On July 22 2019, the Internal Revenue Service (IRS) released Revenue Procedure 2019-30 and Revenue Procedure 2019-31. Revenue Procedure 2019-30 provides simplified procedures for an insurance company to obtain automatic consent to change its method of accounting for discounting unpaid losses, estimated salvage recoverable, and unearned premiums attributable to title insurance to comply with modifications made to section 846 by the Tax Cuts and Jobs Act and final regulations thereunder. Revenue Procedure 2019-31 contains revised discount factors for the 2019, 2018 and earlier accident years for use by insurance companies in computing discounted unpaid losses and estimated salvage recoverable.
The Tax Cuts and Jobs Act (TCJA), signed into law on Dec. 22, 2017, made several modifications to the discounting rules for non-life insurance companies for taxable years beginning after Dec. 31, 2017. These modifications: 1) repealed the election permitting a taxpayer to use its own historical loss payment patterns; 2) amended the computational rules for determining loss payment patterns under section 846(d); and 3) bases the discount factors on a corporate bond yield curve rather than applicable federal mid-term rates. A transitional rule requires the amount of unpaid losses as of December 31, 2017 to be recalculated under the new provisions of the TCJA. Such adjustment, often referred to as the “transitional adjustment”, is spread ratably over eight years in the first taxable year beginning in 2018 and the seven succeeding taxable years.
On June 13, 2019, the IRS and Treasury Department released final regulations on the discounting rules for unpaid losses and estimated salvage recoverable of insurance companies for federal income tax purposes. The effective date of these final regulations is June 17, 2019. The final regulations replace proposed regulations previously released in November of 2018. Revenue Procedure 2019-06 (January 2019) prescribed discount factors for the 2018 accident year and earlier accident years under the proposed regulations. In response to industry commentary on Revenue Procedure 2019-06, the final regulations made the following modifications from the proposed regulations: 1) technical improvements to the derivation of loss payment patterns used for discounting and 2) use a single annual rate based on a narrower range of maturities to determine the discount factors.
Revenue Procedure 2019-30, effective for tax years beginning after December 31, 2017 and ending on or before December 31, 2019, provides simplified procedures under section 446 for an insurance company to obtain automatic consent to change its method of accounting in order to conform to the modifications under the final regulations. Generally, a taxpayer must obtain the consent of the Commissioner before changing a method of accounting by filing Form 3115, Application for Change in Accounting Method. This revenue procedure provides that the requirement to file Form 3115 is waived for any taxpayer making a change to its method of accounting for discounting unpaid losses, estimated salvage recoverable, and unearned premiums attributable to title insurance, provided that taxpayer complies with the provisions of this revenue procedure.
According to this revenue procedure, taxpayers are allowed to use either the final revised discount factors in Revenue Procedure 2019-31 (Revised Discount Factors) or the proposed discount factors contained in Revenue Procedure 2019-06 (Proposed Discount Factors) for the 2018 tax year. If the taxpayer uses the revised discount factors for unpaid losses for the 2018 tax year and for computing the transitional adjustment, no additional modification is required.
A taxpayer using the proposed discount factors for unpaid losses for the 2018 tax year and for computing the transitional adjustment will need to calculate a “remainder” transitional adjustment in 2019. This remainder transitional adjustment is the difference between the discounted unpaid losses at the end of 2017 determined using the proposed discount factors and the amount of discounted unpaid losses using the revised discount factors. The remainder transitional adjustment will be recognized over the remaining seven years (2019 and the six succeeding taxable years).
This revenue procedure also changes the transitional adjustment period for estimated salvage recoverable to one year for a negative section 481(a) adjustment and four years for a positive section 481(a) adjustment. The transitional adjustment for estimated salvage recoverable is consistent with the standard section 481(a) rules.
Revenue Procedure 2019-31 contains the final revised discount factors (Revised Discount Factors) for use by insurance companies in computing discounted unpaid losses and estimated salvage recoverable. These factors were revised based on the final regulations released in June of 2019. Under the proposed regulations, the annual rate determined under section 846(c) was based on a specific range of maturities (from one-half year to seventeen and one-half years) from the corporate bond yield curve. Due to industry commentary, the final regulations changed the specific range of maturities (from four and one-half years to ten years) used to determine the annual rate. The annual rate determined for the 2018 calendar year under the proposed regulations was 3.12%, compounded semiannually. The annual rate determined for the 2018 calendar year under the final regulations is 2.94%, compounded semiannually. Revenue Procedure 2019-31 provides revised discount factors for the 2019, 2018 and earlier accident years.