Financial Reporting Developments affecting GAAP and Statutory Accounting for Income Taxes

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Hot Take

The topics covered in this article present a review of issues to consider as you prepare your 2019 income tax provision calculations. Some of the updates discussed include the unrealized gain/loss treatment for GAAP purposes under ASU 2016-01, issues to be aware of under the admissibility calculation of SSAP No. 101, and how changes to the treatment of net operating losses (NOLs) under the Tax Cuts and Jobs Act (TCJA) might impact financial reporting.

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As companies gear up to close their books and finalize financial reporting for the year ended December 31, 2019, it is important to be aware of income tax reporting requirements that might have an impact on financial statements. The tax updates outlined below discuss a few essential points affecting GAAP and statutory financial reporting.

Unrealized Gains and Losses Under ASU 2016-01

ASU 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities is effective for non-public entities, starting with their 2019 financial statements. For insurers, it’s important to note that this is a GAAP standard and will not affect statutory financial statements. ASU 2016-01 requires unrealized gains/losses from equity securities to be reflected in current net income as opposed to accumulated other comprehensive income (AOCI). For income tax purposes, insurers will need to reverse out unrealized gains/losses in calculating taxable income. Additionally, the deferred inventory will need to be revised to reflect that the deferred tax expense/benefit for unrealized gains/losses is running through the income statement.

SSAP No. 101 Deferred Tax Admissibility

The Tax Cuts and Jobs Act of 2017 (TCJA) impacted the admissibility calculation under SSAP No. 101, paragraph 11. Under SSAP No. 101, paragraph 11.a., deferred tax assets (DTAs) are admitted to the extent that taxes paid in prior years can be recovered through loss carrybacks. With the elimination of the net operating loss (NOL) carryback provision for life insurance companies, the admissibility provisions of SSAP 101, paragraph 11.a., will be less relevant. Non-life insurance companies can still carry back NOLs, but life companies can no longer do this. As such, non-life insurance companies will need to consider carryback of NOLs and capital losses under paragraph 11.a., but life companies will only consider the carryback of capital losses.

Paragraph 11.b. of SSAP 101 considers DTAs that are expected to reverse within three years of the year-end, assuming an RBC ratio of greater than 300%. To ensure the 11.b. calculation is appropriate, insurers will need to review their positions with respect to the realizability of various DTAs. For example, now that life NOLs are subject to an 80% taxable income limitation, the 3-year recoverable NOL amount will need to be reconsidered.

Finally, under paragraph 11.c., DTAs are admitted to the extent they can be offset against deferred tax liabilities (DTLs). It is important to consider the character of the DTAs and DTLs. Capital DTAs, such as capital loss carryforwards, can only be offset against capital DTLs. Any remaining capital DTLs after application against capital DTAs can be used to admit ordinary DTAs.

During the NAIC Summer 2019 National Meeting, the SAP working group adopted revisions to SSAP No. 101’s Q&A section. The revisions included updates to align SSAP 101 with the TCJA by updating the statutory tax rate and deleting information that is no longer applicable (such as the repeal of the alternative minimum tax (AMT) regime). The SAP working group also approved an amendment clarifying that for the purposes of the paragraph 11.c. admissibility, scheduling of the reversal patterns of deferred items is not required beyond that necessary in determining the need for a statutory valuation allowance. It further clarified that in the event scheduling is not required or relied upon, the paragraph 11.c. admissibility test need only consider the character of the DTLs being used to admit DTAs.

Valuation Allowance Considerations

Given the revised carryback and carryforward periods for NOLs under the TCJA, it will be prudent to revisit valuation allowance considerations and reassess if they are still appropriate. As prescribed by the TCJA, NOLs generated after December 31, 2017, by entities other than property and casualty insurance companies have an indefinite carryover period, and no carryback is allowed. Additionally, these NOLs are subject to an 80% taxable income limitation. The NOL carryforward and carryback rules for property and casualty insurance companies remain unchanged, whereby NOLs may be carried forward 20 years and carried back two years. The indefinite carryforward period alleviates the tension on the realizability of NOLs generated after December 31, 2017; however, corporations will still need to make a valuation allowance assessment for NOLs generated prior to January 1, 2018. Refer to our article Ownership Changes and the Implications of the Section 382 Limitation for a more detailed discussion on NOLs and how Section 382 affects utilization of NOLs.