Rev. Rul. 75-308

Advice has been requested whether, under the circumstances described below, a change in the computation of reserves held by a life insurance company is a change in the basis for computing such reserves within the meaning of sections 809(d) and 810(d)(1) of the Internal Revenue Code of 1954.

L, a life insurance company within the meaning of section 801 of the Code, issues a so-called "Optional Deferred Income Contract" that provides a retirement annuity or benefits under several optional methods of settlement upon maturity of the contract. When these contracts were first issued, it was anticipated that the maturity value would be sufficient to provide the benefits guaranteed. In 1954, however, L's board of trustees decided that the reserves for matured contracts were not sufficient and should be put on a basis different from that used in computing the reserves when the contracts were issued. This decision was based upon a study indicating that a change in interest and mortality assumptions had occurred since the contracts were first issued and that pursuant to such revised assumptions greater additions should be made to the reserves for such contracts each year than was required under the old assumptions. However, instead of starting immediately to make additions to the reserves pursuant to the revised assumptions the board of trustees adopted a formula in 1954 whereby additions would be made to the reserves on the contracts as they matured, and, accordingly, authorized a transfer of funds from surplus to accommodate the reserve strengthening as the contracts matured.

In 1971, when the contracts began to mature, L, for the first time, determined and added amounts to the reserves on the contracts that matured in that year. This determination was in accordance with the formula adopted by L's board of trustees in 1954. The full amount of the resulting increase in reserves was deducted by L on its income tax return for the year 1971.

In support of its deduction of the full amount of the increase in reserves on its income tax return for 1971, L contends that a new basis for computing reserves with respect to these contracts was determined by the board of trustees in the resolution adopted in 1954, and that all that occurred in 1971 was a change in the status of the contracts from "before maturity" to "after maturity."

Section 809(d)(2) of the Code allows a deduction for the net increase in reserves required to be taken into account by section 810. Section 810 provides, in part, as follows:

(d) Adjustment for change in computing reserves.--

(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. . . .

Section 1.810-3(b) of the Income Tax Regulations sets forth the following example in illustration of the provisions of section 810(d)(1) of the Code:

Example (1). Assume that the amount of an item in section 810(c) of L, a life insurance company, at the beginning of the taxable year 1959 is $100. Assume that at the end of the taxable year 1959, as a result of a change in the basis used in computing such item during the taxable year, the amount of the item (computed on the new basis) is $200 but computed on the old basis would have been $150. Since the amount of the item at the end of the taxable year computed on the new basis, $200, exceeds the amount of the item at the end of the taxable year computed on the old basis, $150, by $50, 1/10 of the amount of such excess, or $5, shall be taken into account as a net increase referred to in section 809(d)(2) and paragraph (a)(2) of section 1.809-5 in determining gain or loss from operations for each of the 10 taxable years immediately following the taxable year 1959.***

Section 1.818-2(c) of the regulations states, in part, that under an accrual method of accounting, a change in the basis or method of computing the amount of liability of any item referred to in section 810(c) of the Code occurs in the taxable year in which all the events have occurred that determine the change in the basis or method of computing the amount of such liability and, in which, the amount thereof (whether increased or decreased) can be determined with reasonable accuracy.

S. Rep. No. 291, 86th Cong., 1st Sess. 34 (1959), 1959-2 C.B. 770, 794, states in part, as follows:

Reserves strengthening or weakening.--A special spread rule is applied under the House bill and your committee's bill where a company determines that its reserves require strengthening and additions are therefore made to its reserves. If no limitations were imposed in these cases, the company could take a substantial additional deduction in computing gain or loss from operations for the year when the reserves were strengthened. To spread the effect of such adjustments, it is provided that, in the case of reserve strengthening, deductions relating to the additions in reserves are to be taken into account ratably over a 10-year period instead of entirely in the year of change.***

Thus, section 810(d)(1) of the Code deals, in part, with the taxable year in which additions are made to reserves on account of a change in the basis of reserves. Neither the adoption of a resolution by the board of trustees authorizing reserve strengthening nor the accompanying authorization to transfer funds from surplus to accommodate the reserve strengthening as the contracts matured is determinative of the taxable year in which a change in basis in computing reserves has occurred for purposes of section 810(d)(1). Neither action constitutes the final event necessary to satisfy section 1.818-2(c) of the regulations.

Accordingly, the change in computing L's reserves with respect to its Optional Deferred Income Contracts is a change in the basis in computing such reserves, within the meaning of section 810(d)(1) of the Code, in 1971, the year in which additions to the reserves were made on the new basis. Consequently, L is required to take into account the resulting increase in reserves described in section 809(d) pro rata over the succeeding 10 taxable years commencing with the taxable year 1972.