November 2017

TAX DEVELOPMENTS

Senate Expected to Pass Tax Reform Bill

As has been widely reported, the Senate GOP leadership has announced that they have secured the votes necessary to pass its version of the Tax Cuts and Jobs Act (S.1).

It has been reported that several amendments have been agreed to in order to secure the necessary votes. The Senate is expected to vote on the bill later this evening (December 1).

We will review and summarize the final Senate version (if it indeed passes) when it becomes available.

REGULATORY DEVELOPMENTS

Proposed Revisions to the Consolidated Reports of Condition and Income for June 30, 2018

On November 8, the Federal Register included a proposal to revise certain aspects of the Call Report to take effect June 30, 2018. The proposal is intended to be “burden-reducing” and was created subsequent to reviewing responses of nine surveys of internal users of Call Report data within the FFIEC member entities.

The proposed changes will not impact the regulatory reporting for BOLI in Schedule RC-F (Other Assets). The proposal noted that regulators use the information provided in Schedule RC-F for off-site monitoring and pre-examination planning. The proposal included the following note regarding the relevance of the life insurance line items in particular:

Because bank-owned life insurance exposes an institution to liquidity, operational, credit, interest rate, and other risks, examiners need to identify significant holdings of life insurance assets and growth in such holdings. In these circumstances, examiners evaluate management’s adherence to prudent concentration limits for life insurance assets and management’s performance of comprehensive assessments of the risks of these assets, either on an offsite basis or during examinations.

The deadline for comments to be submitted is January 8, 2018.

LEGISLATIVE DEVELOPMENTS

Financial Regulatory Reform – Senate Banking Committee Announces Agreement

On November 13, the Senate Banking Committee Chairman Mike Crapo (R-Idaho) and a number of Democratic Committee members announced an agreement on legislative proposals to improve the nation’s financial regulatory framework.

A section-by-section summary of the legislation was also provided. Potentially noteworthy provisions include:

Community banks can opt out of Basel capital rules if they satisfy a leverage ratio of 8%-10%.
Banking entities will be exempt from Section 13 of the Bank Holding Company Act (i.e., the Volcker Rule) if they have (1) less than $10 billion in total consolidated assets, and (2) total trading assets and trading liabilities that are not more than 5% of total consolidated assets.
The threshold for applying enhanced prudential standards will be increased from $50 billion to $250 billion.
- Institutions between $50 and $100 billion would become exempt immediately;
- Institutions between $100 and $250 billion would become exempt 18 months after enactment.
Certain municipal bonds will be eligible for inclusion as high-quality liquid assets (HQLA) under the Liquidity Coverage Ratio rules.

According to the announcement, legislative text is in the process of being finalized and will be released upon completion.

Ad Hoc LRA – November 2, 2017

House Releases the Tax Cuts and Jobs Act

Today, the House Ways and Means Committee released the long-awaited proposed tax reform legislation (HR 1 – Tax Cuts and Jobs Act). A section by section summary was also released.

The Committee is scheduled to mark up the bill on November 6.

While we have not fully reviewed the proposed bill, we note that Subtitle H includes a number of insurance-related provisions. The titles of many of these appear familiar from past legislative proposals. There do not appear to be any contemplated provisions related to life insurance inside build-up, death benefit proceeds, or pro-rata interest expense disallowance under IRC § 264.

Again, we’ll review in more detail and provide additional updates.

Ad Hoc LRA – November 6, 2017

Tax Cuts and Jobs Act Summary

As a follow up to our November 2^nd Ad Hoc LRA Update providing links to the Tax Cuts and Jobs Act, below is a summary of provisions that we believe to be most noteworthy for our BOLI/COLI clients.

Section	Provision	MBSA Observations
Sec. 2001. Repeal of alternative minimum tax	The AMT would be repealed.
Sec. 3001. Reduction in Corporate Tax Rate	The corporate tax rate would be reduced to 20%, except as otherwise provided.	Among other considerations, such a change would likely necessitate increased COLI hedging positions in order to avoid deficient hedging.
Sec. 3301. Interest	Every business, regardless of its form, would be subject to a disallowance of a deduction for net interest expense in excess of 30 percent of the business’s adjusted taxable income.	As drafted, this provision appears to apply to financial institutions; Although it also appears to allow interest expense to fully offset interest income. We have not yet assessed its potential impact.
Sec. 3302. Modification of net operating loss deduction	Taxpayers would be able to deduct an NOL carryover or carryback only to the extent of 90 percent of the taxpayer’s taxable income (determined without regard to the NOL deduction). Carrybacks would be generally repealed (subject to certain exceptions). Carryforwards can be increased by an interest factor to preserve value (federal short term rate plus 4%) and would not have an expiration.	Sec. 3701 includes a specific NOL provision for life insurance companies. The description suggests that it will bring the treatment into conformity with the provisions set forth in Sec. 3302.
Sec. 3303. Like-kind exchanges of real property	Section 1031 of the IRC would be modified to replace references to “property” with “real property.”	The proposed legislation does not make any references to Section 1035.
Sec. 3703. Computation of life insurance tax reserves	Life insurance companies would take into account a specific percentage, 76.5 percent, of the increase or decrease in reserves for future un-accrued claims [as reported on the insurer’s regulatory annual statement and on tax schedule M-3] in computing taxable income. Deficiency reserves, asset adequacy reserves or other types of reserves would not be included.	The summary asserts that the current-law rule generally understates income for life insurance companies. According to the JCT, this provision would increase revenues by $14.9 billion over 2018-2027. According to industry sources, the impact would be much larger; perhaps over $100 billion during that time frame. We anticipate vigorous industry efforts for modification or repeal (at minimum, to bring the impact within the $14.9 billion ballpark).
Sec. 3710. Capitalization of certain policy acquisition expenses	Amend IRC Section 848(c), the so-called Federal DAC Tax rules which require a 10-year amortization of certain policy acquisition expenses. Instead of the current 3 categories and percentages, the provision calls for 2 categories: group contracts covering a group of connected individuals, such as by employment or membership in an organization; and all other specified contracts. The percentage of net premiums that would be spread over ten years would be 4% for group insurance contracts and 11% for all other specified contracts.	This provision would likely have a direct impact on pricing for new contracts. Currently, BOLI/COLI contracts are generally subject to amortization of 7.7% of net premiums. Although we expect the intent is to increase this rate to 11% on COLI/BOLI, as written, it is ambiguous at best whether the 4% rate would apply. As suggested above, it is not clear what types of contracts would meet the definition of “group contracts” in the bill (Sec. 3710(b)); the summary referred to individuals connected by “employment.” The JCT estimated that this provision would increase revenues by ~$7 billion over 2018-2027.
Sec. 3801. Nonqualified deferred compensation	An employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation (i.e., receipt of the compensation is not subject to future performance of substantial services). The provision would be effective for amounts attributable to services performed after 2017. The current-law rules would continue to apply to existing non-qualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to the provision.	This appears to be a very significant proposed change in tax treatment for NQDC plans by way of adding a new section 409(B) and modifying existing rules. The new rules would eventually apply to existing plans. The bill text (p. 302 line 7) states that the Secretary will issue guidance providing an ability to accelerate payments attributable to services performed before 12/31/2017 without violating 409(A) requirements. If enacted as proposed, the rule would likely hamper all future deferrals in the absence of plan changes to counterbalance its effects.

As has been widely reported, today, the House Ways and Means Committee is holding a hearing to mark up the legislation.

Ad Hoc LRA – November 13, 2017

Tax Cuts and Jobs Act Summary – JCT Description of Senate Finance Committee Chairman’s Mark

On November 9, the Senate Finance Committee and the JCT released a Description of the Chairman’s Mark of the Tax Cuts and Jobs Act.

Below is an update to our last summary of provisions that we believe to be most noteworthy for our BOLI/COLI clients. In this table, we attempt to summarize highlights from the Senate Finance Committee’s markup in comparison to the House bill.

Section	House Bill	Senate Chairman’s Mark
Sec. 3801. Nonqualified deferred compensation	An employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation (i.e., receipt of the compensation is not subject to future performance of substantial services). The provision would be effective for amounts attributable to services performed after 2017. The current-law rules would continue to apply to existing non-qualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to the provision.	No meaningful change observed. Note that the effective date for a change in treatment of deferred compensation attributable to services performed before 1/1/2018 is the last taxable year before 2027 (i.e., a one-year extension from the House plan). SEE UPDATE BELOW THE TABLE REGARDING LOBBYING EFFORTS ON THIS PROPOSAL.
Sec. 3703. Computation of life insurance tax reserves	Life insurance companies would take into account a specific percentage, 76.5 percent, of the increase or decrease in reserves for future un-accrued claims [as reported on the insurer’s regulatory annual statement and on tax schedule M-3] in computing taxable income. Deficiency reserves, asset adequacy reserves or other types of reserves would not be included.	Income or loss resulting from a change in method of computing life insurance company reserves is taken into account consistent with IRS procedures, generally ratably over a four-year period, instead of over a 10-year period. The description did not include any references to deficiency reserves or other types of reserves being excluded.
Sec. 3710. Capitalization of certain policy acquisition expenses	Amend IRC Section 848(c), the so-called Federal DAC Tax rules which require a 10-year amortization of certain policy acquisition expenses. Instead of the current 3 categories and percentages, the provision calls for 2 categories: (1) group contracts covering a group of connected individuals, such as by employment or membership in an organization; and (2) all other specified contracts. The percentage of net premiums that would be spread over ten years would be 4% for group insurance contracts and 11% for all other specified contracts.	The Senate provision appears to call for different amortization periods and percentages as compared to the House proposal. The amortization period will be extended from 120 months to 600 months (i.e., 50 years). The proposal provides that for annuity contracts, the percentage is 3.17; for group life insurance contracts, the percentage is 3.72; and for all other specified insurance contracts, the percentage is 13.97.
[Sec. TBD] Tax reporting for life settlement transactions	No provision.	The JCT Description of this provision appears to be very similar in nature to a legislative proposal we covered in our May LRA update (H.R. 1262). Reporting Requirements A “buyer” of an interest in a life insurance contract must report the following information to the IRS, the insurance company, and the seller: The buyer’s name, address, and taxpayer identification number (“TIN”), The name, address, and TIN of each recipient of payment in the reportable policy sale, The date of the sale, and The amount of each payment. [Note, the payment amounts are not required to be provided to the life insurance company.] The insurance company must report the following information: The basis of the contract (i.e., the investment in the contract within the meaning of section 72(e)(6)), The name, address, and TIN of the seller or the transferor to a foreign person, and The policy number of the contract. When a reportable death benefit is paid, the insurance company must report the following information: The gross amount of the payment, The TIN of the payee, and The payor’s estimate of the buyer’s basis in the contract Determination of Basis The provision provides that in determining the basis of a life insurance or annuity contract, no adjustment is made for mortality, expense, or other reasonable charges incurred under the contract (known as “cost of insurance”). This reverses the position of the IRS in Revenue Ruling 2009-13 that on sale of a cash value life insurance contract, the insured’s (seller’s) basis is reduced by the cost of insurance. Transfer for Value Rule The provision provides that the exceptions to the transfer for value rules do not apply in the case of a transfer of a life insurance contract, or any interest in a life insurance contract, in a reportable policy sale. Thus, some portion of the death benefit ultimately payable under such a contract may be includable in income.
Sec. 2001. Repeal of alternative minimum tax	The AMT would be repealed.	No meaningful change observed.
Sec. 3301. Interest	Deduction for net interest expense limited to 30 percent of the business’s adjusted taxable income.	No meaningful change observed. The Senate Markup further describes the inclusion of business interest income as a full offset to interest expense under the plan.
Sec. 3302. Modification of net operating loss deduction	The proposal limits the NOL deduction to 90 percent of taxable income (determined without regard to the deduction). Carryovers to other years are adjusted to take account of this limitation, and may be carried forward indefinitely.	No meaningful change observed.
Sec. 3303. Like-kind exchanges of real property	Section 1031 of the IRC would be modified to replace references to “property” with “real property.” The proposed legislation does not make any references to Section 1035.	No meaningful change observed.

NQDC Lobbying Update

Brian Gaff, Head of the American Retirement Association, provided an update on lobbying efforts related to aspects of the tax reform proposal, including NQDC.

Tax Reform Update After a long weekend of lobbying on Capitol Hill, our good friend Senator Rob Portman (R-OH) is offering an amendment that will strike the provision prohibiting catch-up contributions for small business owners earning more than 500k and the provision practically eliminating most forms of NQDC. The American Retirement Association thanks Senator Portman for his leadership and we will be working hard to make sure this amendment passes.

The Senate Finance Committee has scheduled a hearing to markup the original bill on November 13. Here is a link to all of the proposed amendments to the bill thus far. Amendment number 101 (Portman 3) calls for a full elimination of the NQDC proposal from the Chairman’s Mark.

Ad Hoc LRA – November 16, 2017

Tax Reform Passes House

Today, the House of Representatives approved the tax reform proposal (H.R. 1) by passing H.Res. 619. Discussions continue in the Senate.

As has been widely reported, the version of the tax reform bill that passed the House has been materially modified from the original legislative proposal. Below is an update with regard to provisions we believe to be most noteworthy for our BOLI/COLI clients.

Section	Original House Proposal	Current Version (Passed in the House)
Sec. 2001. Repeal of alternative minimum tax	The AMT would be repealed.	No change.
Sec. 3001. Reduction in Corporate Tax Rate	The corporate tax rate would be reduced to 20%, except as otherwise provided.	No change.
Sec. 3302. Modification of net operating loss deduction	Taxpayers would be able to deduct an NOL carryover or carryback only to the extent of 90 percent of the taxpayer’s taxable income (determined without regard to the NOL deduction). Carrybacks would be generally repealed (subject to certain exceptions). Carryforwards can be increased by an interest factor to preserve value (federal short term rate plus 4%) and would not have an expiration.	No change.
Sec. 3703. Computation of life insurance tax reserves	Life insurance companies would take into account a specific percentage, 76.5 percent, of the increase or decrease in reserves for future un-accrued claims [as reported on the insurer’s regulatory annual statement and on tax schedule M-3] in computing taxable income. Deficiency reserves, asset adequacy reserves or other types of reserves would not be included.	REPLACED with an 8% surtax on life insurance company taxable income. Likewise, the title of the provision has been updated.
Sec. 3710. Capitalization of certain policy acquisition expenses	Amend IRC Section 848(c), the so-called Federal DAC Tax rules which require a 10-year amortization of certain policy acquisition expenses. Instead of the current 3 categories and percentages, the provision calls for 2 categories: (1) group contracts covering a group of connected individuals, such as by employment or membership in an organization; and (2) all other specified contracts. The percentage of net premiums that would be spread over ten years would be 4% for group insurance contracts and 11% for all other specified contracts.	REMOVED. It has been reported that this provision and the proposed change in life insurance tax reserve computations were both removed from the bill and replaced with the proposed 8% surtax noted above.
Sec. 3801. Nonqualified deferred compensation	An employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation (i.e., receipt of the compensation is not subject to future performance of substantial services). The provision would be effective for amounts attributable to services performed after 2017. The current-law rules would continue to apply to existing non-qualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to the provision.	REMOVED. This provision was fully removed from the bill.

Ad Hoc LRA – November 27, 2017

Tax Cuts and Jobs Act – Senate Proposal’s Legislative Text

On November 20, the Senate Finance Committee released the legislative text for the Senate’s version of the Tax Cuts and Jobs Act.

Below is an update with regard to certain provisions that are directly applicable to BOLI/COLI clients. All three of these provisions differ from the tax reform legislation that was passed by the House.

Section	Senate Bill	MBSA Observations
Sec. 13517. Capitalization of certain policy acquisition expenses [pg 253]	Amortization Period: Section 848 is amended by striking “120-month” each place it appears in sub-14 sections (a)(2) and (b)(1) and inserting ‘‘600-month’’. Determination of Expenses: Paragraph (1) of section 848(c) is amended – (1) by striking ‘‘1.75 percent’’ in subparagraph (A) and inserting ‘‘3.17 percent’’, (2) by striking ‘‘2.05 percent’’ in subparagraph (B) and inserting ‘‘3.72 percent’’, and (3) by striking ‘‘7.7 percent’’ in subparagraph (C) and inserting ‘‘13.97 percent’’. Effective Date: The amendments made by this section shall apply to taxable years beginning after December 31, 2017.	The proposed changes to insurance companies’ DAC taxes are limited to modifying the length of the amortization period (i.e., extended from 10 years to 50 years) and the applicable percentages of net premiums by type. As such, it appears that BOLI policies that would have historically been subject to DAC based on the 7.7% determination will be subject to 13.97% under this proposal.
Sec. 13519. Clarification of Tax Basis of Life Insurance Contracts [pg 260]	Would modify section 1016(a) to make clear, that “no such adjustment” to basis shall be made for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract.	As we noted previously, this proposal was reflected in (H.R. 1262) which we covered in our May 2017 LRA update. This reverses the position of the IRS in Revenue Ruling 2009-13 that on sale of a cash value life insurance contract, the insured’s (seller’s) basis is reduced by the cost of insurance.
Sec. 13520. Exception to Transfer for Valuable Consideration Rules [pg. 261]	This proposal would amend section 101(a) to read as follows [new language shown as blue underlined text]: (a) Proceeds of life insurance contracts payable by reason of death. (1) General rule. Except as otherwise provided in paragraph (2) and (3), subsection (d), subsection (f), and subsection (j), gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured. (2) Transfer for valuable consideration. In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee. The preceding sentence shall not apply in the case of such a transfer– (A) if such contract or interest therein has a basis for determining gain or loss in the hands of a transferee determined in whole or in part by reference to such basis of such contract or interest therein in the hands of the transferor, or (B) if such transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer. The term “other amounts” in the first sentence of this paragraph includes interest paid or accrued by the transferee on indebtedness with respect to such contract or any interest therein if such interest paid or accrued is not allowable as a deduction by reason of section 264(a)(4) [26 USCS § 264(a)(4)]. (3) EXCEPTION TO VALUABLE CONSIDERATION RULES FOR COMMERCIAL TRANSFERS.— (A) IN GENERAL.—The second sentence of paragraph (2) shall not apply in the case of a transfer of a life insurance contract, or any interest therein, which is a reportable policy sale. (B) REPORTABLE POLICY SALE.—For purposes of this paragraph, the term ‘reportable policy sale’ means the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in such life insurance contract. For purposes of the preceding sentence, the term ‘indirectly’ applies to the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract.	The proposed language appears to eliminate any ability to apply the existing transfer for value exceptions (from 101(a)(2)(A) and (B)) in the context of commercial transfers of interests in life insurance contracts. Among other implications, it appears that BOLI policies obtained via acquisitions of other institutions structured as asset purchases (e.g., 338 elections) would be materially impacted. If our interpretation of the provision is correct, all such policies’ death benefits would be subject to taxation to the extent they exceed the stepped-up basis at time of acquisition, whereas current law allows for policies covering active officers to be exempt from the transfer for value rule.