Rev. Rul. 73-60

Advice has been requested whether a life insurance company, that has been accruing market discount under the circumstances described below must request permission under Section 446(e) of the Internal Revenue Code of 1954 to change such method to a method not requiring accrual of market discount.

The taxpayer has always employed the accrual method of accounting as required of life insurance companies under section 818(a) of the Code. The taxpayer has been accruing market discount on taxable bonds consistently for all years and now desires to change to the treatment provided by section 818(b)(3) of the Code beginning for the taxable year 1972.

Section 1.818-2(a)(1) of the Income Tax Regulations provides, in part, that the "accrual method" shall have the same meaning and application in section 818 of the Code as it does under section 446 of the Code (relating to general rule for methods of accounting) and the regulations thereunder.

Section 446(e) of the Code provides, in part, that a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary or his delegate.

Section 1.446-1(e)(2)(ii)(a) of the regulations provides, in part, as follows:

"A change in method of accounting includes a change in the overall plan of accounting for gross income or deductions or a change in the treatment of any material item used in each overall plan. Although a method of accounting may exist under this definition without the necessity of a pattern of consistent treatment of an item, in most instances a method of accounting is not established for an item without such consistent treatment. A material item is any item which involves the proper time for an inclusion of the item in income or the taking of a deduction." (Emphasis added.)

Section 818(b)(3) of the Code provides, in pertinent part, that for all taxable years beginning after December 31, 1962, no accrual of discount shall be required on any bond (as defined in section 171(d) of the Code), except in the case of discount which is interest to which section 103 of the Code applies, or which is original issue discount (as defined in section 1232(b) of the Code).

Senate Report No. 830, Eighty-eighth Congress, Second Session, 1964-1 (Part 2) C.B. 505, at 627, states, in part, as follows:

"Under your committee's bill in the future, market discount on bonds held by insurance companies and other corporations will be taxed alike; that is, as capital gain when the bond is sold or redeemed."

The Technical Explanation on Senate Report No. 830 at page 758 states, in part, as follows:

"Under existing law, section 818(b)(1) requires life insurance companies to accrue all discount regardless of whether it is "issue discount," original issue discount, or "market discount". The new paragraph (3) of section 818(b) of the Code changes existing law only with respect to "market discount". Such discount is no longer required to be accrued. Thus, the recognition of gain attributable to market discount is postponed until the disposition of the bond. Upon the disposition of the bond, gain attributable to market discount will ordinarily be taxable as capital gain. The adjustment to basis for the accrual of market discount will no longer be allowed to the extent such discount is not accrued by reason of the new section 818(b)(3)." (Emphasis added).

The words "no longer required" and "to the extent" contained in the above Senate Report (Technical Explanation) show that the taxpayer does have an option of whether to accrue the discount while the bond is being held or to report capital gain at the time the bond is disposed of.

The taxpayer's practice in prior years of accruing market discount is a method of accounting. Any method of not accruing such market discount for 1972 involves the proper time for an inclusion of an item of income and clearly falls within the definition of a change in accounting method under section 1.446-1(e)(2)(ii)(a) of the regulations.

Accordingly, since the accrual of market discount by the taxpayer is a method of accounting, permission to change such method to that provided by section 818(b)(3) of the Code must be obtained in accordance with section 446(e) of the Code and the regulations thereunder. Any subsequent change will also require the consent of the Commissioner.