Some Changes in Computing Insurance Reserves Are Changes in Basis

Some Changes in Computing Insurance Reserves Are Changes in Basis

Internal Revenue Service

The IRS has issued guidance (Rev. Rul. 2020-19) on what constitutes a change in basis of computing life insurance reserves under <a href="/research/federal/usc26/807#cnlm-0000106" resolve="/lr/resolve//cnlm#cnlm-0000106">section 807(f)</a>, as amended by the Tax Cuts and Jobs Act. Rev. Rul. 2020-19 describes 10 situations involving a life insurance company that issues life insurance and annuity contracts directly and reinsures the risks on such contracts issued by other companies. The company must determine life insurance reserves under <a href="/research/federal/usc26/807#cnlm-0000019" resolve="/lr/resolve//cnlm#cnlm-0000019">section 807(d)</a> for both directly written and reinsured contracts and must take net increases or decreases in the reserves into account in computing life insurance company taxable income. The company determines the amount of the life insurance reserve for a contract in accordance with the net surrender value floor of <a href="/research/federal/usc26/807#cnlm-0000021" resolve="/lr/resolve//cnlm#cnlm-0000021">section 807(d)(1)(A)</a> and <a href="/research/federal/usc26/807#cnlm-0000022" resolve="/lr/resolve//cnlm#cnlm-0000022">(B)</a> and the statutory cap of <a href="/research/federal/usc26/807#cnlm-0000160" resolve="/lr/resolve//cnlm#cnlm-0000160">section 807(d)(1)(C)</a>. Rev. Rul. 2020-19 describes changes in determining the reserves for the contracts in each of the 10 situations. <a href="/research/federal/usc26/807#cnlm-0000106" resolve="/lr/resolve//cnlm#cnlm-0000106">Section 807(f)</a> provides rules for when the basis for determining any item referred to in <a href="/research/federal/usc26/807#cnlm-0000012" resolve="/lr/resolve//cnlm#cnlm-0000012">section 807(c)</a>, which includes life insurance reserves, as of the close of any tax year differs from the basis for determining that item as of the close of a preceding tax year. The difference between the amount of an item at the close of the tax year computed on a new basis versus the old basis must be taken into account under <a href="/research/federal/usc26/481#cnxq-0000002" resolve="/lr/resolve//cnxq#cnxq-0000002">section 481(a)</a> as an adjustment attributable to an accounting method change. Reg. section 1.807-4(a) provides that a change in basis of computing an item referred to in <a href="/research/federal/usc26/807#cnlm-0000012" resolve="/lr/resolve//cnlm#cnlm-0000012">section 807(c)</a> is a change in method of accounting. Thus, before computing an item described in <a href="/research/federal/usc26/807#cnlm-0000012" resolve="/lr/resolve//cnlm#cnlm-0000012">section 807(c)</a> under a new basis, a life insurance company must obtain IRS consent. A company adopts a basis of computing an item referred to in <a href="/research/federal/usc26/807#cnlm-0000012" resolve="/lr/resolve//cnlm#cnlm-0000012">section 807(c)</a> when it uses a permissible basis of computing the item on the first federal income tax return that reflects the item. If a company uses an impermissible basis of computing an item on the tax return for one tax year, the computation does not constitute the adoption of a basis of computing the item. However, the consistent use of an impermissible basis of computing an item on two more consecutively filed tax returns establishes the basis of computing the item. If a company has adopted a basis of computing an item, it may not change the basis by amending its prior returns. Also, a change in an item referred to in <a href="/research/federal/usc26/807#cnlm-0000012" resolve="/lr/resolve//cnlm#cnlm-0000012">section 807(c)</a> resulting from a change in underlying facts or from the correction of a mathematical or posting error is not a change in basis of computing the item under <a href="/research/federal/usc26/807#cnlm-0000106" resolve="/lr/resolve//cnlm#cnlm-0000106">section 807(f)</a>.  Applying those rules to the 10 situations, the IRS determined that there was a change in basis under <a href="/research/federal/usc26/807#cnlm-0000106" resolve="/lr/resolve//cnlm#cnlm-0000106">section 807(f)</a> in five of them requiring the insurance company to obtain IRS consent to make the change. In all but one of those five situations, the company also must account for the difference between the tax reserve computed on the new basis versus the old basis as an adjustment under <a href="/research/federal/usc26/481#cnxq-0000002" resolve="/lr/resolve//cnxq#cnxq-0000002">section 481(a)</a>. The IRS determined that there was no change in basis in the remaining five situations.

The IRS has issued guidance (Rev. Rul. 2020-19) on what constitutes a change in basis of computing life insurance reserves under section 807(f), as amended by the Tax Cuts and Jobs Act.

The IRS has issued guidance (Rev. Rul. 2020-19) on what constitutes a change in basis of computing life insurance reserves under section 807(f), as amended by the Tax Cuts and Jobs Act. Rev. Rul. 2020-19 describes 10 situations involving a life insurance company that issues life insurance and annuity contracts directly and reinsures the risks on such contracts issued by other companies. The company must determine life insurance reserves under section 807(d) for both directly written and reinsured contracts and must take net increases or decreases in the reserves into account in computing life insurance company taxable income. The company determines the amount of the life insurance reserve for a contract in accordance with the net surrender value floor of section 807(d)(1)(A) and (B) and the statutory cap of section 807(d)(1)(C). Rev. Rul. 2020-19 describes changes in determining the reserves for the contracts in each of the 10 situations. Section 807(f) provides rules for when the basis for determining any item referred to in section 807(c), which includes life insurance reserves, as of the close of any tax year differs from the basis for determining that item as of the close of a preceding tax year. The difference between the amount of an item at the close of the tax year computed on a new basis versus the old basis must be taken into account under section 481(a) as an adjustment attributable to an accounting method change. Reg. section 1.807-4(a) provides that a change in basis of computing an item referred to in section 807(c) is a change in method of accounting. Thus, before computing an item described in section 807(c) under a new basis, a life insurance company must obtain IRS consent. A company adopts a basis of computing an item referred to in section 807(c) when it uses a permissible basis of computing the item on the first federal income tax return that reflects the item. If a company uses an impermissible basis of computing an item on the tax return for one tax year, the computation does not constitute the adoption of a basis of computing the item. However, the consistent use of an impermissible basis of computing an item on two more consecutively filed tax returns establishes the basis of computing the item. If a company has adopted a basis of computing an item, it may not change the basis by amending its prior returns. Also, a change in an item referred to in section 807(c) resulting from a change in underlying facts or from the correction of a mathematical or posting error is not a change in basis of computing the item under section 807(f).  Applying those rules to the 10 situations, the IRS determined that there was a change in basis under section 807(f) in five of them requiring the insurance company to obtain IRS consent to make the change. In all but one of those five situations, the company also must account for the difference between the tax reserve computed on the new basis versus the old basis as an adjustment under section 481(a). The IRS determined that there was no change in basis in the remaining five situations.

Sec. 807 Rules for certain reserves

Sec. 446 General rule for methods of accounting

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Some Changes in Computing Insurance Reserves Are Changes in Basis