One Last Bite of the Apple – Insurance Tax Considerations
Now that insurers have filed their annual statements, it’s a good time to look ahead to compliance season and the filing of federal income tax returns. There are strategies to consider that can enhance current tax benefits. By taking a little time to evaluate these opportunities before filing 2020 federal returns, companies can feel more confident they didn’t leave any tax benefits on the table. Looking to 2021 and beyond, insurers also can better position themselves for anticipated changes on the horizon. Let’s consider two fact patterns faced by insurers and explore how they can better position themselves for the largest tax benefits.
Insurers with Current Tax Losses
The Tax Cuts and Jobs Act made some significant changes to general corporation and insurance company taxation. First, the graduated tax rate regime that resulted in a 35 percent overall federal tax rate was replaced with a flat corporate tax rate of 21 percent. In addition, net operating loss (NOL) carrybacks generated in 2018 and subsequent years could only be carried forward, except for property/casualty insurers who were still allowed to carry back NOLs two years as under prior law.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) has provided relief during the pandemic and allows all corporations to carry back NOLs generated in the 2018 to 2020 period up to five years. The ability to carry back NOLs to potentially higher tax rate years (2017 and prior) is a significant opportunity and is essentially the last bite of the apple. Absent further legislative relief, NOLs generated in 2021 and subsequent years can’t be carried back by life insurers and C corporations and can only be carried back two years for property/casualty insurers.
Companies projected to be in a NOL position or close to breakeven should consider the following strategies to take advantage of these carryback provisions, assuming they paid taxes in those higher tax rate years. Some strategies worth exploring include:
- Contributing as much as is actuarially allowable to a company’s defined benefit plan by the filing of the tax return. A company’s pension actuary should be able to calculate the maximum tax-deductible amount for 2020 and prior years. By funding up to that amount by the tax return filing, any NOL will be increased, as will the potential tax refund.
- Enhancing bonus depreciation pursuant to Internal Revenue Code Section 168(k).
- Consider a cost segregation study for any recent construction projects to catch up on cumulative depreciation deductions.
- Ensuring compensation-related liabilities, fixed and determinable as of December 31, 2020, and paid by March 15, 2021, are deducted in the 2020 federal return.
- Deducting prepaid expenses in existence as of December 31, 2020, that meet certain requirements. If the company’s tax accounting method is to deduct such expenses as exhausted, consider the adoption of a new tax accounting method (an “automatic change”) by attaching a Form 3115, Application for Change in Accounting Method, to the company’s timely filed federal income tax return.
- Exploring other tax accounting method changes to defer taxable income or accelerate tax deductions, e.g., deducting internally developed software costs.
Insurers with Taxable Income
These are interesting times, and there are opportunities for companies with taxable income to decrease their federal tax burden. But the picture is a bit cloudier for these companies and requires a bit of guesswork as to what the future holds. All signs point to an increase in corporate tax rates in the near future. Although many believe such a change will not be effective until 2022, companies can act now to accelerate income and defer tax deductions.
- Defer contributions to a defined benefit plan until tax rates increase.
- Elect out of bonus depreciation until rates increase (and supplement bonus depreciation with §179 expensing).
- Defer a cost segregation study for construction projects until a higher tax rate year.
- Delay certain compensation payments (bonuses, vacation pay) until after March 15 so such amounts can be deducted in the year of payment (assuming the year of payment is a higher tax rate year).
- Delay requests for certain tax accounting method changes.
Most companies don’t fit neatly into hypothetical fact patterns. The aforementioned strategies aren’t exhaustive and serve more as talking points for tax planning meetings. Given the time-sensitive nature of these ideas, we suggest those meetings happen sooner rather than later.
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