Impact of the Tax Cuts and Jobs Act on the Insurance Industry
While the Tax Cuts and Jobs Act (TCJA) enacts substantial changes to the overall corporate tax structure, there are also a host of provisions specific to insurance companies. In addition to the impact on income taxes, many of these provisions will affect insurance companies’ financial reporting and management decisions in the future.
General corporate provisions
The most significant change impacting all C corporations is the change in the tax rate. Previously, C corporations were taxed on a graduated basis, with rates ranging from 15 percent to 35 percent. The new tax law eliminated the graduated rates, imposing a flat 21 percent income tax rate.
The TCJA also eliminated the corporate alternative minimum tax (AMT). For the 2018-2020 tax years, 50 percent of the unused AMT credit carryforwards are refundable to the extent that they exceed the regular tax liabilities, with the excess being fully refundable in 2021, resulting in taxpayers fully recovering previous alternative minimum taxes.
Another provision that will impact corporations is the repeal of the net operating loss (NOL) carryback, along with changes to NOL carryforward rules. Starting with 2018, most companies can no longer carry back losses and apply them to prior years’ returns. Non-property and casualty insurance companies are still able to carry forward losses, but the amount is limited to 80 percent of their taxable income.
The TCJA also revised the dividends received deductions for corporations. The deduction is reduced from 70 percent to 50 percent and the 80 percent deduction is now 65 percent. The deduction for dividends received from affiliated corporations is unchanged.
Insurance industry specifics
The TCJA contains several sections devoted to insurance company issues. One of the most significant parts includes the retention of the previous NOL rules for property and casualty insurers. If property and casualty insurers are on a different loss carryback and carryforward schedule than life insurers, for example, issues could arise, particularly for a holding company with both life and property and casualty subsidiaries.
The Tax Reform Act of 1986 required that property and casualty insurers discount their loss reserves to account for the time value of money. The TCJA retains the loss reserve discounting requirements but imposes a steeper discount of the reserves and eliminates the ability to utilize a company’s own payout pattern. As a result, future deductions for losses incurred will be decreased, resulting in higher taxable income.
The TCJA also changed the rules for proration. Under prior law, property and casualty insurers were required to reduce the losses incurred deduction by 15 percent of both tax-exempt interest and the dividends received deduction (the thought being that insurers would otherwise be using non-taxed income to fund loss reserves for which they were already getting a deduction, albeit reduced for the time value of money). Under the TCJA, the proration percentage has been modified to a variable formula equal to 5.25 percent divided by the top corporate income tax rate. For years beginning on or after Jan. 1, 2018, the corporate tax rate is 21 percent, which results in a proration percentage of 25 percent. As with the loss reserve discounting change, this will result in greater taxable income for property and casualty entities. Proration rules for the exclusion of tax advantaged investment income for life insurers now are set at 70 percent for the company’s share and 30 percent for the policyholder. Additionally, the TCJA eliminated the small life insurance company deduction. The law did not eliminate a similar deduction for property and casualty companies.
The TCJA also has a major impact on insurance entities with international operations. First, the definition of a US shareholder now includes US persons owning at least 10 percent of either the voting power or value of the entity (previously focused solely on the voting power). As a result, more offshore insurance entities will be subject to the controlled foreign corporation rules.
Another significant change to international businesses in the insurance industry is a restriction on the insurance business exception to the passive foreign investment company (PFIC) rules. Under the TCJA, there is now a requirement that the company’s insurance liabilities exceed 25 percent of the company’s total assets. These liabilities do not include premium, contingency or unearned premium reserves. There are exceptions for those companies in runoff or other similar circumstances. As a result, some insurance companies could become subject to the PFIC rules, and thus might no longer be subject to the favorable tax deferral they previously received.
Other changes include adjustments to certain terms regarding ownership rules in controlled foreign corporations (CFCs) and the definition of US shareholders in CFCs. There is also a new minimum tax on base erosion payments such as interest, rents, royalties, and services and a new tax on US shareholders’ aggregate net income from a CFC that is treated as global intangible low-taxed income (GILTI).
The TCJA provides many tax benefits. Apart from the revised rate structure and elimination of the AMT, the other changes impacting the insurance industry are helping fund many of these benefits. It is important to note that many of these changes are not permanent, and other tax revisions are possible on the horizon.
For more information on how the new tax legislation might impact your business, or for more details about our services for the insurance industry, contact Alan Fine, Tax Partner and Insurance Industry Group Leader, at firstname.lastname@example.org or 314.983.1292.