(Photo: Allison Bell/TA)
The Internal Revenue Service has made a decision that could increase the 2017 income tax bills of U.S. life insurers that control life insurance companies in other countries.
The IRS ruled last week that those companies will have to include the cash in their foreign life insurance subsidiaries when theyâ€™re calculating how much they owe in connection with a new Tax Cuts and Jobs Act (TCJA) tax â€” a one-time â€śtransition taxâ€ť on the earnings and cash of U.S. companiesâ€™ foreign subsidiaries. The TCJA transition tax provision updated Internal Revenue Code (IRC) Section 965.
(Related:Â IRS Postpones Life Settlement Tax Reporting Requirement)
The new IRS ruling on the IRC Section 965 update means that U.S. life insurers with foreign subsidiaries may face big new tax bills based onÂ the foreign subsidiariesâ€™ reserves, even though the life insurers accumulated the reserves to meet obligations to customers, not because they piled up mountains of profits.
The IRS and its parent, the U.S. Treasury Department, put the decision in the introduction to a new batch of TCJA transition tax â€śguidance,â€ť or discussion of how IRS officials expect to apply the law.
The IRS and the Treasury Department are preparing to publish the new guidance in the Federal Register Wednesday. An early version of the Federal Register notice is available here.
Complicated Issue; Big Revenue Drain
In the past, U.S. tax laws let U.S.-based multinationals put off paying income taxes on the earnings of foreign subsidiaries. The parent companies had to pay taxes on the foreign childrenâ€™s earnings only whenÂ the corporate children sent cash home to their parents.
Analysts at the Office of Management and Budget told Congress in May 2017 that the old system, â€śdeferral of income from controlled foreign corporations,â€ť would cost the federal government about $107 billion in tax revenue in 2017.
OMB officials ranked deferral of income from foreign subsidiaries as the fourth biggest â€śtax expenditure,â€ť or planned reduction in federal income tax revenue. The only bigger tax expenditures listed were for an item related to home ownership, the capital gains tax exclusion; and the group health tax exclusion.
Now, U.S.-based multinationals are supposed to shift toward paying income taxes on foreign subsidiariesâ€™ earnings as income is earned.
Under the new IRC Section 965 transition tax system, U.S.-based multinationals are supposed to start by making a big, one-time payment to the IRS. The size of the one-time payment will be based on the foreign income a company has deferred since 1986, and on the companyâ€™s â€śaggregated foreign cash position.â€ť
The IRS has talked about how the new IRC Section 965 transition notice might work in several notices.
What the ACLI Said
Three representatives from the American Council of Life Insurers asked in June, in a comment letter on the IRS notices, for the IRS to keep a foreign life insurance subsidiaryâ€™s reserves out of cash position calculations for transition tax purposes.
Many ACLI members are affected by the IRC Section 965 transition tax issue, the ACLI reps wrote.
â€śThe tax is particularly onerous for life insurers, because most of a life insurerâ€™s assets are held in cash and cash equivalents to satisfy future policy claims and capital requirements,â€ť the reps wrote. â€śUnder Section 965, this subjects life insurers to a higher rate of tax than a manufacturer or retailer.â€ť
The ACLI asked the IRS to let a U.S.-based multinational life insurer use the cash and cash equivalents at the U.S. parent, rather than at the foreign subsidiary, to determine the size of the companyâ€™s Section 965 tax bill.
What the IRS Said
IRS officials say in their guidance that they received many requests for special treatment for certain types of companyÂ assets.
â€śFor example,â€ť officialsÂ write, â€ścomments requested guidance excluding certain assets from a specified foreign corporationâ€™s cash position, or otherwise providing special rules with respect to those assets, including (i) cash used, or intended to be used, to fund foreign acquisitions; (ii) blocked, restricted, or segregated cash; (iii) cash used, or to be used, to pay third-party payables within a specified period (for example, 12 months after a cash measurement date); (iv) obligations with respect to which there was an inclusion under section 956; (v) cash held in a fiduciary or trust capacity; [or] (vi) cash held or attributable to an entity that is engaged in a regulated industry, such as life insurance; and (vii) cash pledged against defined liabilities as well as potential or contingent liabilities.â€ť
IRS officials say the exclusion requests seem to be based on the idea that a companyâ€™s cash position should include only cash and cash equivalents available for general use, not assets devoted to specific purposes.
The legislative history of the new transition tax shows no indication that members of Congress wanted a company to consider how liquid an asset is when calculating a foreign subsidiaryâ€™s cash position, officials say.
The statute does give a list of the items that should be included in a companyâ€™s cash position, officials say, in IRC Section 965(c)(3)(B).
â€śThe Treasury Department and the IRS have determined that the definition of cash position in section 965(c)(3)(B) is the best indication of what Congress believed was a liquid asset,â€ť officials say. â€śDepending on the facts, any particular asset may be required to be used for a specific purpose, or a taxpayer may intend to retain the asset for a lengthy period of time. However, the Treasury Department and the IRS have determined that it would not be administrable to create individual regulatory exceptions to the statute in the absence of a statutory standard for liquidity because it would likely require introducing a facts-and-circumstances test that analyzes the liquidity of every asset, which would be difficult to administer.â€ť
Another problem is that, if a company used liquidity as the main criterion for deciding which items to include in a foreign subsidiaryâ€™s cash position, it mightÂ end up having to include some highly liquid assets other than cash or cash equivalents in the total, officials say.
â€śAccordingly, the proposed regulations doÂ not introduce new regulatory exceptions to the definition of cash position,â€ť officials say. â€śThe TreasuryÂ Department and the IRS welcome comments with respect to the definition of cashÂ position of a specified foreign corporation
Analysts at the Joint Committee on Taxation predicted in December that the Section 965 changes could increase federal revenue by about $339 billion over the period from 2018 through 2027, and by about $79 billion in 2018 alone.
Estimates of life insurersâ€™ share of that total are not readily available. But life insurers spent about $16 billion on federal income tax payments in 2016,Â and they accounted for about 5% of the United Statesâ€™ $293 billion in 2016 federal corporate income tax revenue, according to insurer payment data from the ACLI and corporate tax revenue data compiled by the Tax Policy Center.
IfÂ life insurers contribute 5% of $79 billion in TCJA transition tax revenue in 2018, their share of the TCJA transition tax tab could be about $4 billion.
That means TCJA transition tax bills could, in theory, increase U.S. life insurersâ€™ federal income tax spending by 25%, and, possibly, eat up about 3% of U.S. life insurersâ€™ $450 billion in total annual life and annuity premium revenue.
If, however, multinational life insurers persuade the IRS to postpone implementing the tax, or they find ways to avoid paying the tax, the impact of the TCJA transition tax could be much smaller than that.
â€” ReadÂ 10 Big Tax Expenditures and How Theyâ€™ve Changed,Â on ThinkAdvisor.
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