On February 2, the Obama administration released its Fiscal Year 2016 Budget Proposal. The Department of the Treasury also released its Greenbook. The proposal and general explanations include the same series of proposals relating to insurance and other financial products that we have highlighted in previous years, including:
This year’s proposal adds one more insurance-related proposal that applies to life insurance companies. The proposal would conform the net operating loss rules of life insurance companies to the same carryback and carryforward periods that apply to corporations. Currently, life insurance companies are allowed a three-year carryback (versus two years for corporations) and a fifteen-year carryforward (versus twenty years for corporations). The projected budget impact of this new proposal is a little more than $300 million over ten years.
Below is a brief overview of the recurring proposals. None appear to be materially different from the Obama administration’s previous proposals.
Expansion of Pro-Rata Interest Expense Disallowance
IRC section 264(f) reduces interest expense deductions that are allocable to unborrowed policy cash values (i.e., of permanent life insurance policies owned by corporations) based on a statutory formula. However, policies covering 20% owners, officers, directors, or employees of the taxpayer are exempted from the pro-rata interest expense disallowance. The proposal seeks to limit the exemption to policies covering 20% owners, thereby expanding the pro-rata interest expense disallowance to encompass policies covering officers, directors, and employees of the taxpayer.
The proposed change is prospective in nature; if legislation were enacted consistent with the proposal, it would only impact policies purchased after the effective date and existing policies that are subsequently subject to a material change (or IRC §1035 exchange). This proposal is projected to produce roughly $6.3 billion in tax revenue over ten years, an increase of more than 13% over last year’s projection.
Modification to the Proration Rules for Life Insurance Company General and Separate Accounts
Companies are allowed a tax deduction for a portion of dividends received from other corporations in order to prevent or limit triple taxation of dividends (e.g., at the corporate payor level, the corporate receiver level, and the individual shareholder level). Similarly, life insurance companies are allowed a deduction that is prorated between a policyholder’s share and the company’s share. The proposal seeks to modify the proration rules for this purpose. In the government’s view, the modification would result in the allowed deductions being more reflective of a life insurance company’s actual economic interest in the dividends.
This proposal is projected to produce roughly $7.5 billion in tax revenue over ten years, an increase of more than 19% over last year’s projection.
Require Information Reporting for Private Separate Accounts of Life Insurance Companies
This proposal would require life insurance companies to report to the IRS the policyholder’s taxpayer identification number (TIN), the policy number, the amount of accumulated untaxed income, the total contract account value, and the portion of that value that was invested in one or more “private separate accounts.” A private separate account would be defined as any account with respect to which a related group of persons owns policies whose cash values, in the aggregate, represent at least 10% of the value of the separate account. The stated purpose of this reporting requirement is to help the IRS more easily identify which contracts qualify as insurance contracts and which should be disregarded under the investor control doctrine.
It is our understanding that this initiative is directed primarily towards the high-net-worth-individual market, where it is not uncommon for wealthy individuals and/or families to invest substantial sums in hedge funds on a highly bespoke basis. If nothing else, this serves as an excellent reminder of how important it is to maintain familiarity with and ensure compliance with investor control safe harbors.
This proposal is projected to produce an estimated $8 million in tax revenue over ten years, unchanged from the prior year’s projection.
Modification of Rules Applying to Secondary Market Sales of Life Insurance Contracts
This proposal applies to sales of life insurance contracts in the secondary market (e.g., Life Settlements and Viatical Settlements). The proposal includes some recordkeeping requirements and would modify the existing transfer for value rule to ensure that exceptions to the rule would not apply to buyers of policies. This proposal is projected to produce approximately $0.5 billion in tax revenue over ten years, an increase of about 1% over last year’s projection.
Limit the Total Accrual of Tax-Favored Retirement Benefits
Under current law, the maximum benefit permitted to be paid under a qualified defined benefit plan in 2015 is $210,000 per year, adjusted for increases in cost of living. Although subject to contribution limits, defined contribution plans and IRAs currently do not limit the amount that can be accumulated within the accounts.
This budget proposal seeks to implement an aggregate cap on accumulated amounts within tax-favored retirement plans whereby total accumulations may not exceed an amount required to fund a joint and survivor annuity for the maximum amount permitted for tax-qualified defined benefit plans. Currently, the maximum permitted accumulation under this proposal for an individual age 62 would be roughly $3.4 million. If a taxpayer reached the maximum permitted accumulation, no further contributions or accruals would be permitted, but the taxpayer’s account balance could continue to grow with investment earnings.
This proposal is projected to produce approximately $26 billion in tax revenue over ten years, a decrease of about 8% over last year’s projection.
Require that Derivative Contracts be Marked-to-Market with Gain or Loss Treated as Ordinary
Currently, different derivative transaction structures have varied tax timing and/or uncertain tax treatment. This proposal seeks to require all derivative contracts (other than those that are identified in advance of acquisition and accounted for as hedging positions) to be marked-to-market by the last business day of the year and the gain or loss to be treated as ordinary. This proposal is projected to produce an estimated $19.8 billion in tax revenue over ten years, an increase of about 5% over last year’s projection.
As we noted in our Ad Hoc LRA Update distributed February 3, the regulators recently released a revised schedule for the standardized approach RWA. The revised schedule provided desirable clarification regarding treatment of BOLI. At present, BOLI values are reflected in the following forms/schedules:
After discussions with interested clients, we have been asked to submit another comment letter seeking greater alignment across these call report schedules. The comment submission deadline is March 4.
As we reported last month, in January the District Court largely denied Transamerica and Clark Consulting’s motion to dismiss this matter in which FNB is seeking $2.5 million that it asserts should have been paid by Transamerica upon the surrender of BOLI contracts last year. On February 6, Transamerica and Clark Consulting (the Defendants) answered FNB’s complaint. The Defendants’ position is that they are not liable for the “Bank Enhancement Amount” because FNB failed to perform a condition precedent found in part of the stable value agreement which entitled JPMorgan not to pay the Bank Enhancement Amount. The Defendants also allege that they rightfully deducted the Bank Enhancement Amount from the Investment Value of the subaccount because JPMorgan did not pay the amount. Specifically, the Defendants allege that FNB could not make a representation that the policies have not been previously owned by an entity other than the policyholder. The original policy owner was Park View, which merged into FNB, and Transamerica and Clark Consulting allege that this means the policies have been previously owned by a different policyholder.
On February 20, Transamerica and Clark Consulting filed a third-party complaint against JPMorgan Chase Bank, N.A. The third-party complaint mirrors their answer to FNB’s complaint, in that it alleges that Transamerica was allowed to deduct the Bank Enhancement Amount if JPMorgan decided not to pay it, and that JPMorgan rightfully did not have to pay it because the conditions for payment were not “strictly satisfied.“ However, they also allege that because FNB’s damages were solely caused by JPMorgan’s decision not to pay the Bank Enhancement Amount, if there is liability it should belong to JPMorgan.
Due to the third-party complaint filed against JPMorgan, the court cancelled the case management conference that was scheduled for February 27; it will be rescheduled at a later date.
On February 2, the agencies published in the Federal Register a notice proposing a revised draft Schedule RC-R to capture the reporting requirements for risk-weighted assets under the Standardized Approach rules that became effective January 1, 20151. The revised form is open for public comments until March 4.
The revised draft form and instructions provide additional guidance regarding how BOLI programs should be reflected in Schedule RC-R. In particular, the regulators are proposing to add a line item (8.a.) that will specifically capture the aggregate carrying value of separate account and hybrid BOLI (column R) and the total RWA associated with those assets (column S). These values appear to include the general account portions of separate account products.
BOLI that is solely a general account insurance product should be reported in column I (of line item 8) for a 100% risk weight.
Overall, the form and instructions (as they relate to BOLI) appear to be straightforward and largely in line with our understanding of the instructions for the Advanced Approach RWA Schedule (Form 101 Schedule R). However, it does not appear to be entirely clear whether the Equity Exposures to Investment Funds lines of the Advanced Approach form are supposed to (or allowed to) include the general account portions of separate account BOLI exposures.
Advanced Approach institutions may want to seek clarification or confirmation that they can apply the same treatment to separate account BOLI (i.e., including the general account portions thereof) under both the Standardized and Advanced Approach schedules.
1 On behalf of interested clients, we submitted a comment letter to the regulators on August 19, 2014 requesting clarification on the treatment of BOLI exposures under this form.