By Thomas Barber, Steven Greene, Jay Wang and Erin Schatzle of Mazars
The passage of the Tax Cuts and Jobs Act, (“TCJA”) on December 22, 2017 had significant impacts on the insurance industry, both domestic insurers and multi-nationals. With this in mind we address how provisions will impact insurers today and in the future, and how it will impact insurers’ GAAP and Statutory financial statements for the December 31, 2017 year-end and going forward. Many areas of the TCJA need further clarification, and we will monitor future guidance, rulings and regulations and advise appropriately. This article represents the first of a three part series which will eventually cover the impacts on P&C Companies and International Provisions.
The TCJA contains several changes to general corporate taxation rules that will also the insurance industry companies. Insurers will need to pay attention to these changes as several long standing and commonly accepted provisions have been amended.
Reduced Corporate Tax Rate
Under the old law, corporations were subject to graduated tax rates of 15%, 25%, 34% or 35% depending on their taxable income. For tax years beginning after December 31, 2017, the TCJA amended the corporate rate to a flat 21% across all taxable income levels.
Mazars Insight: Overall, this is seen as a beneficial change for corporations in the higher income brackets. More dollars in the business’s budget can lead to increased investment and job growth.
Due to the law’s enactment in 2017, insurers will need to take the tax rate change into account when preparing their 2017 Statutory and GAAP tax provisions as any deferred tax assets and liabilities will reverse at the lower tax rate. The reduced rate will significantly reduce the value of deferred tax assets (“DTA”) on the balance sheet (notably those with sizeable net operating loss carryforwards and insurance reserves) and cause an increase in the amount of deferred tax expense that must be reported for 2017. Conversely, the reduced rate will significantly reduce the future deferred tax liabilities (“DTL”) on the balance sheet (such as companies with unrealized portfolio gains) and cause a decrease in the amount of deferred tax expense that must be reported for 2017.
Under current GAAP guidance, the difference between the DTA and DTL previously measured at the 35/ 34% tax rate and the DTAs and DTLs re-valued at the 21% tax rate will have to be reflected through the current year income statement, even for deferred tax items reflected through Other Comprehensive income (“OCI”) items. However, February 14, 2018, the FASB issued ASU No. 2018-2 (the “ASU”) which allows companies the ability to reclassify to retained earnings of tax effects of items remaining within accumulated OCI resulting from the TCJA. This would alleviate the potential effects of previously established deferred taxes on unrealized gains/losses at the old 35/34% rate while reversals are occurring at the lower 21%, thus “stranding” deferred taxes in OCI. The update would be limited in scope specifically to the TCJA. The ASU is effective fir periods beginning after December 15, 2018, but early adoption is permitted, so companies can make this reclassification in their 2017 GAAP financial statements along with appropriate disclosures.
Under current statutory accounting guidance (see SAPWG INT 18-01), the difference between the DTAs and DTLs previously measured at the 35/34% tax rate and the DTAs and DTLs re-valued at the 21% tax rate is recorded differently than GAAP treatment. This gross change in net deferred tax, excluding any change reflected in unrealized capital gains, and excluding any change in nonadmitted DTAs is to be reflected in the “Change in Deferred Income Tax” line in changes in capital and surplus. Tax effects previously reflected in unrealized capital gains (to present unrealized gains (losses) as “net of tax” shall be updated in the “Change in Net Unrealized Capital Gains (Losses) less Capital Gains Tax” line in changes in capital and surplus. Also, future tax rates in the second prong of the admissibility test will need to be revised accordingly.
AMT Repealed and AMT Credit Refundable
The TCJA repealed the Alternative Minimum Tax (“AMT”) for years beginning after December 31, 2017. For tax years beginning after 2017 and before 2022, any AMT credit carry forward balances at December 31, 2017 can offset regular tax, and any remaining unused AMT credits are refundable at 50% of the amount remaining each year to the extent they exceed regular tax through 2020, with any remaining AMT credit refunded in 2021.
Mazars Insight: Both the repeal of the AMT and the refund of the AMT credits cause cash back in the corporation’s budget, leading to greater investments. Generally, refundable credits would not create a carry forward scenario and thus not be subject to section 383 limitation. However, it should be noted that there is uncertainty as to whether AMT credit carry forwards that are now refundable by statute are subject to past section 383 limitations or future section 383 limitations based on post-2017 ownership changes and, if so, how a taxpayer should calculate the refunded amounts by year.
Because any available AMT credits are fully refundable, insurers will need to recognize this gross DTA in their STAT and GAAP provisions if previously it was subject to a full or partial valuation allowance as it is guaranteed to be utilized and/or refunded no later than 2021. As a dollar for dollar credit, the AMT credit is not impacted by the change in corporate tax rates. For insurers with AMT credits in their DTAs, even if they no longer need a valuation allowance for STAT purposes they will need to consider the favorable impact it will likely have in the admissibility test under SSAP 101 paragraph 11.b.in order to understand the true surplus impact.
Net Operating Loss Changes
Under previous law, corporations were allowed to carry back 100% of any net operating losses (“NOL”) for two years and carry them forward for 20 years. For tax years beginning after December 31, 2017, the TCJA repeals the two year carryback for regular corporations (which will now also apply to life insurers) and limits the NOL deduction each year to 80% of taxable income. Any remaining NOLs can be carried forward indefinitely. Losses that were generated before January 1, 2018 are grandfathered in under the old NOL regime and, as such, are not subject to the 80% restriction.
It should be noted that for property and casualty (“P&C”) insurance companies, the old rules still apply (i.e., P&C companies are still allowed the two year carryback and a 20 year carry forward of NOLs, which can still be applied to 100% of taxable income, even for post 2017 NOLs).
Mazars Insight: The loss of the ability to carryback current year losses, starting in 2018, to recoup prior year taxes paid could be detrimental to some corporations. The ability to carry forward the losses indefinitely is a benefit as corporations no longer need to worry about expiring NOLs. Separate tracing of NOLs for pre and post 2017 TCJA changes as well as for consolidated tax groups with both life and non-life insurance companies will be necessary. Additionally, insurers in a consolidated group containing P&C Insurers and non-insurance companies will need to track their future NOLs separately due to the differing carryback/carryforward regimes along with limitations that apply to non-insurers could be absorbed by non-limited P&C insurance companies’ losses. Could there be bumping rules akin to the existing life/non-life rules that remain unchanged by the TCJA, only time will tell.
The loss of carryback ability for future NOLs and indefinite carryforward of NOLs may require valuation allowances and DTAs to be revalued, but this should be determined on a case by case basis. For P&C insurance companies, the admissibility test pursuant to SSAP 101, paragraph 11 would remain unchanged; however, life insurance companies will have to immediately adjust the admissibility test to account for the loss of carryback ability (i.e. paragraph 11 a would no longer be applicable to life insurers) in their 2017 statutory admissibility test.
Limitations on the Deductions of Business Interest
For tax years beginning after December 31, 2017, the TCJA limits the deduction of net interest expense to 30% of adjusted taxable income. For tax years beginning after December 31, 2017 and before January 1, 2022, adjusted taxable income is determined without the deductions for depreciation, amortization or depletion. Any business interest disallowed as a deduction can be carried forward indefinitely. There is an exemption from these rules for taxpayers with average annual gross receipts for the three year tax period ending with the prior tax year that do not exceed $25 million.
Mazars Insight: Because the TCJA limits how much interest a corporation can deduct in a given year, companies will need to account for this as a DTA similar to NOLs. As insurers typically have sizable investment portfolios, since the limitation is based off of net interest expense, we believe that this will not likely impact most insurers.
Section 179 - For tax year 2018, the TCJA increased the maximum amount a taxpayer may expense under Section 179 from $500,000 to $1 million. The phase-out threshold was also increased to $2.5 million. For years beginning after December 31, 2018, the maximum amount will be adjusted for inflation. As before, Section 179 expensing is limited to taxable income in a given tax year.
Bonus Depreciation - For property placed in service after September 27, 2017 and before January 1, 2023, the TCJA increased the amount of first year depreciation to 100% from 50% as allowed under the prior law. Unlike the old bonus depreciation rules which limited first year expensing to only new assets, the TCJA allows additional first year depreciation for new and used assets (restrictions do apply). For tax years after December 31, 2022, the bonus depreciation deduction will phase down 20% each year until 2026 when it will be completely eliminated.
Mazars Insight: The changes to depreciation expensing rules are very beneficial to corporations, as they will be able to get the deduction for capitalized fixed assets in the tax year they outlay the cash. This may lead to companies making a greater investment in capitalized assets in the years where full expensing is in place. Although insurers are typically not capital intensive, this could very well impact pass-through income related to partnership investments that have capital intensive aspects.
The increased deduction for fixed assets could potentially put a corporation into a DTL position. As with any tax accounting adjustment for depreciation, careful tracking will need to be done for the STAT/GAAP/Tax differences to properly determine the correct DTA or DTL.
Dividends Received Deductions
In general, for corporate shareholders receiving a dividend from certain domestic corporations, the TCJA reduces the dividends received deduction (“DRD”) for the 70% and 80% brackets, to 50% and 65%, respectively. The 100% DRD remains intact for dividends from affiliated group members. The DRD provision is effective for tax years beginning after December 31, 2017.
Mazars Insight: Taking into account the drop in the corporate tax rate, the change in the proration provisions of the TCJA, and the drop in the DRD percentages, the effective tax rate for P&C insurers on greater than 20% owned stock drops from 11.2% to 10.7625% and less than 20% owned stock from 14.175% to 13.125%.
This article was previously published in the PAMIC 360.
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