Accountant/Tax Attorney Dialogue on Internal Revenue Code Deference to NAIC: Part IV: Insurance Tax Accounting Issues

Note from the Editors: Welcome to the fourth and final part of a significant journey. At the outset, it was anticipated to be our most ambitious dialogue yet. Our goal was to explore the important and evolving topic of the extent to which the tax law defers to the NAIC in taxing life insurance companies.

Originally anticipated to be a three-part series, it was expanded to four parts due to the breadth of the topics to be covered under “Part III: Insurance Classification Tax Issues” and “Part IV: Insurance Tax Accounting Issues.” “Part I: Tax Reserves” appeared in our June 2015 issue and “Part II: Policyholder Tax Issues” appeared in our October 2015 Issue and “Part III: Insurance Classification Tax Issues” appeared in our March 2016 issue.

We would like to thank our panel of highly experienced tax professionals. Peter Winslow of Scribner, Hall & Thompson developed the concept for this dialogue and volunteered to serve as moderator. Joining Peter was the core group of panelists who participated in each Part of the series: Mark Smith of PricewaterhouseCoopers, LLP and Sheryl Flum of KPMG LLP (both of whom have previously headed the IRS Chief Counsel’s Insurance Branch), along with Susan Hotine of Scribner, Hall & Thompson, LLP and John T. Adney of Davis & Harman LLP. Susan, John and Peter were all active in the legislative process “In the Beginning”—during the enactment of the Tax Reform Act of 1984. We are also grateful to the other panelists who contributed their expertise: Tim Branch with respect to “Part I: Tax Reserves,” and Brian King with respect to “Part II: Policyholder Tax Issues.”

In this Part IV, the panelists will address legal and accounting questions relating to insurance tax accounting issues, examining issues related to premium income, policyholder dividends, the accounting differences between life and nonlife companies, investment income, and the use of hedges, particularly hedges to offset the cost of variable annuity minimum guaranteed benefits.

We hope you enjoy the conversation!

Peter Winslow: This is the fourth, and final, installment of our extended dialogue on the issue of federal tax law’s deference to insurance regulatory rules. We have covered in some depth the deference issues as they relate to tax reserves, policyholder tax issues, and insurance classification tax issues. Now we will consider this question: to what extent does NAIC annual statement accounting govern for tax purposes for items other than insurance reserves? In this last dialogue we plan to talk about accounting for income items (premiums, investment income and hedging), as well as other expenses not included in insurance reserves. As in the prior dialogues, I will start with John Adney and Susan Hotine to give us an historical perspective on these issues. John, could you begin this discussion by describing how the 1959 Act and its interpretation dealt with the tax accounting for premiums?

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John Adney: Peter, “deference” is a good term to use in describing the 1959 Act’s attitude on tax accounting issues for life insurers, and it also fairly characterizes the Code’s approach in dealing with nonlife (part II) companies’ tax accounting both before and after the 1984 enactment. As a general matter, under the 1959 Act premiums reported on a life insurer’s annual statement were included in its gross income, overturning the disregard of such amounts under the “net investment income” approach that had been used to tax life insurers since 1921. The great issue in this respect that was resolved in the waning years of the 1959 Act was the extent to which deferred and uncollected premiums for life insurance were to be taken into account in life insurance reserves, assets, and gross premium income under the tax rules then in place. A diversity of views among five courts of appeals on how this question should be resolved led the Supreme Court to hear the case of Commissioner v. Standard Life & Accident Insurance Company.

The principal statutory provision at issue in the Standard Life case was section 818(a) as it existed under the 1959 Act; its successor under current law is section 811(a), which is similar, but not identical, to its predecessor. Section 818(a) first required all computations under part I of Subchapter L to be made using an accrual method accounting or, as permitted under regulations, an accrual method combined with another method permitted for income tax purposes (but not the cash receipts and disbursements method). Then, significantly, it added: “Except as provided in the preceding sentence, all such computations shall be made in a manner consistent with the manner required for purposes of the annual statement approved by the National Association of Insurance Commissioners.” The relationship of these two sentences was at the heart of Standard Life controversy.