Potential Tax Reform’s Effect on Insurance Companies
Author: Thomas Wheeland
Tax reform is coming! Well, maybe. OK, we really don’t know if tax reform is coming, or when, or exactly what form it will take. Insurance companies, however, need to be prepared just in case Congress moves beyond the current issues and gets a tax reform bill passed and signed into law.
What will tax reform look like? We have a good idea based on the proposed changes in the Trump and House Blueprint tax reform packages as well as provisions from the Camp proposal a few years back. Potential changes such as a corporate income tax rate reduction and repeal of the alternative minimum tax (AMT) certainly sound appealing. But the income tax accounting implications also are important and bear consideration. So let’s take a look at a couple of the proposals that could have an adverse effect on generally accepted accounting principles (GAAP) and statutory accounting principles (SAP) deferred tax assets (DTA).
Reduction in Federal Corporate Income Tax Rates
Both tax reform packages include significant reductions in the federal corporate tax rate from its current level of
35 percent, the highest in the industrialized world. The Congressional Blueprint calls for a reduction to 20 percent, whereas the Trump package goes even lower to 15 percent.
That rate reduction sounds pretty appealing, but it does come at a cost. For many insurance companies, DTAs for GAAP and SAP purposes are measured at 35 percent.1 Thus, an insurer with a recognized DTA for GAAP or an admitted DTA for SAP of $3.5 million would potentially have to reduce that DTA to $2 million or $1.5 million, with a corresponding reduction in equity or surplus. This reduction in the DTA will affect GAAP net income and the GAAP and SAP effective tax rates.
Net Operating Losses
Net operating losses (NOL) and operations loss deductions (OLD) for life insurers can be carried forward 20 years and 15 years, respectively. Companies with losses generally will have different NOLs and OLDs for regular tax and AMT purposes. The regular NOLs and OLDs can offset up to 100 percent of regular taxable income, but their AMT counterparts can only offset up to 90 percent of AMT income in a given year.
With the proposed repeal of AMT, the House Blueprint and Camp proposals would apply the same 90 percent limitation on the regular tax side. Note that this provision isn’t part of the Trump proposal.
Furthermore, the House Blueprint proposes to abolish NOL and OLD carrybacks altogether.2 From a GAAP perspective, taxes paid in the carryback period are a source of income in evaluating the need for a valuation allowance. The repeal of carrybacks would eliminate recoverable taxes as a source of income, potentially reducing GAAP DTAs. From a SAP perspective, the effect could be greater, as SSAP 101, paragraph 11.a.’s hypothetical carryback provision would be moot. DTA admissibility would then be limited to the paragraph 11.b. and 11.c. tests with admissibility dependent upon future income and DTL offset.
As mentioned above, tax reform may not even happen. Even assuming that tax reform is enacted, the form it will take is uncertain. Companies that understand the proposed changes and potential effects to current and deferred taxes should be able to limit any surprises and better prepare for the future.
Keep up to date with tax reform developments by visiting BKD’s Tax Reform Resource Center or contact a BKD advisor.
1 Most insurers do not establish GAAP state DTAs or liabilities because they write business in states that do not impose an income tax or because state income taxes are considered immaterial. For SAP purposes, SSAP 101 does not provide for the establishment of state deferred income taxes.
2 Under current law, NOLs for C corporations, including nonlife insurers, can be carried back two years and forward 20 years pursuant to Internal Revenue Code (IRC) Section 172. Life company OLDs can be carried back three years and forward 15 years as prescribed in IRC §810. Tax reform proposals have been focused on §172 NOLs, but life insurers should be prepared for similar legislation regarding OLDs under §810.