The IRS has published simplified procedures (Revenue Procedure 2019-30) through which an insurance company may obtain automatic IRS consent to change its methods of accounting for discounting (1) unpaid losses and expenses, (2) estimated salvage recoverable and (3) unearned premiums attributable to title insurance, in order to comply with IRC Section 846, as amended by the Tax Cuts and Jobs Act (TCJA). The simplified procedures apply to tax years beginning on or after December 31, 2017 and ending by December 31, 2019.

Discounting rules

Generally, under IRC Section 832, a non-life insurance company must compute its taxable income for federal income tax purposes by reducing underwriting income by unpaid losses and unpaid loss adjustment expenses and then reducing those reserves by its estimated salvage recoverable for the tax year. Unpaid losses and unpaid loss adjustment expenses are discounted under IRC Section 846, while the salvage recoverable is discounted in accordance with regulations under IRC Section 832. The unpaid losses and unpaid loss adjustment expenses, as well as estimated salvage recoverable, are generally discounted using discount factors published by Treasury. If elected by the taxpayer, unpaid losses and unpaid loss adjustment expenses could be discounted using company-specific discount factors. Underwriting income is also reduced by discounted unearned premiums attributable to title insurance.

Generally, a life insurance company computes its taxable income for federal tax purposes by deducting all losses incurred during the tax year on insurance and annuity contracts (IRC Section 805(a)(1)) and taking into account the change over the tax year in any unpaid losses described in IRC Section 807(c)(2). A life insurance company's unpaid losses are subject to discounting under IRC Section 846 only to the extent that the contracts to which the unpaid losses relate are not discounted under the life insurance provisions. Under IRC Section 846, discounting of unpaid losses must be determined separately for each line of business each accident year.

TCJA changes

The TCJA amended IRC Section 846, effective for tax years beginning after December 31, 2017. Specifically, the TCJA: (1) amended the IRC Section 846(c) definition of annual rate and the IRC Section 846(d) computational rules for loss payment patterns; (2) repealed the IRC Section 846(e) election to use the insurance company's own historical loss payment pattern instead of the pattern published by Treasury; and (3) provided a transition rule for applying amendments made to code provisions defining unpaid losses and expenses unpaid.

To ease the transition from prior law to amended IRC Section 846, Section 13523(e) of the TCJA includes a transitional rule that requires taxpayers to determine the difference between reserves computed under the pre-TCJA rules and the new rules. The difference is calculated (1) as if the TCJA amendments had applied to that earlier year (generally calendar year 2017), and (2) by using the annual rate and loss payment patterns applicable to accident years ending during calendar year 2018. If an adjustment results from this determination, the insurance company includes it in gross income ratably over eight years, beginning with the first TCJA year (generally calendar year 2018).

Recent guidance

Proposed regulations (REG-103163-18; see Tax Alert 2018-2286), published in November 2018, would base the annual rate determined under amended IRC Section 846(c) on a range of maturities (0.5 year to 17.5 years) from the corporate bond yield curve.

Revenue Procedure 2019-06, published in January 2019, prescribes proposed unpaid loss discount factors (Proposed Discount Factors) for the 2018 accident year and preceding years when computing discounted unpaid losses under IRC Section 846, as amended by the TCJA, based upon the proposed regulations.

Under final regulations (T.D. 9863), published June 17, 2019 and applicable to tax years beginning after December 31, 2017, the annual rate determined under IRC Section 846(c) is based on a range of maturities (4.5 years to 10 years) from the corporate bond yield curve.

Revenue Procedure 2019-31, published concurrently with Revenue Procedure 2019-30, provides final unpaid loss discount factors for the 2018 accident year and prior years (Revised Discount Factors), as determined under IRC Section 846 and the final regulations. These Revised Discount Factors must be used for all lines of business for the 2018 accident year and prior accident years to discount unpaid losses and estimated salvage recoverable for tax years ending on or after June 17, 2019. For any tax year that began on or after January 1, 2018 and ended before June 17, 2019, "an insurance company must consistently use either the Revised Discount Factors or the Proposed Discount Factors for all lines of business for all accident years" to discount unpaid losses and estimated salvage recoverable, Revenue Procedure 2019-30 states. As discussed later, there are transitional rules for taxpayers using the Proposed Discount Factors to file their 2018 income tax returns.

Accounting method changes

The IRS published Revenue Procedure 2019-30 to provide simplified procedures for a taxpayer to change its methods of accounting for discounting unpaid losses, estimated salvage recoverable or unearned premiums attributable to title insurance to comply with the TCJA's amendments to IRC Section 846. Revenue Procedure 2019-30 characterizes the changes that the TCJA made to IRC Section 846 as changes to the "proper time for the inclusion of the item in income or the taking of the item as a deduction" and therefore the change constitutes "a change in method of accounting subject to [IRC Section] 446(e) and [Treas. Reg. Section] 1.446-1." Under IRC Section 446(e) and Treas. Reg. Section 1.446-1, a taxpayer must obtain the Commissioner's consent to change a method of accounting for federal income tax purposes. The general procedures for requesting the Commissioner's consent for a change in method of accounting are provided in Revenue Procedure 2015-13. A taxpayer generally obtains the consent of the Commissioner by filing a Form 3115, Application for Change in Accounting Method. However, the Commissioner may prescribe other terms and conditions for effecting a change in method of accounting.

As stated in Revenue Procedure 2019-30, the timing of the release of the proposed and final regulations implementing the TCJA amendments to IRC Section 846 "poses unique challenges for taxpayers subject to the discounting rules of [IRC Section] 846," as such taxpayers make accounting method changes to comply with the TCJA's amendments to IRC Section 846. Fortunately, for most taxpayers affected by the changes to IRC Section 846, Revenue Procedure 2019-30 relieves certain taxpayers of the requirement to file a Form 3115 for making changes to comply with amended IRC Section 846 for tax years beginning after December 31, 2017 and ending on or before December 31, 2019, and provides simplified procedures for securing the consent of the Commissioner for these changes.

Scope of Revenue Procedure 2019-30

Revenue Procedure 2019-30 applies to:

• Property and casualty insurance companies that change their accounting method for: (1) discounting unpaid losses under IRC Section 846; and/or (2) discounting salvage recoverable under IRC Section 832 to comply with IRC Section 846; or (3) discounted unearned premiums attributable to title insurance under IRC Section 832(b)(8) to comply with IRC Section 846, and
• Life insurance companies that change the accounting method for discounting certain unpaid losses to comply with IRC Section 846
• Any insurance company with a tax year beginning after December 31, 2017, including those with short tax years ending before June 17, 2019

To change its method of accounting under Revenue Procedure 2019-30, an eligible insurance company must timely file either:

• An original return for its first TCJA year using either the revised factors or proposed factors

or

• An amended return for first TCJA year using the revised factors

Companies that file their first TCJA return using proposed factors must use revised factors in subsequent years.

Using Revised Discount Factors

For their first TCJA return onward, eligible insurance companies may use Revised Discount Factors to determine their discounted unpaid losses and loss adjustment expenses under IRC Section 846 (as of the end of the first TCJA year and the preceding tax year) and estimated salvage recoverable under IRC Section 832 (as of the end of the first TCJA year). They must also take into account any IRC Section 481(a) adjustment by making a TCJA transition rule adjustment as described previously, plus a Salvage adjustment. The Salvage adjustment must equal the difference in the estimated salvage recoverable as of December 31, 2017, on the as-filed basis compared to the same estimated salvage recoverable discounted using the Revised Discount Factors. Companies retaining their 2017 discounted estimated salvage recoverable as the amount reported on their 2017 federal income tax return, however, must apply a salvage adjustment of zero because the adjustment will flow through with the discounting of salvage recoverable using the Revised Discount Factors at the end of 2018.

Using Proposed Discount Factors in first TCJA year and Revised Discount Factors thereafter

For their first TCJA year, eligible insurance companies may use Proposed Discount Factors to determine their discounted unpaid losses and unpaid loss adjustment expenses under IRC Section 846 (as of the end of the first TCJA year and the preceding tax year) and estimated salvage recoverable under IRC Section 832 (as of the end of the first TCJA year). Beginning in the second TCJA year, insurance companies must use Revised Discount Factors to determine their discounted unpaid losses and unpaid loss adjustment expenses under IRC Section 846 and estimated salvage recoverable under IRC Section 832. They must also take into account any IRC Section 481(a) adjustment by:

• Applying the partial TCJA transition rule adjustment previously described using the Proposed Discount Factors, plus
• Applying a partial salvage adjustment equal to the difference in the estimated salvage recoverable as of December 31, 2017, on the as-filed basis compared to the same estimated salvage recoverable discounted using the Proposed Discount Factors

Companies that retain their 2017 discounted estimated salvage recoverable as the amount reported on their 2017 federal income tax return, however, must apply a partial salvage adjustment of zero because the adjustment will flow through with the discounting of salvage recoverable using the Proposed Discount Factors at the end of 2018. Companies that apply the Proposed Discount Factors in their first TCJA year must also account for the following adjustments in their second TCJA year:

• A remainder TCJA adjustment (the difference between the transition adjustment on unpaid losses and unpaid loss adjustment expenses computed using Proposed and Revised Discount Factors), which is reported beginning in the second TCJA tax year (calendar year 2019)
• A supplemental adjustment, if any, which is intended to prevent amounts from being duplicated or omitted due to the change from using Proposed Discount Factors to Revised Discount Factors, and is reported in the second TCJA tax year (calendar year 2019)

Companies choosing to use the Proposed Discount Factors in 2018 will, in effect, have adjustments in 2018 and 2019 to reflect the change in method of accounting. Title insurance companies implementing changes in the discounting of their unearned premium reserves will follow similar rules depending upon whether they use the Revised or Proposed Discount Factors in 2018.

Adjustment periods

Rules applicable to the IRC Section 481(a) adjustment period provide the following:

1. For the TCJA adjustment determined in the first TCJA year computed using either the Proposed or Revised Discount Factors, the adjustment period is eight tax years, beginning in the first TCJA year.
2. For the remainder TCJA adjustment, the period is seven tax years, starting in the second TCJA year.
3. For title insurance companies, if the Revised Discount Factors are used in the first TCJA year, there is no IRC Section 481 adjustment since a cut-off method is required.
4. The Partial salvage adjustment period follows the general IRC Section 481 adjustment period of one year for a negative adjustment or four years for a positive adjustment.
5. The Supplemental adjustment period is one year for a negative adjustment or seven years for a positive adjustment that begins in the second TCJA year.
6. The title adjustment when the taxpayer uses the Proposed Discount Factors in the first TCJA year requires an IRC Section 481 adjustment in the second TCJA year for the difference in the TCJA change using the Proposed and Revised Discount Factors.
7. Beginning in the second TCJA year, the 481 period is one year for a negative adjustment or four years for a positive adjustment.

Consent to change accounting method

The IRS automatically grants consent to any taxpayer that falls within the scope of Revenue Procedure 2019-30 to change an accounting method for: (1) discounting unpaid losses; (2) estimated salvage recoverable; and (3) unearned premiums attributable to title insurance to comply with IRC Section 846.

Detailed terms and conditions for making a change in accounting method under Revenue Procedure 2019-30 are laid out in Section 6 of Revenue Procedure 2019-30. The requirement to file Form 3115 to make a change in accounting method is waived, as long as the taxpayer satisfies the terms and conditions set out in Section 6, properly reports the amount of any IRC Section 481(a) adjustment and/or salvage adjustment on its federal income tax return and satisfies the applicable terms and conditions of Revenue Procedure 2015-13. To meet the requirements under Revenue Procedure 2019-30, a taxpayer with a short tax year must take into account the IRC Section 481(a) adjustments described previously as if the short tax year were a full 12-month year.

Audit protection

Audit protection is granted for changes in method of accounting for discounting unpaid losses, estimated salvage recoverable, or unearned premiums attributable to title insurance made under Revenue Procedure 2019-30. This means the IRS will not require a taxpayer that makes a change in method of accounting for discounting unpaid losses, estimated salvage recoverable, or unearned premiums attributable to title insurance to change its method of accounting for the same item for the tax years prior to the year of change. To benefit from this protection, however the taxpayer must comply with the provisions of Revenue Procedure 2019-30. Additionally, the taxpayer's method of accounting for the same item may not be an issue under consideration (under examination, before an Appeals office, or before a federal court) within the meaning of Section 3.08 of Revenue Procedure 2015-13, on 22 July 2019.

Implications

The guidance provided by Revenue Procedure 2019-30 is helpful in removing doubt about whether a Form 3115 is required and helping to lay out what IRC Section 481(a) adjustments are required, depending upon whether Proposed or Revised Discount Factors are used in 2018. Further, the waiver of the requirement to file a Form 3115 (along with the grant of audit protection for these changes) greatly reduces the administrative burden of complying with the amendments to IRC Section 846.

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