The House Ways and Means Committee released initial draft legislative language for the long awaited “Tax Cuts and Jobs Act of 2017” (HR 1), or “the bill” – a 400+ page tax cut/reform proposal on November 2, 2017. The draft bill proposes to lower business and individual tax rates, create a territorial international tax system and create a more simplified tax system.
The Ways and Means Committee is scheduled to begin consideration of the draft bill within several days of its release. Chairman of the Ways and Means Committee, Kevin Brady (R-TX) has stated that he may propose modifications to the bill in advance of the committee ‘markup’ sessions where additional amendments offered by other committee members could be incorporated into the bill before it moves along to the House floor for consideration.
The proposed legislation is generally effective for tax years beginning after December 31, 2017, notwithstanding some calls for retroactive application to January 1, 2017. Particular provisions of the bill have separate effective dates, with some effective after the November 2, 2017 release date. The bill also proposes some temporary measures and provides transition rules for certain proposals.
This tax alert will summarize some of the key corporate tax provisions contained in the bill, but will more specifically focus on provisions of particular note for insurance companies. This is a high level summary of a proposal that will certainly change a great deal as it makes its way through the legislative process.
Corporate Tax Rate Reduction
The current 35 percent top corporate rate would be reduced to 20 percent for tax years beginning after 2017. Of note here is the rate reduction does not call for a phase-in period – this will simplify the application of the new tax rate to existing deferred tax assets and liabilities for insurance companies and may eliminate the need to “schedule” reversals in future periods in order to apply the appropriate tax rate.
Net Operating Loss (NOL) Provisions
The bill would limit the use of NOLs to 90 percent of taxable income meaning that even a taxpayer with significant loss carryforwards will likely pay some level of current tax.
Changes to existing law would eliminate the current carryback rules; create an unlimited carryforward period; and provide for an increase in carryforwards by an interest factor. The elimination of the ability to carryback an NOL could have a significant impact on the recognition of deferred tax assets (DTA), both on a GAAP and Statutory basis. In particular, the 11.a. test in SSAP101 would effectively yield no benefit resulting in the possible decline of admitted DTA’s.
The bill would create a 100 percent dividends received deduction (DRD) for certain qualified foreign-source dividends received by U.S. corporations from foreign subsidiaries, effective for distributions after 2017, creating a “territorial” tax system that would allow certain U.S. owned businesses to operate more competitively overseas. If enacted, this could have a positive impact on the effective tax rates of U.S. corporations, including the application of the indefinite reversal criteria or permanent reinvestment considerations contained in APB#23.
The bill would impose a one-time “deemed repatriation” tax, after allowable foreign tax credits, on all previously untaxed earnings and profits (E&P) of foreign subsidiaries of U.S. corporations. Under this provision, a 12 percent rate would apply to E&P relating to cash or cash-equivalent assets and a 5 percent rate would apply to the remaining amount of E&P subject to the tax. Taxpayers may elect to pay this tax liability in equal annual installments over 8 years.
Certain Insurance Specific Provisions:
Life Insurance Reserves
Under the bill, companies may generally deduct only 76.5 percent of reserves for future claims as reported on the insurer’s annual statement. This represents a dramatic potential increase in the taxable income of life insurers since under current law, the percentage of the statutory reserve allowed as a tax deduction is usually greater than 90 percent.
Deferred Acquisition Cost – Section 848
Under the bill, the capitalization rates for certain types of business would be contained in 2 categories instead of 3 and increase substantially. Annuity contracts will attract a capitalization rate of 11 percent (as compared to 1.75 percent under existing law); group contracts will attract a capitalization rate of 4 percent (as compared to 2.05 percent under existing law); and all other specified contracts will attract a capitalization rate of 11 percent (as compared to 7.70 percent under existing law). If enacted, this proposal could dramatically increase the potential for taxable income as a company expands the volume of premium it writes.
Life Company Proration
Under the bill, life proration, determined as a function of the relationship between the “company share” and the “policyholder share,” would become prescribed at set percentage. The company share would become 40 percent while the policyholder share would become 60 percent. This approach could impact the portion of tax exempt income and/or dividends received deduction that is added back into taxable income.
Under the bill, the ability of a nonlife insurer to elect its own payment patterns in the discounting of loss reserves is repealed – industry payment patterns will become mandatory. Additionally, payment patterns used to determine discount factors will be lengthened for both short tail and long tail lines. Finally, the interest rate used to calculate discount factors will be a corporate bond yield specified by Treasury replacing the current AFR rates. In summary, the expectation is that discount factors will get deeper meaning an increase in current taxable income. Any transition adjustment required will be spread ratably over the initial year and the succeeding 7 years.
Nonlife Company Proration
The bill calls for an increase in the fixed proration percentage from 20 to 26.25 percent - this will maintain the effective tax rate of 5.25 percent on tax advantaged investment income when coupled with the new 20 percent corporate tax rate.
Other Insurance Provisions
There are a number of other insurance related measures that range in impact from potentially significant to fairly minor. The most significant item is a provision that may affect affiliated reinsurance with a foreign company – a new 20 percent excise tax is proposed on certain payments to related foreign corporations. It remains to be seen how this provision will apply to domestic insurers with foreign affiliates or Parents.
Finally, the bill calls for the repeal of the small company life deduction and elimination; the repeal of Section 847; and the repeal of the policyholder surplus account rules.
In summary, the bill is simply the opening gambit in what may prove to be an intense political debate as both individuals and industries determine its impact. As the picture becomes clearer with respect to particular provisions, it will require companies to model the expected impacts as the process unfolds in Congress.