IRS to Rule on the Meaning of Statutory Reserves

The Department of Treasury 2007-2008 Priority Guidance Plan dated Aug. 13, 2007 includes the following new topic under the heading “Insurance Companies and Products:”

“Revenue ruling concerning the meaning of the term ‘statutory reserves’ under section 807 when the company is subject to different statutory reserve requirements in different states.”

The IRS does not usually place issues with clear answers on the priority guidance plan. Therefore, we are surprised the IRS believes taxpayers need priority guidance on this topic because those in the insurance industry who have studied it generally think current law is clear and not subject to debate.

The term “statutory reserves” in I.R.C. § 807 has a well-recognized meaning under current law. “Statutory reserves” are defined in I.R.C. § 807(d)(6) as “the aggregate amount set forth in the annual statement with respect to items described in section 807(c).” The “annual statement” is defined in Treas. Reg. § 1.6012-2T(c)(5) as “the form ... which is approved by the National Association of Insurance Commissioners (NAIC), which is filed by an insurance company for the year with the insurance departments of States, Territories, and the District of Columbia.” For purposes of determining discounted unpaid loss reserves (see I.R.C. § 807(c)), the annual statement is defined in I.R.C. § 846(f)(3) to mean “the annual statement approved by the National Association of Insurance Commissioners which the taxpayer is required to file with insurance regulatory authorities of a State.”

When the aggregate amount of statutory reserves reported on the annual statement differs by state, Treas. Reg. § 1.801-5(a) permits the taxpayer to select the applicable annual statement to use for purposes of filing its tax return. The regulation permits the taxpayer to select the annual statement that reflects the highest aggregate reserve in any state or jurisdiction in which it transacts business. This rule has been in the regulations since the Revenue Act of 1921. See former Treas. Reg. §§ 39.201-4(d) and 1.803-1(d); Pan-American Life Ins. Co. v. Commissioner, 38 B.T.A. 1430 (1938). Treas. Reg. § 1.6012-2T(c)(1) further requires an insurance company to file with its Federal income tax return, a “copy of its annual statement which shows the reserves used by the company in computing the taxable income reported on its return.” This regulation suggests, consistent with Treas. Reg. § 1.801-5(a), that the applicable annual statement used for reserves is selected by the company and filed or associated with the tax return. Although the regulations permit the taxpayer to choose the annual statement for tax purposes, the taxpayer cannot pick and choose among annual statements for different purposes. Rather, the taxpayer must use the same annual statement for all reserve purposes in computing taxable income.