In a Revenue Procedure, IRS has provided the procedures under Code Sec. 446 and Reg § 1.446-1(e) for an insurance company changing its basis of computing reserves pursuant to Code Sec. 807(f), as amended by the Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017), to obtain automatic IRS consent to change its accounting method. The Revenue Procedure also provides guidance on (i) accounting for an adjustment that arose under Code Sec. 807(f)prior to its amendment by TCJA; and (ii) how a change in basis of computing life insurance reserves must be taken into account for purposes of computing amounts under the transition relief rule of TCJA. Rev Proc 2019-10 is effective for tax years beginning after Dec. 31, 2017.
Background. Under Code Sec. 446(e), taxpayers must obtain IRS’s consent before changing a method of accounting for federal income tax purposes. (Reg § 1.446-1(e)) In most cases, a taxpayer that wishes to change its method of accounting must apply and secure the prior consent of IRS. For some accounting method changes, IRS provides an automatic procedure for obtaining its consent to the change. In general, a taxpayer uses Form 3115 for an accounting method change. Code Sec. 481(a) requires those adjustments necessary to prevent amounts from being duplicated or omitted to be taken into account when the taxpayer’s taxable income is computed under a method of accounting different from the method of accounting used to compute taxable income for the preceding tax year.
Under pre-TCJA law, if a life insurance company’s basis for determining reserve items changes during the course of a tax year, and that basis affects the reserves for contracts issued in an earlier year, then the amount of reserve change could have been taken into account over a 10-year period. Under Former Section 807(f)(1), if the change was an increase, under the so-called the 10-year spread rule, one-tenth of the total increase was deducted from life insurance company taxable income as an increase in reserves each year for ten years, starting in the year of the change. And if the change was a decrease, one-tenth of the total decrease was added to gross income as a decrease in reserves each year for ten years, starting in the year of the change.
For tax years beginning after Dec. 31, 2017, the 10-year spread rule was repealed by the TCJA. Instead, reserve changes are to be taken into account under Code Sec. 481‘s general rule for making tax accounting method changes as adjustments attributable to changes initiated by the taxpayer with IRS consent. (Code Sec. 807(f)(1))
As noted in Rev Proc 2019-10, to avoid duplication or omission of amounts related to changes that arose under Code Sec. 807(f) in a year beginning prior to Jan. 1, 2018, a taxpayer must continue the 10-year spread under prior law by taking such amounts into account as described in Former Section 807(f)(1). (Code Sec. 807(d)(1)(D))
The TCJA also amended Code Sec. 807(d) to provide a new method for computing the amount of life insurance reserves, effective for tax years beginning after Dec. 31, 2017. A transition relief rule generally requires the difference between (1) the amount of life insurance reserves with respect to any contract as of the close of the tax year preceding the first tax year beginning after Dec. 31, 2017, computed using the method prescribed by the TCJA (the post-TCJA closing balance) and (2) the amount of such reserves computed using the method prior to the amendments by the TCJA (the pre-TCJA closing balance), to be taken into account over the eight succeeding tax years.
As noted in Rev Proc 2019-10, to avoid duplication or omission of income, the computation of the pre-TCJA closing balance must take into account any change in basis that is taken into account as required by Code Sec. 807(f).
New guidance. IRS has provided that a change in the basis of computing reserves, as described in Code Sec. 807(f), by a life insurance company or by an insurance company that is not a life insurance company, is an automatic accounting method change not needing IRS’s specific consent. (Rev Proc 2019-10, Sec. 3; Rev Proc 2018-31, Sec. 26.04)
If the basis of computing any reserves referenced in Code Sec. 807(c) is changed during a tax year (year of change), then for purposes of applying Code Sec. 807(a) and Code Sec. 807(b) with respect to contracts issued before the year of change, the amount of reserves at the close of the year of change attributable to those contracts is determined on the old basis and the amount of reserves at the opening of the succeeding tax year attributable to those contracts is determined on the new basis. Reserves attributable to contracts issued during the year of change and thereafter must be computed on the new basis.
A taxpayer that changes its basis of computing reserves is subject to the procedures that apply to obtain the automatic IRS consent of to change an accounting method. Under these procedures, (a) the taxpayer must file Form 3115; (b) the taxpayer may receive audit protection for tax years prior to the year of change in connection with the change; and (c) the Code Sec. 481(a) adjustment period generally will be one tax year (year of change) for a negative Code Sec. 481(a) adjustment, and four tax years (year of change and next three tax years) for a positive Code Sec. 481(a) adjustment, as provided in Rev Proc 2018-31.
In general, a change in basis of computing reserves under Code Sec. 807(f) requires an adjustment under Code Sec. 481(a). The adjustment is computed as of the end of the year of change and is only with respect to contracts issued before the year of change. The eligibility rule in Rev Proc 2015-13, Sec. 5.01(1)(f) (dealing with eligibility for additional change within five tax years), does not apply to this change. Multiple changes during the same tax year in methods, assumptions, or factors, each of which alone would constitute a change in basis of computing reserves under Code Sec. 807(f) for the same type of contract (life insurance, annuity, etc.), are considered a single change in basis, and the effects of such multiple changes are netted and treated as a single net negative Code Sec. 481(a) adjustment or net positive Code Sec. 481(a) adjustment.
A change in basis of computing the reserve for each type of contract (life insurance, annuity, etc.) is considered a separate change in basis. A separate Code Sec. 481(a) adjustment must be determined for each type of contract, and each such Code Sec. 481(a) adjustment must be taken into account separately.
The automatic consent is not an IRS determination that the new basis of computing reserves is a permissible basis of computing reserves and does not create any presumption that the new basis is a permissible basis of computing reserves. IRS may ascertain whether the new accounting method is a permissible method of accounting. Thus, a taxpayer that changes its basis of computing reserves under this procedure may be required to change or modify that basis of computing reserves for the year of change or any subsequent year if it is determined by IRS that the basis to which the taxpayer changed does not meet the requirements of federal income tax law.
In view of the amendment of Code Sec. 807(f) by the TCJA and the information required in Rev Proc 2018-31, Sec. 26.04, the information required under Reg § 1.801-5(c) is not required to be furnished with the taxpayer’s return or on Form 3115. The information required by a taxpayer that files a Form 3115 under this procedure is set out in Rev Proc 2018-31.
A taxpayer that makes multiple changes in basis under this procedure may file a single Form 3115 that includes all the changes in basis for the year of change. Similarly, a single Form 3115 may be filed for all changes in basis for members of a group filing a consolidated return. The information required by Rev Proc 2018-31, Sec. 26.04(2)(d)(ii), is required for each separate change for each member of the group.
References: For accounting method changes, see FTC 2d/FIN ¶G-2100 et seq.; United States Tax Reporter ¶4464.21. For computing life insurance reserves, see FTC 2d/FIN ¶E-4956; United States Tax Reporter ¶8074.