Continuing developments in the taxation of insurance companies

Transcription

1 Continuing developments in the taxation of insurance companies 2012: The year in review FPO

2

3 Table of contents The year in review 1 Legislation 6 Federal 7 International 14 Multi-state 16 Tax accounting 34 Appendix A 39 Appendix B 43

4 The heart of the matter The American Taxpayer Relief Act of 2012 addressed certain fiscal cliff issues, but continued debate over federal deficits and spending will be a key factor in consideration for 2013 tax legislation and efforts to reform US tax laws. Continuing developments in the taxation of insurance companies

5 The year in review After a year-long, heated political campaign, on November 6, 2012, President Barack Obama was re-elected for a second term. For the insurance industry, the re-election of President Obama reaffirmed the future of the Affordable Care Act (ACA), the 2010 law that makes significant changes to the US healthcare system and creates regulated insurance exchanges where individuals and small businesses may purchase health insurance coverage. However, as the President entered his second term, harsh financial pressures a looming $600 billion fiscal cliff and a growing longterm debt continued to add to an already challenging implementation plan. According to the Congressional Budget Office, the ACA reduces the deficit over the next decade, a finding that helps President Obama protect core elements of the law. At the same time, the President himself has indicated a willingness to reduce federal health spending, raising the prospect of tighter margins for the industry. While the American Taxpayer Relief Act of 2012 addressed certain fiscal cliff issues, continued debate over federal deficits, revenues, and spending will continue to be a key factor in consideration of 2013 tax legislation and efforts to reform US tax laws to promote economic growth and competitiveness. As expected, fiscal policy dominated legislative discussions in early 2013 as President Obama began his second term and the 113th Congress was underway. The Obama Administration and Congress continue to address automatic spending reductions ( sequestration ), the expiration of a temporary funding measure for federal departments and agencies, and a federal debt limit that was suspended through May 18. President Obama and Congressional leaders continue to call for tax reform. While permanent extension of individual tax rates no longer is a primary driver of tax reform efforts, a more competitive and streamlined tax code is seen as a way to promote growth and, for some, as a way to reduce the deficit or provide revenue to support federal programs and services. However, until the debate over the debt limit, spending cuts, and funding for federal departments and agencies is resolved, it is difficult to foresee Congress having time to focus on business tax reform. On April 10, President Obama submitted to Congress a $3.77 trillion federal budget for Fiscal Year The budget separates the Administration s revenue proposals into three categories tax reform, deficit reduction, and offsets for certain tax relief proposals and new programs. The President s budget asks Congress to immediately begin the process of reforming the individual and business tax systems. The budget includes a number of international and insurance industry tax reform proposals estimated to raise $157 billion and $30.5 billion, respectively, over 10 years. Of specific importance to foreign-owned US insurance companies is a provision that limits deductions for reinsurance premiums paid by a US insurance company to its foreign affiliates. The provision is similar to previous budget proposals, as well as to the Neal Bill originally introduced by Congressman Richard Neal (D-MA) in Under this proposal, a US insurer with an affiliate that is based abroad and not subject to US tax law, could not deduct as an expense reinsurance premiums paid to that affiliate. See WNTS Insight, Obama Administration FY 2014 budget focuses on tax reform, deficit reduction, and new initiatives, April 10, 2013, and Insurance Tax Bulletin, Budget proposal to disallow deduction for reinsurance premiums paid to affiliates; other insurance tax provisions, April 11, 2013, for more information on the President s FY 2014 budget. Meanwhile, the Senate has confirmed the President s nominees for several key positions, including Secretary of the Treasury. President Obama on January 10 nominated White House chief of staff Jacob (Jack) Lew to succeed Timothy Geithner as Treasury Secretary. With Douglas Shulman s retirement as IRS Commissioner in November 2012, President Obama this year is expected to nominate a new IRS Commissioner to a five-year term. 2012: The year in review 1

6 American Taxpayer Relief Act of 2012 President Obama on January 2 signed into law the American Taxpayer Relief Act of 2012 (the Act ). The Act includes perm anent extensions of certain 2001 and 2003 tax provisions for individuals with income below $400,000, and joint filers with income below $450,000. For individuals whose taxable income exceeds these thresholds, the top income tax bracket will be 39.6% and dividends and longterm capital gains will be taxed at 20% (an additional 0.9% health insurance wage tax and 3.8% net investment income tax also became effective in 2013 under health care legislation enacted in 2010). Other provisions of the Act include permanent indexing of individual alternative minimum tax (AMT) exemption levels for 2012 and subsequent years, and a reinstatement of a personal exemption phaseout (PEP) and phaseout of itemized deductions for single filers (Pease) with adjusted gross income above $250,000 ($300,000 for joint filers). The legislation also permanently extends the $5 million per-person estate and gift tax exemption (indexed for inflation) and provides a top estate and gift tax rate of 40%. In addition, the Act extends through 2013 a 50% bonus depreciation provision for qualified property, and also includes extensions through 2013 of certain expired business and energy tax provisions. Business tax provisions renewed retroactively include the research credit (with modifications); look-through treatment for payments between related controlled foreign corporations (CFCs); the Subpart F exception for active financing income; 15-year straight-line cost recovery for qualified leasehold, retail, and restaurant improvements; and certain other provisions that expired at the end of The Act also extends through 2013 a federal deduction for individual state sales taxes, tax-free charity IRA rollovers, and certain other temporary individual provisions. In addition, the Act provides for a temporary Roth IRA conversion period. See WNTS Insight, New tax law extends business tax incentives, January 3, 2013, for a list of the tax provisions included in the Act. Debt ceiling Former Treasury Secretary Timothy Geithner early this year informed House and Senate leaders that the federal government s $ trillion statutory debt limit was reached on December 31, 2012, and that Treasury had begun taking extraordinary measures to postpone the date on which the United States would otherwise default on its legal obligations. A temporary suspension of the statutory debt limit expired on May 18, but economists projected that the Treasury Department could rely on extraordinary measures to meet the government s obligations until October. The improved deficit forecast was detailed in a Congressional Budget Office (CBO) report released on May 14 containing updated projections of federal government revenues and outlays through In a May 20 letter, Treasury Secretary Jack Lew informed Congress that the Treasury Department has begun to utilize such extraordinary measures following the reinstatement of the debt limit. The debate over raising the debt limit will continue during 2013 and the House is expected to consider debt ceiling prioritization legislation (H.R. 807, as amended by the House Ways and Means Committee). House Republicans have called for linking a future increase in the statutory debt limit to action on tax reform legislation. Republican leaders have suggested considering debt limit legislation before the August recess that would set forth GOP budget priorities. There are 55 remaining federal tax extender provisions set to expire at the end of An additional 25 provisions are scheduled to expire at various points over the coming decade. 2 Continuing developments in the taxation of insurance companies

7 Sequestration The Budget Control Act of 2011 reduces federal discretionary spending by $1 trillion over 10 years, and provides for an additional $1.2 trillion in automatic defense and non-defense spending cuts that had been set to begin on January 2, 2013, if Congress could not agree on alternative proposals providing an equal amount of deficit reduction. While unable to agree on alternative proposals for deficit reduction, Congress did pass the American Taxpayer Relief Act of 2012 which delayed the automatic across-the-board sequestration spending cuts until March 1st. Despite multiple meetings between the President and Congressional leaders, no agreement was reached to avert the March 1st implementation of the scheduled spending cuts. In the Senate, neither the Democratic nor Republican proposals to address sequestration received the 60 votes needed to move forward. On March 26, to avoid the imminent partial shutdown of the federal government, President Obama signed into law a bill (H.R. 933) to fund the federal government through the end of FY 2013 (September 30). However, the bill included an amendment, approved previously by the House, to maintain the sequestration automatic spending cuts. H.R. 933 also provided increased discretion and greater flexibility to certain government agencies in implementing the sequestration spending cuts. For example, the IRS on April 19 informed employees that they would be furloughed for up to seven days, and that the first enacted furlough days would be May 24, June 14, July 5, July 22, and August 30, with another two days possible in August or September. The White House Office of Management and Budget issued a memorandum on April 4 noting that the Administration will continue to urge Congress to take action to eliminate the sequestration cuts as part of a balanced agreement on deficit reduction. Congressional budgets The Republican-controlled House on March 21, by a largely party-line vote of 221 to 207, approved an FY 2014 budget resolution that would balance the budget over 10 years through spending cuts only and no additional revenue. The House budget resolution calls for revenue-neutral tax reform in 2013 that reduces the top tax rates on individuals and corporations to 25% and transitions the tax code to a more competitive system of international taxation. The Senate on March 23 voted 50 to 49 to approve an FY 2014 budget resolution. The Senate-passed budget would reduce federal budget deficits by $1.85 trillion over 10 years, through $975 billion in new revenue and $975 billion in spending reductions. Administration, Congressional positions on deficit reduction On December 31, 2012, President Obama stated that we re going to have to do more to reduce our debt and our deficit. While commenting that he was prepared to accept some reductions in the cost of Medicare and other federal programs, President Obama stated it s going to have to be balanced, and that kind of [entitlement] reform has to go hand-in-hand with doing some more work to reform our tax code so that wealthy individuals, the biggest corporations can t take advantage of loopholes and deductions that aren t available...to most Americans. At the start of the 113th Congress, House Speaker John Boehner (R-OH), in his opening remarks to the new House, focused on the need to address the federal debt. Our government has built up too much debt, Speaker Boehner said. Our economy is not producing enough jobs. These are not separate problems. At $16 trillion and rising, our national debt is draining free enterprise and weakening the ship of state. Speaker Boehner, Senate Minority Leader Mitch McConnell (R-KY), and other Republican Congressional leaders have stated that they will not support additional revenue increases as part of any new deficit reduction legislation. 2012: The year in review 3

8 By contrast, Congressional Democratic leaders are expressing support for the Administration s position that revenue increases must accompany reductions in federal spending, especially cuts in Medicare and other mandatory spending programs. Addressing the new Senate on January 3, Majority Leader Harry Reid (D-NV) stated, Any future budget agreements must balance the need for thoughtful spending reductions with revenue from the wealthiest among us and closing wasteful tax loopholes. The need for tax reform The need to strengthen the competitiveness of US firms in the global marketplace together with slow economic growth, high unemployment rates, and projections of significant future budget deficits under current policies has increased interest in tax reform as a way of promoting US economic growth, controlling federal deficits, and spurring job creation. Since Japan reduced its corporate tax rate in April 2012, the United States has had the highest corporate tax rate among advanced economies. The United Kingdom last year announced an additional corporate rate reduction, lowering its rate to 23% effective April 2013, and to 21% effective April Including average state and local levies on top of the 35% federal rate, the combined US rate is 39.1%; the average comparable rate among the other OECD countries was 25% in The United States also is one of the few developed countries to tax foreign earnings under a worldwide tax system. All other G-7 countries and 28 of the 34 OECD countries use territorial tax systems under which all or most foreign dividends are exempt from domestic taxation. Many analysts believe the present US worldwide system reduces the ability of American companies to compete effectively in foreign markets. Others highlight that the present system imposes a substantial tax barrier to repatriation of earnings for use in the US economy, noting that nearly $2 trillion in foreign earnings is held by foreign subsidiaries that cannot be invested in US parents without being subject to US tax. The Senate Permanent Subcommittee on Investigations (PSI) on May 21 held a hearing on offshore profit shifting and the US tax code with testimony by representatives of Apple Corporation, Treasury and IRS officials, and academics. An earlier PSI hearing on offshore profit shifting was held in September 2012 with testimony from representatives of Microsoft and Hewlett-Packard (HP). During the May 21 hearing, Apple CEO Tim Cook and several Senators called for tax reform to make the US tax code more competitive. Following the hearing, PSI Chairman Carl Levin (D-MI) reportedly said that he plans to introduce new legislation to address profit shifting. The PSI hearing memorandum called for strengthening Section 482, reforming check-the-box and look-through rules, taxing CFCs under US management and control, and increased IRS enforcement of certain Subpart F rules. The need to strengthen the competitiveness of US firms in the global marketplace together with slow economic growth, high unemployment rates, and projections of significant future budget deficits under current policies has increased interest in tax reform as a way of promoting US economic growth, controlling federal deficits, and spurring job creation. 4 Continuing developments in the taxation of insurance companies

9 Approaches to tax reform President Obama and Congressional leaders have put forth general tax reform principles in an effort to set the stage for an overhaul of US tax law. Both the President and House Republican leaders are proposing a corporate rate reduction that would be offset by base-broadening measures that is, by limiting or repealing tax deductions, exclusions, credits, or preferences. Because businesses could be affected significantly by emerging tax reform efforts, many companies and trade associations are actively engaged in assessing the potential benefits and risks of tax reform, and have been participating in ongoing Congressional hearings and meetings with Members of Congress and their staff. Senate Finance Chairman Max Baucus (D-MT) stated in a June 11, 2012 address on tax reform goals that any tax reform plan must be developed with a sound budget in mind that reduces deficits and debt. Senator Charles Schumer (D-NY), the third-ranking Senate Democratic leader, recently proposed that tax reform should generate increased revenues for deficit reduction through budget reconciliation legislation, which would require only a 51-vote Senate majority instead of the 60-vote majority generally needed. (See Appendix B for a discussion of the Congressional budget process.) Ultimately, whether deficit reduction should be a goal of tax reform will be a fundamental issue to be resolved by lawmakers. There is disagreement among Members of Congress over whether tax reform should be entirely revenue-neutral or should raise revenue. Allocating part of the revenue from base-broadening measures to deficit reduction would affect the extent to which corporate and individual tax rates could be reduced in revenue-neutral tax reform legislation. During House debate on the American Taxpayer Relief Act, Ways and Means Chairman Dave Camp (R-MI) stated that by making Republican tax cuts permanent, we are one step closer to comprehensive tax reform. This legislation settles the level of revenue Washington should bring in. Next, we need to make the tax code simpler and fairer for families and small businesses, Chairman Camp said. 2012: The year in review 5

10 Legislation Enacted legislation H.R Moving Ahead for Progress in the 21st Century Act (Biggert-Waters Flood Insurance Reform Act of 2012) Reauthorizes the National Flood Insurance Program (NFIP) until September 30, Key changes phase out subsidies on properties with repetitive losses, allow FEMA to purchase reinsurance, allow annual premium increases up to 20%, create a technical mapping advisory council to handle map modernization, and require the development of a plan to repay debt owed by FEMA to the United States Treasury. The act will provide stability in property loan closings and give Congress needed time to address current debt in NFIP and proposed program revisions. H.R National Flood Insurance Program Extension Act Amends the NFIA Act of 1968 to extend the NFIP, including its funding, from May 31, 2012 to July 31, The bill also excluded vacation homes and second homes from receiving subsidized premium rates ( any residential property which is not the primary residence of an individual ). The bill was passed on January 3, H.J. RES. 117 Continuing Appropriations Resolution, 2013 Continues government funding at its current level for federal agencies, programs, and services until March 27, 2013 in order to prevent a government shutdown at the end of the current fiscal year. Section 101 of the resolution also continues funding for the Federal Emergency Management Agency (FEMA) Disaster Relief Fund, which is used in recovery efforts following a natural disaster such as a flood or hurricane. Noteworthy legislation not enacted S Amends the Internal Revenue Code, with respect to the tax treatment of certain life insurance contract transactions, to require reporting to the IRS of: (1) identity of persons acquiring a life insurance contract; (2) identity of sellers of a life insurance contract and the seller s investment in the contract; and (3) reportable death benefit payments. The Bill contains three sections: one section would add new Code Section 6050X and conforming amendments; the second section would clarify rules to determine the tax basis of life insurance contracts; and the third section would provide an exception to the transfer for valuable consideration rules. H.R Flood Insurance for Farmers Act of 2012 Would amend the National Flood Insurance Act of 1968 to offset the premiums paid under the National Flood Insurance Program (NFIP) by farmers whose properties are considered at-risk due to substandard levee systems recently downgraded by the FEMA. The act would prohibit FEMA from placing prohibitions, restraints, or conditions, including requiring flood proofing or flood damage mitigation activities or related features, upon either new construction or substantial improvement of an agricultural structure in any area having special flood hazards. H.R A bill to authorize the Administrator of FEMA to waive the 30-day waiting period for flood insurance policies purchased for private properties affected by wildfire on federal lands Would amends the National Flood Insurance Act of 1968 to exempt from the statutory 30-day waiting period for a new contract for flood insurance coverage for private property if: (1) the Administrator of FEMA determines that the property is subject to elevated risk of flood due to wildfire on federal land, and (2) the coverage was purchased within 60 days after the fire containment date for the wildfire that caused the elevated flood risk. H.R Insurance Consumer Protection and Solvency Act of 2012 Would amend the Dodd-Frank Wall Street Reform and Consumer Protection Act to exclude an insurance company from the definition of a financial company. S Terminating the Expansion of Too Big to Fail Act of 2012 Would amend the Financial Stability Act of 2010, Title I of the Dodd-Frank Wall Street Reform and Consumer Protection Act, with the intention of stopping federal regulation from spreading to non-banking institutions. The bill would eliminate the duty of the Financial Stability Oversight Council to identify systemically important financial market utilities and payment, clearing, and settlement activities. 6 Continuing developments in the taxation of insurance companies

11 Federal Life-nonlife consolidations Tacking rule In PLR , Parent is the common parent of an affiliated group of corporations that includes life companies and non-life companies. Parent was organized in Year 1, and since Year 4, the Parent Group has filed a consolidated life/non-life federal income tax return. Sub is a subsidiary of Lifeco, which is a life insurance company and a whollyowned subsidiary of Parent. Through Year 4, Sub did not conduct an insurance business but held investment assets all of which were contributed by Lifeco as capital. In Year 5, Sub will begin writing insurance contracts that will require life insurance reserves under Section 816(b), such as reserves required by law and policies covering life, accident, and health insurance premiums combined in one policy issued on the weekly payment plan, continuing for life, and not subject to cancellation. Given the nature of Sub s activities, the IRS ruled that in Year 5, Sub qualifies as an eligible corporation to be included as a life member of the life subgroup of the parent s consolidated group. Alternative minimum tax In State Farm Mutual Automobile Insurance Company v. Commissioner, 698 F.3d 357 (7th Cir. 2012), the Seventh Circuit Court of Appeals affirmed the Tax Court s decision that the revised alternative minimum tax (AMT) computation that the Taxpayer proposed during prior litigation for the calculation of its AMT liability was improper (See 130 T.C. 263 (2008)). The Taxpayer argued that Congress intended the AMT calculation to better approximate book income and that the applicable regulations were ambiguous with respect to the calculation of the AMT liability for consolidated life and non-life groups. The Court rejected that argument stating that the issue revolved around the proper determination of AMT income before the adjusted current earnings (ACE) adjustment as used in the ACE adjustment, and in conjunction with the application of the life/non-life consolidated return rules, noting that there were two basic approaches: subgroup, which results in a direct calculation of the ACE adjustment per subgroup, or consolidated, which requires an allocation of the consolidated ACE adjustment to the subgroups. Moreover, the Court noted that the Taxpayer would assign different meanings to the same term pre-ace alternative minimum taxable income, or pamti and the Taxpayer failed to apply the normal practice of statutory construction by giving the same meaning to a term or phrase throughout a statute. Consequently, the Court affirmed the ruling of the Tax Court that held in favor of the consolidated approach. Definition of an insurance company Section 831 In PLR , the IRS ruled that a company in the business of providing roadside assistance coverage to policyholders of unrelated property and casualty insurers qualifies to be taxed as an insurance company under Section 831. Taxpayer provides motorists with roadside assistance under risk- and non-risk-based contracts. These services are provided through a network of independent contractor towing operators and locksmiths paid on a fee-for-service basis, with risk-based contracts solicited directly and through credit card issuers and other channels. In this ruling, the IRS concluded that because Taxpayer accepted a very large number of unrelated, independent, homogeneous risk-based roadside assistance contracts, the taxpayer achieved the requisite risk distribution, and that the contracts constitute insurance for federal income tax purposes. Residual value insurance A case recently docketed at the Tax Court, R.V.I. Guaranty Co., Ltd. v. Commissioner, T.C. Docket No , will decide whether residual value insurance (RVI) contracts are insurance for federal tax purposes. The case follows a technical advice memorandum issued in 2011 (TAM ) in which the IRS concluded that RVI policies that insure assets against market decreases are not insurance contracts. The IRS said that the RVI contracts were similar to insurance contracts but they did not represent insurance in its commonly accepted form. If the Tax Court holds that RVI contracts are not insurance, it could change the way compensatory damages and punitive damages are viewed under the NAIC rules for insurers unpaid loss reserves. The Court s ruling could affect all types of insurance contracts, not only RVI contracts. The R.V.I. trial is scheduled to begin in April : The year in review 7

12 Exempt status Section 501(c)(9) In PLR , the IRS ruled that an insurance trust failed to meet the burden of proof required for exemption from federal income taxes as required by Section 501(c)(9). The IRS concluded that the Trust did not function primarily as a Voluntary Employees Beneficiary Association because it was not an association of employees whose eligibility is determined by objective standards constituting an employment-related common bond among such individuals. Membership was not defined by reference to a common employer, affiliated employers, and coverage under a collective bargaining agreement, or a labor union. In addition, the IRS determined that the Trust failed to satisfy the requirement that it does not discriminate in favor of highly compensated individuals because it did not maintain adequate compensation records. Section 501(c)(29) The IRS issued temporary regulations (T.D. 9574) that provide the IRS with the authority to determine the procedures for the application for recognition as a Section 501(c)(29) qualified nonprofit health insurance issuer (QNHII) to benefit from federal income tax exemption status for organizations that participate in the Consumer Operated and Oriented Plan (COOP) programs established by the Centers for Medicare and Medicaid Services. The Temporary Regulations serve to address the requirements of Section 501(c)(29), which was added by Section 1322(h) of the Patient Protection Affordable Care Act of March 23, The Temporary Regulations provide that unless an organization notifies the Commissioner that it is applying for QNHII treatment under Section 501(c)(29) and in the manner prescribed by the Commissioner in published guidance which has not yet been published the organization will not be treated as a QNHII. Moreover, for an organization to qualify as a QNHII for purposes of federal income tax exempt status at a date earlier than the date of issuance of the required notice to the Commissioner, the organization s purposes and activities prior to the notice must accord with the requirements set forth under Section 501(c)(29). However, an organization may not receive such status before the later of its formation or March 23, The Temporary Regulations are effective from February 7, 2012, and expire on February 6, Policyholder dividends Dividend deduction In Massachusetts Mutual Life Insurance Company v. United States, Fed. Cl., No T (1/30/12), the Court ruled that a deduction for the declared guaranteed minimum amount of policyholder dividends is allowed in the year of declaration. The IRS argued that the Taxpayer lacked evidence to show that it was obliged to pay the entire guaranteed amount and that there was not an identifiable group of policyholders eligible to receive the dividend guarantee in the year the resolutions were adopted. Furthermore, the Taxpayer had no liability to pay the entire guarantee amount until a later event occurred and that event was not simply the passage of time and the preservation of the status quo, observing that the Board could reverse itself and the Insurance Commissioner could prevent the payment. The Taxpayer countered the arguments citing court rulings, such as Washington Post Co. v. United States in which the Court declared that although a liability does not accrue, as long as it remains contingent, uncertainties unrelated to the fixing of the amount of the liability do not prevent the Taxpayer from meeting the all-events test. The Taxpayer argued that the liability was, in fact, fixed with the Board s resolution. Ultimately, the Court ruled in favor of the Taxpayer, stating that the matching requirement under Section 461(h) was met and that the criteria for economic performance were satisfied. The Court concluded that dividend guarantees created an unconditional obligation to pay dividends the following year and were not subject to a condition precedent. Moreover, neither the IRS s concerns about enforceability or revocability prevented the liability from being fixed in the year in which the dividend guarantees were declared. With that, the Court ruled that the deductions the Taxpayer claimed with regard to policyholder dividends were allowable. 8 Continuing developments in the taxation of insurance companies

13 Insurance premiums Risk distribution The Fifth Circuit Court ruled in F.W. Services v. Commissioner, 5th Cir., No (1/25/12), that monetary funds paid to insurer by a business and held for reimbursement purposes were not insurance premiums because the contract lacked adequate risk distribution. Therefore, the Taxpayer did not meet the statutory requirements for deduction under Section 162(a). Taxpayer, a temporary personnel agency, purchased two insurance policies from insurer. Both policies contained a loss reimbursement endorsement requiring the Taxpayer to reimburse the insurance company for each claim. Taxpayer engaged with a third party to make payments to insurer on its behalf. Per the agreement, if the payments made exceeded the final premium at the end of the contract, then the Taxpayer would receive reimbursement for the difference; if payments were less, then the Taxpayer would make additional payments. At the end of the contract, the Taxpayer deducted the entire premium paid on the two policies under Section 162(a), for which the IRS issued a notice stating that the payments were not deductible as insurance premiums. Furthermore, the Court ruled that the payments did not constitute insurance premiums because the Taxpayer s contract with the third party lacked adequate risk distribution. Taxpayer cited Helvering v. Le Gierse, 312 US 531 (1941), highlighting that its contracts with the insurer and the third party, when read together, proves a shift in risk. However, the Court ruled that reading the contracts together does not warrant an adequate shift in risk and thus is not insurance. Consequently, the Court ruled that payments made to insurer and held for reimbursement purposes were not insurance premiums because the third-party contract lacked a shift in risk. Priority guidance plan The IRS and Treasury released an update to the priority guidance plan, noting the addition of 10 projects between January 1 and March 31, The original plan, released November 19, 2012, included 317 projects identified as priorities for the July 2012 June 2013 plan year. Priority guidance plan projects related to insurance companies and products include the following (two of which have been completed): Final regulations under Section 72 on the exchange of property for an annuity contract. Proposed regulations were published on October 18, Guidance on annuity contracts with a long-term care insurance rider under Sections 72 and 7702B. Revenue Ruling under Section 801 addressing the application of Revenue Ruling or Revenue Ruling to health insurance arrangements that are sponsored by a single employer. Guidance to clarify which table to use for Section 807(d) (2) purposes when there is more than one applicable table in the 2001 CSO mortality table. Notice clarifying whether deficiency reserves should be taken into account in computing statutory reserves under Section 807(d)(6). This was published on April 1, 2013, as Notice Revenue Ruling on the determination of the company s share and policyholder s share of the net investment income of a life insurance company under Section 812. Guidance clarifying whether the Conditional Tail Expectation Amount computed under AG 43 should be taken into account for purposes of the Reserve Ratio Test under Section 816(a) and the Statutory Reserve Cap under Section 807(d)(6). Regulations under Section 833 to establish the method to be used by Blue Cross Blue Shield entities in determining the medical loss ratio required by that section. This was published on May 13 as REG under Treas. Reg. sec : The year in review 9

14 Guidance on exchanges under Section 1035 of annuities for long-term care insurance contracts. Regulations under Section 7702 defining cash surrender value. Regulations under Section 882 regarding inbound transactions involving insurance companies. Despite industry requests, the Priority Guidance Plan does not include any mention of guidance concerning Life Principles-Based Reserves. The IRS and Treasury s priority guidance plan contains 10 projects related to insurance companies and products that are identified as priorities for the July 2012 June 2013 plan year. Bad-debt deductions The Large Business and International (LB&I) Division of the IRS released an Industry Director Directive (IDD) allowing insurance companies to elect what is effectively a safe harbor for partial worthlessness deductions with respect to loan-backed and structured securities as defined in Statement of Statutory Accounting Principle (SSAP) 43R. The new safe harbor is patterned after the safe harbor under Treas. Reg. Section (d). Taxpayers are permitted to make this one-time election going back to the 2009 taxable year, through the 2012 taxable year, with a true-up adjustment and full audit protection for years prior to, and including, the year of election. The safe harbor method prescribed by the IDD requires conformity with the statutory accounting treatment for impairment of loanbacked securities for which a deduction would be allowed under Section 166. The safe harbor method requires that, except to the extent of any market-related impairment, postimpairment tax basis will equal post-impairment statutory carrying value. Life insurance products Life insurance contracts In PLR , the IRS concluded that a reduction in the face amount of a life insurance contract was not an alteration under the terms of the contract. Instead, the reduction in face amount was treated as the issuance of a new contract as of the date of alteration. As a result, the contract was required to be retested under Section 7702 using the 2001 CSO mortality tables to determine whether the contract qualified as a life insurance contract for Federal income tax purposes. Corporate-owned life insurance Notice and consent requirements In PLR , the IRS ruled that corporate-owned life insurance policies purchased by a closely held corporation on the lives of its shareholders sufficiently satisfied the notice and consent requirements of Section 101(j)(4). Taxpayer is a closely held corporation whose shareholders are also its employees. Taxpayer executed an agreement with each shareholder providing that Taxpayer will obtain life insurance on the life of each shareholder, and that Taxpayer will be the owner and beneficiary of the life insurance. Prior to purchasing these life insurance contracts, Taxpayer did not obtain separate documentation from each affected shareholder. However, Taxpayer obtained separate documentation after purchasing these life insurance contracts. The IRS found that through the agreement and the application, each shareholder was informed in writing that Taxpayer will be a beneficiary of any proceeds payable upon the death of the shareholder. The IRS considered all of the documentation as a whole, and ruled that the requirements of Section 101(j)(4) were met. 10 Continuing developments in the taxation of insurance companies

15 Transfer of BOLI policies In PLR , the IRS ruled that the transfer of life insurance policies by two banks to a limited liability company (LLC) in exchange for membership interests in the LLC will not be treated as a transfer to an investment company, within the meaning of Section 351, if the company was already incorporated. The IRS also addressed the tax implications of the deductibility of unrelated interest expenses under Section 264(f)(1) and the status of each bank under Section 264(f)(8). The LLC in this case has three member-partners, two of which are banks. The banks own life insurance policies on the lives of current and former employees. Some of the banks policies are general account life insurance policies (general account BOLI) and some are separate account life insurance policies (separate account BOLI). The banks will transfer some of their respective general account and separate account BOLI to the LLC solely in exchange for membership interests. The LLC s third member-partner will manage the BOLI. The LLC has represented that it satisfies the requirements of Section 52 to be treated as a single employer as one of the banks that has less than 50% interest. The IRS concluded that the transfer of the policies to the LLC will not be treated as a transfer to an investment company within the meaning of Section 351, assuming the LLC was incorporated. The IRS also concluded, among other things, that the LLC and one of the banks will be treated as one taxpayer under Section 264(f)(8), while the second bank will be treated separately. Therefore, only the BOLI policies held by the LLC where the LLC is the beneficiary will constitute an employer-owned life insurance contract if the policy covers the life of an insured who is an employee of the LLC or of the first bank. Long-term care benefits rider In PLR , the IRS ruled that a long-term care benefits rider (Rider) added to a single premium deferred annuity contract offered by a stock life insurance company was considered an insurance contract under Section 7702B(b)(1). Taxpayer is a stock life insurance company taxable under Section 801, and is the issuer of certain annuity contracts, which include a single-premium deferred annuity contract. The annuity contract is not a variable contract within the meaning of Section 817(d). Taxpayer proposed to offer a non-cancellable rider option to provide certain long-term care benefits (LTC Benefits) during the time the person covered by the Rider is a chronically ill individual within the meaning of Section 7702B(c)(2) and receives qualified long-term care services within the meaning of Section 7702B(c)(1) through the agency or facility identified in the plan of care. Through the Rider, Taxpayer assumes the risk that the insured will be ineligible for long-term care benefits. The risk assumed by Taxpayer will be distributed across the large number of insureds who purchase the Rider. Accordingly, the IRS concluded that LTC benefits paid under the Rider are excludable from gross income under Section 104(a)(3). After-death distribution option In a pair of letter rulings, PLR and PLR , the IRS ruled that a distribution option under an annuity contract qualifies under Section 72(s) where the option provides for after-death distributions and is available to a non-spouse beneficiary if the owner dies before the annuity has begun. The taxpayers are stock life insurance companies that offer non-qualified deferred variable annuity contracts. The owner of an annuity contract may designate the beneficiaries, who are entitled to the contract s death benefits. The taxpayers developed a new after-death distribution option that would be made available to a non-spouse beneficiary when an annuity contract owner with a guaranteed lifetime withdrawal benefits option with two covered persons, one of whom is the non-spouse beneficiary, dies prior to the contract s annuity starting date. Under Section 72(s), a non-qualified annuity contract will not be treated as an annuity contract for federal income tax purposes unless it provides for certain distributions in the event that the contract holder dies. The IRS found that the intent of Section 72(s) does not prevent the non-spouse beneficiary of a non-qualified annuity contract from electing to be treated for tax purposes as if he or she had received the entire interest. 2012: The year in review 11

16 Captives Definition of insurance The IRS ruled in PLR that a general insurance captive, licensed and organized under the laws of a foreign country, qualified as a domestic insurance company for income tax purposes because the captive was able to demonstrate risk shifting and risk distribution, and that the reinsurance premiums paid to a reinsurance pool are ordinary and necessary business expenses for federal income tax purposes. The taxpayer, a corporation, offers four types of contracts, including a policy covering buildings, business personal property, etc., to various insured corporations that are owned by the taxpayer s sole shareholder. To assist in achieving its overall risk distribution, the taxpayer takes part in a reinsurance pool with 14 unrelated insurers. According to case law, a contract must include both risk shifting and risk distribution in order to constitute insurance. The IRS found that through the taxpayer s arrangement in the reinsurance pool, there were a significant number of unrelated covered entities such that none is paying for a significant portion of their own risk. Thus, the IRS concluded because insurance risks were covered, risk shifting and distributed were achieved and the contracts issued by the taxpayer to its insureds were insurance contracts for tax purposes. Reserves Extracontractual obligations In State Farm Mutual Automobile Insurance Company v. Commissioner, 698 F.3d 357 (7th Cir. 2012), the Seventh Circuit Court of Appeals affirmed and reversed in part a Tax Court decision regarding the tax treatment of bad-faith damage awards that have not been paid and used in determining insurance loss. Previously, the Tax Court ruled that the adverse award for bad-faith damages should not have been included in computing the Taxpayer s insurance loss reserve. The Taxpayer appealed, and the Court ruled that bad-faith awards for compensatory damages should be included in the computation of loss reserves. However, upon reliance on the authoritative guidance issued by the National Association of Insurance Commissioners (NAIC), the Court reasoned that the punitive damages portion of the bad-faith award is a regular business loss deductible only when paid. According to NAIC, only compensatory damages for bad-faith judgments are taken into consideration for calculating unpaid loss reserve, not punitive damages. Loss discount factors Rev. Proc set forth, for purposes of Section 846, the loss payment patterns and discount factors for each property and casualty line of business for the 2012 accident year. These factors are to be used by property and casualty insurance companies in discounting unpaid losses. Rev. Proc set forth, for purposes of Section 832, the salvage discount factors for the 2012 accident year that must be used for each line of business to compute discounted estimated salvage recoverable. All the factors were determined using the applicable interest rate under Section 846(c), which was 2.89%. 12 Continuing developments in the taxation of insurance companies

17 Small insurance company election Effect of a mistaken election In PLR , the IRS denied a taxpayer s request to revoke a mistaken election for treatment as a small insurance company, finding the election invalid since the taxpayer was not an insurance company in the year the election was made. The taxpayer provided home insurance to homeowners, but incurred start-up business expenses and earned interest income only during its first year of operations. The taxpayer inadvertently made the small insurance company election when filing its first-year income tax return, but realized the mistake the next year and requested a ruling for the election to be revoked. The IRS concluded that the election was invalid so it did not need to be revoked. Demutualization In a demutualization transaction, the US District Court of Arizona held in Bennett Dorrance et ux. v. United States, No. 2:09-cv-01284, that the basis of shares received upon the demutualization could be reasonably determined. The Court further ruled that the open transaction doctrine did not apply; noted that it should be used only in rare circumstances; and held that the basis of the shares should be apportioned according to Treas. Reg. Section (a). The court s approach differed from the approach of the Court of Federal Claims in Fisher v. US, 82 Fed. Cl. 780 (Fed. Cl. 2008), and the US District Court for the Central District of California in Reuben v. US, No. CV SJO PJWX. Top Issues: The Insurance Industry in 2013 Top Insurance Industry Issues in 2013 describes in detail the challenges insurers are facing and the strategies they can use to cope with change, manage risk, enhance their operations, and grow. assets/pwc-top-insurance-industry-issues-2013.pdf Strategic Risk Management: Facilitating Risk- Based Insurance Decisions As described in the thought leadership piece, PwC believes that insurers require a strategic risk management (SRM) solution that identifies, assesses, and economically manages potentially enterprise-threatening losses over time. In other words, SRM is a way to mitigate evolving risks before they spiral out of control. assets/pwc-insurance-strategic-risk-management.pdf 2012: The year in review 13

18 International FATCA Final regulations Final regulations for the Foreign Account Tax Compliance Act (FATCA) were released on January 17, The final regulations contain over 500 pages of guidance that will undoubtedly take a significant amount of time to digest and implement for stakeholders including banks, investment funds, insurance companies, and their clients. The final regulations follow the February 2012 release of the proposed regulations, and provide significant clarity on a number of open items the insurance industry had identified in the proposed regulations. While some of the provisions in the final regulations attempt to simplify the impact on the insurance industry, other provisions have ultimately complicated FATCA s impact. FATCA was enacted as part of the Hiring Incentives to Restore Employment Act (HIRE Act) in March 2010 to serve as an administrative tool to prevent and detect US tax evasion and improve taxpayer compliance. As a result, Chapter 4 (Sections ) was added to Subtitle A of the Internal Revenue Code. Chapter 4 expands the US information reporting regime by imposing documentation, withholding, and reporting requirements on payments to Foreign Financial Institutions (FFIs) and Non-Financial Foreign Entities (NFFEs). Taxpayers should begin taking action now by analyzing current policies, procedures, and processes to determine enterprise risk, assess current preparedness, and develop a long-term sustainable implementation roadmap for compliance with FATCA by its effective date of January 1, Captive insurance companies Foreign captive insurance companies may be subject to FATCA as either FFIs or NFFEs. When FATCA was enacted, it was made to be broadly applicable and intentionally capture a variety of entities in order to mitigate increasing offshore tax evasion. While a captive insurance company would not be considered a financial institution in the traditional sense, it may be subject to the reporting and withholding obligations under FATCA. Even if the foreign captive insurance company has made a Section 953(d) election to be treated as a US entity for tax purposes, the company may not qualify as a US person under the final FATCA regulations, leaving it to fall under the FFI or NFFE provisions. Under the FATCA rules for NFFEs, any US source insurance premiums will be considered withholdable payments subject to 30% withholding without valid documentation. Therefore, foreign captive insurance companies should be ready to provide appropriate tax documentation to US withholding agents. FATCA registration The IRS released draft Form 8957, Foreign Account Tax Compliance Act (FATCA) Registration, for public review and comment on April 5, No accompanying instructions were included. Form 8957, when issued in final form, may be used by FFIs to register for FATCA purposes. In the IRS release of the draft Form 8957, the IRS reiterated its intention to utilize an online registration portal for FATCA registration. The portal is expected to be available in July The IRS also released more information about the schema of its so-called December List, a published list of FFIs that have registered with the IRS by October 25 and their corresponding global intermediary identification number (GIIN). The online Portal and Form 8957 (when finalized) will enable FFIs to obtain a GIIN and be included in the list. The final FATCA regulations: 500 pages of guidance downloadable in an easy-to-read format The final FATCA regulations formatted with references is an easy-to-read format from PwC s Global Information Reporting (GIR) practice. The PDF includes bookmarks for major sections, a clickable table of contents, and reference hyperlinks. Read more on FATCA for the insurance industry: How do the final FATCA regulations impact insurers? The insurance industry and FATCA Moving from assessment to implementation: Top 13 in Continuing developments in the taxation of insurance companies

19 Update on IGAs In July 2012, the US Treasury as well as the Treasury Departments of France, Germany, Italy, Spain, and United Kingdom (the G5 countries) released a model intergovernmental agreement (IGA) for implementing the broad-ranging provisions of FATCA. Following the release of the Model Agreement, the US Treasury and United Kingdom s HM Treasury in September 2012 announced the signing of the first IGA. As anticipated, the US-UK IGA closely followed the Model Agreement but specifically identified the UK institutions and products that are seen as presenting a low risk of being used to evade US tax and therefore will be effectively exempt from FATCA requirements. In November 2012, the US Treasury issued a press release announcing that it is working with more than 50 countries and jurisdictions around the world to improve international tax compliance and to efficiently and effectively implement the information reporting and withholding tax provisions of FATCA. According to the Treasury, this development marks an important milestone in establishing a common intergovernmental approach to combating tax evasion. The press release lists jurisdictions in which the Treasury is in the process of finalizing an IGA, as well as those in which it is actively engaged in a dialogue and those it is working with to explore options. Shortly thereafter in November 2012, the US Treasury signed IGAs with Mexico and Denmark. Although the articles and annexes for the Mexico and Denmark IGAs follow a similar format as the Model IGA, some differences do exist. Similar to the US-UK IGA, the most significant differences are contained in Annex II, which is customized to identify the local entities, accounts, and products that present a low risk of being used by US persons to evade US tax. An onslaught of similar IGAs implementing the tax reporting and withholding procedures associated with FATCA are expected in the coming months. Domestic asset liability percentages In Rev. Proc , the IRS provided the domestic asset/liability percentages and domestic investment yields for foreign life insurance companies needed to compute minimum effectively connected net investment income under Section 842(b) for the 2011 tax year. For the 2011 tax year, the relevant domestic asset/liability percentages and domestic yields were: Type of company Domestic asset/liability percentages Domestic investment yields Foreign life insurance companies 166.1% 3.2% Foreign property and liability insurance companies 189.6% 3.2% Transfer pricing In 2011, a Dutch lower court issued a ruling relating to the transfer pricing arrangements between a Dutch vacation resort and its Irish captive insurance company. At the time of reservation, tourists can buy cancellation insurance, which the resort subcontracts to its captive insurance company in Ireland. The Dutch Tax Administration added the entire profit of the Irish captive insurance company to taxable income of the Dutch resort. The Dutch Tax Administration argued that the various agreements between the Netherlands and Ireland were all closely connected and did not change how the cancellation insurance was operated by the group. It also argued that the Irish organization lacked key elements of reinsurance, such as diversification, value creation by reducing costs, and costs of capital as well as asset/liability management. The Court followed the argument of the Dutch Tax Administration that in Ireland only administrative services have been rendered with no insurance or reinsurance activities. It ruled that those services can be rewarded at cost plus a modest mark up. The insurance risk does not require a separate remuneration. The remainder of the Irish insurance profit must be taxed at the Dutch resort. The Court also held that the investment income from the interest on the group loan can be allocated to the Irish captive insurance company. 2012: The year in review 15

20 Multi-state Alabama H.B. 257 (effective 08/01/2012) provides a tax credit for investments in businesses located within qualified low-income communities. The credit is transferable, nonrefundable, and may be used to offset state income, financial institution excise, and premium tax. Any unused portion of the credit may be carried forward to be used in subsequent taxable years. For investments in a downtown core area or central business district, the credit would be 8.33% of the investment for six years beginning the year after investment, for a total of 50%. For investments in other locations, the credit would be 7% of the investment for five years beginning the year after the investment and 4% for the sixth year after the investment, for a total of 38%. The investment is capped at $10 million per affiliated group. H.B. 323 (effective 08/01/2012) provides that each insurer authorized to write insurance in Alabama shall be assessed an annual fee of $200 by the Commissioner of Insurance to fund the operations of the insurance fraud unit. Assessments are due 30 days after the insurer receives written notice from the state. Assessments shall accrue interest at 6% per year on and after the due date. Failure to pay the assessment will result in the suspension or revocation of the insurer s certificate of authority. S.B. 230 (effective 08/01/2012) provides a nonrefundable premium tax credit to insurers for covering homeowners insurance policies with wind coverage in areas covered by the Alabama Insurance Underwriting Association (i.e., the Gulf of Mexico region). The credit is 20% of the insurance premium tax otherwise due on property in Zone 4 and 35% of the premium tax otherwise due on the property in Zones 1, 2, and 3. To qualify for the credit, the premium payment must be 12% less than the premium due by the homeowner under the Alabama Wind Pool Plan. Alaska S.B. 23 (effective 05/30/2012) amends various provisions regarding the film production tax credit available against the income and premium tax by extending the sunset date from July 1, 2013 to July 1, Further, the Department of Revenue is now responsible for the administration, review, and approval of the film production credit (previously, the Department of Commerce, Community, and Economic Development). Additionally, it reduces the minimum amount of film production expenses that eligible taxpayers must incur in Alaska from $100,000 to $75,000 and increases the measurement period from 24 months to 36 months. The maximum credits that may be awarded to all eligible film productions are increased from $100 million for productions before July 1, 2013 to $200 million for productions after June 30, 2013 and before July 1, Arizona H.B amends the quality jobs tax credit against income and insurance premium tax to eliminate the 400 employees-per-employer per-year limitation, but adds a requirement that all hiring must be made within 12 months after the start of the required capital investment. (Credit is applicable retroactively for taxable years beginning after June 30, 2011.) S.B (effective retroactively to taxable years beginning 07/01/2011) revises the new employment tax credit against the premium tax to specify that the credit is allowed against the premium tax liability for increases in full-time employees residing in the state and hired in qualified employment positions in Arizona. The amount of the tax credit is equal to $3,000 for each full-time employee in a qualified position for the first year or partial year of employment (unless hired in the last quarter). Additionally, clarifies that the 5% penalty on failure to remit tax payments via EFT is based on the amount of funds not properly remitted by EFT (versus the tax liability reflected on the return). 16 Continuing developments in the taxation of insurance companies

21 California A.B (effective 01/01/2013) authorizes the Department of Insurance to issue a certificate of authority to Consumer Operated and Oriented Plans (CO-OPs). Further, admitted CO-OPs are subject to the same premium taxes as are imposed on for-profit health insurers with a certificate of authority. A.B (effective 09/22/2012) increases the annual anti-fraud assessment on A&H disability insurance to $0.20 per insured person. Insurer may recover this fee via a policyholder surcharge or through the inclusion of this fee in their premium rates. Regulation Sections (effective 09/21/2012) provide that an insurer may file its premium tax return on a cash basis or an accrual basis; however, the amount of taxes paid must be at least equal to the amount of taxes that would be due for premiums received by the insurer. Further, the return must be filed by the due date for filing a cash-basis return. Once the taxpayer elects to switch from the accrual basis to the cash basis, they may not switch back to accrual in any subsequent tax year. Filing on a part cash and part accrual basis requires an extraordinary event (such as a merger) and Department of Insurance approval. Colorado H.B (effective 08/08/2012) provides changes to the Non Admitted Insurance Act to coincide with the requirements of the federal Nonadmitted and Reinsurance Reform Act of S. 110 (effective 07/01/2012) allows the Commissioner of Insurance to assess a nonrefundable, annual insurance fraud fee upon insurers. Further, it authorizes the Commissioner of Insurance to set a two-tiered fee structure for regulated entities having greater than $1 million in direct written premiums (DWP) and those with under $1 million in DWP. The fee will be a pro rata amount based on prior-year DWP and annually set to approximate the state s legal costs of investigating and prosecuting insurance fraud. The fee cannot exceed $3,000 (currently, the annual fee is $561). Connecticut H.B (effective 12/21/2012) decreases the limitation by which an insurer can reduce its insurance premium tax liability in 2012 through the use of the film production and film production infrastructure tax credits from 55% to 30%. The legislation also protects taxpayers affected by the lower credit limit for the 2012 calendar year from interest penalties for any underpayment of estimated tax. H.B (effective 07/01/2012) expands the health and welfare assessment against insurance companies used to fund the state s childhood immunization program. Under the new legislation, the assessment applies only to those domestic health insurance companies and HMOs that cover basic hospital expenses, basic medical-surgical expenses, major medical expenses, and hospital or medical services. It also excludes life insurers from the assessment, but extends the assessment to 1) licensed third-party administrators (TPAs) that provide administrative services for self-insured health benefit plans, and 2) domestic insurers exempt from TPA licensure that administer self-insured health benefit plans (exempt insurers). TPAs and exempt insurers must pay the assessment on behalf of the health benefit plans they administer. In addition, under current law, any entity aggrieved by the assessment can appeal to the Connecticut Superior Court. DOR Announcement 2012(2) (effective 01/12/2012) Under Connecticut insurance premiums tax law, each insurer that is a member of the Connecticut Insurance Guaranty Association must pay a portion of assessments refunded in December 2011 to the Connecticut Department of Revenue Services on or before February 14, Reg. Section b-1 to b-13 (effective 09/17/2012) Regarding the credit for the conversion of a listed historic commercial or industrial structure for mixed residential and nonresidential use, a taxpayer must recapture 100% of the tax credit if the residential portion of a mixed residential and nonresidential rehabilitation is not completed within the scheduled time frame. Additionally, it is clarified that the Department of Economic and Community Development administers the credit instead of the Connecticut Commission on Culture and Tourism. 2012: The year in review 17

22 Delaware H.B. 275 (effective 01/01/2012) provides the Veterans Opportunity Credit to employers hiring qualified veterans. Credit may be used to offset income, bank, and premium tax. The credit is 10% of the qualified veteran s wages, limited to $1,500 per employee. Employers may take the credit in the year the qualified veteran is hired and the two subsequent tax years. A qualified veteran is someone honorably discharged or currently in the reserves and hired between January 1, 2012 and December 31, S.B. 80 (effective 01/26/2012) increases the annual assessment imposed on all insurance companies licensed in Delaware to fund the operation of the Delaware Insurance Fraud Prevention Bureau to $750 from $500. S.B. 271 (effective 07/01/2012) provides employers that relocate jobs to Delaware an additional way of qualifying for the New Economy Jobs Program tax credit, available against the income, bank, and premium tax. An employer that relocates 200 jobs to Delaware would be eligible to receive a tax credit equal to 25% of the withholding paid by the employer on behalf of the relocated employees. If the employer relocates more than 200 jobs, the size of the tax credit is increased by 0.05% for each employee above the 200-employee threshold, up to a maximum of a 40% tax credit; the equivalent of relocating 500 employees. The bill specifies that the average compensation of the relocated employees must be at least $70,000. In addition, an employer would be able to earn up to an additional 25% tax credit for relocating jobs to redeveloped Brownfield sites and into municipalities and counties identified as targeted growth areas. The measure caps the tax credit at 65% of the withholding paid on behalf of the relocated employees. The tax credit is good for 10 years. Insurers Bulletin No. 55 (effective 09/24/2012) requires property and casualty companies receiving premiums covering risks located in the state to use a geographic information system in order to source premiums to the City of Wilmington, and the counties of New Castle, Kent, and Sussex. All affected companies must have submitted an action plan on their compliance to the state by 12/20/2012. District of Columbia Act (effective 01/01/2013) lowers the electronic funds transfer threshold from $10,000 to $5,000 and provides that the interest on overpayments is equal to the Federal Reserve Primary Discount Rate plus 1%, not to exceed 6% (current rate is 6% through 12/31/2012). Florida H.B. 859 (effective 03/23/2012) increases the total tax credits available under the Florida tax credit scholarship program from $140 million to $229 million for the state s fiscal year. The bill also revises student eligibility requirements for participation in the program. This credit may be taken against the following taxes: corporate income, insurance premium, and severance taxes on oil and gas production; sales tax of direct-pay permit holders; and alcoholic beverage taxes. H.B (effective 07/01/2012) provides a reduction of the recovery via regular assessments by the Citizens Property Insurance Corporation for any projected deficit in the coastal account from 6% to 2% for the prior calendar year. Any remaining projected deficits in personal and commercial lines accounts are recovered through emergency assessments, after taking into account the Citizens policyholder surcharge. H.B (effective 07/01/2012) increases the corporate income and bank franchise tax exemption from $25,000 to $50,000. Bulletin (implemented 12/19/2012) The Florida Surplus Lines Service Office has announced that the service fee imposed on surplus lines agents, surplus lines insurers, and independently procured coverage filers will increase from 0.1% to 0.2% of total gross premiums for new or renewal policies effective on or after April 1, Continuing developments in the taxation of insurance companies

23 Technical Assistance Advisement 12(C)1-005 (05/17/2012) A consolidated group was granted permission to cease filing Florida consolidated corporate income tax returns as a result of the taxpayer s growth and diversification. The taxpayer had grown from a moderately sized domestic entity to a multinational, broad-line entity offering multiple products and services in multiple countries. In addition, the taxpayer s sales force increased dramatically, the taxpayer also increased in size and efficiency, and the taxpayer significantly streamlined its supply chain and inventory levels, thereby allowing its branches to focus on sales and customer service rather than on tracking inventory. Technical Assistance Advisement, No. 12(C)1-008 (06/14/2012, released 07/17/12) An insurance company was denied permission to use an alternative apportionment formula to calculate its Florida corporate income tax. The insurance company had requested inclusion of the sales price of its Florida license in the numerator and the sales price of all licenses sold in the denominator of the apportionment factor to properly reflect the deemed asset sale of its stock under Section 338(h)(10). The taxpayer, however, failed to prove grossly distorted results under Rule 12C Admin. Code Section (effective 01/25/2012) removes language limiting the corporate income tax and insurance premium tax credit to 75% of the tax due after the required deductions. Further, it provides that the 5-year carryforward period is applicable to all credits approved under the program for carryforward on or after July 1, 2011, and to all unused carryforward credits that were eligible to be carried forward as of July 1, Georgia H.B. 100 (effective 07/01/2012) establishes the Georgia Tax Court in the state s judicial branch as a pilot project that would exist until July 1, H.B. 477 (effective 03/22/2012) transitions agent license fees from an annual renewal to a biennial renewal basis. H.B. 786 (effective 07/01/2012) provides for comprehensive revision of the provisions relating to the Georgia Life and Health Insurance Guaranty Association, including an increase in Class A assessments to $300 from $150 per company. S.B. 385 (effective 07/01/2012) provides guidance on collection of premium tax on nonadmitted insurance and interaction with any multistate compact. H.B. 87, Georgia Section and (effective 01/01/2012) The Georgia Illegal Immigration Reform and Enforcement Act of 2011 requires all applicants for business licenses to submit: 1) a secure and verifiable document for identification purposes and 2) a signed and sworn affidavit verifying the applicant s lawful presence in the United States. Some municipalities have deemed that this provision applies to the municipal premium tax (i.e., business license tax) and are requiring the respective documentation for valid return filings. The Association County Commissioners of Georgia has issued guidance that these verification procedures do not apply to the municipal premium tax, as these are not true licenses but merely validation of payment. Emergency Admin. Code Section 12(CER)12-01 (effective 01/20/2012) provides that taxpayers are required to add back to the federal deduction claimed under IRC 167 and IRC 168(k) for bonus depreciation and under IRC 179 for the amount that exceeds $250,000 for tax years beginning in 2010 and $128,000 for tax years beginning in : The year in review 19

24 Hawaii H and S.B (effective 07/01/2012) amends captive insurance company law to provide that riskretention captive insurance companies comply with the accreditation standards of the National Association of Insurance Commissioners. S.B (effective 07/01/2012) removes obsolete provisions to streamline licensing and regulation of mutual benefit societies, fraternal benefit societies, and health maintenance organizations. Additionally, the legislation updates the financial regulatory requirements and fees to be more consistent with traditional insurance company requirements. S.B (effective 07/01/2012) updates the laws governing guaranty associations in compliance with the NAIC Model Acts. The maximum non-pro-rata assessment for Class A assessments administered by the Hawaii Life and Disability Insurance Guaranty Association is increased from $150 to $300 per member insurer during any calendar year. A member insurer wanting to protest all or part of a Hawaii Life and Disability Insurance Guaranty Association assessment must send a payment of the full amount of the assessment when due, along with a statement that the payment is being made under protest. Idaho H.B. 653 (effective 04/03/2012) clarifies that if the due date for filing any report, claim, tax return, statement, other document, or making payment dealing with taxation filed/paid to the state or any subdivision falls on a Saturday, a Sunday, a legal holiday, or a holiday recognized by the Internal Revenue Service, such filings are considered timely if performed on the next business day. Illinois H.B (effective 08/14/2012) amends the surplus line insurance provisions to adopt several definitions contained in the federal Nonadmitted and Reinsurance Reform Act (NRRA) of 2010 (15 USC 8201 et seq.). The legislation requires the participation of Illinois in the national insurance producer database of the NAIC or a similar uniform national database for the licensure of surplus line producers and the renewal of such licenses. In addition, the legislation deletes the bond requirement related to an application for a surplus line producer s license and amends other surplus line producer licensing requirements. The legislation also provides that for NRRA purposes, a domestic surplus line insurer will be considered a nonadmitted insurer with respect to risks insured in Illinois. H.B (effective 07/01/2013) establishes an independent Tax Tribunal. Illinois has stated that the court will not hear premium tax cases. S.B (effective 08/07/2012) extends the sunset of the Illinois Enterprise Zone Program for 25 years and creates an application process for jurisdictions to obtain the designation. Additionally, it creates an Enterprise Zone Board to approve the enterprise zone applications and increases the reporting requirements for companies receiving tax from the Enterprise Zone and High Impact Business programs. S.B (effective 07/09/2012) creates an income tax credit for wages paid to qualified veterans. The credit is for an amount equal to 20% of the gross wages paid by the taxpayer to the qualified veteran in the course of that veteran s sustained employment during each taxable year ending on or after the date of hire by the taxpayer. The credit is capped at $5,000, but excess credit may be carried forward 5 years. However, the veteran must have been unemployed for an aggregate period of 4 weeks or more during the 6-week period ending on the Saturday immediately preceding the date of hire. 20 Continuing developments in the taxation of insurance companies

25 Metropolitan Life Insurance Co. et al. v. Hamer et al.; No , March 5, 2012 The Illinois Court of Appeals, First Division, held that an insurance company was not subject to an amnesty double-interest penalty for additional income taxes paid as a result of an audit because the company did not know about the additional taxes during the amnesty period. The court held that MetLife was not liable for the double-interest penalty because the statutory phrase all taxes due means those taxes that a taxpayer knew were due and owed during the amnesty period. It explained that MetLife could not have participated in the amnesty program because the department did not make its final determinations until after the amnesty period. Finally, the court rejected the department s reliance on 86 Ill Adm. Code , which requires a taxpayer to pay taxes based on a goodfaith estimate of an unknown amount, and held that the department exceeded its authority in promulgating this rule. On September 26, the Illinois Supreme Court accepted review of Met Life. Marriot International Inc. v. Hamer et al.; 2012 IL App (1st) , No , August 22, 2012 The Illinois Court of Appeals, First Division, reversed a trial court s decision holding that a corporation remained liable for the amnesty double-interest penalty because the corporation failed to pay all corporate income taxes due during an amnesty period. The court noted the plain reading of all taxes due in the Amnesty Act revealed that a taxpayer s entire tax liability is due on the fixed date for filing the taxpayer s return and without the department s need to issue a formal assessment or demand. The court also determined that the Department of Revenue s final assessment issued after the amnesty period did not relieve Marriott of its obligation to report its taxable income and pay all taxes due on the dates fixed for filing its returns. Marriott s petition for review is still pending before the court, but it is likely that the court will accept the case and consolidate it with Met Life due to the opposite holdings in these cases. 86 Ill. Adm. Code Section (effective 04/12/2012) amended regulation governing e-filings to clarify that for any taxpayer required to file its federal income tax return by electronic means is required to file its equivalent Illinois income tax return for the same taxable year by electronic means for any taxable years ending on or after December 31, This electronic filing mandate does not apply to amended returns, returns of individuals or estates, or any return the Department of Revenue has announced cannot be filed by electronic means. General Information Letter IT GIL (03/15/2012) In response to a taxpayer s request for clarity regarding nexus with Illinois and corporate income tax filing requirements, the Department of Revenue issued a ruling stating that it does not issue rulings regarding whether a particular taxpayer has nexus with the state. Indiana H.B (effective 07/01/2012) provides that a capital investment tax credit will no longer be available for investments made after December 31, However, unused tax credits attributable to a taxable year beginning before January 1, 2017 may be carried forward to a taxable year beginning after December 31, 2016 and before January 1, Additionally, for purposes of the computer equipment donation credit, the buddy system project is defined as a statewide computer project placing computers in homes of public school students and any other educational technology program or project jointly authorized by the state superintendent of public instruction and the governor. These credits are effective against the income and premium tax. Dep t of Revenue v. United Parcel Service Inc.; No. 49S TA-417, June 21, 2012 The Indiana Supreme Court held that income received by a package delivery company s foreign reinsurance affiliates was not exempt from the state s adjusted gross income tax because reinsurance transactions taking place out of state did not subject the affiliates to the state s premium tax. 2012: The year in review 21

26 DOR Information Bulletin IT19 (05/01/2012) provides an updated listing of exempt and taxable federal obligations for Indiana purposes. Interest earned from a direct obligation of a state or political subdivision other than Indiana is subject to the adjusted gross income tax if the obligation is acquired after December 31, Iowa H (effective 03/29/2012) establishes regulations to permit increased access to surplus lines insurance. It permits the sale of surplus line insurance by insurers not licensed by the state, requires licensed surplus line insurance producers to file reports and remit premium taxes, and imposes the premium tax on the insured when self-procured. Penalties will be imposed for failure to file. Additionally, it allows the Insurance Commissioner to declare a nonadmitted insurer ineligible to place surplus lines insurance. H.B (effective 05/25/2012) exempts premiums collected by insurers for benefits acquired by the state board of regents from the insurance premium tax. Kentucky H.B. 338 (effective 7/12/2012) provides that the insurance premium surcharge rate calculated by the Commissioner of Revenue shall take effect no earlier than six months from the date that the Commissioner of Insurance notifies the affected insurers. The provision that the rate is continued on a biennium basis was removed. H.B. 295 (effective 7/12/2012) establishes the expiration date for a certificate of authority as April 30 (previously, June 30) and requires a fine for reinstatement of $1,000 if the insurer fails to meet the due date. Additionally, the minimum penalty for failure to remit the surplus lines tax due was increased from $25 to $500. The maximum penalty will remain unchanged at 25% of the tax due. Furthermore, commencing April 1, the fine for brokers that fail to file quarterly (formerly, annual) reports has changed from $10 for each day of delinquency to a fixed $500 penalty. Louisiana H.B. 969 (effective 01/01/2013) allows income tax filers to claim a rebate for donations made to certain school tuition organizations (STO) that provide scholarships to qualified students to attend a qualified school for the school year and thereafter. The amount of the rebate is equal to the amount of the taxpayer s donations used by the STO to fund a scholarship to a qualified student, excluding administrative costs. The rebate is payable only after the conclusion of the school year. H.B. 160 (effective 08/01/2012) imposes an annual $1,000 financial regulation fee on domestic and foreign insurance companies covering vehicle mechanical breakdown and property residual value for the examination and analysis of its financial condition. S.B. 391 (effective 07/01/2012) provides that the authorization for a municipal or parochial corporation to impose taxes on insurers engaged in the business of issuing insurance policies or contracts terminates on August 16, 2012 for any municipal or parochial corporations that have not imposed such tax prior to August 16, However, municipal or parochial corporations that have imposed a tax on or before August 15, 2012 shall retain their authority to renew that existing tax provided such renewal does not exceed the statutory time limit. Additionally, it states that premiums paid to insurers by Louisiana Medicaid programs shall be exempt from the tax imposed by municipal or parochial corporations. S.B. 205 (effective 08/01/2012) reduces the minimum unimpaired paid-in-capital and surplus requirements for pure captive insurers from $1,000,000 to $500,000; however, association captive insurers minimum unimpaired paid-in capital and surplus requirements remain at $1,000,000. In addition, it removes the prohibition on captives from providing workers compensation and employee liability insurance. 22 Continuing developments in the taxation of insurance companies

27 H.B (effective for tax years 2013, 2014, and 2015) authorizes the Department of Revenue to make payments of tax overpayment refunds by means of a debit card at the option of the taxpayer. Attorney General Opinion (04/26/2012) Opined that insurance agents and brokers are not exempt from occupational license tax because municipalities have the authority to impose the tax on any person conducting business within the jurisdiction. Revenue Information Bulletin (effective 01/01/2012) provides that taxpayers seeking to obtain an income tax return filing extension must request the extension via electronic application. The Department of Revenue will no longer accept federal filing extension application forms in lieu of the Louisiana state filing extension application form. The Department further clarifies that this change applies to tax returns due on or after January 1, Revenue Information Bulletin No (11/08/2012) provides guidance that the credit for the Louisiana Citizens Property Insurance Corporation assessments resulting from Hurricanes Katrina and Rita should be claimed in the year the assessment was actually paid, regardless of the due date of the premium or renewal date of the policy. The credit may be claimed on the premium tax return or on Form R-620INS at time of payment or within four years following the date the payment was made. Maine H.P (effective 04/09/2012) contains the following insurance tax technical corrections: 1) updates retaliatory tax language; 2) specifies that all gross direct insurance premiums and annuity considerations paid to nonadmitted insurers are subject to the nonadmitted insurance tax of 3% (unless the retaliatory rate is higher); 3) specifies that the nonadmitted insurance tax is imposed on the surplus lines producer or the insured, who must file a return in accordance with 2521-A; 4) clarifies that an insurance company that does not do business in Maine and is not subject to the Maine insurance premiums tax is eligible for the refundable new markets capital investment credit (applicable to tax years beginning on or after January 1, 2012); 5) authorizes the new market credit against the premium tax; and 6) authorizes the historic building rehab credit against the premium tax. H.P (effective 01/01/2012) creates a statutory framework within which service contracts are defined and regulated, including rules on when insurance premium taxes apply. Specifies that provider fees collected on service contracts are not subject to premium taxes; however, premiums for reimbursement insurance policies are subject to premium taxes. H.P (effective 04/30/2012) requires all health insurance carriers, third-party administrators, and employee benefit excess insurance carriers to pay an access payment on all paid claims, except claims under accidental injury, specified disease, hospital indemnity, dental, vision, disability income, long-term care, Medicare supplement, or other limited-benefit health insurance. The legislation further removes the statutory reduction in the assessment rate, which had been scheduled to decline from 1.87% to 1.64% on July 1, The rate is still scheduled to decrease to 1.14% for July 1, 2013 to December 31, 2013, and will be eliminated thereafter. Rule 325 ( CMR 325) (10/03/2012) The new-markets capital investment credit against income and premium tax is adjusted to: 1) expand the per project limit from $10 million to $40 million for certain manufacturing entities, and 2) expand the eligible communities to include high-unemployment areas in addition to federally designated areas. 2012: The year in review 23

28 Maryland H.B. 114 (effective 07/01/2012) excludes the amount of certain medical benefits under a specified settlement agreement under specified circumstances as defined within the legislation from the Subsequent Injury Fund and the Uninsured Employers Fund assessments imposed by the Workers Compensation Commission. H.B. 568 (effective 07/01/2012) allows the sustainable communities tax credit against the income and premium taxes to be allocated among the partners, members, or shareholders of an entity in any manner agreed to in writing by those persons. The bill provides that this provision does not apply to any commercial rehabilitation project for which an application was approved by the Maryland Historic Trust before the effective date of the bill. H.B (effective 07/01/2012) extends the sunset date for the job credit against income and premium taxes for specific industries in revitalization areas to January 1, 2020 (previously, January 1, 2014). The bill also provides that after termination of the credit, a business entity may be considered for eligibility for the tax credit based on positions filled before termination of the credit if the other requirements of the credit are satisfied. H.B. 764 and S.B. 739 (effective 07/01/2012) establish a legislative review and evaluation process for specified tax credits allowed against taxes (including the premium tax); establishes dates for review and other legislative action with regard to specified tax credits; provides for termination of specified tax credits under certain circumstances; and provides for the repeal of obsolete tax credits. business entities to claim a prorated share of the One Maryland Tax Credit awarded by the Department of Business and Economic Development if the number of qualifying positions filled by the qualifying businesses falls within a certain range. The amended definition of qualified distressed county terminates on June 30, S.B. 167 (effective 06/01/2012) extends the sunset date for the credit against income and premium taxes for employing qualifying employees with disabilities through June 30, 2013 (previously, through June 30, 2012). The bill also extends the time that any excess credit may be carried forward and applied as a credit for taxable years beginning on or after January 1, 2016 (previously, January 1, 2015). Massachusetts Letter Ruling 12-3 (03/01/2012) An insurance company may utilize a Brownfields tax credit it purchased from another taxpayer without being subject to the maximum credit provision which limits the credit to 50% of the tax liability. The limitations do not apply because an insurance company is not subject to the corporate excise tax or the personal income tax, but is taxed upon a percentage of gross premiums for policies written or renewed. Letter Ruling 12-9 (07/27/2012) held that an HMO must file a corporate return in Massachusetts as a member of a parent s combined group for its 2010 tax year, as it was not considered to be an insurance company and otherwise exempt. H.B (effective 07/01/2012 and retroactively affects tax years beginning after 12/31/2010) amends the One Maryland Economic Development Tax Credit against income and premium taxes and changes the definition of qualified distressed county to include counties with unemployment rates at least two percentage points higher than the state average. The bill also authorizes qualified 24 Continuing developments in the taxation of insurance companies

29 Michigan Self-Insurance Institute of America Inc. v. Snyder, US Dist. Ct., E.D. Mich., Dkt. No , August 31, 2012 The Michigan US District Court held that the Michigan Health Insurance Claims Assessment Act, which imposes a 1% tax on all health claims paid for medical services rendered in the state to a Michigan resident, is not preempted by the federal Employee Retirement Income Security Act (ERISA; 29 U.S.C et seq.). The court found that the Act does not impermissibly relate to an ERISA plan and the Act does not have an impermissible connection with an ERISA plan. Notice to Taxpayers on Disregarded Entities (01/26/2012) clarifies the Michigan Business Tax (MBT) treatment of federally disregarded entities to reflect the changes due to recent legislation (Laws 2011, S. 369 (P.A. 305)) that added MCL , retroactive to January 1, The amendment indicates that federally disregarded entities that did not file as a separate entity for the 2008 through 2010 MBT tax years, either originally or amended by 01/01/2012, are not allowed to file separately thereafter. However, those that did file separately prior to 01/01/2012 may still file separately any amended MBT returns as long as within statute of limitations provided in MCL a. Notice to Taxpayers (01/26/2012) clarifies that all Health Insurance Claims Assessment payments are required to be remitted by electronic funds transfer (EFT). In order to be registered to make payments by EFT, a taxpayer must complete and submit Form 4926, Electronic Funds Transfer Application Health Insurance Claims Assessment, to Treasury. The first annual return for tax year 2012 is due February 28, Minnesota S.F (effective 07/01/2013) reduces the fire safety premium surcharge rate from 0.65% to 0.5%. Revenue Notice (03/12/2012) clarifies that the Department of Revenue s position in regard to the Historic Structure Rehabilitation Credit is that only an original recipient of the tax credit certificate who is listed on the certificate can assign the certificate to another taxpayer (1:1 assignment), and that the credit certificate can be assigned only once. Distribution from an owning partnership to a partner is not considered a credit assignment. Mississippi H.B (effective 07/01/2012) amends the tax credit for equity investments in community development entities available against the insurance and corporate income taxes to include a new markets tax credit and revises the tax credit for equity investments in community development. It further authorizes public entities to create public benefit corporations, public entities, and public benefit corporations, with respect to new markets tax credit transactions, to enter into financing arrangements in order to leverage funds for the acquisition, construction, or renovation of properties. Also, revises the time period to be no more than 60 days for which a qualified community development entity allocated a qualified equity investment tax credit must issue the qualified equity investment to which the credit pertains. H.B (effective 04/16/2012) exempts the payment of the surplus line premium tax on any property risk written by the Department of Finance and Administration on behalf of the state of Mississippi. The exemption from tax is repealed after July 1, : The year in review 25

30 S.B (effective 07/01/2012) provides that manual or electronic signature on a document filed with the Department of Revenue is validation by the signer under oath that all information contained in the document is true and correct and that they have the authority to sign as the duly authorized representative of the person or entity for whom the document is being filed. If a person knowingly signs a document that is false, it subjects them to criminal penalties for perjury. Additionally, it authorizes the Department of Revenue to release any information or a copy of any document to a person holding a valid power of attorney or other document authorizing the release of the information executed by the person or the duly authorized representative of the entity to whom the information or document pertains, if the authorization has not expired or been revoked, cancelled, or otherwise rendered ineffective by death or other circumstances. The Department can require the prepayment of the cost of the production of such information or records and retains the right to deny the release of information and documents for good cause. S.B (effective 07/01/2012) increases the total creditable amount against the premium tax from 80% to 100% of the investment in designated capital in a Mississippi small business investment company. The annual credit amount is 20% of the investment for tax years 2015 through 2019 (previously, 16%). Mississippi Windstorm Underwriting Association, et al. v. Union National Fire Insurance Co., et. al., Miss. S. Ct., Dkt. No CC SCT, January 26, 2012 The Insurance Commissioner s finding that assessments made by the Mississippi Windstorm Underwriting Associate (MWUA) were akin to a privilege tax, were refundable if overpaid, and were subject to a 3-year statute of limitations was reversed. By statute, MWUA assessments are funds received for the sole purpose of providing insurance coverage and paying claims for insured Mississippi citizens and are not to be considered taxes, fees, licenses, or charges. Unlike privilege taxes assessed against a specified group for the privilege of doing business in the state, the MWUA assessments were directed only to its member insurance companies to cover losses arising from Hurricane Katrina, who voluntarily choose to write essential property insurance in that area. Nebraska L.B. 983 (effective 01/01/2012) increases the number of years that the research tax credit may be claimed against the income tax from 4 years following the year the credit is first claimed to 20 years following the year the credit is first claimed. L.B (effective 03/14/2012) permits the procurement of sickness and accident insurance from nonadmitted insurers under the Surplus Lines Insurance Act. L.B (effective tax years beginning on or after 01/01/2012) creates a $15 million New Markets Tax Credit program providing income tax credits for corporations, individuals, and estates and trusts; a related insurance premium tax credit; and a bank franchise tax credit. L.B (effective 03/07/2012) provides tax breaks for companies investing at least $200 million and creating at least 30 jobs for building data centers. Such tax breaks include the following: refund of all sales/use taxes from the date of acquisition through the meeting of the required levels of investment and employment; refund of all sales and use taxes paid during each year of the entitlement period; a tax credit based on the average wage of new employees; an investment credit of 10% of the investment made in the project; a 10-year property tax exemption for all personal property at the project; and a cash payment from the state equal to all real property taxes paid from the year of acquisition through the carryover period. 26 Continuing developments in the taxation of insurance companies

31 New Hampshire H.B. 102 (effective 08/17/2012) establishes a committee to study merging the insurance department, banking department, and securities division of the Office of the Secretary of State. H.B. 242 (effective 05/23/2012) provides that the net operating loss carryforward for purposes of the business profits tax cannot exceed $10 million (currently, $1 million). The increase had been scheduled to go into effect on July 1, 2013, but has now been accelerated to January 1, H.B (effective 07/01/2012) clarifies that a taxpayer can apply the credit for the business enterprise tax against the business profits tax on a quarterly basis when making estimated tax payments. H.B (effective 06/21/2012) increases the filing threshold for the Business Enterprise Tax to $200,000 (currently, $150,000) of gross receipts, indexed annually, and indicates no filing is required when tax liability for the Business Enterprise Tax is less than $260 (currently, $200). New Jersey S.B (effective 08/07/2012) increases the maximum amount of credit from $1.5 billion to $1.75 billion for the Urban Transit Hub Tax Credit program, and extends the deadline for applications so that businesses may apply for the credit prior to July 1, 2014 and submit documentation no later than July 28, Horizon Blue Cross Blue Shield of New Jersey v. Division of Taxation, A T3, March 7, 2012 The New Jersey Superior Court held that A (Laws 2005), which eliminated Health Service Corporations (HSC) from the 12.5% tax cap, was constitutional. The Court held that A.4401 did not constitute special legislation because the purpose of the amendment was to raise revenue in the face of a budget deficit and to end preferential tax treatment for HSCs. The Court noted that while Horizon is the only entity that falls within the scope of A.4401, that fact does not make the amendment special legislation. Department of Banking and Insurance Order No. A (08/23/2012) provides that the rate of recoupment for insurers paying the Property and Liability Guaranty Association Assessment due 09/14/2012 is 0.9% per year for applicable lines. Any over-assessments from prior years are to be offset against amounts collected for the current year. New York S.B (effective 07/18/2012) increases the aggregate cap on liabilities for life insurers under the New York Life Insurance Guaranty Corporation from $500 million to $558 million. A.B (effective 07/18/2012) provides for the consolidation of the bank and insurance regulatory departments into a single financial service division. Prudential Insurance Co. of America v. Wrynn, New York Supreme Court, NY County, No , April 16, 2012 The New York Supreme Court rejected the taxpayer s claim that the Department of Insurance erred in denying a retaliatory tax refund and credit. Prudential sought relief as a result of a 2006 payment of additional franchise taxes for tax year 1995, as a result of a recalculation prompted by a federal audit which disallowed a portion of the taxpayer s NOL deductions. The Superintendent s determination that the taxpayer failed to demonstrate an error in calculation was not irrational or contrary to the clear wording of Insurance Law In addition, even if an error of fact occurred, the Superintendent s determination had to be upheld in light of the 3-year statute of limitation. The Superintendent s position that 9109 requires some form of year-to-year matching was also deemed consistent with the statutory scheme. Regulation 20 NYCRR (12/17/2012, effective for tax years beginning on or after 01/01/2013) clarifies the combined reporting requirements to include: 1) defining that a unitary business requirement is a prerequisite for combination; 2) interest on intercompany loans where the loan constitutes subsidiary capital will be considered in the substantial inter-corporate transactions determination; 3) transfers of assets other than for stock or paid-in capital, including through a nonmonetary 2012: The year in review 27

32 property dividend, will not be considered in the substantial inter-corporate transactions determination unless the principal purpose of the transfer is the avoidance or evasion of tax; and 4) income from the sale of items produced from transferred assets, by itself, would not constitute gross income derived directly from the transferred assets, but a transfer of assets constituting substantially all of the production process, including associated intangibles, such as might occur in the transfer of an operating division, would constitute gross income derived directly from the transferred assets. Technical Service Bureau Memorandum 12(4)C (02/17/2012) provides guidance regarding the filing requirements and the calculation of the Article 33 franchise taxes for unauthorized insurance corporations, as computed under N.Y. Tax Law For taxable years beginning on or after January 1, 2012, the tax on unauthorized life insurance companies is not subject to the limitation on the amount of tax imposed under N.Y. Tax Law 1505(a)(2). This interpretation of the law represents a change from an earlier interpretation, contained in advisory opinions issued by the Department, that the limitation did apply to unauthorized life insurance companies. Similarly, for unauthorized property-casualty insurance companies, the tax on these corporations is not subject to the limitation on the amount of tax imposed under N.Y. Tax Law 1505(a)(2), applicable for all open years. Technical Service Bureau Memorandum 12(6) C (07/09/2012) clarifies that the Department of Revenue will not treat amounts received as deductible reimbursements as premium for purposes of Tax Law 1510(c)(1). The deductible reimbursement amounts must be received or accrued by an insurance corporation from or on behalf of an insured policyholder pursuant to a contract of insurance containing a provision obligating the policyholder to repay some or all of the deductible amount. Furthermore, the insurance company must not have passed on a cost to cover the premium tax as regards deductible reimbursement amount, and the deductible reimbursement amounts cannot be treated for statutory accounting purposes as premium. This policy applies prospectively and to those tax periods for which the statute of limitations for issuance of a notice of deficiency is open. North Carolina H.B. 462 (effective 07/01/2012) prohibits the Department of Revenue, counties, and municipalities from hiring in whole or in part, any third party on a contingent-fee basis to determine tax liability. However, the Treasurer may contract any third party on a contingent-fee basis to conduct audits of life insurance companies where the audit is being conducted for the purpose of identifying unclaimed death benefits or to conduct audits of holders of unredeemed bond funds. State and local governments collection activities are not be affected by the ban. H.B (effective 06/26/2012) sets the insurance regulatory charge at 6.0% for tax year 2012, same as H.B (effective 06/20/2012) extends tax credits aimed at creating jobs or purchasing property for a year, until January 1, Additionally, it reinstates the work opportunity tax credit that expired January 1, 2012 and extends the credit until 2014, and extends the tax credits for rehabilitating mills and historic structures until January 1, Ohio H.B. 18 (effective 08/06/2012) provides a one-time $500 per-employee grant to any business that 1) occupies a facility that has been vacant for 12 months, 2) increases payroll through the hiring of new full-time employees, and 3) provides employment to 50 employees or 50% of its Ohio employees at the vacant facility with the option of entering into a 3-year pilot program. H.B. 327 (effective 09/04/2012) provides a six-year trial period in which a job creation or job retention tax credit is eligible for employers with home-based employees (previously, the employees had to work at a corporate office location). H.B. 508 (effective 09/04/2012) adds an in lieu of provision for surplus lines companies. 28 Continuing developments in the taxation of insurance companies

33 Oklahoma H.B (effective 04/16/2012) provides modifications made to the Unauthorized and Surplus Lines Insurance Act, including modifications to: 1) definitions, 2) prohibited insurer actions, 3) domestic surplus line insurer requirements, 4) service of process requirement, 5) exemption from service of process, 6) attorney fee allowance, and 7) capital and surplus requirements. Also, specifies that the Insurance Commissioner shall not be compelled to join certain agreements or compacts. S.B (effective 06/08/2012) conforms state tax law for unauthorized insurers and surplus lines insurance with the federal Nonadmitted and Reinsurance Reform Act. Changes the imposition of the surplus lines tax to the broker or licensee (currently, the domestic surplus lines insurer) and caps the captive insurance tax at $100,000 per year. In the Matter of the Income Tax Protest of Scioto Insurance Co., Supreme Court of Oklahoma, No , May 1, 2012 The Supreme Court of Oklahoma held that payments a Vermont captive insurance company received from an Oklahoma taxpayer for intellectual property consisting of trademarks and operating practices did not create sufficient nexus to subject it to the Oklahoma corporation income tax. This case was distinguished from Geoffrey, Inc. V. Oklahoma Tax Commission because Scioto was not a shell entity and the licensing agreement was not a sham obligation to support a deduction. Oregon H.B (effective 09/29/2013) adds an exemption from the definition of gross premium for assessment purposes for accident only, specified disease, and hospital indemnity policies if the policies pay benefits on an indemnity basis. S.B (effective 03/27/2012) allows the formation of single-parent captives, association captives, branch captives, and reinsurance captives in Oregon. Additionally, it sets minimum capital and surplus requirements and allows the director of the state s Department of Consumer and Business Services to require that any captive maintain higher capital and surplus levels, if necessary. Lastly, it requires captives to pay a $5,000 annual fee which the Department of Consumer and Business Services may raise. Costco Wholesale Corp. et al. v. Dep t of Revenue; TC 4956, July 19, 2012 The Oregon Tax Court held that a membership warehouse retailer must include its foreign captive insurance affiliate s income to compute corporate excise tax because the retailer and affiliate are engaged in a unitary relationship. Stancorp Financial Group Inc. et al. v. Department of Revenue; TC 5039, August 2, 2012 The Oregon Tax Court upheld the holding in Costco that a licensed insurer doing business in Oregon was subject to separately filed, insurance-specific Excise Tax, but unlicensed insurers were subject to the standard Excise Tax and combination (if applicable). Further, the Oregon Tax Court held that a parent corporation was not required to add dividends received from a subsidiary because the dividends were eliminated under the federal consolidated return regulations and there was no Oregon statutory authority to require an addback modification. Pennsylvania H.B. 761 (effective 07/01/2012) contains numerous tax and credit provisions applicable against the premium tax, including: 1) changes to the technical wording in the premium tax statutes; 2) increases to the total annual cap on the Educational Improvement Tax Credit from $70 million to $100 million and permits the credit against the surplus lines tax; 3) establishes a new Educational Opportunity Scholarship Tax Credit of up to $8,500 ($10,550 for special education) per student for contributions funding groups providing scholarships to the lowest 15% of school districts; 4) establishes a new Resource Manufacturing Tax Credit of $0.05 per gallon of ethane purchased for use in manufacturing from 01/01/ /31/2042; 5) establishes a new Historic Preservation Tax Credit of 25% of the expenditures for rehabbing a qualified historic structure, not to exceed $500,000 per taxpayer or $3,000,000 statewide annually 2012: The year in review 29

34 as of 07/01/2013; and 6) establishes a new Community- Based Services Tax Credit of 50% of the contributions made to non-profit service providers, not to exceed $100,000 per taxpayer or $3,000,000 statewide annually as of 07/01/2013. H.B (effective 10/26/2012) provides retention of 95% of the income tax state withholding tax to for-profit employers that enter into an agreement with the state to create at least 250 new jobs in Pennsylvania within five years, of which at least 100 must be created within two years. The company has to provide health benefits for new full-time workers and pay at least 50% of the health insurance premium. Qualified employers can retain these payroll taxes for 7 years if they pay at the average county rate, 8 years if new employees are paid at 110% of the county average wage; 9 years if they earn 120% of the county average wage; and 10 years if they are compensated at 140% of the county average wage. The aggregate annual tax benefits to employers are capped at $5 million and bars the state from entering into any new agreements with employers under the law after January 1, Allstate Life Insurance Co. v. Commw., Pa. S. Ct. Dkt. No. 68 MAP 2010, August 2, 2012 The Pennsylvania Supreme Court upheld a Commonwealth Court decision which held that the correct method for calculating the credit against gross premiums and annuity consideration tax available under the Insurance Guaranty Act is to use separate proportionate part fractions for each assessment class and to include the portion of premiums received on account of guaranteed premium annuity policies in the numerator of the fraction. The high court found that the statute is in fact ambiguous, but not because of confusing language or the omission of words, but because the language of the statute conflicts with its statutory intent. 61 Pa. Code Sections 5.3, 5.5, and 5.7 (effective 12/01/2012) lowers the electronic funds transfer threshold from $20,000 to $10,000. The regulation applies to most taxes, including the sales/use, franchise, and insurance premium tax. Rhode Island H.B (effective 07/01/2012) establishes a tax amnesty program for all taxes imposed by the state and collected by the Tax Administrator. The tax amnesty program would be conducted for a 75-day period ending on November 15, 2012 and would abate all penalties and 25% of the interest due. Additionally, it reduces the minimum required total production budget from $300,000 to $100,000 and sets a $5 million credit cap for the motion picture tax credit, effective July 1, 2012 and sunsetting July 1, Lastly, it enacts a tax credit equal to 25% of the total production expenditures for an accredited theater production for up to $5 million ($15 million total statewide for both this credit and the motion picture credit) which would sunset on July 1, The amnesty program and credit provisions are applicable to the premium tax. H.B (effective 06/20/2012) requires the transition of the current assessments levied upon health insurance premiums (including the premium tax on health insurers) to a surcharge based on healthcare claims. The plan must be presented to the legislature no later than February 15, South Dakota H.B (effective 02/24/2012) provides that lists of premium taxpayers, premium tax returns, and premium tax return information are confidential and may be disclosed only in specific circumstances: as permitted by the taxpayer, per statute and as required in a legal proceeding. Tennessee H.B (effective 02/28/2012) extends the Tennessee life and health insurance guaranty association sunset date to June 30, Continuing developments in the taxation of insurance companies

35 Texas Nestle USA, Inc., et al., Tex. S. Ct., Dkt. No , February 10, 2012 & Nestle USA, Inc., et al., Tex. S. Ct., Dkt. No , October 19, 2012 The Texas Supreme Court determined it did not have jurisdiction over an original proceeding brought by corporations seeking to have the state franchise tax declared unconstitutional, since the corporations failed to meet the statutory prerequisites of paying the taxes under protest or requesting refunds of taxes paid. On subsequent review, the court determined that it does have original jurisdiction over challenges to the constitutionality of the tax, because the importance to the state of quickly and finally resolving challenges that strike at the foundation of such a tax. The Texas Supreme Court held that the state franchise tax does not violate the Texas Constitution s Equal and Uniform Clause nor the federal Equal Protection, Due Process, and Commerce Clause. Tax Policy News L (02/01/2012) clarifies that life, accident, and health insurers must claim credits for the entire amount of Class A assessments as a tax credit for the year in which they are paid; however, credits for Class B assessments are allowed at a maximum of 20% per year, beginning with the year after the assessment is paid. Property and casualty insurers can claim up to 10% of their assessments as a credit per year, beginning with the year the assessment is paid. Title insurers may recover the assessment through the rates charged in an amount up to 1% of their premium, and any excess not recovered may be taken as a 20% premium tax credit per year over a minimum of five years. Unused guaranty assessment credits may be transferred to another licensed insurer only in limited circumstances. Tax Policy News L (09/01/2012) clarifies that for a Health Maintenance Organization (HMO), the maintenance tax is a per capita amount for the certificate holder and each covered dependent. Basic, single, and limited healthcare services are all charged at different rates, which are determined by the type of license applied for and issued to the HMO by the Texas Department of Insurance. Tax Policy News 3 (03/01/2012) clarifies that the maintenance taxes on annuities are assessed when the annuities are purchased from insurance companies at the time of annuitization. The instructions for reporting and paying maintenance taxes refer to the National Association of Insurance Commissioner s Schedule T; however, Texas statutes do not rely on the Schedule T for tax purposes. As such, insurers are subject to a tax audit adjustment if their allocation for tax purposes does not agree with the tax statutes. Tax Policy News 5 (05/30/2012) provides a reminder that every unauthorized insurer is required to file the Texas Annual Insurance Tax Report (Form ) and its supplement (Form ) on or before March 1 subsequent to the calendar year that the insurance was effectuated, continued, or renewed. All insurance activities in Texas outside of the licensed market are categorized as unauthorized insurance unless it falls within the legislative safe harbors of surplus lines or independently procured insurance. Tax Policy News 7 (07/01/2012) clarifies that premium for tax reporting purposes includes premiums, membership fees, assessments, dues, and any other consideration for insurance. By definition, this includes agent fees that are charged in addition to, or in lieu of, a commission. Fees charged that are not related to procuring a policy of insurance are not considered premium; however, these fees could be subject to sales tax if charged for the performance of taxable insurance services. Utah H.B. 29 (effective 05/08/2012) increases the administrative assessment against admitted and nonadmitted insurers transacting insurance under Utah law to the following: $200 for an insurer with total premiums for Utah risks of $1 million or less; $450 for risks more than $1 million to $2.5 million; $800 for risks more than $2.5 million to $5 million; $1,600 for risks more than $5 million to $10 million; $6,100 for risks more than $10 million to less than $50 million; and $15,000 for risks of $50 million or more. The bill also amends the definition of corporation for purposes of the insurance law to include a surplus lines producer. 2012: The year in review 31

36 Vermont H.B. 558 (effective 03/07/2012) changes the annual publishing date of the list of health insurers subject to the healthcare claims assessment and the healthcare information technology reinvestment fee, from September 1 to on or before October 1. In addition, effective retroactively to January 1, 2012, the definition of health insurance has been amended to include any policy providing coverage for dental services. Virginia H.B. 35 (effective 07/07/2012) reduces the statute of limitations for the collection of state taxes from 10 years to 7 years. The bill also provides that if no contact has been made with a delinquent taxpayer for a period of 6 years (currently, 7 years) after the assessment, then interest and penalty will not be added to the delinquent tax liability. H.B. 321 and S.B. 131 (effective 07/01/2012) provides an education improvement scholarship tax credit against the premium tax equal to 65% of monetary donations made to qualified scholarship foundations providing scholarships to low-income students or eligible students with disabilities for attendance at non-public elementary or secondary schools. This credit is applicable for tax years beginning on or after January 1, 2013, but before January 1, In addition, the legislation extends the sunset date of the Neighborhood Assistance Act credit until July 1, 2017, increases the credit percentage to 65% of the value of eligible donations, increases the credit cap to $15 million, and increases the credit cap for educational proposals to $8 million. H.B. 841 (effective 01/01/2012) amends the major business facility job tax credit and enterprise zone job creation grant, both eligible to be taken against the premium tax, to allow a business creating permanent, full-time positions to be eligible for both credits. However, the bill prohibits both the tax credit and the grant being allowed for the same job created. H.B and S.B. 578 (effective 07/01/2012) extends until January 1, 2017 (previously, January 1, 2015) the barge and rail usage tax credit applicable against the premium and income taxes. S.B. 532 (effective 07/01/2012) revises the procedure for collecting the Maintenance Tax Assessment on insurers to repeal the quarterly estimated payments and collect the assessment in full annually on March 1. S.B. 576 (effective 07/01/2012) provides that the maximum rate at which the tax financing of the Uninsured Employer s Fund can be imposed will continue to be 0.5% until July 1, Prior to this legislation, the rate ceiling had been scheduled to revert back to 0.25% on July 1, Washington Admin Code (03/02/2012) clarifies the requirement under RCW that surplus line brokers remit by March 1 a premium tax on surplus line insurance transacted in the preceding calendar year. The date the coverage is bound or the date coverage is effective, whichever is later, is the date the insurance was transacted. H.B. 714 and S.B. 368 (effective 07/01/2012) extends the time during which the major business facility job tax credit (applicable against income and premium tax) may be taken over a two-year period from December 31, 2012 to December 31, Continuing developments in the taxation of insurance companies

37 West Virginia H.B (effective 06/07/2012) amends the provisions relating to captive insurance companies to provide that risk retention groups may not retain any risk on any subject of insurance, whether it is located or will be performed in West Virginia or elsewhere, exceeding 10% of the statutorily required surplus, unless approved by the commissioner. The new legislation also requires captive insurance companies to notify the commissioner in writing within 30 days of becoming aware of any material change in information previously submitted to the commissioner, including information submitted in or with the license application. S.B. 287 (effective 04/10/2012) authorizes the promulgation of administrative rules by the various executive or administrative agencies of the state, including: 1) a legislative rule relating to the use of electronic funds transfer for the payment of taxes; 2) a legislative rule authorizing the Insurance Commissioner to promulgate the licensing and conduct of insurance producers and agencies; 3) a legislative rule authorizing the Insurance Commissioner to promulgate surplus lines insurance; and 4) a legislative rule authorizing the Insurance Commissioner to promulgate the systems of an insurance holding company. S.B. 378 (effective 04/19/2012) implements portions of the federal Nonadmitted and Reinsurance Reform Act. With respect to the 3% premiums tax on surplus lines insurance, the legislation provides that the tax is required only if Wisconsin is the home state of the insured. In addition, the tax is levied on the entire gross premium charged, including premiums attributable to those portions of the risk located outside Wisconsin. These changes apply to policies issued or renewed on or after July 21, The legislation also eliminates language that had provided for a lower rate of tax on ocean marine insurance. This change applies to surplus lines ocean marine insurance issued or renewed on or after April 20, Wyoming H.B. 15 (effective 03/03/3012) provides for regulation of tax on nonadmitted insurance to conform to the federal Nonadmitted and Reinsurance Reform Act. Additionally, the legislation imposes a premium tax on independently procured insurance. Wisconsin S.B. 369 (effective 04/19/2012) establishes a new income tax credit for employers who hire unemployed disabled veterans, starting with the 2012 tax year. For each disabled veteran hired for a full-time job, the employer may claim a $4,000 credit in the tax year in which the disabled veteran was hired and $2,000 per year for the next three taxable years in which the veteran is employed. Taxpayers hiring a disabled veteran to work part-time may claim a $2,000 credit in the tax year the disabled veteran was hired and $1,000 per year for the following three taxable years in which the veteran is employed. 2012: The year in review 33

38 Tax Accounting SSAP 101 Q&A As background to the adoption of SSAP 101, in May 2011, the interested parties provided comments on an exposure draft of SSAP 101, and in August 2011, the NAIC s Statutory Accounting Principles Working Group released the draft. Shortly thereafter, in September 2011, the NAIC s Financial Condition Committee approved the adoption of SSAP 101, and it was unanimously adopted on November 6, SSAP 101 became effective on January 1, In August 2012, the NAIC published on its website a Q&A on the implementation of SSAP 101. The Q&A is effective for tax years beginning on or after January 1, It clarifies some of the key provisions of SSAP 101, and includes several examples that may be useful for adopting the key provisions of SSAP 101. Q&A 10 A Guide to Implementation of SSAP No. 101 on Accounting for Income Taxes : Questions and Answers To access NAICs Q&A, please click on the link below. sapwg_exposures_ssap_101_qa_clean.pdf Key provisions of SSAP 101 Tax rate The tax rate used to measure gross deferred tax assets (DTAs) and liabilities (DTLs) is the enacted regular tax rate expected to apply to taxable income in the period in which the DTA/DTL is projected to be realized or settled. The impact of future changes in tax laws and rates or special tax status (e.g., AMT) are not anticipated. Accordingly, the values of the gross DTAs and DTLs reported in the footnotes to the financial statements represent amounts determined at that enacted tax rate. However, the admitted adjusted gross DTA may not reflect the same tax rate. This is because the asset admitted under paragraphs 11.a. and 11.b. is affected by applicable tax rules, which may result in the value of reversing temporary differences being less than the enacted tax rate. For instance, application of the small life insurance company deduction, the Blue Cross/Blue Shield special deduction, or companies anticipating a tax loss will likely result in the use of a marginal tax rate less than 34% or 35%. Grouping of temporary differences Grouping of temporary differences is a critical and often overlooked step in the SSAP 101 exercise. Consider, for example, fixed assets. Within a pool of fixed assets, one may find taxable and deductible temporary differences. Taxable temporary differences may be $100 and deductible temporary differences $60. The issue is whether one should consider the pool to represent a single taxable temporary difference of $40 (net method) or separate taxable and deductible temporary differences (gross method). Mechanically, the admissibility test will never yield a lower admitted DTA if the gross method is used, and will may result in a better admitted result using that method. Of course, one must consider the administrative cost of accessing the information and monitoring the inventory of items. Q&A 2.9 indicates that groupings should be done in a reasonable and consistent manner. The Q&A further states that such groupings should remain consistent from period to period and that internal documentation should be retained to support grouping methodologies. Modifications of groupings are justifiable if events or circumstances 34 Continuing developments in the taxation of insurance companies

39 change, but they must be disclosed. Examples of justification for modifications include a change in materiality of the underlying assets and liabilities, an increase or decrease in administrative costs of maintaining such groupings, and changes in computer systems that allow access to more detailed information. Changes in deferred tax assets and liabilities The change from one period to the next in the value of gross DTAs/DTLs impacts surplus. The location of these surplus adjustments is where the process gets tricky. The [c]hange in net deferred income tax line in the surplus reconciliation includes the change in gross deferred tax balances without regard to unrealized gains and losses and admissibility of DTAs, but would include any change in the statutory valuation allowance (SVA). Net unrealized gains or (losses) are reported net of the related tax, without regard to the admissibility of any DTA or the change in the SVA allocable to unrealized losses. The change in the portion of any DTA that is not admitted becomes part of the [c]hange in nonadmitted assets line in the surplus reconciliation. Other surplus adjustments should not be presented net of tax, absent specific statutory accounting authority. It should be noted that SSAP 10R required companies to separately present the benefit associated with expanded admissibility in the surplus section of the balance sheet and as a component of the change in surplus in the capital and surplus roll forward, but this is not required under SSAP 101. The impact of SSAP 101 adoption should be accounted for and presented as a change in accounting principle under SSAP 3. SSAP 101 permanently replaced SSAP 10R and SSAP 10 on January 1, There are a number of differences between the two sets of tax accounting principles, including grouping of temporary differences. Interdependence of tests The Q&A makes it clear that a single temporary difference can be considered in all three parts of the admissibility test. However, equally clear is that the net admitted DTA may not exceed the excess of the adjusted gross DTA over the gross DTL. If a DTA is initially admitted in an amount less than the enacted tax rate in one part of the test, the remaining nonadmitted value may be admitted in subsequent parts of the test. For example, a deductible temporary difference related to loss-reserve discounting may only yield a 20% benefit in paragraph 11.a. because the company paid AMT in the carryback period or was subject to AMT as the result of the loss carryback. This temporary difference can be considered again in paragraphs 11.b. and 11.c., until the entire 34% or 35% benefit is recognized. SSAP 101 employs an anti-duplication mechanism to prevent the recognition of benefits beyond the maximum expected tax rate of 34% or 35%. Income taxes incurred Income taxes incurred includes current-year estimates of federal and foreign income taxes, including refunds anticipated from carryback claims filed or expected to be filed. These anticipated, yet unfiled, refund claims (and the resulting tax recoverables) represent admitted assets not subject to the 90-day admissibility rule. Also included are amounts incurred or received during the current year relating to prior periods, to the extent not previously recognized. Additionally, income taxes incurred includes changes in federal and foreign income tax contingencies established under paragraphs 3.a.i.-iii. Note that P&C and life insurers must separately reflect the portion of federal and foreign income taxes incurred related to realized capital gains and losses as elements of the respective realized capital gain/loss amounts. Further, the Q&A states that interest and penalties related to federal and foreign income taxes (including tax contingencies) must be included in income taxes incurred. 2012: The year in review 35

40 State income taxes Current state income taxes should be included as Taxes, licenses, and fees by P&C insurers and as Insurance taxes, licenses, and fees, excluding federal income taxes by life and accident and health insurers. State income taxes should not be included as Income taxes incurred. No state deferred taxes may be recognized. State income tax recoverables that are reasonably expected to be recovered in subsequent periods are admitted assets. As such, these recoverables may be outstanding more than 90 days and still be admitted assets. See SSAP 101, paragraph 4. It should be noted that the new tax contingency regime of SSAP 101 applies only to federal and foreign income taxes. State tax contingencies are governed by the probable standard of SSAP 5R s liability recognition model. Items excluded from deferred income taxes SSAP 101, paragraph 7.b, states that [t]emporary differences include unrealized gains and losses and nonadmitted assets but do not include asset valuation reserve (AVR), interest maintenance reserve (IMR), Schedule F penalties and, in the case of a mortgage guaranty insurer, amounts attributable to its statutory contingency reserve to the extent that tax and loss bonds have been purchased. [Emphasis added.] Some have questioned the reasoning for not recording DTAs for the asset valuation reserve (AVR) and interest maintenance reserve (IMR). With respect to the AVR, the NAIC might have believed that the AVR is not a liability that will be settled (see language in Q&A 2.1) and, therefore, cannot produce a tax deduction. Because the AVR is computed on a pool of assets, rather than an individual investment-by-investment basis, it would be impossible to know when the liability would be settled. Regarding the IMR, under current SAP accounting, the increase or decrease in the IMR in any given year is reduced by the related tax; thus, the IMR balance represents the deferred gains or losses already net of tax. Schedule F penalties apply only to non-life companies. A liability is booked to the extent that the company is ceding business to an unauthorized reinsurer. A similar statutory penalty applies to life insurers, but is taken from Schedule S (vs. Schedule F). It seems reasonable that a statutory penalty applicable to life insurers (one that is consistent with the Schedule F penalty applicable to non-life insurers) should also not give rise to a DTA. The contingency reserve for mortgage guaranty insurers (to the extent that tax and loss bonds are purchased) is also not considered a temporary difference. The purchase of tax and loss bonds secures a tax deduction for the company. As such, the SAP and tax values of the contingency reserve are the same. Also, the tax and loss bonds are recognized as an asset in the statutory balance sheet, and, as such, recognition of a DTA would result in an overstatement. Tax allocation agreements Income tax transactions between affiliated parties filing consolidated returns shall be recognized if such transactions are economic transactions pursuant to SSAP 25; are pursuant to a written income tax allocation agreement; and income taxes incurred are accounted for in a manner consistent with the principles of SSAP 101 and GAAP. Any amounts owed to a reporting entity, that are not settled within 90 days of the filing of a consolidated income tax return or the receipt of a refund, shall be nonadmitted. Q&A 8 clarifies that tax allocation agreement language cannot provide a company with a greater admitted DTA than would be achieved on a separate company basis, but could be applied to reduce the admitted DTA. Realized and unrealized capital gains and losses The component of the current tax provision or benefit related to realized capital gains and losses must be netted against the gains and losses in the income statement. SSAP 101 does not specifically prescribe a method for allocating the current tax provision or benefit between realized capital gains/losses and income/loss from operations. However, see Q&A 10a., which discusses the allocation of true-up adjustments between ordinary and capital items. GAAP intraperiod allocation rules may also be helpful in allocating the current tax expense between capital gains/losses and operating income. The change in unrealized gains and losses shall be recorded net of any DTA or DTL without regard to the change in the admissibility of any DTA. 36 Continuing developments in the taxation of insurance companies

41 Tax planning strategies Companies can use prudent and feasible tax planing strategies to support the admissibility of DTAs. A tax planning strategy does not have to be implemented (except in the case of an expiring attribute, such as a net operating loss or capital loss carryover) and can be used to accelerate reversals of DTAs into the short-term reversal period, or generate more taxable income to absorb existing short-term reversal items. It is important to remember, however, that if the item supporting a planning strategy (i.e., unrealized gain in bond portfolio) disappears, so does the DTA that it supported. Therefore, it is critical to revisit planning strategies at least quarterly to identify at-risk DTAs. SSAP 101 (paragraphs 13 15) discusses the application of tax planning strategies for SAP. Paragraph 14 defines tax planning strategies as strategies that: a. Are prudent and feasible, b. A reporting entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused, and c. Would result in realization of DTAs. GAAP literature, which is relevant as the tax planning strategy model is borrowed from FAS 109, also states that the action shall be primarily within the control of management to be considered a viable tax planning strategy. Disclosures Certain disclosures required by GAAP are required by SSAP 101. Disclosures related to the statutory valuation allowance and the nonadmissibility of all or a portion of the DTAs are required. Also, SSAP 101 requires an effective tax rate analysis, similar to that required for nonpublic companies under GAAP. The rate reconciliation is similar to that required for GAAP reporting. Reconciling items will typically include permanent differences, such as the tax effects of exempt interest and the dividends received deduction, as well as any change in the statutory valuation allowance. Temporary differences will generally not be included in the rate reconciliation. The reconciliation is from pre-tax statutory income at the enacted tax rate to the sum of income taxes incurred (current taxes, including taxes netted against realized gains/losses) plus the change in the DTA/DTL (which excludes the tax effect of unrealized gains and losses and is calculated before the admissibility test). Companies will have to include the change in the DTA/DTL related to nonadmitted assets (such as furniture, fixtures, and receivables past 90 days due) as a reconciling item; the change in these nonadmitted assets has no impact on current taxes, but does impact deferred taxes. The effective tax rate reconciliation would also include any change in the SVA. The following components of the net DTA/DTL must be disclosed: The total DTAs (admitted and nonadmitted) The total DTLs The total DTAs nonadmitted as the result of the application of SSAP 101 The net change during the year in the total DTAs nonadmitted The following additional disclosures must be made: The amount of unrecognized DTLs Net operating loss carryforwards and credits with their origination and expiration dates The substance of any tax allocation agreement and a list of members of the consolidated group, if applicable Additional disclosures are required by SSAP 101. Select disclosures include: Listing of DTAs and DTLs by character (ordinary vs. capital) Certain disclosures related to the statutory valuation allowance An early warning disclosure for expected significant increases in tax contingencies within 12 months of the statement date Disclosure of the impact of tax planning strategies on DTA admissibility, including a statement as to whether a reinsurance-related tax planning strategy was employed 2012: The year in review 37

42 Interim reporting Q&A 11 provides an illustration of quarterly reporting. The Q&A expands upon the requirement for a company to project its annual effective tax rate (current provision plus the change in DTAs/DTLs without regard to unrealized capital gains and losses) and determine the interim tax accounts using that information. The tax effect of unrealized capital gains and losses should be booked based upon year-to-date results (a discrete basis). To calculate the portion of the DTA to be admitted, companies must estimate the amount of asset that will be admitted at year end, based on the annual projections. In this regard, SSAP 101 requires that the determination of the applicable paragraph 11.b. reversal period and surplus limitation is based upon a combination of current-period total adjusted capital, or TAC, and prior-year-end RBC. However, a reporting entity that is aware of factors that will substantially impact the RBC should make appropriate adjustments. The estimation of the annual effective tax rates (total, current, and deferred) can prove very challenging. Nevertheless, the guidance requires that the estimate be made based upon the best available information. In cases where the estimated annual effective tax rate is determined to be unreliable, the reporting entity may calculate the interim tax provision on a discrete period basis. premiums, have amended their Standard Valuation Law. For individual life products, including term, whole life, universal life, and variable life, the approach to reserves changes considerably from what CRVM, Regulation XXX, and AG38 currently prescribe. These changes likely will require many companies to take a fresh look at their systems, processes, data, and governance for both pricing and valuation. In addition, the statutory earnings or profit signature likely will change as well, introducing the potential for increased volatility year over year. There are three components of PBR for life insurance products that Section VM-20 of the Valuation Manual covers: a net premium reserve (NPR), a deterministic reserve (DR), and stochastic reserve (SR). The NPR is a minimumpolicy-level reserve that is calculated using prescribed assumptions and is formula based. Companies will need to determine and hold the greater of a DR and SR unless the product meets the requirements of either the deterministic or stochastic exclusion tests. The DR and SR are calculated using projected asset and liability cash flows and are based on a gross premium rather than net premium basis. Reserves calculations are based on a combination of a company s prudent estimate assumptions (own experience assumptions with margin) and market assumptions in certain situations in which the company has little to no control over market forces (e.g., credit spreads and default rates). New Standard Valuation Law and Principles-Based Reserves In December 2012, the NAIC voted to adopt the current version of the Valuation Manual, recognizing that the manual will see some modifications in future months. This was a first and crucial regulatory step in the move to principles-based reserves (PBR) for life products. This adoption now enables state legislatures to include the revised Standard Valuation Law, which incorporates the Valuation Manual, in their legislative proceedings beginning this year, a crucial date because all legislatures will be in session. The Valuation Manual will become effective when the legislatures of 42 states, representing 75% of written 38 Continuing developments in the taxation of insurance companies

43 Appendix A Cases American Financial Group et al. v. United States, 678 F.3d 422 (6th Cir., 2012) In an opinion filed on May 4, 2012, the Sixth Circuit upheld a district court decision that allowed a tax deduction under Section 807 for an insurance company that increased its annuity contract reserves based on new accounting guidelines. The Court found that the new guidelines applied to the existing annuity contracts, only clarifying the requirements that existed when the contracts were issued. Bennett Dorrance et ux. v. United States, No. 2:09- cv (D. Ariz., 2012) In an opinion decided on April 19, 2013, the US District Court of Arizona amended its prior opinion that the basis in shares received upon an insurance company s demutualization transaction could be reasonably determined, the open transaction doctrine would not apply, and the basis of shares should be apportioned according to Treas. Reg. Section (a). The Court ordered the parties to confer and submit a proposed form of judgment to the court. Cigna Corp. et al. v. Commissioner, T.C. Memo. 104 T.C.M. 314 (2012) In an opinion filed on September 13, 2012, the Tax Court declined to rule on whether an insurance company s tax reserves calculation for reinsurance treaties can be computed with a method adopted after the treaties were executed. The Court said its opinion would only be advisory because the IRS conceded the deficiency and held that the calculations were correct. F.W. Services Inc. et al. v. Commissioner, 459 Fed. Appx. 389 (5th Cir., 2012) In an opinion filed on January 25, 2012, the Fifth Circuit upheld a Tax Court decision that denied a business expense deduction under Section 162(a) for a corporation that paid amounts to an insurer under a retrospectively rated deductible reimbursement policy. The Court ruled that the funds were not insurance premiums because the contract lacked adequate risk distribution and were instead nondeductible deposits toward deductibles. Massachusetts Mutual Life Insurance Co. v. United States, 103 Fed. Cl. 111 (2012) In an opinion filed on January 30, 2012, the Court of Federal Claims ruled that an insurance company may deduct declared guaranteed minimum policyholder dividends in the year of declaration (i.e., when the board of directors makes its resolution to pay the dividends) because the all-events test for accrual has been met. State Farm Mutual Automobile Insurance Co. v. Commissioner, 698 F.3d 357 (7th Cir., 2012) In an opinion decided on August 31, 2012, the Seventh Circuit affirmed and reversed in part a Tax Court decision, holding that punitive damages in bad-faith lawsuits are regular business losses and deductible when actually paid (i.e., not earlier as part of its loss reserves), but that compensatory damages should be included in loss reserves. The Seventh Circuit relied upon NAIC authoritative guidance and found that only compensatory damages for bad faith against insurers should be included in loss reserves, not punitive damages. 2012: The year in review 39

44 IRS advice/notices/procedures/ rulings ECC In ed Chief Counsel Advice released on March 22, 2013, the National Office instructed that an Agent be advised to apply the rule in the Internal Revenue Manual (i.e., to include deficiency reserves in the statutory reserve cap of Section 807) pending published guidance. ILM In a legal memorandum released on December 14, 2012, the IRS concluded that it may disclose third-party return information in the exams of unrelated taxpayers that participated in a substantially similar captive insurance program. However, the documents must satisfy the item test of Section 6103(h)(4)(B) to be disclosed. ILM In a legal memorandum released on December 14, 2012, the IRS addressed the tax consequences of a pre-1995 bankruptcy, subsequent restructuring, and settlement distributions of a holding company and its two subsidiary insurance entities under Section 108(e)(10). The IRS found that no interest was ever payable or paid by the successor related to its unpaid claims, and thus no deduction was allowed, because the amount of the unpaid claims was much larger than the stock value distributed in settlement of the claims. LB&I In a directive issued on July 30, 2012, the IRS LB&I Division instructed examiners not to challenge an insurance company s partial worthlessness deduction under Section 166(a)(2) for eligible securities, effectively allowing insurance companies to elect a safe harbor for the 2009 to 2012 taxable years. Eligible securities include loan-backed and structured securities under SSAP 43R that are partially worthless. Notice In guidance released on February 26, 2013, the IRS provided that deficiency reserves are included in the amount taken into account for a life insurance contract in determining statutory reserves under Section 807(d)(6) for purposes of applying the statutory reserve cap under Section 807(d)(1). Rev. Proc In a revenue procedure issued on September 5, 2012, the IRS provided the domestic asset/liability percentages and domestic investment yields for foreign life insurance companies to compute their minimum effectively connected net investment income under Section 842(b) for tax years beginning after December 31, Rev. Proc In a revenue procedure issued on November 9, 2012, the IRS set forth the loss payment patterns and discount factors for the 2012 accident year to be used for computing discounted unpaid losses under Section 846. Rev. Proc In a revenue procedure issued on November 9, 2012, the IRS prescribed the salvage discount factors for the 2012 accident year to be used for computing discounted estimated salvage recoverable under Section 832. Rev. Rul & Rev. Rul In revenue rulings released on January 23, 2012 and January 31, 2013, the IRS supplemented prevailing stateassumed interest rates in Rev. Rul , which are used by insurance companies to compute their reserves for life insurance and supplementary total and permanent disability benefits; individual annuities and pure endowments; and group annuities and pure endowments. 40 Continuing developments in the taxation of insurance companies

45 Private letter rulings/technical advice memoranda PLR In a letter ruling released on December 30, 2011, the IRS ruled that the transfer of life insurance policies by two banks to a LLC in exchange for membership interests in the LLC will not be treated as a transfer to an investment company under Section 351 if the company was already incorporated. The IRS also addressed the deductibility of unrelated interest expenses under Section 264(f)(1) and the status of each bank under Section 264(f)(8). PLR In a letter ruling released on March 9, 2012, the IRS ruled that a non-life subsidiary qualifies as an eligible corporation of the parent s consolidated group under Treas. Reg. Section (d) when it starts writing insurance contracts that require life insurance reserves. PLR In a letter ruling released on March 30, 2012, the IRS ruled that a long-term care benefits rider added to a singlepremium deferred annuity contract offered by a stock life insurance company should be treated as an insurance contract under Section 7702B(b)(1). Therefore, the longterm care benefits paid under the rider are excludable from gross income under Section 104(a)(3). PLR In a letter ruling released on April 27, 2012, the IRS ruled that corporate-owned life insurance policies purchased by a closely held corporation on the lives of its shareholders sufficiently satisfied the notice and consent requirements of Section 101(j)(4). The IRS concluded that the shareholders signatures on agreements and information disclosed in the policy application provided their consent. PLR In a letter ruling released on May 4, 2012, the IRS denied tax-exempt status to a nonprofit captive insurance company that provided worker compensation and employer liability coverage, finding that the company s mere operation as an insurance business is a commercial activity. PLR , PLR , PLR In a series of letter rulings released on May 11, 2012, the IRS ruled that arrangements between a surgical clinic/ partnership and a foreign insurance company constitute insurance for federal tax purposes. PLR In a letter ruling released on June 15, 2012, the IRS ruled that a general insurance captive incorporated in a foreign country and electing under Section 953(d) qualified as a domestic insurance company, and that reinsurance premiums paid to a reinsurance pool were ordinary and necessary business expenses. The IRS found that, through the captive s arrangement in the reinsurance pool, its contracts constituted insurance because it was able to demonstrate risk shifting and risk distribution. PLR In a letter ruling released on June 15, 2012, the IRS ruled that an insurance trust failed to meet the burden of proof required for tax-exempt status under Section 501(c)(9). The IRS concluded that the insurance trust did not function primarily as a voluntary employees beneficiary association because its membership is not defined by reference to an employment-related common bond, such as a common employer, affiliated employers, coverage under a collective bargaining agreement, or membership in a labor union. PLR In a letter ruling released on June 22, 2012, the IRS denied a taxpayer s request to revoke an inadvertent Section 831(b) election for treatment as a small insurance company, finding that the election was invalid because the taxpayer was not an insurance company as defined under Section 816 in the year the election was made. PLR In a letter ruling released on July 20, 2012, the IRS ruled that a company in the business of providing roadside assistance coverage to policyholders of unrelated property and casualty insurers qualifies to be taxed as an insurance company under Section : The year in review 41

46 PLR In a letter ruling released on July 27, 2012, the IRS ruled that a reduction in the face amount of a life insurance contract was not an alteration under the terms of the contract; instead, the contract should be treated as newly issued as of the date of the alteration for purposes of the Section 7702(c) (3)(B)(i) reasonable mortality charge requirements. PLR In a letter ruling released on August 31, 2012, the IRS ruled that a stock life insurance company that sells pension and non-pension contracts based on segregated asset accounts will be treated as the owner of the assets funding the pension contracts. PLR In a letter ruling released on October 5, 2012, the IRS ruled that a stock life insurance company, not the contract holders, owns the assets used to support its obligations from nonqualified annuity contracts. PLR In a letter ruling released on November 23, 2012, the IRS denied tax-exempt status for a benevolent life insurance association, finding that it did not meet the operations definition under Section 501(c)(12) and it failed the 85 percent income source test after paying a stipulated cash premium. PLR & PLR In a pair of letter rulings released on January 11, 2013, the IRS ruled that a distribution option under an annuity contract qualifies under Section 72(s) where the option provides for after-death distributions and is available to a non-spouse beneficiary if the owner dies before the annuity has begun. PLR In a letter ruling released on January 25, 2013, the IRS ruled that a trust should not recognize any gain or loss from the exchange of an existing life insurance policy for a new life insurance policy with the same beneficiary because the insured did not change. PLR In a letter ruling released on March 1, 2013, the IRS ruled that investment funds containing premium payments do not fail the diversification requirements of Section 817(h) if an asset composition discrepancy arises out of a transaction proposed by a variable life insurance issuer. PLR In a letter ruling released on April 5, 2013, the IRS ruled that vehicle service contracts constitute insurance and thus a company that issues and administers the contracts will be treated as insurance companies under Section 831, given that the company issues such contracts for more than 50 percent of its business during the tax year. PLR In a letter ruling released on April 26, 2013, the IRS granted an extension to a foreign insurance company to elect the alternative tax under Section 831(b)(2)(A). TAM In a technical advice memorandum released on August 31, 2012, the IRS concluded that unearned premium reserves must be reduced by the amount of insurance contracts that are reinsured by another insurance company under Treas. Reg. Section (4)(a)(8)(i). The IRS rejected the taxpayer s assertion that its risk of having to refund premiums to policyholders who cancel their contracts is covered by the reinsurance agreement. PLR In a letter ruling released on January 18, 2013, the IRS granted an extension to a foreign insurance company to elect to be treated as a domestic corporation and an extension to elect the alternative tax under Section 831(b)(2)(A). 42 Continuing developments in the taxation of insurance companies

47 Appendix B Insurance tax leaders Atlanta, Georgia Brian Anderson [email protected] Sherrie Winokur [email protected] Bermuda Richard Irvine [email protected] Scott D. Slater [email protected] Birmingham, Alabama Karen Miller [email protected] Boston, Massachusetts John Farina [email protected] Julie Goosman [email protected] Kevin Johnston [email protected] James Kress [email protected] Maura McKinnon [email protected] Marie-Claire Moglia [email protected] Peter Sproul [email protected] David Wiseman [email protected] Phil Zinn [email protected] Cayman Islands Ian Bridges [email protected] Chicago, Illinois Rob Finnegan [email protected] Haskell Garfinkel [email protected] Kurt Hopper [email protected] Michael Palm [email protected] Yolanda Torres-Caron [email protected] Columbus, Ohio Arthur Scherbel [email protected] Fort Worth, Texas Chuck Lambert [email protected] Kansas City, Missouri Dave Rudicel [email protected] Los Angeles, California Michael Callan [email protected] Jessie Foster [email protected] Patricia Gergen [email protected] Minneapolis, Minnesota Matthew Lodes [email protected] 2012: The year in review 43

48 New York, New York Arash Barkhordar Steve Chapman Kevin Crowe Joseph Foy* Brian Frey Timothy Kelly Gayle Kraden Michele Landon Tom Lodge Mark Lynch Lisa Miller Philadelphia, Pennsylvania Dan Fraley John Peel St. Louis, Missouri Byron Crawford Katherine Freed Jeffrey Kohler Washington, DC Metro Anthony DiGilio Surjya Mitra David Schenck** Mark Smith Corina Trainer * US financial services tax leader ** US insurance tax leader 44 Continuing developments in the taxation of insurance companies

49 Acknowledgements This report represents the analysis and efforts of many individuals within PwC s Insurance Industry Service Group and Washington National Tax Services. This publication was produced under the direction of Anthony DiGilio. The text was prepared by a team of professionals, including Yasmin Noel Dirks, Jessica Riehl, Juan Feliciano, Michael Palm, Mark S. Smith, Rob Finnegan, Surjya Mitra, and Umar Salahuddin. 2012: The year in review 45

50 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. Solicitation