Is IRS Consent Needed to Conform Tax Accounting to a Change in Statutory Accounting?

Life insurance companies are accrual basis taxpayers subject to the same general tax accounting rules applicable to other corporate taxpayers. There are a few exceptions to this general rule. One exception is that accrual accounting does not apply to items that are unique to insurance company accounting, most notably insurance reserves. Another exception is that life insurance companies are not subject to generally applicable accrual rules for original issue discount (OID) or amortization of bond premium. For these items, in general, life insurance companies are entitled to use statutory accounting.

When a life insurance company changes its basis for computing tax reserves, a special 10-year spread rule found in section 807(f) of the Internal Revenue Code applies to the change. But, what happens if the statutory accounting for OID or bond premium changes? Is the company required, or even permitted, to change its tax accounting method to conform with the new statutory accounting method? The answer to this question is determined by identifying the tax accounting method being used by the company and whether there has been a change to that method.

Guidance on whether a change in tax treatment of an item rises to the status of a change in method of accounting can be found in regulations under section 446. The regulations broadly define the term “method of accounting” to include not only the overall method of accounting but also the accounting treatment of any item. This general rule is not very helpful. Fortunately, the regulations provide additional guidance and state that a change in method of accounting includes a change in the overall plan of accounting for gross income or deduction or a change in the treatment of any material item used in such overall plan. A “material item” is any item that involves the proper time for the inclusion of the item in income or the taking of a deduction. Importantly, a change in method of accounting does not include an adjustment in the treatment of an item resulting from a change in underlying facts.