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IRS Rules On Reserve Interest Calculations

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NU Online News Service, Dec. 2, 2003, 6:05 p.m. EST – A new Internal Revenue Service ruling could change the amount of taxes that some life insurers pay on interest income.[@@]

A life insurer must pay federal income taxes on its own interest earnings, but the insurer can exclude policyholders’ interest earnings from taxable income.

When a life insurer is separating its own share of interest income from policyholders’ share, it computes the minimum amount of interest that state and federal laws require it to pay to policyholders. The insurer can deduct that amount, along with other amounts, from its own share of interest income.

Up till now, the Internal Revenue Code has not said whether a life insurer should compute the legally required interest payments using the amount of reserves it holds at the beginning of the tax year, the amount it holds at the end of the tax year, or some other figure.

The new ruling, Revenue Ruling 2003-120, holds that a life insurer should get the reserve figure used in the computation by adding the reserve figure for the beginning of the tax year to the reserve figure for the end of the year, then dividing by two.

If, for example, a life insurer starts the tax year with $1,000,000 in reserves and ends the tax year with $1,224,434 million in reserves, it should use the mean figure, or $1,112,217, when computing the amount of interest that it is required to pay to policyholders, Stephen Hooe, an official in the IRS Office of Associate Chief Counsel, writes in the revenue ruling, which appears in Internal Revenue Bulletin 2003-48.

Although current law does not tell life insurers to use the mean reserve figure in interest rate computations, the tax law in effect before 1984 told insurers to multiply the legally required interest rate by “the means of the amount of the reserves computed at that rate at the beginning and the end of the taxable year,” Hooe notes.

Because, in most respects, the current formula for separating the life insurer’s share of interest income from the policyholders’ share is based on the formula used in the old law, life insurers should continue to follow the old approach to coming up with a reserve figure, Hooe writes.

The ruling is on the Web at //