Rev. Rul. 74-57

Advice is requested with respect to the time when a life insurance company takes into account the net increase or net decrease in reserves that results from strengthening or weakening, respectively, certain of its life insurance reserves during the taxable year that is also the last taxable year in which the company qualifies as a life insurance company under section 801 of the Internal Revenue Code of 1954.

Prior to 1971, X and Y were both insurance companies that qualified as life insurance companies under section 801 of the Code. During 1970 X determined that certain of its life insurance reserves needed to be strengthened. Accordingly, it changed the basis upon which those reserves had been computed and took all other steps necessary to strengthen such reserves. As a result of this strengthening X's life insurance reserves for the taxable year 1970 were increased by 10x dollars.

During 1970 Y insurance company determined that certain of its life insurance reserves should be weakened. It, too, changed the basis upon which such reserves were computed and took all other steps necessary to weaken its reserves. As a result of this weakening Y's life insurance reserves for the taxable year 1970 were decreased by 10x dollars.

The taxable year 1970 is the last taxable year that both X and Y qualified as life insurance companies under section 801 of the Code both having failed to qualify as life insurance companies in 1971.

Section 809(d)(2) of the Code provides, in effect, that a life insurance company shall be allowed a deduction for a net increase in its life insurance reserves for the taxable year in which such increase occurs.

Correspondingly, section 809(c)(2) of the Code provides, in effect, that a life insurance company shall include in income the net decrease in its life insurance reserves for the taxable year in which such decrease occurs.

Section 810(d)(1) of the Code provides as follows:

(1) In general.--If the basis for determining any item referred to in subsection (c) as of the close of any taxable year differs from the basis for such determination as of the close of the preceding taxable year, then so much of the difference between--

(A) the amount of the item at the close of the taxable year, computed on the new basis, and

(B) the amount of the item at the close of the taxable year, computed on the old basis, as is attributable to contracts issued before the taxable year shall be taken into account for purposes of this subpart as follows:

(i) if the amount determined under subparagraph (A) exceeds the amount determined under subparagraph (B), 1/10 of such excess shall be taken into account, for each of the succeeding 10 taxable years, as a net increase to which section 809(d)(2) applies; or

(ii) if the amount determined under subparagraph (B) exceeds the amount determined under subparagraph (A), 1/10 of such excess shall be taken into account, for each of the 10 succeeding taxable years, as a net decrease to which section 809(c)(2) applies.

Also, section 810(d)(2) of the Code and section 1.810-3(c) of the Income Tax Regulations provide, in effect, that if for any taxable year a company is not a life insurance company, then the entire balance of any adjustment remaining to be made under the 10-year spread rule described in section 810(d)(1) shall be taken into account for the preceding taxable year. Thus, the time when the adjustment attributable to the change in basis is taken into account as affected by the fact that the company may cease to be a life insurance company before the period covered by the 10-year spread rule has begun or elapsed.

In the instant situations, both X and Y insurance companies ceased to be life insurance companies after the change in basis was made to strengthen and weaken certain of their life insurance reserves, respectively, but before the beginning of the period when the adjustment for such change in basis could be taken into account in accord with section 810(d)(1) of the Code. Therefore, pursuant to section 810(d)(2) and section 1.810-3(c) of the regulations, the entire balance of such adjustment shall be taken into account for the taxable year preceding the year in which the company ceases to qualify as a life insurance company.

Accordingly, the full amount of the net increase in X's life insurance reserves due to the change in basis in computing such reserves shall be taken into account as a net increase referred to in section 809(d)(2) of the Code in determining gain and loss from operations for the taxable year 1970. Similarly, the full amount of the net decrease in Y's life insurance reserves due to the change in basis in computing such reserves shall be taken into account as a net decrease referred to in section 809(c)(2) in determining gain and loss from operations for the taxable year 1970.