February 28, 2023
IRS provides welcome interim guidance for insurance providers on CAMT and invites comments
The IRS has issued interim guidance (Notice 2023-20) to help insurance companies and some other taxpayers comply with the new corporate alternative minimum tax (CAMT) until proposed regulations are issued. The notice addresses how to determine adjusted financial statement income (AFSI) with regard to (1) variable (and similar) contracts, (2) funds-withheld reinsurance and modified coinsurance agreements, and (3) the basis of certain assets held by previously tax-exempt entities that received a "fresh start" basis adjustment. The IRS requests comments on the notice by April 3, 2023.
The Inflation Reduction Act (IRA) amended IRC Section 55 to add the 15% CAMT to the AFSI of certain corporations for tax years beginning after December 31, 2022. Generally, AFSI is defined as a taxpayer's net income or loss set forth in the taxpayer's applicable financial statement (AFS) for the tax year, as adjusted under IRC Section 56A.
The CAMT applies to any corporation (other than an S corporation, regulated investment company, or real estate investment trust) with average annual AFSI exceeding $1 billion for any three consecutive tax years ending after December 31, 2021, and preceding the current tax year (Average Annual AFSI Qualification Test). A corporation that is a member of an international financial reporting group with a foreign parent that meets the $1 billion threshold must also have average annual US-related AFSI (i.e., income of the US corporation(s), income of controlled foreign corporations and effectively connected US income) of $100 million or more for purposes of the Average Annual AFSI Qualification Test. A corporation meeting the Average Annual AFSI Qualification Test will be considered an "applicable corporation."
IRC Section 56A defines AFSI as the net income or loss of the taxpayer set forth on the taxpayer's AFS, with certain adjustments. The calculation of AFSI starts with a corporation's financial statement net income or loss attributable to members of the taxpayer's US consolidated tax return group. Adjustments are then made to increase or decrease AFSI.
The CAMT is calculated by first determining the tentative minimum tax (TMT), which is done by multiplying AFSI by 15% and reducing that amount by CAMT foreign tax credits (FTCs). The TMT is compared to an applicable corporation's regular tax liability, plus its liability for the base erosion and anti-abuse tax (BEAT). The applicable corporation's regular tax liability is the tax liability before consideration of tax credits other than FTCs.
If the CAMT liability exceeds the regular tax liability plus the BEAT liability, the applicable corporation pays the CAMT. (For details, see Tax Alert 2023-0087.)
The IRS issued interim CAMT guidance (Notice 2023-7) in December 2022, on which taxpayers may rely, pending the release of proposed regulations. (See Tax Alert 2023-0091.) Notice 2023-7 also informed taxpayers that additional interim guidance would be issued, including guidance addressing certain issues around how particular items are treated under the CAMT, particularly: (1) life insurance company separate account assets that are marked to market for financial statement purposes; (2) certain items reported in other comprehensive income (OCI); and (3) the treatment of embedded derivatives arising from certain reinsurance contracts.
Notice 2023-20 supplements the interim guidance provided under Notice 2023-7.
Notice 2023-20 defines a "Covered Insurance Company" as either:
The notice refers to "Covered Variable Contracts," essentially meaning variable contracts as described in the notice. It defines a Covered Investment Pool as "a pool of investment assets designated to support one or more Covered Variable Contracts."
Covered Obligations are defined as "financial accounting liabilities, including contract reserves and claims or benefits payable, that reflect a Covered Insurance Company's obligations under one or more Covered Variable Contracts and are taken into account in determining Net Income." Net Income refers to income or loss on the AFS.
Covered Reinsurance Agreements refer to "funds withheld reinsurance or modified coinsurance agreements as previously described in the notice, and any retrocession of all or part of the risk under such agreement."
Some insurance companies issue variable life insurance and annuity contracts for which the company's obligation depends, at least in part, on the value of assets held in an account segregated from the insurance company's general asset accounts. IRC Section 817(c) requires insurance companies issuing variable contracts (as defined in IRC Section 817(d)) to separately account for items of income, exclusion, deduction, asset, reserve and other liability items attributable to the variable contracts.
Although IRC Section 807 generally requires that increases in life insurance reserves to be deducted and decreases in life insurance reserves to be included in income, IRC Section 817(a) disregards amounts subtracted from or added to separate account reserves due to the depreciation or appreciation of separate account assets (whether or not realized) for purposes of determining net increases or decreases in reserves under IRC Section 807(a) or (b).
Section 2.02(2) of Notice 2023-20 also incorporates other "similar" contracts that are not specifically covered under IRC Section 817 but may follow accounting treatment in a corporation's AFS, similar to that of variable contracts. Examples include "closed block contracts" created for the benefit of holders of certain insurance contracts issued by a mutual insurance company that has engaged in a demutualization to convert to a stock insurance company and contracts issued by foreign insurance companies.
Variable contracts and similar contracts are generally subject to equivalent treatment under US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), section 2.02(3) states.
AFSI adjustments for Covered Variable Contracts
Section 3 of the notice establishes rules that apply in determining AFSI for a Covered Insurance Company issuing Covered Variable Contracts. Specifically, the change in a Covered Insurance Company's obligation to contract holders is disregarded to the extent of the IRC Section 56A(c)(2) exclusion amount for the tax year, to the extent that:
The notice explains that, for these purposes, the IRC Section 56A(c)(2) exclusion amount for the tax year equals the gains/losses in the Covered Investment Pool for the Covered Variable Contract to which the obligations relate that are (1) taken into account in the Covered Insurance Company's Net Income for the tax year and (2) disregarded under IRC Section 56A(c)(2)(C) or (D)(i) in determining the company's AFSI for the tax year.
Reinsurance is insurance purchased by an insurance company (ceding company) from another insurance company (assuming company or reinsurer). The ceding company compensates the reinsurer for protection from losses that the ceding company might incur as a result of a claim under the primary insurance contract. If the reinsurer transfers all or part of the reinsured risk to another reinsurer, the transaction is called a retrocession.
Reinsurance is a vital part of the insurance industry as it (1) allows insurance companies to further diversify their risks and manage capital and liquidity levels, (2) enables direct writers to write more business than they otherwise would due to regulatory constraints, and (3) ensures that insurance providers have the financial means to pay all valid claims made by their policyholders.
Reinsurance agreements (known as "treaties") take various forms. Regardless of the form, an indemnity reinsurance agreement transfers risk of an insurable loss from the ceding company to the reinsurer, but the ceding company remains in privity of contract to the insured. In a traditional indemnity reinsurance agreement in the life insurance industry (known as "coinsurance"), the ceding company pays the reinsurer a proportion of the premiums collected from the insured. In return, the reinsurer reimburses the ceding company for the same proportion of the claim payment and other benefits provided by the policy. In coinsurance, the ceding company transfers assets to the reinsurer to cover the reinsured liabilities, and the reinsurer must also establish the required reserves for the portion of the risk it has assumed.
In a funds-withheld reinsurance or a modified coinsurance agreement, the ceding company retains the supporting assets (Withheld Assets) as security to ensure the reinsurer fulfills its obligations under the treaty. Section 4.02 of the notice explains that the ceding company records a liability (Withheld Assets Payable) to reflect the Withheld Assets owed to the reinsurer. Increases or decreases in the value of the Withheld Assets are generally accounted for through OCI in the AFS of the ceding company, with a corresponding increase or decrease in the Withheld Assets Payable recorded through net income. The reinsurer has a corresponding asset (Withheld Assets Receivable) and unrealized gain or loss in the Withheld Assets are accounted for through net income in the reinsurer's AFS. The change in the Withheld Assets Payable and Withheld Assets Receivable associated with unrealized gains and losses on the Withheld Assets is referred to in the financial accounting literature as an "embedded derivative."
In some circumstances, the notice explains, the ceding company and the reinsurer may be able to make "fair value" elections for AFS purposes to change the accounting treatment of one or more items relevant to their funds-withheld reinsurance or modified coinsurance agreement and thus cause both offsetting items related to the unrealized change in Withheld Assets value to run through OCI or through the net income or loss set forth on the AFS.
AFSI adjustments for Covered Reinsurance Agreements
Section 4 of Notice 2023-20 generally requires a Covered Insurance Company that is a party to a Covered Reinsurance Agreement to exclude from AFSI certain changes accounted for separately in the AFS for each agreement.
This exclusion of income will not apply to the extent that the Covered Insurance Company elects to account for an item relevant to the Covered Reinsurance Agreement at fair value on its AFS and the election changes the fair value of (a) the Withheld Assets Payable (for the ceding company) or the Withheld Assets Receivable (for the reinsuring company) and (b) the offsetting item.
Legislative changes over the years have revoked the tax-exempt status of certain organizations, which Notice 2023-20 refers to as "Fresh Start Entities." They include:
AFSI determination respects congressional "fresh start"
Section 5 of the notice essentially provides for conformity to the regular tax system for AFSI gain or loss associated with disposal of assets held as of the "fresh start" date for the applicable entity.
The Federal Home Loan Mortgage Corporation or its successor will determine, for purposes of computing AFSI, gain or loss on disposal of assets held since January 1, 1985, by applying the adjusted basis rules under Section 177(d)(2) of the Deficit Reduction Act of 1984.
The remaining Fresh Start Entities will determine gain or loss, for purposes of computing AFSI, for the disposal of assets held on the first day of their first tax year beginning after the testing date using the adjusted tax basis for the asset on the testing date. The term testing date means December 31, 1986, for Blue Cross and Blue Shield organizations and December 31, 1997, for the pension business of Mutual of America and the Teachers Insurance Annuity Association-College Retirement Equities Fund.
Notice 2023-20 states that the IRS anticipates future proposed regulations will be consistent with the notice and apply for tax years beginning after December 31, 2022. Taxpayers may rely on the rules enunciated in sections 3 through 5 of Notice 2023-20 until proposed regulations are issued.
Request for comments
The IRS asks interested parties to submit, by April 3, 2023, comments on specific issues pertaining to sections 3 through 5 of the notice.
Notice 2023-20 will help ameliorate some unintended adverse consequences facing many insurers in the application of the CAMT and will likely be viewed as a positive development for an industry in which many large companies, absent this guidance, faced potentially significant CAMT liabilities.
Additionally, Notice 2023-20 offers perhaps the clearest indication to date of how the IRS views unrealized gains and losses recorded in the AFS. The notice seems to imply, if not directly state, that fair-value adjustments associated with nonconsolidated corporate equities and partnership investments, which are generally recorded through Net Income in a US GAAP AFS, are disregarded from AFSI.4 Although one could argue that the plain language in IRC Section 56A(c)(2)(C) is clear on this point, it has remained an item for which taxpayers had been hoping for confirmation given the potential magnitude of the item.5
Similarly, although not as explicit, the IRS seems to acknowledge that unrealized gains and losses recorded in OCI are not includible in AFSI. This is evident throughout Section 4 of the notice; one could argue that if unrealized gains and losses in OCI were intended to be included in AFSI, then the ceding company guidance in this section would not be needed. This is because the unrealized gains and losses recorded on the Withheld Assets and corresponding Withheld Assets Payable would net to zero within AFSI, making an exclusion unnecessary.
Though Notice 2023-20 provides significant progress, several questions remain that, if not addressed, will continue to cause uncertainty in the insurance industry around the CAMT. A handful of examples follow.
If a taxpayer is a partner in a partnership, its AFSI with respect to the partnership only takes into account the taxpayer's distributive share of the partnership's AFSI.6 Although Notice 2023-20 seems to acknowledge that fair-value adjustments related to such partnerships are not includible in AFSI, significant questions remain on how to determine "distributive share." This presents technical and operational challenges for insurance companies, many of which own interests in hundreds or even thousands of partnerships. Seemingly aware of this point, the IRS requested comments on this topic in Notice 2023-7.7
Accounting standard changes
Many insurance companies have adopted, or are in the process of adopting, ASU 2018-12, Targeted Improvements to the Accounting for Long-Duration Contracts, under US GAAP or IFRS 17, Insurance Contracts. Many insurers will be recording negative adjustments to equity to transition to these new accounting standards and may expect greater financial statement income in the future as a result. Without transition relief, certain insurers may have greater CAMT liabilities, simply due to the transition to these new accounting standards.
Life/non-life consolidation rules
IRC Section 1503(c) limits the non-life net operating loss (NOL) that can be used against life insurance income (35% of the lesser of qualifying NOLs or life subgroup taxable income) for affiliated groups that (1) include one or more life insurance companies and one or more non-life insurance companies or other non-insurance companies; and (2) elect to file a consolidated return under IRC Section 1504(c)(2). The consolidated return regulations under Treas. Reg. Section 1.1502-47 provide additional rules for "life/non-life" consolidated groups and provide limitations and ordering rules around other mechanics, such as NOL and capital loss carrybacks. Currently, the CAMT rules do not contemplate treating life insurance companies any differently than other corporations (i.e., no conformity with the life/non-life consolidation rules).
Foreign tax credits
The CAMT foreign tax credit (FTC) rules are generally separate from the FTC rules for regular income tax purposes and will require separate tracking and analysis of FTCs for CAMT purposes, which will undoubtedly generate issues and questions. The statute expressly authorizes Treasury to address the treatment of current and deferred taxes, including the time at which those taxes are properly taken into account for AFSI purposes. Insurance companies with significant direct FTC carryforwards for regular tax purposes (particularly carryforwards relating to taxes paid or accrued before the corporation becomes an applicable corporation) may be more likely to incur a CAMT liability in the year(s) the carryforwards are utilized.
Loss carrybacks and carryforwards
Under current law, most corporations may carry NOLs forward indefinitely. NOL deductions, however, are limited to 80% of taxable income in the year to which the NOL is being carried. NOL carrybacks are not permitted. IRC Section 172(b)(1)(C) provides an exception to the general rule for non-life insurance companies, allowing for a carryback period of two years, a limited carryforward period of 20 years, and no limits on the use of NOL carryforwards.
Similarly, current tax law allows all corporations to carry capital losses back three years and forward five years for. The CAMT allows financial statement NOLs to be carried forward indefinitely, subject to an 80% limitation similar to the general IRC rule for corporations. The financial statement NOL rules neither provide exceptions for non-life insurance companies or any other type of entity, nor distinguish between ordinary and capital losses. Treasury has, however, been granted regulatory authority in this area and requested comments in Notice 2023-78 on whether certain limitations, such as those provided in IRC Sections 382 and 383, as well as Treas. Reg. Sections 1.1501-21(c) and 1.1502-15, should apply. The potential disconformity between regular tax NOLs and financial statements NOLs may cause non-life insurance companies to incur CAMT liabilities when regular tax NOLs are utilized. Insurance companies, both life and non-life, may be disproportionately affected by disconformity in capital losses because investing activities are a significant component of their business model. Also, in the future, carrying back regular tax NOLs to a year in which the CAMT is in effect (i.e., when the carryback period includes the 2023 tax year and beyond) may provide little cash tax benefit.
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1 P.L. 98-369, 98 Stat. 494, 709 (1984).
2 P.L. 99-514, 100 Stat. 2085, 2390-94 (1986).
3 P.L. 105-34, 111 Stat. 788, 939 (1997).
4 See for example, Section 2.02(3), which states: "However, unrealized gain or loss on some categories of the supporting assets, but not the offsetting adjustment to liabilities, is required to be disregarded under Section 56A(c)(2)(C) or (D)(i) for purposes of determining AFSI, resulting in a mismatch that could significantly overstate or understate AFSI relative to taxable income."
5 In the request for comments section, 9.02(18), of Notice 2023-7, the following question lends some uncertainty as to how the IRS views mark-to-market adjustments in AFSI: "To what extent should guidance provide adjustments to AFSI to disregard mark to market unrealized gains and losses that are otherwise included in AFSI?"
6 IRC Section 56A(c)(2)(D).
7 See Notice 2023-7, Section 9.02(2).
8 See Notice 2023-7, Section 9.02(13).