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 they’re calculating how much they owe in connection with a new Tax Cuts and Jobs Act (TCJA) tax — a one-time “transition tax” on the earnings and cash of U.S. companies’ foreign subsidiaries. The TCJA transition tax provision updated Internal Revenue Code (IRC) Section 965.
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 on the foreign subsidiaries’ 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 “guidance,” 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 children’s earnings only when 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, “deferral of income from controlled foreign corporations,” 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 “tax expenditure,” 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 subsidiaries’ 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, for the 2017 tax year. The size of the one-time payment will be based on the foreign income a company has deferred since 1986, and on the company’s “aggregated foreign cash position.”
The payment is supposed to equal 8% of the illiquid assets at the controlled foreign corporations and 15.5% of cash and cash equivalents.
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 subsidiary’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.
“The tax is particularly onerous for life insurers, because most of a life insurer’s assets are held in cash and cash equivalents to satisfy future policy claims and capital requirements,” the reps wrote. “Under Section 965, this subjects life insurers to a higher rate of tax than a manufacturer or retailer.”
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 company’s Section 965 tax bill.
What the IRS Said