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August 2012 WWW.BDO.COM
An Alert from the BDO Insurance Practice
BDO knows: Insurance SUBJECT
PARTIAL WORTHLESSNESS DEDUCTION FOR ELIGIBLE SECURITIES IRC §166 & SSAP 43R u Details On July 30, the IRS released an industry director directive (the Directive) allowing insurers a tax deduction for partial worthlessness of certain impaired securities. It stated that “examiners should not challenge an insurance company’s partial worthlessness deduction under IRC § 166(a)(2) for the amount of the Statement of Statutory Accounting Principle (SSAP) 43R credit-related impairment charge-offs of eligible securities as reported on its Annual Statement.” Ordinarily for tax purposes a deduction can only be taken upon complete worthlessness. This creates a timing difference or deferred tax asset for financial reporting purposes which would be capital in nature and which may not be admissible for statutory reporting purposes if an entity has a history of capital losses and/or insufficient unrealized gains. It also creates the often onerous task of tracking the book-tax basis differences and related accretion and amortization differences on these impaired securities until they are eventually disposed of. This could wreak havoc on one’s ability to arrive at the proper annual tax adjustments required for impaired securities and subsequent recapture adjustments upon their ultimate disposal. IRC § 166(a)(2) stipulates that the Secretary may allow a partially worthless deduction for tax purposes in the year the debt has been impaired. The Directive advises insurance companies how to apply this rule to certain securities. Adopting the procedures allowed by the Directive can ease burdensome bookkeeping and may also result in the added cash flow benefit from tax refunds.
u BACKGROUND SSAP 43R became effective on Sept. 30, 2009, and provided guidance on recording otherthan-temporary impairments (OTTIs) on loan-backed and structured securities. SSAP 43R gives the insurer guidance as to how to treat securities with an unrealized loss. If the insurer intends to sell the security or does not have the intent and ability to retain the security until its amortized cost is recovered, the security is considered OTTI and must be written down to fair value and the write-down is recognized in earnings as a realized loss. u Read more
contact: Thomas Hiller Insurance Practice Leader 616-774-7000 [email protected] Richard Bertuglia Assurance Partner, New York 212-885-8342 [email protected] Phil Forret Assurance Partner, Dallas 214-665-0769 [email protected] Carla Freeman Assurance Partner, Los Angeles 310-557-8247 [email protected] Jay Goldman Assurance Partner, Atlanta 404-979-7237 [email protected] Brent Horak Assurance Partner, Dallas 214-665-0661 [email protected] Imran Makda Assurance Partner, New York 212-885-8461 [email protected] Barb Woltjer Assurance Partner, Grand Rapids 616-802-3368 [email protected]
2
BDO Insurance practice ALERT
If the holder of a security with an unrealized loss does not intend to sell the security and has the intent and ability to hold it long enough to recover the amortized cost, then the security is further divided into three categories with varying methodologies on how to “present value” the security. But the resulting write-down is also recognized in earnings as a realized loss. Due to the housing/mortgage crisis coupled with the investment requirements of insurers, many found themselves saddled with significant OTTI securities.
u HOW THE DIRECTIVE CAN BE APPLIED The insurance company will have a choice to either amend tax returns no earlier than the 2009 tax year, or apply the provisions of the Directive no later than the company’s 2012 tax year (the “Adjustment Year”1). The company’s partial worthlessness deduction under IRC § 166(a)(2) for “eligible securities”2 is the same amount as the company’s SSAP 43R credit-related impairment charge-off for the same securities as reported on its Annual Statement except that the company may need to reduce or increase its deduction by a “positive or negative adjustment.”3 The insurance company must attach a statement to its federal income tax return for the adjustment year stating that it is implementing the provisions of the directive; a separate statement should be attached to each insurance subsidiary in a consolidated return. For this Directive to apply, the insurance company must be subject to regulation as an insurance company, must be subject to federal income tax as either a life or non-life insurance company, must file an annual statement for which a state regulator has examination authority and must use the SSAP 43R credit-related impairment charge-off amount for all eligible securities.
u UNDER EXAMINATION If the company is presently under exam it should discuss the application of this directive with the examiners.
1 The first taxable year in which an insurance company applies the provisions of this directive. 2 Eligible securities means investments in loan-backed and structured securities within the scope of SSAP 43R, subject to IRC § 166, and not subject to IRC § 165(g)(2)(C), including Real Estate Mortgage Investment Conduit (REMIC) regular interests. 3 The positive or negative adjustment is determined on Dec. 31 of the Adjustment Year and is the difference between (i) the tax basis of eligible securities over (ii) the statutory carrying value of the same securities increased by any non-credit-related portion of any charge-off not allowed as deductible under the directive.
BDO Insurance Industry practice BDO’s Insurance practice understands the complexities of the industry and the implications for your business. Whether you’re looking to tap our extensive SEC experience in order to enter the public market, discuss the latest insurance accounting and reporting requirements from the NAIC, or comply with state regulatory agencies, BDO’s Insurance practice provides proactive guidance to our clients. We know that no two insurers are alike, and we tailor our services accordingly. We’re proud of our industry focus and experience, and our commitment to delivering the right team with relevant industry experience, both as we begin our relationship and for the long term. ABOUT BDO BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through more than 40 offices and more than 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multinational clients through a global network of 1,118 offices in 135 countries. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information, please visit: www.bdo.com. To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. Material discussed in this alert is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs. © 2012 BDO USA, LLP. All rights reserved. www.bdo.com
An Alert from the BDO Insurance Practice
BDO knows: Insurance SUBJECT
PARTIAL WORTHLESSNESS DEDUCTION FOR ELIGIBLE SECURITIES IRC §166 & SSAP 43R u Details On July 30, the IRS released an industry director directive (the Directive) allowing insurers a tax deduction for partial worthlessness of certain impaired securities. It stated that “examiners should not challenge an insurance company’s partial worthlessness deduction under IRC § 166(a)(2) for the amount of the Statement of Statutory Accounting Principle (SSAP) 43R credit-related impairment charge-offs of eligible securities as reported on its Annual Statement.” Ordinarily for tax purposes a deduction can only be taken upon complete worthlessness. This creates a timing difference or deferred tax asset for financial reporting purposes which would be capital in nature and which may not be admissible for statutory reporting purposes if an entity has a history of capital losses and/or insufficient unrealized gains. It also creates the often onerous task of tracking the book-tax basis differences and related accretion and amortization differences on these impaired securities until they are eventually disposed of. This could wreak havoc on one’s ability to arrive at the proper annual tax adjustments required for impaired securities and subsequent recapture adjustments upon their ultimate disposal. IRC § 166(a)(2) stipulates that the Secretary may allow a partially worthless deduction for tax purposes in the year the debt has been impaired. The Directive advises insurance companies how to apply this rule to certain securities. Adopting the procedures allowed by the Directive can ease burdensome bookkeeping and may also result in the added cash flow benefit from tax refunds.
u BACKGROUND SSAP 43R became effective on Sept. 30, 2009, and provided guidance on recording otherthan-temporary impairments (OTTIs) on loan-backed and structured securities. SSAP 43R gives the insurer guidance as to how to treat securities with an unrealized loss. If the insurer intends to sell the security or does not have the intent and ability to retain the security until its amortized cost is recovered, the security is considered OTTI and must be written down to fair value and the write-down is recognized in earnings as a realized loss. u Read more
contact: Thomas Hiller Insurance Practice Leader 616-774-7000 [email protected] Richard Bertuglia Assurance Partner, New York 212-885-8342 [email protected] Phil Forret Assurance Partner, Dallas 214-665-0769 [email protected] Carla Freeman Assurance Partner, Los Angeles 310-557-8247 [email protected] Jay Goldman Assurance Partner, Atlanta 404-979-7237 [email protected] Brent Horak Assurance Partner, Dallas 214-665-0661 [email protected] Imran Makda Assurance Partner, New York 212-885-8461 [email protected] Barb Woltjer Assurance Partner, Grand Rapids 616-802-3368 [email protected]
2
BDO Insurance practice ALERT
If the holder of a security with an unrealized loss does not intend to sell the security and has the intent and ability to hold it long enough to recover the amortized cost, then the security is further divided into three categories with varying methodologies on how to “present value” the security. But the resulting write-down is also recognized in earnings as a realized loss. Due to the housing/mortgage crisis coupled with the investment requirements of insurers, many found themselves saddled with significant OTTI securities.
u HOW THE DIRECTIVE CAN BE APPLIED The insurance company will have a choice to either amend tax returns no earlier than the 2009 tax year, or apply the provisions of the Directive no later than the company’s 2012 tax year (the “Adjustment Year”1). The company’s partial worthlessness deduction under IRC § 166(a)(2) for “eligible securities”2 is the same amount as the company’s SSAP 43R credit-related impairment charge-off for the same securities as reported on its Annual Statement except that the company may need to reduce or increase its deduction by a “positive or negative adjustment.”3 The insurance company must attach a statement to its federal income tax return for the adjustment year stating that it is implementing the provisions of the directive; a separate statement should be attached to each insurance subsidiary in a consolidated return. For this Directive to apply, the insurance company must be subject to regulation as an insurance company, must be subject to federal income tax as either a life or non-life insurance company, must file an annual statement for which a state regulator has examination authority and must use the SSAP 43R credit-related impairment charge-off amount for all eligible securities.
u UNDER EXAMINATION If the company is presently under exam it should discuss the application of this directive with the examiners.
1 The first taxable year in which an insurance company applies the provisions of this directive. 2 Eligible securities means investments in loan-backed and structured securities within the scope of SSAP 43R, subject to IRC § 166, and not subject to IRC § 165(g)(2)(C), including Real Estate Mortgage Investment Conduit (REMIC) regular interests. 3 The positive or negative adjustment is determined on Dec. 31 of the Adjustment Year and is the difference between (i) the tax basis of eligible securities over (ii) the statutory carrying value of the same securities increased by any non-credit-related portion of any charge-off not allowed as deductible under the directive.
BDO Insurance Industry practice BDO’s Insurance practice understands the complexities of the industry and the implications for your business. Whether you’re looking to tap our extensive SEC experience in order to enter the public market, discuss the latest insurance accounting and reporting requirements from the NAIC, or comply with state regulatory agencies, BDO’s Insurance practice provides proactive guidance to our clients. We know that no two insurers are alike, and we tailor our services accordingly. We’re proud of our industry focus and experience, and our commitment to delivering the right team with relevant industry experience, both as we begin our relationship and for the long term. ABOUT BDO BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through more than 40 offices and more than 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multinational clients through a global network of 1,118 offices in 135 countries. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information, please visit: www.bdo.com. To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. Material discussed in this alert is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs. © 2012 BDO USA, LLP. All rights reserved. www.bdo.com
