Time to make a sec. 846(e) election to use company historical payment patterns.

• Author: Kovel, Timothy

Once every five years (referred to as a determination year) an insurer has an opportunity to elect to use its own payment pattern to discount losses (loss reserves and loss adjustment expenses.) for tax purposes, as opposed to relying on the IRS industrywide pattern that the. IRS derives from Best's Aggregates & Averages to calculate consolidated industry loss payment patterns. For 2012, insurance companies that choose not to elect to use their own payment patterns must use the industry averages published in Rev. Proc. 2012-44.

Because 2012 is a determination yea; insurance companies need to determine if this method is better for them than using the IRS's industrywide loss calculations. This election, which needs to be made when filing 2012 tax returns (Sec. 846(e) (2)(C)) and can be revoked only with IRS consent (Sec. 846(02)(B)), can reap significant reductions in current taxes payable, effectively increasing cash flow, an important advantage in the current environment of lower investment returns. This means that if the benefits are significant for many consecutive years, insurance-companies can, in essence, turn a temporary benefit into a long-term benefit.

On the flip side, it is rare but possible that this could be used as a tax planning strategy if a taxpayer needed to generate additional current taxable income (i.e., an unfavorable company payment pattern) to help support its deferred tax assets and validate the lack of a valuation allowance.

Good candidates for this election are organizations with the following traits:

* They pay claims faster than the industry average.;

* They have a consistent mix of predominantly long-tail business (i.e., lines of business in which losses may not he known for a long time and/or claims may take a long time to settle);

* They have steady payment patterns; and

* They are taxpaying entities.

What Is an Eligible Line of Business?

There are two scenarios to determine if a line of business is eligible for this election.

The first general eligibility test is:

A line of business is an eligible line of business in a determination year it, on the most recent annual statement filed by the taxpayer before the beginning of that determination year, the taxpayer reports losses and loss expenses incurred ... for at least the number of accident years for which losses and loss expenses incurred for that line of business are required to be separately reported on that annual statement. [Regs. Sec. 1.846-2 (b)(1)]...