ACLI Update
By Regina Rose and Sarah Lashley
TAXING TIMES, June 2023
In the October 2022 ACLI Update Column in TAXING TIMES, ACLI provided an overview of some of the provisions of the Inflation Reduction Act, including the Corporate Alternative Minimum Tax on Book Income (CAMT). Since then, the ACLI has submitted four comment letters relating to the CAMT and engaged with the government on numerous issues affecting the insurance industry. Issues addressed in ACLI’s comments include:
- Accounting for unrealized gains and losses on the assets supporting variable and similar-type contracts,
- Distortions arising from an accounting construct in funds withheld and modified coinsurance (FWH/Modco) arrangements,
- Government requests for comments in Notice 2023-7[1] relating to mark-to-market (MTM) accounting and inclusion of Other Comprehensive Income (OCI) in Adjusted Financial Statement Income (AFSI),
- Accounting for partnership income in the determination of AFSI,
- Accounting for acquisitions and dispositions,
- The effect of adoption of Long-Duration Targeted Improvement (LDTI) and IFRS 17 changes in accounting standards affecting insurance contracts,
- The application of the life-nonlife rules,
- Inconsistency between the CAMT and Regular Tax in the carryback and carryforward of losses, and
- Life insurer Foreign Tax Credits from foreign countries with non-calendar tax years.
A summary of the industry comments is included below.
Accounting for Unrealized Gains and Losses on the Assets Supporting Variable and Similar-Type Contracts
Section 56A(c)(2)(C) and (D) appear to create significant noneconomic differences between insurance companies’ AFSI and regular taxable income relating to certain insurance products. For financial reporting and regular tax purposes, income or loss resulting from changes in the value of equity asset investments (Variable Contract Assets) supporting certain insurance products (Variable and Similar-Type Contracts) is offset by a corresponding income or loss generated by changes in the related contractual obligations (Corresponding Liabilities). This offset results in no net income to the contract issuer.
Variable and Similar-Type Contracts include not only variable insurance contracts, but also certain foreign policies and closed block contracts of demutualized companies. Additionally, insurance companies may develop new insurance products in the future for which the value of equity assets supporting the products is offset by a corresponding income or loss generated by changes in the related Corresponding Liabilities.
While the Variable Contract Assets and the Corresponding Liabilities offset for financial reporting and regular tax purposes, without guidance, it is possible they will not offset in AFSI because section 56A(c)(2)(C) (and any similar adjustments under section 56A(c)(2)(D)) would appear to exclude any income or loss on life insurance company’s financial statements attributable to unrealized gains and losses on Variable Contract Assets. As a result, the income or loss resulting from changes in the value of the Variable Contract Assets would no longer offset income or loss resulting from changes in the value of the Corresponding Liabilities and the income and losses on the Corresponding Liabilities would be included in AFSI.
ACLI identified the potential impact of section 56A(c)(2)(C) and (D) in its September 27 comment letter and engaged with Treasury and the IRS to address the issue. Notice 2023-20, described in a separate article entitled “2022 Tax Legislation Affects a Number of Large Life Insurers” in this issue of TAXING TIMES, provides a description of guidance on this issue.
Distortions Arising from an Accounting Construct in FWH/Modco
ACLI also commented on potential distortions arising from an accounting construct in FWH/Modco arrangements. In a typical coinsurance arrangement, the assets supporting the reinsured liability are transferred to the reinsurer and the reinsurer generally earns any investment income on those assets. However, in FWH/Modco reinsurance arrangements, the assets supporting reinsurance liabilities are retained by the ceding company (Retained Assets). Both the ceding company and the reinsurer establish payables or receivables so that the net economic impact on the companies’ balance sheets has the same economic impact of a coinsurance arrangement.
Assets supporting general account reserve liabilities and Retained Assets are predominately available-for-sale debt securities. For GAAP accounting purposes, insurance companies record changes in the fair value (FV) of available-for-sale debt securities through OCI.[2] For GAAP and IFRS accounting purposes, OCI is not included in AFSI, so changes in the value of the assets supporting general account reserves and Retained Assets are excluded from AFSI.
However, in FWH/Modco arrangements, the change in the FV of the Retained Assets is reflected in net income as an “embedded derivative.”[3] The embedded derivative is generally the amount of the payable by the ceding company or receivable on the reinsurer’s balance sheet attributable to the unrealized gain or loss on the Retained Assets. Because derivatives are generally reported at FV in net income, changes in the FV of the Retained Assets and thus the embedded derivative result in income or loss in AFSI.
The embedded derivative accounting concept for FWH/Modco results in a distortion in the computation of AFSI because the change in FV that is required to be recorded for the embedded derivative and reported through net income relates to the changes in FV of the reinsurance assets that are reported through OCI for coinsurance. The embedded derivative is an accounting construct that simply passes through the income statements of the ceding company and the reinsurer from the ceding company’s OCI income or loss on assets supporting the reinsured liabilities to the reinsurer.
The ACLI noted this distortion in its September 27 letter to Treasury and the IRS and in discussions with the government. Treasury and the IRS then addressed the distortion in Notice 2023-20, described in a separate article entitled “2022 Tax Legislation Affects a Number of Large Life Insurers” in this issue of TAXING TIMES.
Government Requests for Comments Relating to MTM Accounting
In Questions (18) and (19) of Section 9.02 of Notice 2023-7, Treasury and the IRS asked whether unrealized gains and losses should be included in AFSI and if whether that determination should depend on whether an item of income or loss is marked to market for regular tax purposes. The ACLI generally supports the exclusion of unrealized gains and losses from AFSI, but some situations may require use of MTM accounting to ensure that asset gains and losses on the one hand, and corresponding items on the other, are appropriately matched, such as in situations where liabilities also are marked to market.
Government Requests for Comments Pertaining to the Inclusion of OCI in AFSI
Question (16) of Notice 2023-7, Section 9.02, asked if items included in OCI should be included in AFSI. In its comments, ACLI recommended against including any items included in OCI in AFSI, expect those amounts necessary to prevent mismatches or distortions in the computation of a taxpayer’s AFSI. ACLI explained that to do so would be contrary to the plain meaning of the statute and Congressional intent. Under section 56A(a), AFSI is based on a corporation’s net income. Because net income and OCI are separate components of “total comprehensive income,” AFSI could not include OCI. Additionally, in a colloquy between Senator Cardin (D-Md.) and Senator Wyden (D-Ore.) during consideration of the legislative statute on CAMT, Senator Cardin asked whether it was intended that OCI be included in AFSI. Senator Wyden responded that it was not. Moreover, for GAAP accounting purposes, OCI is not included in the computation of earnings per share, which is the measure of income reported to common stockholders.[4]
Accounting for Partnership Income in the Determination of AFSI
ACLI’s comments responding to Section 9 of Notice 2023-7’s requests for comments on partnerships focused primarily on accounting for noncontrolling interests in partnerships. Section 56A(c)(2)(D) requires that a corporation’s AFSI include the corporation’s distributive share of the AFSI of a partnership in which the corporation is a partner. Life insurers are disproportionately affected by the CAMT provisions for partnership income or loss, due to the significant number and aggregate amounts of investments life insurers make in partnership form. Numerous life insurers are partners in 1,000 or more partnerships. Insurance companies’ ownership interests in these partnerships are usually investments representing a small percentage of the entire partnership. Because life insurance companies are invested in so many partnerships, how partnerships are accounted for in AFSI is of great importance to the life insurance industry.
How a partner’s income with respect to a partnership interest is reported on the partner’s financial statement depends on the level of control the partner has over the partnership. If a partner has a controlling interest in a partnership, then the partnership is consolidated on the partner’s financial statement for GAAP and IFRS accounting purposes. However, the majority of partnership investments insurers own are small noncontrolling interests because insurers lack the requisite control to consolidate these investments.
While a partner with a controlling interest in a partnership may be able to obtain information to calculate AFSI, for partners holding noncontrolling interests, obtaining accurate information to calculate AFSI can be much more difficult. Investment partnerships do not have a consistent financial statement reporting methodology and partnerships’ financial statements usually do not include the information necessary to compute AFSI. Additionally, noncontrolling partners may not have access to a partnership’s financial statements or be able to obtain additional detailed information.
Because Schedule K-1 is readily available and will not impose any additional burden on partnerships, ACLI recommended in comments responding to Notice 2023-7 that the IRS allow partners with noncontrolling partnership interests to use Schedule K-1 to determine its distributive share of partnership AFSI.[5]
For partnerships in which partners hold a controlling interest, ACLI recommended that the partner's share of partnership income that is included in “net income attributable to the company” on the insurer’s financial statement (adjusted to take into account any necessary AFSI adjustments) should be used. ACLI interprets the CAMT requirement to begin the computation of AFSI with net income or loss of the taxpayer set forth in the taxpayer’s applicable financial statement to mean net income attributable to the company reduced by the income attributable to the noncontrolling interests of other partners.
In addition to how partnership income is accounted for in AFSI, it is important that a partner’s foreign tax credits included in its distributive share of partnership foreign tax credits be available as a credit against all federal taxes imposed on taxable income, including the CAMT.
Accounting for Acquisitions and Dispositions
Section 3 of Notice 2023-7 describes rules to address issues under the CAMT regarding Subchapter C and Subchapter K of the Internal Revenue Code, troubled corporations, and tax consolidated groups. ACLI commented in its September 27 letter that there are many aspects of acquisitions and dispositions of insurance business that are unique, including the use of reinsurance. ACLI may provide comments on future guidance relating to acquisitions and dispositions if there is a potential impact to items important to life insurers.
Changes in Accounting Standards
While guidance relating to changes in accounting standards will eventually be needed for all corporate taxpayers, the need is acute for life insurance companies due to the effective date of the implementation of LDTI for GAAP accounting and IFRS 17 for IFRS accounting on Jan. 1, 2023 for large public companies, commensurate with the implementation of the CAMT tax regime. Notice 2023-7 did not request comments relating to changes in accounting standards specifically. However, ACLI submitted a separate letter requesting guidance on changes in accounting standards due to the importance of the issue to the industry and insurer’s urgent need for such guidance.
Under the new accounting standards, prior period revisions that are required to allow for the comparison of financial statements filed before and after the changes in accounting standards will be necessary for 2021 and 2022 for GAAP and 2022 for IFRS. Under section 59(k), status as an Applicable Corporation is determined based on average AFSI over a 3-year period. For 2023, the 3-year period is 2020 through 2022. For insurance companies transitioning to LDTI or IFRS 17, guidance is needed as to whether financial statements used in the 3-year test are the originally-filed statements or the retrospectively revised amounts for the accounting standard change. ACLI recommended that the originally-filed financial statements be used because, among other reasons, they are readily available at the time a taxpayer makes estimated payments and files a tax return and represent the amounts originally reported to shareholders.
In addition to the impact to the applicable corporation test, the accounting standard changes required by IFRS 17 will result in tens of billions of dollars of cumulative effect adjustments to IFRS net assets across the life insurance industries. This affects many foreign-parented U.S. life insurers which are subject to a lower income threshold of the U.S. members of the worldwide group for applicability of the CAMT. For most companies, the changes required by IFRS 17 will result in a decrease in beginning-of-year retained earnings by removing earnings that were reported in prior years. These adjustments to retained earnings will then flow back through net income again in future years over the life of the insurance contracts, creating a duplication of income from the accounting standard change. Without a section 481(a)-like adjustment of the type authorized by section 56A(c)(15)(A), the cumulative effect adjustment would result in a duplication of income or expense for AFSI purposes. ACLI recommended a 15-year 481-like spread for the cumulative effect adjustment to retained earnings to prevent any such duplication or omission.
Application of the Life-nonlife Rules
ACLI’s comments in response to Notice 2023-7 also expanded on the issues that we first raised in our Sept. 27, 2022 comment letter, arising from the application of the life-nonlife rules. The consolidated return rules include provisions unique to life insurance companies, including limitations on when a life insurance company can join in filing a consolidated return with nonlife insurance companies under section 1504(b)(2) and (c)(2) and the extent to which the losses of nonlife insurance and life insurance members of the consolidated group can be used to offset each other under section 1503(c) and the regulations thereunder. The life-nonlife consolidated return limitations do not apply for computing AFSI. Because of the interaction of the CAMT statute and the regular consolidated tax return calculation, the limitations on when a life insurance company can join in the filing of a consolidated return with nonlife insurance companies can result in a subsidiary’s earnings that are paid as a dividend being included in AFSI multiple times and distort the income of corporations that join in the filing of a consolidated financial statement, but are not permitted to file a consolidated tax return. Additionally, the limitations on losses can result in a double deferral of losses, once when they are deferred under the life-nonlife rules and a second time when the deferred losses cause CAMT and create a CAMT carryover that lengthens the time when companies are able to use their economic losses. ACLI has recommended several narrow modifications to the comparison of life insurance companies’ CAMT liability and regular tax liability or to the computation of AFSI under section 56A to prevent duplications, omissions, and distortions resulting from the application of the life-nonlife rules.
Inconsistency Between the CAMT and Regular Tax in the Carryback and Carryforward of Losses
Another item for which Treasury and the IRS did not specifically request comments, which ACLI addressed in our comments responding to Notice 2023-7, was the inconsistency between the CAMT and regular tax in the carryback and carryforward of losses. Section 56A(d), permits the carryfoward of a net loss on a taxpayer’s applicable financial statement, but does not permit a carryback. For regular tax purposes, life insurance companies are required under section 1211(a) to carry back capital losses up to three years. If capital loss carrybacks are required for regular tax, but not for CAMT, distortions are created when regular tax liability is decreased in carryback years in comparison to CAMT, potentially resulting in CAMT liability. This disproportionately impacts life insurers because investment activities are core to the overall business model and creates a higher likelihood for capital losses. For purposes of calculating the CAMT, carrying back AFSI related losses to the same years to which tax losses are carried would result in greater consistency in treatment of completed transactions and would conform to the treatment of loss carryforwards.
Life Insurer Foreign Tax Credits from Foreign Countries with Non-Calendar Tax Years
ACLI also raised a new issue in our response to Notice 2023-7, relating to life insurer foreign tax credits from foreign countries with non-calendar tax years. Some foreign countries have non-calendar tax years. Guidance is needed for life insurance companies with operations in foreign countries with non-calendar tax years to ensure a full corporate AMT foreign tax credit is allowed. To the extent a controlled foreign corporation (CFC) has a tax year that is different than their tax year for U.S. tax purposes, CFCs (or the United States shareholders of such CFCs) and branches should be allowed to choose to apportion foreign taxes actually paid on a closing-of-the-books basis for purposes of calculating the corporate AMT foreign tax credit so that a full calendar year of foreign taxes paid are creditable for CAMT purposes.
ACLI will continue dialogue with the government on these issues as well as with respect to any new issues that arise from future guidance that is issued.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.
Regina Rose is senior vice president, Taxes and Retirement Security, for the American Council of Life Insurers and may be reached at reginarose@acli.com.
Sarah Lashley is assistant vice president, Taxes and Retirement Security, for the American Council of Life Insurers and may be reached at sarahlashley@acli.com.
[1] 2023-3 I.R.B. 390 (Jan. 17, 2023). Notice 2023-7 was the first formal guidance issued by Treasury and IRS on the CAMT.
[2] If the insurance company makes a fair value election, the available for sale debt securities are carried at FV with changes in FV reported through net income.
[4] Basic EPS is computed under ASC 260-10-45-10 as the income available to common stockholders divided by the weighted average number of common stock shares.
[5] A special rule may be needed for a foreign owned interest in a foreign partnership. As a practical matter, where there is no Schedule K-1—and possibly no determination of US status as a partnership—some other measure, such as earnings and profits attributable to the interest may be the only feasible approach for purposes of determining applicable corporation status.