Subchapter L: Can You Believe It?

Author’s Note:
As an original member of the editorial board of, and frequent contributor to, TAXING TIMES, I have been pleased with how it has developed. Newsletters work best when they have a mix of articles and regular columns. As of now, TAXING TIMES has regular columns from the editor, the chair of the SOA Taxation Section Council, and the American Council of Life Insurers (ACLI). With this edition of TAXING TIMES, I am starting what I hope will be a short regular column that is mostly for fun—pointing out quirks in life insurance taxation. I hope readers will enjoy it and that it will encourage others to think about volunteering to start a regular column for future editions of TAXING TIMES.

Former I.R.C. § 818(c) permitted life insurance companies to elect for tax purposes to convert their life insurance reserves computed on a preliminary term basis to a net level premium basis using either an exact method or an approximate method. The preliminary term reserve revaluation provision was repealed by the Tax Reform Act of 1984. Nevertheless, I.R.C. § 818(c) is still in effect. Can you believe it?

Prior to the 1984 Act, stock life insurance companies were required to maintain a policyholders’ surplus account that was built up by adding certain tax advantages, which included an untaxed portion of gain from operations, and certain special deductions for nonparticipating, accident and health, and group life contracts. Technically, these stock company tax benefits were not permanent, but instead under I.R.C. § 815 were subject to tax (the so-called “Phase III tax”) when a release of some or all of the policyholders’ surplus account occurred. One triggering event under I.R.C. § 815(d)(4) resulted when the policyholders’ surplus account exceeded the greater of three limitations, one of which was 15 percent of life insurance reserves at the end of the taxable year. The level of the policyholders’ surplus account and the amount of life insurance reserves at year-end used to be closely monitored by stock companies to ensure that the Phase III tax under I.R.C. § 815 would not be triggered.