Finally, Final Regulations on Loss Discounting
The Internal Revenue Service (“IRS”) issued Final Regulations on the unpaid loss and salvage and subrogation discount factors. In November 2018, the IRS released the Proposed Regulations for changes made to loss reserve discount factors under Section 846 due to the Tax Cuts and Jobs Act (“TCJA”), which generated many comments. These comments helped revise and amend the Proposed Regulations to better reflect reasonable loss discounting factors. The main changes from the proposed Regulations are discussed below.
Prior to the TCJA, the discount factors were based on an annual interest rate equal to the average monthly applicable federal mid-term rates. With changes under tax reform, the rate is now based on monthly bond yield curves. The IRS initially proposed for the maturity range of corporate bond yield curve to be from 6 months to 17 ½ years. Due to concerns expressed about such a large range, the IRS changed the maturity to span from 4 ½ to 10 years in order to more closely match the 6 to 7 year average maturity of P&C bond investments. This change determined a new annual interest rate that will drive a revision of the discount factors previously issued in the Rev. Proc. 2019-06.
Another change within the Final Regulations includes the continuance of the composite method and composite discounting factors, which the Proposed Factors had previously indicated would be discontinued. That decision to discontinue the method had caused concern among commentators relating to data compilation and reporting; however, the Final Regulations provide that the IRS will continue to annually publish composite discount factors in order to alleviate such concerns.
As a result of these late changes to the discount rates, tax years beginning January 1, 2018 through June 17, 2019 will allow taxpayers to use either the proposed discount factors from Revenue Procedure 2019-06 or the revised and final discount factors that have yet to be provided. For tax years ending on or after June 17, 2019, the revised discount factors must be used. The forthcoming guidance will address the adjustment needed by any taxpayer that uses the proposed discount factors for their 2018 tax return. It will also address the potential need for taxpayers to file Form 3115, Application for Change in Accounting Method, as it may relate to any changes in loss discounting stemming from those provided in the Tax Cuts and Job Acts of 2017.
The Final Regulations describe the changes on various items, but do not actually give us the revised data and implementation processes to follow. The IRS has up to 18 months to publish guidance on new Regulations so if the timeline from the Proposed to Final Regulations is any indicator, perhaps we can expect additional details by the middle of August.