Key Tax Reform Provisions Impacting Life Insurance Company Taxation

Transcription

1 Key Tax Reform Provisions Impacting Life Insurance Company Taxation Matt MacMillen, Lincoln Financial Tom Talajkowski, Northwestern Mutual Regina Rose, ACLI March 21, 2018

2 Agenda Introduction Key H.R. 1 tax reform provisions General corporate International Life insurance company Tax reform capital matters NAIC Tax reform accounting and financial reporting matters SEC, FASB, and NAIC 2

3 Introduction On December 22, 2017, President Trump signed what was formerly known as the Tax Cuts and Jobs Act (H.R. 1), arguably the most significant tax legislation enacted since at least The legislation was developed and passed by House and Senate Republicans on a party-line basis using budget reconciliation to avoid the need for 60 votes in the Senate. The bill moved quickly through Congress, from introduction in the House Ways & Means Committee on November 2 to final passage on December 20 by the House ( ) and Senate (51-48) of a conference bill resolving the differences between the House and Senate bills. 3

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5 Key H.R. 1 General Corporate Tax Reform Provisions 5

6 General Corporate Tax Permanently reduces the 35% corporate tax rate to a flat 21%, effective for tax years beginning after Repeals the corporate alternative minimum tax (AMT). Taxpayers with AMT credit carry forwards can claim a refund of 50% of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning in 2018, 2019, and o o All remaining credits can be claimed as a refund in the tax year beginning in The Federal budget rules treat refundable tax credits that exceed a taxpayer's liability as "direct spending" and, pursuant to the Balanced Budget and Emergency Deficit Control Act of 1985 (BBEDCA), subject such payments to sequestration 6.6% reduction for FY18. Limits the deduction of net interest expense to 30% of EBITDA through 2021 and to 30% of EBIT thereafter. 6

7 General Corporate Tax Requires taxpayers computing taxable income under an accrual method of accounting to recognize income no later than the tax year in which such income is taken into account as income on an applicable financial statement (GAAP) or another financial statement under rules specified by the Secretary. This requirement does not apply to any item of gross income for which the taxpayer uses a special method of accounting provided under another provision of this chapter, other than the special rules for bonds and other debt instruments. Gross income items for which I.R.C. subchapter L specifies the accounting treatment would be excepted from this new rule. 7

8 General Corporate Tax Other Corporate Changes With Impact 162(m) limitations on executive compensation Immediate expensing of capital asset purchases for five years Other non-deductible business expenses o Entertainment, settlements of sexual harassment claims Like-kind exchanges limited only to real property Changes to various tax credits Amortization of R&E costs starting in % deduction for some pass-through income 8

9 Key H.R. 1 International Tax Reform Provisions 9

10 International Tax Moves to a quasi-territorial system with a 100% dividends received deduction. Replaces the current worldwide system of taxation with a dividend-exemption system that exempts from U.S. taxation 100% of the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder owning at least 10% of the foreign corporation. 10

11 International Tax One-time tax on previously unrepatriated earnings Generally requires a 10% U.S. shareholder of a CFC to include in income its pro rata share of the CFC s pre-2018 accumulated E&P that has not previously been subject to U.S. tax. The portion of the E&P comprising cash and cash equivalents is taxed at a 15.5% rate and the remainder at an 8% rate. There is an election to pay the tax over eight years. 11

12 BEAT Earnings stripping by certain foreign headquartered multinationals was long recognized as a problem by the U.S., with deductible royalty payments, interest payments, and service payments to a foreign parent reducing U.S. tax liabilities. H.R. 1 potentially subjects businesses with more than $500 million in annual gross receipts and more than a de minimis amount of certain related-party payments to a new 10% minimum tax (5% for 2018 and 12.5% for tax years beginning after 12/31/2025), called the base erosion anti-abuse tax (BEAT). 12

13 BEAT The alternative tax base is similar to the regular tax base except otherwise deductible payments to a foreign related party (base erosion payments and any NOLs attributed to such payments) are added back in arriving at the alternative tax base. Base erosion payments include deductible payments to related foreign persons for certain reinsurance arrangements, but not for costs of goods sold or for services provided at cost. BEAT is not applicable to deductible payments to a foreign corporation treated as a U.S. corporation pursuant to an election under section 953(d). 13

14 GILTI H.R. 1 taxes U.S. corporate shareholders currently on their portion of a CFC s global intangible low-taxed income (GILTI). GILTI generally is income that is low-taxed roughly, less than a 10.5% effective tax rate (ETR), grading up to a % ETR for tax years beginning after 12/31/25 and generates a high rate of return. 14

15 FDII H.R. 1 added section 250 to the Internal Revenue Code, effectively creating a new preferential tax rate for income derived by domestic corporations from serving foreign markets. The new deduction is described as a deduction for foreign-derived intangible income, or FDII. A lower tax rate of % on routine income arising from foreign markets provides a new benefit for owning intangible property and conducting business operations in the United States. The FDII deduction is available to domestic corporations that are taxed as C corporations, including U.S. corporate subsidiaries of foreign-based multinationals. Foreign corporations with income effectively connected with a U.S. trade or business, S corporations, regulated investment companies, real estate investment trusts, partnerships, and individuals are not eligible to claim a FDII deduction. 15

16 PFIC H.R. 1 amends the passive foreign investment company (PFIC) exception for insurance companies to apply only if the foreign insurance company has insurance liabilities that constitute more than 25% of its total assets. For this purpose, insurance liabilities includes loss and loss adjustment expenses and life and P&C reserves, but would exclude unearned premium, deficiency, and contingency reserves as reported on the insurer s applicable financial statement. If the foreign insurer s reserve percentage falls below 25% solely due to run-off or rating-related circumstances, an alternate test would be available for a company whose insurance liabilities constitute at least 10% of its assets. 16

17 Key H.R. 1 Life Insurance Company Tax Reform Provisions 17

18 Reserves Modifies current law rules for determining the deduction for life insurance company reserves to reflect developments in how reserves are determined for state insurance regulatory purposes, particularly the increasing use of principle-based reserve (PBR) methods. Establishes, among other changes, the amount of life insurance reserves for any contract as the greater of either the net surrender value of the contract or 92.81% of the reserve determined under the tax reserve method applicable to the contract. 18

19 Reserves Establishes life insurance reserves for variable contracts as the sum of: (a) the greater of (i) the net surrender value of the contract, or (ii) the portion of the reserve that is separately accounted for under I.R.C. 817, plus (b) 92.81% of the excess (if any) of the reserve determined under the tax reserve method applicable to the contract over the amount in (a). 19

20 Reserves Tax reserve method generally is the method prescribed by the National Association of Insurance Commissioners (NAIC) and applicable to the contract at the valuation date. A transition rule requires that the difference in the amount of in-force reserves computed under the new method versus the old method as of year-end 2017 must be taken into account ratably over eight years, beginning with the 2018 tax year. 20

21 Proration DRD and Tax-Exempt Interest Modifies the life insurance company proration rules for purposes of determining a company s dividends received deduction (DRD) and tax-exempt interest by setting the company s share at 70% and the policyholders share at 30%. Note: Base for computing a life insurers general account and separate account DRD also was impacted by a conforming change in H.R. 1 to the general corporate DRD (reducing the 80% DRD to 65% and the 70% DRD to 50%) that was designed to adjust for the benefit to corporations of the lower corporate tax rate. Effect: Instead of starting with a 70% general corporate DRD to which the company share applies to determine a life insurer s general account or separate account DRD, the starting point for the proration calculation is a 50% general corporate DRD. 21

22 Deferred Acquisition Costs (DAC) Changes the deferred acquisition cost (DAC) tax capitalization period from 10 years to 15 years, and increases the amount of specified policy acquisition expenses (measured as a percentage of net premiums) deferred for each of the law s three categories of contracts to the following percentages: 2.09% for annuity contracts (instead of current law 1.75%); 2.45% for group life insurance contracts (instead of current law 2.05%); and 9.20% for all other specified insurance contracts (instead of current law 7.7%). Retains the five-year amortization for the first $5 million of specified policy acquisition expenses (which begins phasing out when those expenses exceed $10 million). 22

23 Change in Reserve Basis and Small Company Deduction Change in reserve basis: Repeals the 10-year period for taking into account adjustments resulting from a change in the basis for computing reserves, and subjects reserve basis changes to the general tax code rules on spread periods that cover tax accounting method changes. Accounting method changes are generally reported over four years for pro-government changes (i.e., items that produce additional taxable income) and one year for pro-taxpayer changes (i.e., items that produce additional deductions). It is unclear from the language of the statute whether the spread period for reserve basis changes is subject to the above rules or whether both positive and negative spreads would be subject to a four year spread. Small company deduction: Repeals the special deduction for small life insurance companies. 23

24 NOLs Repeals life insurance company special operations loss carry back (three years under old law) and carry forward (15 years under old law) rules. Instead subjects life insurance companies to the new net operating loss (NOL) rules applicable to corporations generally. NOLs cannot be carried back, but can be carried forward indefinitely; and NOL deductions are allowed only to the extent of 80% of taxable income (determined without regard to the NOL deduction). 24

25 NOLs Property and casualty insurance companies are carved out of the new NOL rules applicable to corporations generally. Instead, current-law rules continue to apply to P&C insurers. NOLs can be carried back two years and carried forward 20 years, and NOL deductions are not limited to a percentage of taxable income. 25

26 Life Settlement Reporting Imposes reporting requirements on both the buyer and the insurer that issued the life insurance or annuity contract in the case of the purchase or acquisition of an interest in an existing life insurance contract, directly or indirectly, if the acquirer has no substantial family, business or financial relationship with the insured. The buyer is required to notify the insurer a sale has occurred and the insurer is then required to report to the IRS and the seller the basis of the contract, the name, address, and identification number of the seller, and the policy number of the contract Upon payment of a death benefit, the insurer is required to report to the IRS and the payee the amount of the payment, the identification number of the payee, and the insurer s estimate of the buyer s basis in the contract. o The new law reverses the previous IRS position that the cost of insurance reduces the basis of the contract upon sale of a life policy. 26

27 Tax Reform Capital Matters 27

28 NAIC Tax reform significantly impacts life insurers risk-based capital (RBC) requirements and several other measures due to the rate drop from 35% to 21%. RBC could decline at life insurers by up to 20%, though there could be some offsets depending upon how changes are implemented by the NAIC. Tax reform also impacts the value of deferred tax assets (DTAs) and liabilities (DTLs). Attributable to the rate drop as well as the elimination of NOL carrybacks. 28

29 NAIC Changes to RBC will impact the PBR small company exemption. ACLI is working with the NAIC to make the required changes to all the items impacted for regulatory reporting purposes and to implement the changes on a suggested timeline that is reasonable and transparent from an industry perspective. 29

30 Tax Reform Accounting and Financial Reporting Matters 30

31 SEC, FASB, and NAIC SAB 118 (issued December 22, 2017, the same day President Trump signed H.R 1) addresses reporting effects of the new tax law for public companies. Provides important relief to companies filing December 31, 2017 financial statements by allowing them to take a reasonable period to determine and recognize the effects of the new tax bill and addresses the challenges entities may face in accounting for and reporting on the effects of the new tax bill because of incomplete information and accounting. 31

32 SEC, FASB, and NAIC On January 10, 2018, FASB held a public board meeting and indicated they would adopt the SEC reporting approach for U.S. GAAP reporting purposes. FASB also gave more specific guidance on financial reporting issues related to tax reform, including how to properly restate deferred taxes on unrealized gains and losses on securities recorded through accumulated other comprehensive income, as requested by ACLI on December 21, ACLI met with the FASB on January 9, 2018 in advance of the public board meeting to discuss items of particular interest to the industry. FASB subsequently issued guidance on the financial accounting treatment of repatriation tax liabilities, AMT tax credit refund receivables, the BEAT and GILTI. 32

33 SEC, FASB, and NAIC On January 11, 2018, the NAIC exposed revisions to statutory accounting principles to reflect the effects of tax reform and on January 30, the NAIC Statutory Accounting Principles Working Group released an interpretation which would allow for relief similar to SAB 118 for 2017 statutory annual statement filings. ACLI had requested immediate relief similar to SAB 118 issued by the SEC for purposes of statutory annual statement accounting and has provided comments to the NAIC on the proposed accounting revisions. 33

34 Questions? 34