On December 22, President Trump signed into law the “Tax Cuts and Jobs Act” (TCJA). The implications of the TCJA are, of course, wide reaching for businesses. In this LRA update, we highlight several potential implications for BOLI/COLI. We will be publishing more detailed analyses of our findings as we are able to more fully research key topics in the coming months.
Corporate Rate Reduction
The corporate tax rate is reduced from 35% to 21% effective 1/1/2018. While this doesn’t change the tax treatment of BOLI/COLI directly, it nevertheless has a number of potentially significant implications.
Repeal of Corporate AMT
Effective 1/1/2018, a business’ determination of alternative minimum taxable income (AMTI) under IRC Section 55 shall be done without regard to sections 56 through 59 of the Code. Among other things, section 56 requires the inclusion of life insurance inside build-up and death benefit proceeds as AMTI.
Life Settlement – Cost Basis Provisions
Section 13521 of the TCJA modifies IRC Section 1016(a) to make clear that a taxpayer’s cost basis is not adjusted for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract.
Life Settlement – Transfer for Value Provisions
Section 13522 of the TCJA eliminates, in the event of a “Reportable Policy Sale,” the exclusions to the transfer for value rules under IRC Section 101(a)(2) that previously applied to carryover basis transactions [§101(a)(2)(A)] or if the transfer was to a corporation in which the insured is a shareholder or officer [§101(a)(2)(B)].
The Act defines Reportable Policy Sale as follows:
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.’’
As we’ve noted in prior LRA updates, these provisions may impact certain transactions, such as M&A transactions. This is an area we will be researching further.
Note: Reportable Policy Sales are also subject to numerous information reporting requirements that apply to the buyer, the seller and the insurance underwriter. To the extent that any BOLI-related transactions are deemed to be a Reportable Policy Sale, these requirements should be carefully reviewed.
DAC and Life Insurer Reserves
The TCJA increases the DAC tax rate for new BOLI/COLI contracts from 7.7% of net premiums to 9.2% and extends the amortization period from 10 years to 15 years. While the base rate and amortization period have been increased, it is worth noting that the marginal rate reduction more than offsets the cost impact of this provision. For example, one leading BOLI issuer historically calculated a DAC asset of 4.146% [i.e., 7.7% x 35%/(1-35%) = 4.146%]. Using the new variables (9.2% charge and a 21% tax rate), the resulting DAC asset would be 2.446%.
The TCJA also modifies existing rules regarding life insurers’ tax reserves. It is expected that the changes will increase the tax cost to insurers; however, it remains to be seen by how much and what, if any, impact such a change will have on new and existing products.
On December 18, First National Bank of Pennsylvania agreed to dismiss, with prejudice, its appeal of a District Court’s summary judgment ruling in favor of Transamerica.
This dispute centered on whether FNB was paid the entire amount it was owed after it surrendered certain Separate Account BOLI policies. FNB claimed that in addition to the amount it was paid at surrender (approximately $18 million), it was owed an amount known as the “Bank Enhancement Amount” (worth more than $2.5 million) from a third-party, and that Transamerica’s actions directly prevented FNB from receiving it.
The District Court’s opinion summarized the central issues of the case, and ultimately concluded that JPMorgan was correct with respect to each determination:
The amount owed to the Policyowner at surrender under the Stable Value Subaccount is governed by various provisions in the SVA and the EAA. Under the EAA, JP Morgan promised that, subject to certain limits and conditions which had to be “strictly satisfied,” it would pay an amount known as the “Bank Enhancement Amount” to Commonwealth General [Transamerica’s affiliate] at surrender. Two conditions in the EAA are relevant to this dispute. The first condition was that “[t]he Polices are not, and have not been previously, owned by an entity other than the Policyowner on or prior to the Immunization Termination Date.” The second condition required that, within a specified time period, the Policyowner deliver “a fully executed and complete Surrender Certificate” that is “substantially in the form of the document attached as Exhibit C” to the EAA. Failure to strictly satisfy either of these conditions under the EAA discharged JP Morgan’s obligation to pay the Bank Enhancement Amount to Commonwealth General.
Citation: US-APP-CA3 17-2691
On December 7, the US banking regulators issued an interagency statement in support of the conclusions reached to reform the international bank capital standards initiated in response to the global financial crisis.
Here is a link to the BIS release of the finalized post-crisis reforms. Below are a few noteworthy aspects of the final Basel regulatory standard:
1 A risk weight of 30% may be applied if the exposure to the bank satisfies all of the criteria for Grade A classification and if the counterparty bank has (i) a CET1 ratio of 14% or above; and (ii) a Tier 1 leverage ratio of 5% or above.
2 In some cases, these floors consist of recalibrated values of the existing Basel II floors. In other cases, the floors represent new constraints for banks’ IRB models.
It is worth noting that the regulators will consider how to apply the revisions to the Basel III reform package in the United States, and any proposed changes based on this agreement will be made through the standard notice-and-comment rulemaking process.
On December 15, the Conference Committee released its final, reconciled legislative text of the Tax Cuts and Jobs Act. The Committee also released a Conference Report and updated JCT revenue estimates.
The final bill removes the Corporate AMT. The last-minute retention of the Corporate AMT under the Senate plan, if retained, would have created material negative consequences for various income exclusions and deductions, including the tax treatment of COLI/BOLI. Of note, since life insurance inside build-up and death benefit proceeds are subject to inclusion under the AMT and the proposed AMT tax rate matched the regular tax rate (20%), it would have effectively made BOLI/COLI growth and death proceeds taxable.
As it relates to the insurance-related provisions, the final bill largely embodies the Senate proposals. Below is an updated summary of certain life insurance-related provisions that we have been monitoring.
Summary of Final Provision
|Surtax on life insurance company taxable income
|The 8% surtax on life insurance company taxable income set forth in the House bill was not retained.
|Computation of life insurance tax reserves
The final text retains, with modification, the Senate bill’s provision regarding the taxation of life insurance company reserves.
The JCT estimates this provision to raise $15.2 billion in tax revenue over ten years.
One contact at a prominent BOLI/COLI carrier informally advised us that this provision was the most economically impactful provision under consideration for its business and thought the legislators were underestimating the implications of the original provision. This view was echoed during a recent ALI CLE conference in Washington D.C.
We are seeking updated views on the likely impact of modifications incorporated in the final bill.
Capitalization of certain policy acquisition expenses
The conference agreement follows the Senate version with modifications.
Amortization Period: Extended from 120 months to 180 months.
DAC Tax Rates: For annuity contracts, the percentage is 2.09 percent; for group life insurance contracts, the percentage is 2.45 percent; and for all other specified insurance contracts, the percentage is 9.20 percent.
Effective Date: This section shall apply to taxable years beginning after December 31, 2017.
This provision will make new BOLI/COLI contracts more expensive for life insurance companies to issue. BOLI policies that would have historically been subject to DAC based on the 7.7% determination will be subject to 9.2% rate and the amortization will be extended by 5 years.
The JCT revenue estimate for the DAC provisions is $7.2 billion over ten years.
Clarification of Tax Basis of Life Insurance Contracts
The conference agreement follows the Senate version regarding “Tax reporting for life settlement transactions, clarification of tax basis of life insurance contracts, and exception to transfer for valuable consideration rules” without modification.
This provision 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.
|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.
|Exception to Transfer for Valuable Consideration Rules
The conference agreement follows the Senate version without modification.
This provision would amend section 101(a) 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 asset purchase acquisitions of other institutions will be materially impacted. If our interpretation of the provision is correct, all such policies’ death benefits will become subject to taxation (on amounts in excess of adjusted bases). Under current law, policies covering active officers at time of acquisition are exempt from the transfer for value rule and thus not subject to tax on death proceeds.
The Republican leadership in the House and Senate are anticipating final votes on the bill in the next couple of days.