five years, and without the 80 percent taxable income limitation on NOL carryovers (the latter was afforded to them under the TCJA and is unchanged). However, nonlife companies still are limited to a 20-year carryforward period. The new provisions permit life insurance companies the same five-year carryback that applies to other corporate taxpayers, and clarify that the losses carried back to pre-2018 years otherwise are deductible as if they were operating loss deductions under pre-TCJA rules.

Observation: The ability to carry back losses to pre-TCJA years resulted in taxpayers obtaining permanent tax benefits by recouping tax originally paid at a 35 percent statutory rate.

a. Split-Waiver Election

The restoration of the NOL (and operating loss deduction) carryback rules under the CARES Act was welcome news for many taxpayers, but came with additional compliance complexity and ambiguity for consolidated groups that recently had sold a member with NOLs, or for consolidated groups that had an entity with NOLs that were generated while a member of another consolidated group.

The NOL carryback split-waiver election rules — which afforded acquiring consolidated groups the ability to waive carryback requirements for acquired company NOLs without relinquishing the carryback for NOLs generated by the existing members — were eliminated in the TCJA. The 2020 temporary regulations allowed acquiring groups with post-2017 consolidated NOLs to waive retroactively some or all of the portion of the five-year extended carryback period of an acquired member that includes pre-acquisition years.24

Observation: The 2020 temporary regulations provide much-needed relief for acquiring consolidated groups that as a practical matter would not have considered a split-waiver election for NOLs arising in the 2018, 2019, and 2020 tax years. This relief allows acquiring consolidated groups to take affirmative steps to preserve the expectations of the parties to acquisitions in these years.

Observation: Carryback waiver elections are made on a subgroup basis. If a loss carryback has been waived, the use of the loss is limited to the same subgroup and, depending on the specific facts applicable to the taxpayer, the use of the loss may be further limited to specific entities within the subgroup. Taxpayers should consider the implications of waiving a loss carryover and the ability to use losses in the future.

2. Priority Guidance Plan

Each year, the IRS and Treasury priority guidance plan informs taxpayers and practitioners of projects that will be prioritized for published guidance. As of the fourth quarter release of the 2019-2020 plan, 51 projects were identified for publication under the heading “Implementation of Tax Cuts and Jobs Act (TCJA).” The initial release of the 2020-2021 plan still included 38, including substantial international guidance and guidance under section 807. In contrast, only two insurance-specific projects appeared under the subheading “Insurance Companies and Products”:

  • “Regulations under [section] 72 on the exchange of property for an annuity contract. Proposed regulations were published on October 18, 2006.”

  • “Guidance relating to the diversification requirements under [section] 817(h) for certain mortgage-backed securities purchased in the To-Be-Announced (TBA) market and for certain TBA contracts. Rev. Proc. 2018-54 was published on November 5, 2018.”

Neither project was published in 2020, presumably because of the volume of other guidance competing for scarce resources. With most TCJA guidance completed, the 2021-2022 priority guidance plan will give an early indication of the new administration’s regulatory agenda.

3. Tax Administration — LB&I Campaigns

In 2020 LB&I announced two new campaigns concerning life insurance reserves, with the goal of improving return selection, identifying issues representing a risk of noncompliance, and making the greatest use of limited resources.

The first campaign — titled “Section 807(d) — Computation of life insurance reserves campaign” — examines Forms 1120-L filed by life insurance companies for their 2017 and 2018 tax years to understand how taxpayers implemented changes the TCJA made to the determination of life insurance reserves. The second campaign — titled “Section 807(d) — Re-computation of life insurance reserves campaign” — identifies companies that elected under prior provisions to redetermine every five years the interest rate used to compute life insurance reserves for federal income tax purposes. In 2019 the IRS issued chief counsel advice,25 concluding that such an election could not be made on amended returns and, if elected in 2017, could apply only to contracts issued in 2012.

Observation: The issue likely will continue to generate controversy as cases under examination move forward to appeals or to litigation.

Also in 2020 LB&I continued its efforts to scrutinize microcaptive insurance companies, which are nonlife insurance companies that are small enough to elect under section 831(b) to be taxed only on investment income, not on underwriting income. Not only are these arrangements the subject of an active LB&I campaign, but they also remain “transactions of interest,” requiring special reporting to the IRS, and are the subject of close scrutiny and unfavorable settlement terms reflecting the IRS’s view that many of these arrangements do not qualify as insurance.

III. State Tax Issues

A. State Tax Impact of COVID-19 Remote Working Arrangements

As states responded to the COVID-19 pandemic with stay-at-home orders to limit the spread of the coronavirus, many businesses were forced to pivot to a mobile workforce strategy nearly overnight. The sudden shift to work-from-home arrangements resulted in many employees working from states other than their historic work locations, triggering both states and businesses to consider the impact on tax liabilities, as well as filing and withholding obligations. Many states facing budget deficits are also still looking for tax revenue and may assert that these new arrangements result in filing requirements.

1. State Income-Based Tax Nexus

States impose an income tax on companies doing business within their borders. Historically, the determination of whether a company was doing business in a state, and thus had nexus and a filing responsibility, largely was based on the business’s physical presence in the state (for example, payroll or property). Before the pandemic, many states took the position that the presence of a single employee working from his or her home within the state triggered nexus for the employer, obligating the employer to register for and file and pay income taxes to the state.

During the early months of the pandemic, some states reevaluated their historic income tax nexus positions and issued guidance providing temporary relief to help alleviate the tax burden created by the mandated shift to remote work locations. States such as New Jersey indicated that nexus would not be created for any tax type solely based on an employee working remotely in the state because of the pandemic.26 Other states, such as Oregon, narrowed the scope of the temporary relief to provide that the nexus relief only applies to specific tax types.27 Others indicated that any nexus considerations relating to a taxpayer’s work-from-home arrangements would be determined on a case-by-case basis.28 Many states have not provided any guidance to date indicating an intention to deviate from their general income tax nexus approach. Thus, applying a state’s historic nexus standard could expose businesses to additional tax return filing obligations as a result of an employee working in a state where the company has not historically filed.

Many questions remain unanswered, even in states that have provided guidance. The ones that did generally limit relief to an emergency period that soon may expire, leaving open the question of how to comply afterward. Further, many businesses are making decisions about the nature of their workforce and its location in the future. Some companies have announced that they will be reducing office space because they intend to continue allowing employees to work remotely. In that case, it may be difficult for the business to take a position that an employee’s presence in the state is attributable to an emergency. These announcements might be viewed as signaling that the business is permanently doing business in that remote work state, potentially creating nexus and income tax return filing responsibilities.

There also is an ongoing question regarding whether having just one employee in the state would equate to doing business in the state. If the employee is part of the C-suite, as opposed to some other internal function, and is relocating to a low-tax jurisdiction, it may be particularly difficult to argue that the company is not doing business in the state given the many different duties that she performs.

For insurance companies, the impact of shifting to a mobile workforce may give rise to some additional concerns. Insurance companies generally are subject to a premium tax in states where they are licensed to sell insurance. Insurance companies may be exempt from state income tax if they are paying — or are subject to — the premium tax. Some states exempt insurance companies from the income tax if they are licensed as insurance companies in any jurisdiction.

One concern in that regard is that an employee of an insurance company may have relocated to a state where that company is not licensed to write insurance. This potentially raises a question whether that insurance company could be subject to income tax in that state because the company is not paying — or subject to — a premium tax in the state.

2. State Income-Based Apportionment

Two issues generally arise regarding remote workers from an apportionment perspective. The most obvious one regards those states that still calculate apportionment using, in part, a payroll factor. The other is whether an employee in a state will factor into a cost-of-performance analysis and shift sales to that state.

States have taken various approaches regarding apportionment relief, with many that have issued nexus relief also indicating that compensation paid to employees working from home because of the pandemic — and any associated property used in that context — will not be included in the payroll and property factors of the company’s apportionment formula (to the extent property and payroll are factors in the apportionment formula).29

IV. Looking Ahead

A change in administration makes tax policy predictions particularly difficult, even in “normal” times. Although both the House and Senate are in Democratic control, the ability to achieve significant change in 2021 is limited by slim majorities (particularly in the Senate), the continuing pandemic, and growing budget shortfalls, even with potential availability of the budget reconciliation process. Nevertheless, speculation is widespread about the timing and magnitude of potential increases in corporate tax rates and other legislative priorities of the new administration, particularly those reflected in recent proposals such as the American Jobs Plan, Made in America Tax Plan, and American Families Plan.

LB&I campaigns in insurance — particularly those that target life insurance reserves — are in the early stages, and results of those campaigns are only beginning to emerge. With TCJA guidance largely in the rearview mirror, the administrative agenda for insurance is relatively wide open, and the IRS and Treasury have yet to signal what projects they might take up.

With such broad areas of uncertainty, one might safely predict the theme for 2021 will be agility. That is, 2021 will require all taxpayers — and insurance companies in particular — to remain vigilant and be prepared to respond promptly to anticipated and unanticipated legislative and administrative developments.30

FOOTNOTES

1 P.L. 116-123.

2 P.L. 116-127.

3 P.L. 116-136.

4 P.L. 116-260.

5 P.L. 117-2.

6 As a practical matter, the IRS previously granted automatic consent regarding those changes.

7 The regulations also state that the reporting guidance may provide for how separate account items are reported. The regulations do not, however, provide any details as to the actual reporting requirements. It is anticipated that the IRS will take comments into account before imposing new requirements.

8 Currently, an insurance company that files Form 1120-L or Form 1120-PC electronically is not required to include its annual statement (or pro forma annual statement) with the return. Final regulations provide that the company must include its annual statement (or pro forma annual statement), or a portion thereof, as — and to the extent — required by forms or instructions.

9 See, e.g., Rev. Rul. 94-74, 1994-2 C.B. 157.

10 Rev. Proc. 2019-43, 2019-48 IRB 1107.

12 Nonlife insurance company losses may be carried forward 20 years and carried back two years. The TCJA did not modify the rules for nonlife insurance company NOLs.

14 T.D. 9910, 85 F.R. 64346.

15 T.D. 9902, 85 F.R. 44620.

16 REG-127732-19, 85 F.R. 44650.

17 T.D. 9901, 85 F.R. 43042.

18 T.D. 9922, 85 F.R. 71998.

19 REG-101657-20, 85 F.R. 72078.

20 T.D. 9905, 85 F.R. 56686.

21 T.D. 9943, 86 F.R. 5496.

22 T.D. 9927, 85 F.R. 67966.

23 T.D. 9900, 85 F.R. 40892.

24 Id.

25 ILM 201939003 (June 27, 2019).

26 See, e.g., New Jersey Division of Taxation, “Telecommuter COVID-19 Employer and Employee FAQ” (May 27, 2020), and “Tele-Commuting and Corporate Nexus” (Mar. 31, 2020).

27 See, e.g., Oregon Department of Revenue, “Oregon COVID-19 Tax Relief Options” (July 28, 2020).

28 See, e.g., Kentucky Department of Revenue, Frequently Asked Questions (July 16, 2020).

29 See, e.g., California Franchise Tax Board, “COVID-19 Frequently Asked Questions for Tax Relief and Assistance” (last updated Apr. 9, 2021).

30 PwC refers to the U.S. member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisers.

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