Closed refund years do not prevent open-year insurance adjustments

Plain-English summary

A property and casualty insurer used section 847 deductions, special loss discount accounts, and matching special estimated tax payments. After a net operating loss carryback generated a refund, the insurer failed to adjust its account records and later received the benefit of the same special estimated tax payments a second time. Chief Counsel advised that section 6511 barred the insurer from amending a later return to obtain a refund that included amounts from closed years. Even though refunds and assessments for those years were time-barred, the IRS could correct the closed-year calculations when those adjustments affected accounting for the section 847 election in an open year.

Ruling snapshot

• Question: Could an insurer recover section 847 amounts from closed years, and could the IRS correct those errors in an open year?
• Outcome: Advice that the refund was barred, but open-year adjustments could reflect corrected closed-year accounting.
• Key authorities: IRC §§ 847, 6501, 6511; Rev. Rul. 56-286.

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           Number: 201640017
           Release Date: 9/30/2016
           CC:FIP:B04:WTSullivan                    Third Party Communication: None
           POSTS-126965-15                          Date of Communication: Not Applicable

 UILC:     847.00-00, 6501.00-00, 6511.00-00

  date:    June 22, 2016

     to:   Thomas F. Harriman
           Attorney, (Chicago)
           (Large Business & International)

  from:    Rebecca L. Baxter
           Senior Technician Reviewer, Branch 4
           (Financial Institutions & Products)


subject:   Application of Section 847 in Closed Years

           This Chief Counsel Advice responds to your request for assistance. This advice may
           not be used or cited as precedent.

           ISSUES

           1. Can Taxpayer amend its ------ tax return to reduce its taxable income by the
              aggregate amount of the special loss discount account (SLDA) that was incorrectly
              taken into income over its -------------- tax years?
           2. How should the Service correct the errors that occurred in accounting for the § 847
              election in closed years?

           CONCLUSIONS

           1. Taxpayer is barred by § 6511 from amending its ------ tax return to reduce its taxable
              income by the aggregate amount of the SLDA, which includes amounts from closed
              years, that was incorrectly taken into income over its -------------- tax years.
           2. The Service can make adjustments in an open year to address errors that occurred
              in accounting for § 847 in closed years.

           FACTS

           Taxpayer is a property and casualty insurance company taxable under § 831. Taxpayer
           is required to discount its reserves for unpaid losses under § 846. Taxpayer elected to
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deduct additional loss deductions under § 847. Taxpayer added the § 847 deductions
to a SLDA and made corresponding special estimated tax payments (SETPs) equal to
the tax benefits attributable to the § 847 deductions. In subsequent years, as Taxpayer
paid losses and the related § 846 discount declines, corresponding amounts were
subtracted from the SLDA and included in Taxpayer’s gross income. Any additional tax
liability resulting from the inclusion of the previously deducted § 847 amounts was
covered through Taxpayer’s previously made SETP. Taxpayer kept track of SLDA and
SETP accounts for each accident year separately on Forms 8816, Special Loss
Discount Account and Special Estimated Tax Payments for Insurance Companies.

During examination of Taxpayer’s deposits made into the SETP, it was discovered that
there are numerous discrepancies between the SETP yearly deposits/withdrawals per
the § 847 control card and the SETP yearly deposits/withdrawals per Taxpayer’s Forms
8816. The discrepancy is partially due to the effect of a net operating loss (NOL)
carryback. In ------, Taxpayer had a NOL that it elected to carry back five years. As a
result of the NOL carryback, Taxpayer was refunded both the tax that it paid for -----------
------ and the SETP account as of ------. However, Taxpayer did not adjust its Forms
8816 to take this refund into consideration and as a result Taxpayer continued to take
back into income over the years the § 847 deductions that were initially deducted on the
filed tax returns for --------------. As Taxpayer took into income the reductions from the
SLDA, the corresponding increase in tax was paid through reductions of the SETP.
Therefore, the SETP was refunded to Taxpayer twice, first when Taxpayer filed
amended returns as a result of the NOL carryback and a second time over the years as
it took into income the amounts previously deducted under § 847.

Taxpayer agrees that there is a shortage in the SETP. However, Taxpayer argues that
the shortage in the SETP was caused by Taxpayer incorrectly taking into income the
SLDA from ---------------over the ---------------tax years. Taxpayer argues it should be
allowed to amend its ------ tax return to reduce its taxable income by the aggregate
amount of the SLDA that was incorrectly taken into income, and the resulting refund
should be deposited back into the SETP. However, the statute of limitations is expired
for most of the years in which Taxpayer took the amount (SLDA) back into income.
Taxpayer argues that because § 847 is supposed to be revenue neutral, if the Service
does not allow Taxpayer to reduce its income by the SLDA amount that were incorrectly
taken into income, Taxpayer would have a permanent adjustment to its taxes.

LAW AND ANALYSIS

Section 832 requires that property and casualty insurance companies discount their
deductions for insurance loss reserves in order to take into account the time value of
money. Section 846 provides the methodology for computing the discount and
determining the amount of the discounted loss deduction.

Section 847(1) permits an insurance company an additional deduction for the amount of
the discount computed under § 846. Thus, by claiming a deduction for discounted
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losses in accordance with § 846, and the additional deduction for the amount of the
discount in accordance with § 847(1), a taxpayer may essentially deduct its full,
undiscounted reserve for losses.

Section 847 was not intended to give the taxpayer an additional tax benefit. The
purpose of § 847 is to offset the negative effects on financial accounting reporting
caused by the discounting requirement of § 846. Thus, the legislative history indicates
that Congress intended § 847 to be revenue neutral. See H.R. Conf. Rep. No. 1104,
100th Cong. 2nd Sess. 173 (1988). While § 847(1) allows the taxpayer an additional
deduction, § 847(2) offsets the tax benefit of that deduction by requiring that the
taxpayer make a SETP in an amount equal to the tax benefit derived from the § 847(1)
deduction.

Taxpayers who are allowed a deduction under § 847(1) are required by § 847(3) to
establish and maintain a SLDA to keep track of the unreversed discount for each year
for which a § 847(1) deduction was claimed. The amount of the discount claimed as a
deduction for any taxable year is added to the account. Pursuant to § 847(5), amounts
are subtracted from the account, and simultaneously included in the taxpayer's gross
income, as time passes and the unreversed discount decreases. Assuming this
inclusion in income gives rise to an additional tax liability, § 847(2) provides that the
special estimated tax payments previously made are used to pay the additional tax
liability.

Section 847(8) provides that the tax benefit attributable to the § 847 deduction shall be
determined by taking into account tax benefits that would arise from the carryback of
any net operating loss for the year, as well as current year tax benefits.

Section 6511(a) provides that a claim for refund of an overpayment of any tax shall be
filed within three years from the time the return was filed or two years from the time the
tax was paid, whichever of those periods expires the later. Section (b)(1) provides that
no refund shall be allowed or made after the expiration of the period prescribed in
§ 6511(a). The period prescribed in § 6511(a) for most of the years in which Taxpayer
took the SLDA back into income has expired. Section 847 does not extend any of the
normal rules under § 6511. Therefore, Taxpayer may not amend its ------ turn to reduce
its taxable income by the aggregate amount of the SLDA, which includes amounts from
closed years, that was incorrectly taken into income over its -------------- tax years.

Nor can the Service carryback any additional net operating losses from ------ to offset
income from -------------- and give an additional refund for those years. Such a refund
would also be precluded by § 6511. Section 6511(b) states that no refund can be paid if
the taxpayer failed to file a claim within three years from the time the return was filed or
two years from the time the tax was paid, whichever is later. Those periods have long
passed for the -------------- taxable years. There is an exception for net operating loss
carrybacks under § 6511(d)(2), but that only extends the period that a claim can be
made until 3 years after the due date of the return for the year of the NOL. In this case
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that would be ------, and therefore, that period too has long passed. Therefore, there
can be no refund based on the carryback from the ------ year to the -------------- taxable
years.

Although a refund may be barred under § 6511, and similarly assessment of an
underpayment may be barred by § 6501, neither provision bars the actual adjustment to
Taxpayer’s return. There is no statute of limitation that bars the adjustment to the
return. See Rev. Rul. 56-286, 1956 C.B. 134; Hill v. Commissioner, 95 T.C. 437 (1990).
Therefore, if it is determined that the closed years were not calculated correctly, the
Service may make adjustments to those years. Those adjustments could affect
accounting for the § 847 election in open years.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS




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