The Tax Cuts and Jobs Act (TCJA) signed into law by President Trump on December 22, 2017 (date of enactment) enacts some of the most significant changes to U.S. tax law in a generation. Several of the provisions may be of particular interest to property and casualty (P&C) insurance companies, while many others will affect insurers. Most of the changes become effective on January 1, 2018, but the law will have certain impacts on financial statements for periods ending after the date of enactment.
Corporate rate reduction
Beginning on January 1, 2018, corporate income will be taxed at one flat rate of 21 percent. Previously, the corporate tax was determined based on graduating rate tables, with phase-outs, from 15% on taxable income under $50,000 to a top rate of 35% on taxable income over $10,000,000.
Financial statement impact
While the rate change won’t affect corporate tax returns until 2018, deferred tax assets should be valued in financial statements based on enacted tax rates. As a result, financial statements for periods ending after the date of enactment should calculate deferred tax assets using the 21 percent federal rate, adjusted for any state income tax impacts as applicable.
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For GAAP reporting, the effect of the tax rate change will be reflected as an adjustment to net income as part of the provision for income taxes. Since there may be tax effects included in accumulated other comprehensive income (AOCI) such as unrealized gains or losses on available-for-sale securities, the adjustment through earnings leaves these amounts “stranded” in AOCI. Companies now have the option to reclassify these stranded amounts with a direct adjustment to retained earnings.
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Under statutory accounting principles, the effect of the rate change will be reported as a component of surplus, consistent with existing reporting instructions.
Corporate alternative minimum tax (AMT) repealed
For tax years beginning after December 31, 2017, the corporate AMT is repealed in its entirety. For tax years beginning after 2017, unused AMT credits will reduce regular tax liability dollar for dollar. In addition, AMT credit carryforwards will be 50 percent refundable in each year to the extent they are not utilized against regular tax liability. In the 2021 tax year, any remaining AMT credits are fully refundable.
Companies should determine the appropriate presentation of existing AMT credits including the classification as a deferred tax item or current recoverable. There may be different approaches taken due to limited guidance addressing this type of refundable credit. Previously deferred tax valuation allowances related to AMT credits should be reassessed based on the full recoverability of these credits.
Net operating loss (NOL) carrybacks and carryforwards unchanged for P&C companies
The TCJA makes significant changes to NOL rules for most businesses, eliminating the two-year carryback of net operating losses and making NOL carryforwards indefinite with a limitation on use to 90 percent of taxable income. However, P&C companies are specifically designated to maintain their current treatment of NOLs. P&C carrybacks/carryforwards are treated as follows:
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NOLs carry back two years.
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NOLs carry forward 20 years.
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A P&C company’s NOL carryforward can still offset 100 percent of taxable income.
Proration of P&C company tax-exempt investment income
The deduction for tax-exempt income is typically reduced by an amount to reflect the portion of reserves funded by tax-exempt interest and other untaxed amounts. The new law increases the proration rate for tax years beginning after December 31, 2017 to 25 percent from 15 percent in order to more accurately reflect the new corporate tax rate.
Reserve discounting for P&C companies
P&C companies are allowed to deduct from their taxable income amounts included in the liability for unpaid losses which represent claims that will be paid at a future date. To reflect the time value of money, the reserves are discounted for federal income tax purposes.
The TCJA extends the period over which reserves must be discounted and includes the following requirements:
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Reserves for 10-year lines discounted over a maximum of 24 years after the accident year.
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Reserves for two-year lines discounted over a maximum of three years after the accident year.
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The reserves must be discounted using a rate based on the corporate bond yield curve for the preceding 60-month period.
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An election for companies to calculate reserves based on their own payment patterns has been repealed.
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The reserve method changes will be calculated based on December 31, 2017 reserves. Any increase in taxable income that results from the initial application in 2018 will be included in taxable income ratably over eight tax years, beginning with 2018.
The bond yield curve rate in the new law is higher than under previous rules, and the discounting period for the 10-year “long tail” lines will generally be longer.
Special loss discounting for insurance companies under section 847 and related estimated payment rules repealed
The TCJA repeals a provision that allowed insurance companies a full deduction for undiscounted losses but also required the companies to make special estimated tax payments equal to any tax benefit of the discounting that was not treated as taxable income. Section 847 is repealed in its entirety effective January 1, 2018. Estimated tax payments made under Section 847 will be applied against the additional tax attributed to the increase in taxable income caused by the inclusion of the discount.
Other notable corporate provisions
Other provisions that all corporate taxpayers should keep in mind include:
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100 percent bonus depreciation deductions for assets purchased on or after September 27, 2017.
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An increase in the disallowance of deductions for fines and penalties.
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Limitations on interest expense deductions:
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Interest expense disallowed to the extent it exceeds 30 percent of “adjusted taxable income” (ATI).
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ATI is defined in tax years after 2017 and before 2022 as taxable income without regard to the deductions for depreciation, amortization, or depletion.
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For tax years beginning in 2022 and after, ATI will be taxable income including the deductions for depreciation, amortization, and depletion.
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The dividends received deduction is reduced from 70 percent to 50 percent (the general rate for dividends received from other taxable domestic corporations) and from 80 percent to 65 percent (for 20-percent owned corporations).
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Excessive compensation rules have been modified.
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Excessive compensation rules still apply to compensation in excess of $1 million a year, but the previous exception for performance-based compensation has been repealed.
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The list of “covered employees” has been expanded to include the chief financial officer.
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Once someone becomes a covered employee, that person remains a covered employee even if he or she no longer holds the position. Excessive compensation rules are applied to compensation paid to that individual at any time in the future.
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Entertainment expenses are no longer deductible at all.
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Includes amounts paid for sports, concerts, or other events.
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Meals with a valid business purpose are still 50 percent deductible.
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Meals purchased by an employee while traveling are still 50 percent deductible.
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Meals provided on-premises for the convenience of the employer are 50 percent deductible until 2025 and non-deductible after that.
Additional guidance expected
Given the size and scope of the TCJA, it’s reasonable to expect that we’ll see considerable guidance from tax administrators on these topics in the months and years ahead. In the meantime, if you have any questions, please give us a call.
