American Council of Life Insurers Issues Public Comment on IRS Notice

WASHINGTON, July 27 -- Regina Rose, senior vice president for taxes and retirement security, and Mandana Parsazad, vice president for taxes and retirement security, at the American Council of Life Insurers, have issued a public comment on the Internal Revenue Service's notice entitled "Priority Guidance Plan; Public Recommendations Invited on Items to be Included". The comment was written and posted on July 22, 2020:

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On behalf of the American Council of Life Insurers (ACLI), we request that the items described below be included on your Priority Guidance Plan (PGP) list for 2020-2021. In addition, we write in support of the requests made by the Committee of Annuity Insurers to you in their letter dated July 22, 2020, including guidance relating to RMD waivers under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, and guidance relating to RMDs and IRA Annuity Policy Forms under the Setting Every Community Up for Retirement Enhancement (SECURE) Act.

We appreciate the need to prioritize resources. We have limited this list to those items that are most important to life insurers and that satisfy the criteria set forth in Notice 2020-47. The requested guidance is relevant to a broad class of taxpayers and will greatly reduce controversy and lessen burdens on both taxpayers and the IRS. We have identified those items for which we previously provided substantive comments.

A. Guidance under Sec. 807

On April 2, 2020, the IRS published in the Federal Register a Notice of Proposed Rulemaking providing guidance on the computation of life insurance reserves and changes in basis of computing reserves for insurance companies. The NPRM addressed other issues as well, including reserve and separate account reporting under Sec. 807(e)(6), which was added by the Tax Cuts and Jobs Act ("TCJA"), the definition of life insurance reserves, the removal or revision of regulations with no future application, and other conforming changes to update existing guidance for changes made by the TCJA.

This guidance was on the 2018-2019 and 2019-2020 Priority Guidance Plans, and it remains a priority as a part of the implementation of the TCJA. We agree this is an important guidance priority, and on June 1 we provided our comments on the proposed regulations.

In the course of finalizing the guidance, we believe it is particularly important to keep four points in mind:

* Any definition of nondeductible asset adequacy reserves should identify not only items that are included and therefore nondeductible, but also items that Congress clearly intended would not be treated as asset adequacy reserves, in particular reserves determined under principles-based methods;

* Any discussion of changes in basis under Sec. 807(f) should clearly indicate that the change in spread period under Sec. 807(f), and the requirement in the proposed regulations to follow IRS procedures for automatic approval of such changes, does not alter the fact that Congress intended the specific life insurance company provisions of Secs. 811(a) and 807, not Sec. 446, to govern how reserves should be determined to clearly reflect life insurance company taxable income;

* Additional guidance is needed on the treatment of certain insurance-specific reserve changes as changes in basis that are subject to Sec. 807(f); and

* The industry should have an opportunity to comment beforehand on whatever reporting requirements are proposed to be imposed for life insurance reserves and separate accounts; reporting on these items should be realistic based on information that already is available, should not involve an unreasonable compliance burden, and should produce information that is actually meaningful for tax administration.

We also commend the IRS on its efforts to modernize existing regulations under Part I of Subchapter L by withdrawing or replacing existing guidance that is obsolete as a result of the Tax Cuts and Jobs Act or prior legislation, and we encourage further efforts to eliminate deadwood and bring such regulations up-to-date. Our June 1 letter discusses these points in considerable detail, and also addresses other issues on which the IRS requested comments. We would be pleased to provide whatever additional information would be helpful to the development of final regulations.

B. Proposed Regulations under Sec. 382 Related to Built-In Gain and Loss

On September 10, 2019, the IRS published proposed regulations (REG-125710-18) in the Federal Register regarding the items of income and deduction that are included in the calculation of built-in gains and losses under Sec. 382 of the Internal Revenue Code for corporations that experience an ownership change under Sec. 382. ACLI submitted comments on the proposed regulations in a letter dated November 11, 2019.

The ACLI comment letter made the following points with respect to application of the proposed regulations to an acquisition of a life insurance business:

* The computation of net unrealized built-in gain ("NUBIG") and net unrealized built-in loss ("NUBIL") under the proposed regulations' assumption of a hypothetical sale of assets at fair market value to an unrelated third party that assumes no liabilities is unworkable in the context of acquisition of a life insurance business. A sale of insurance contracts is effectuated through a reinsurance transaction, which necessarily requires an assumption of the obligations under the contracts.

* Existing regulations recognize that tax deductible reserves, as determined under the requirements of Subchapter L of the Code, are the proper measure for valuing the intangible asset for in-force insurance contracts ("value of insurance in-force" or "VIF") for other Federal income tax purposes, and should likewise be the measure of VIF for purposes of Sec. 382. Furthermore, such deductible tax reserves, as properly determined under Part I of Subchapter L, should not be treated either as a non-contingent liability under Prop. Reg. Sec. 1.382-7(c)(3)(i)(C) or as a contingent liability under Prop. Reg. Sec. 1.382-7(c)(3)(i)(D) in computing NUBIG or NUBIL. Instead, they should be taken into account in the same manner as a deductible accrued liability.

ACLI urges that if the final regulations retain the approach to the computation of NUBIG and NUBIL set forth in the proposed regulations, a life insurance company exception should recognize these points. Additionally, the ACLI comment letter maintained that the proposed regulations violate the "neutrality principle" underlying the statutory provisions of Sec. 382 by denying, except in the case of a disposition, recognition of intangible assets such as VIF as recognized built-in gain ("RBIG") as they are earned during the recognition period. Accordingly, ACLI recommends that final regulations make allowance for such recognition.

C. Changes to the Life/Nonlife Consolidated Return Regulations

ACLI has long maintained that certain aspects of the life-nonlife consolidated return regulations (Treas. Reg. Sec. 1.1502-47) are outdated and unnecessary. These regulations, which affect almost every major U.S. insurance group, have remained virtually unchanged since they were promulgated nearly 40 years ago, despite significant subsequent changes to the taxation of both life and property and casualty insurance companies. Most of these tax law changes affecting insurers were enacted in the 1980's, but further major changes, particularly affecting life insurers, were made by the TCJA.

Failure of the life-nonlife consolidated return regulations to keep pace with enacted statutory law changes - and with changes to the consolidated return regulations over the past four decades that apply to taxpayers generally - have made the life-nonlife regulations difficult for taxpayers to apply and for the IRS to administer. The changes that ACLI recommends will improve clarity and understandability for both taxpayers and the Government, thereby reducing controversy and promoting sound tax administration through more consistent application of the rules.

Recently, a notice of proposed rulemaking [REG-125716-18] was published that updates the life-nonlife regulations to reflect certain statutory changes and to remove deadwood items. ACLI plans to submit written comments on these proposed amendments by the August 31 due date. ACLI very much appreciates this effort to update the life-nonlife regulations; however, the revisions are focused mainly on clearing away years of accumulated underbrush and make few substantive changes. Accordingly, ACLI continues to strongly advocate for further substantive changes necessitated by statutory changes in the taxation of insurance companies and by the evolution of the consolidated return regulations. In this regard, we are pleased that the preamble to the NPRM states that Treasury and the IRS continue to study other issues pertinent to life-nonlife groups for purposes of potential future guidance.

Among the further substantive changes to the life-nonlife regulations advocated by ACLI are the following:

* Apply "normal" consolidated return loss allocation rules to losses of eligible and ineligible nonlife members;

* Apply SRLY principles to utilization of ineligible nonlife losses, including in the context of acquired nonlife groups;

* Apply "normal" consolidated return rules to allow the netting of capital losses against capital gains of all members of the group; and

* Simplify the eligibility and tacking rules.

The life-nonlife regulations ultimately deal with the determination, allocation and utilization of losses among the members of a life-nonlife group. ACLI believes it imperative that such losses be limited only to the extent required by the statutory provisions and that "normal" consolidated return rules apply to the extent possible. ACLI's recommendations are directed towards those ends.

D. Guidance under Sec. 954, Including Foreign Base Company Sales and Services Income, and the Use of Foreign Statement Reserves for Purposes of Measuring Qualified Insurance Income under Sec. 954(i)

The 2017-2018, 2018-2019, and 2019-2020 PGPs anticipate guidance for taxpayers seeking to use foreign statement reserves for purposes of calculating the amount of income that qualifies as an exception to the Subpart F rules under Sec. 954(i) of the Internal Revenue Code. The need for guidance is enhanced given the changes made by the TCJA to Sec. 807(d) and the lack of clarity in how those changes affect the Sec. 954(i) calculation. In fact, although the need for guidance in this area was acknowledged before TCJA because it will ultimately preserve substantial IRS and taxpayer resources, we believe this PGP item should be considered and prioritized as guidance to implement TCJA since clarification is necessitated by TCJA./1

We appreciate the strains on Treasury and IRS resources particularly with the demands of COVID-19, but are concerned that taxpayers may be without guidance in any form because our member company advisors have been informed that IRS is not currently entertaining private letter rulings in this area./2

The IRS and the industry will be better served by guidance that would replace, in most circumstances, the private letter ruling process that has been utilized for this purpose for many years.

Guidance for this project may be issued in the form of a revenue procedure to allow updates (additions to or removal of foreign statement reserves methodologies, or other principles used to determine appropriate reserves) to ensure the proper administration of tax policy as warranted. We look forward to working with you to develop principles for using foreign statement reserves for purposes of measuring insurance company Subpart F income.

E. Paid Family and Medical Leave Programs

The IRS included guidance on contributions to and benefits from paid family and medical leave programs in the October 2019 update to its Priority Guidance Plan. We believe such guidance should remain a priority.

We commend the IRS in its 2019-2020 Priority Guidance Plan for noting the need for guidance on contribution to and benefits from paid family and medical leave programs. Many state programs are coming online with benefits paid by a private insurance company or the self-insured plan of employers. One state, New York, has taken a position as to the federal tax treatment while others are waiting for Treasury and IRS to issue federal guidance. Private insurers issuing PFML products need IRS clarification on PFML contributions and benefit regulations, categorizing PFML as either wage replacement or wage continuation under the regulatory definitions.

We appreciate the guidance in Notice 2020-54 on reporting requirements for Qualified Sick Leave Wages and Qualified Family Leave Wages under the Families First Coronavirus Response Act and believe additional and broader guidance is still needed. This will assist private insurers in meeting statutory obligations to the IRS and customers.

F. Combination Annuity/Long-Term Care Contracts and Exchanges of Annuities for Long-Term Care Insurance

The changes made under Sec. 844 of the Pension Protection Act of 2006, P.L. 109-280 (PPA of 2006), permitting issuance of contracts that combine life insurance, annuity, and qualified long-term care coverages and providing for the expansion of Sec. 1035 tax-free exchanges to include qualified long-term care insurance contracts became effective January 1, 2010. On that date, policyholders also became able to exchange their life insurance and annuity contracts for qualified long-term care insurance contracts. This additional category of policy options provides essential flexibility to policyholders whose insurance needs change over time.

ACLI has requested guidance on the tax treatment of annuity contracts with a long-term care rider and on the exchanges of annuities for long-term care insurance contracts since 2009. Treasury and IRS have included guidance on annuity contracts with a long-term care feature as a project on the PGP since November 2009./3

Treasury, IRS, and the ACLI have each devoted time and resources to discuss and develop guidance needed to establish appropriate tax reporting systems and to advise owners of combined annuity/long-term care policies of the tax consequences of policy ownership. We reiterate the continued need for guidance the industry believes is critical to providing potential policyholders with new, more affordable options for long-term care insurance coverage. Predictability of federal tax treatment for a combination annuity/long-term care insurance policy is a necessary feature for policyholders who seek to protect their retirement savings by planning for their long-term care needs. Similarly, predictability of federal tax treatment when exchanging annuities for long-term care insurance coverage is a significant component of protecting one's retirement savings and income.

The design and implementation of new products in this area is hampered, in part, by a continuing lack of tax guidance. Combination annuity/long-term care policies are uniquely important in providing Americans with more solutions to their long-term care needs, and guidance still is needed to implement the policy of Sec. 844 of the Pension Protection Act.

G. Partnership K-1 Reporting

Life insurers are significant investors in partnerships, mostly as limited partners, and collect tens of thousands of Schedule K-1s each year. Issues surrounding both the information contained on Schedule K-1, and the ability to receive Schedule K-1s timely, present substantial issues for ACLI member companies. ACLI asks that the IRS take a comprehensive approach to address the challenges presented by Schedule K-1 reporting. We believe that a formal rulemaking project, subject to notice and public comment, is the best way to implement changes to the process and substance of Schedule K-1 reporting. Such a project would allow for the development of tax reporting rules and the coordination of such rules with all existing regulations that further the goal of accurate partnership income reporting, and would be preferable to piecemeal changes to K-1s, such as the current Tax Capital Reporting proposed guidance in Notice 2020-43. A more holistic guidance project would ensure that input from all impacted parties is solicited and considered in a manner consistent with the requirements of the Administrative Procedures Act and would allow the IRS to address all Schedule K-1 issues in an integrated manner.

H. The Generation Skipping Transfer Tax (GSTT) Withholding Obligation on Insurance Companies Should Be Eliminated

The current withholding requirement imposed on issuers of life insurance policies and annuity contracts is unduly burdensome and should be eliminated.

Under Example 5 of current Treasury Regulation Sec. 26.2662-1(c)(2)(vi), all life insurance policies and annuity contracts issued in the ordinary course of business are treated as "trust arrangements" for purposes of the GSTT. In those instances where the aggregate proceeds payable from those policies exceeds $250,000 and those proceeds are payable to individuals or trusts that are defined as "skip persons" for purposes of the GSTT, the insurance company is subject to a withholding obligation. The current regulation imposes this withholding obligation on the insurance company even though (1) the insurance company has only a contractual relationship with the policy owner and the designated beneficiaries, (2) the insurance company is neither a trustee nor personal representative of the deceased policy owner or the insured, and (3) the insurance company does not have, and cannot easily obtain, the information that is needed to accurately determine whether the designated beneficiaries are "skip persons" for purposes of the GSTT.

Whether an individual beneficiary or trust is defined as a "skip person" for purposes of the GSTT is dependent upon the application of complicated generation assignment rules that are set forth in Chapter 13 of the Internal Revenue Code. The application of those rules requires facts that are not collected and maintained in the usual course of an insurance company's operations and are facts that often cannot be readily and accurately obtained by the company. The facts needed include the familial relationship of the policy owner to each beneficiary having an interest in the proceeds. Intricate facts involving the blood line, adoptive, and marital relationships among the decedent and the various beneficiaries unknown to the insurer are implicated./4

Because the application of the GSTT depends upon an analysis of that type of information, the requirement of this portion of the regulation is impossible to consistently and accurately administer without collecting and verifying personal information that is not readily accessible to the life insurance company. Gathering and verifying such information from the various beneficiaries (a task performed by a decedent's personal representative or trustee) requires time consuming back-and-forth communications that unnecessarily delay the payment of claims by the company, frustrate beneficiaries, and rarely result in any actual withholding.

If not entirely withdrawn, we believe that the withholding obligation under this regulation should be modified to relieve the insurance company of any withholding obligation unless the cumulative policy values transferred by the company to skip persons exceed the value of the federal GSTT exemption applicable in the year of the policy owner's date of death. Since no federal generation-skipping transfer tax liability attaches until the cumulative value of all transfers subject to the tax by any one individual exceeds the individual's exemption from that tax ($11.4 million for decedents dying in 2019), the tax rarely applies, further making the compliance burden imposed by the current regulation grossly disproportionate to any benefit it may serve.

I. Required Minimum Distribution Guidance

Changes are still needed to the Required Minimum Distribution (RMD) regulations to modify the minimum income threshold test (MITT) to remove barriers to annuitization at later ages. The current MITT rules prevent individuals from receiving common forms of life annuities in certain circumstances that do not involve inappropriate deferral. This situation is impairing the retirement security of American savers.

More specifically, improvements in mortality, coupled with historically low interest rates, have made compliance with the minimum distribution rules promulgated under Sec. 401(a)(9) impossible for many annuity payment streams that were permissible when these rules were first developed. The rules now limit the use of guarantee periods and return of premium death benefits, severely constraining the use of annuities with even modest annual increases and making annuitization less attractive when compared to the required minimum payments for non-annuity arrangements. It is important that the IRS amend the rules to address improvements in longevity and to eliminate the rules' distortive application in the face of unusual interest rate developments.

J. Secure Act Beneficiary Guidance

Section 401 of the SECURE Act added Sec. 401(a)(9)(H) to the Code which generally requires distributions to individual beneficiaries to be completed by the end of the 10th year following the account holder's death. Exceptions are provided for spouses and other eligible designated beneficiaries.

We believe that it is important for the IRS to generally declare what provisions of the existing RMD regulations remain in effect and which have been superseded. The current uncertainty complicates the efforts of our member companies to administer the RMD provisions, including preparation of forms, disclosures and other materials, system programming and customer support.

This is not simply a matter of noting direct inconsistencies, such as the unavailability of payments over life expectancy to beneficiaries other than eligible designated beneficiaries. For deaths before the required beginning date, Reg. Sec. 1.401(a)(9)-3, Q&A-4 establishes the stretch rule as the default for individual beneficiaries. Post-SECURE, this rule can only apply to eligible designated beneficiaries. However, continuing to apply the rule to the extent still possible may not be consistent with either the statutory scheme or sound tax policy.

The SECURE Act has made the 10-year rule the general rule and created a favored class that can still stretch. It would be anomalous for stretch to be required in cases where the taxpayer would be happy to forego special treatment and use the 10-year rule. Conversely, it would be unreasonable to deny stretch treatment to eligible designated beneficiaries who belatedly learned of a death or otherwise missed taking distributions by the required beginning date. These competing considerations suggest that guidance should adopt a policy of flexibility with regard to both the default distribution method and beneficiary elections.

Otherwise eligible designated beneficiaries who have missed the required beginning date should, subject to any applicable penalties, be able to elect to stretch over life expectancy, while those that do not wish to stretch should be covered by the 10-year rule. This recommendation also takes into account the special circumstances of surviving spouses who could generally have until age 82 to receive full payment under the 10-year rule. For some, the flexibility of payout during the 10-year payment period may outweigh the possibility of taking payments for a longer period. The 10-year rule may also be attractive to guardians of older minors, who might otherwise be required to arrange for small payments for a few years before the minor reached age 18.

We appreciate this is an ambitious request for guidance. In the interest of conserving resources, we note that the 2019-2020 PGP included one insurance-related item for which the industry believes no guidance is necessary. That item is guidance on the exchange of property for an annuity contract, which was the subject of regulations proposed in 2002. At this point, we are unaware of controversy in this area, nor are we aware of any burden these transactions impose on tax administration. You might wish to consider removing the item from the 2020-2021 and future PGPs in favor of issues for which guidance is more urgent.

Thank you for your time on, and attention to, these recommendations for the 2020-2021 PGP. We welcome the opportunity to discuss our recommendations and to work with you on these issues in the coming months.

Sincerely,

Regina Y. Rose

Mandana Parsazad

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Footnotes:

1/ As amended, Sec. 954(i)(5) still refers to the federal mid-term rate under Sec. 1274(d) and the highest assumed interest rate permitted to be used in the foreign jurisdiction, even though Sec. 807(d) no longer includes analogous references to the applicable federal interest rate and the prevailing state assumed interest rate. The publication of guidance on the use of foreign statement reserves would significantly reduce uncertainty. We believe that after the TCJA it is appropriate for guidance to be issued that provides the proper way to understand the Sec. 954(i)(5) reference to subchapter L is that local statutory reserves without a haircut should be used for purposes of Sec. 954(i)(5).

2/ See generally Rev. Proc. 2020-1, 2020-1 I.R.B. 1, section 6.09 (generally no letter ruling if the request presents an issue that cannot readily be resolved before a regulation or other published guidance is issued); Rev. Proc. 2020-3, 2020-1 I.R.B. 131, section 3.02(10) (generally no letter ruling addressing questions the IRS determines, in its sole discretion, should not be answered in the general interests of sound tax administration, including due to resource constraints).

3/ The project was subsequently bifurcated into two distinct projects: one on combined annuity long-term care contracts, and the other on Sec. 1035 exchanges of annuities for long-term care insurance.

4/ For example, the question of whether certain ancestors of the designated beneficiaries who are also lineal descendants of the policy owner's grandparents are living or dead at the time of the policy owner's death needs to be resolved.

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The notice can be viewed at: https://www.regulations.gov/document?D=IRS-2020-0015-0001

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