Revised Loss Discounting Factors are on the Horizon
News on the revised loss discounting factors has been much anticipated by the insurance industry as taxpayers have been hoping for the release of these factors all year. Although we are still waiting, the November 7 release of proposed Regulations by the Internal Revenue Service (“IRS”) provides hope that the new factors will be available for near-future use as the end of the year approaches. Public commentary has been solicited, and a public hearing has been scheduled for further discussion of the regulations on December 20, 2018.
The tax reform act of 2017 instituted the use of new loss discounting factors which would be based on the corporate bond yield – a change that is expected to generate greater discounts and increase taxable income. Tax reform also provided that these factors would be applied with a retroactive effect via a recapture of the difference between the discount as of December 31, 2017 as determined under “old rules” vs what the discount would have been under the revised factors prescribed by tax reform. Although taxpayers will be allowed to amortize that differential over an 8-year period, the question all year has been: What are the new discount factors such that taxpayers can determine the effects on taxable income, estimated tax payment requirements and their financial statements?
Although not the conclusive guidance we have been hoping for, the release of these proposed regulations represents the first major step in receiving answers from the IRS. The narrative contained within this document outlines the challenges the IRS has been facing in attempting to implement new discount factors. Namely, identifying the most appropriate methodology in calculating the applicable annual interest rate to be applied.
Under former Regulations, discounting factors were determined using the Federal mid-term rates. In order to more closely match the investment in bonds used to fund undiscounted losses, the new legislation requires discounting factors to be based off of the corporate bond yield curve with the annual rate being the average of the monthly spot rates for bonds with times to maturity of not more than 17.5 years. While this might be appropriate for long-tailed lines of business, Treasury also contemplated situations in which it may be more appropriate to refer to bonds with variable maturity rates, or to apply different annual rates to long-tailed vs short-tailed lines of business. Because of the variations and the differing effects on taxable income, it was decided to first solicit public comment and discussion.
Discounting of salvage recoverable is also discussed in the proposed Regulations which have recommended the netting of salvage and subrogation with undiscounted losses, and then applying the discount factor to the net amount. The intent is to simplify the calculation, though public comment is also sought on this approach.
Many questions still remain, but the insurance industry is hopeful that this step forward means that the revised discount factors will be released soon. The proposed regulations demonstrate a commitment by the IRS to provide clarity in a way that is fair and just, and insurance companies and their representatives are encouraged to join the conversation in order to be a part of the ultimate resolution in determining tax methods that will impact us all going forward.
Read the entire proposal here. We will continue to provide guidance as further information becomes available.