Tax Reform: One Year In

1. Tax Reform:One Year In Association of Life Insurance Counsel May 21, 2019 Aditi Banerjee Prudential Bryan Keene Davis & Harman LLP Peter Schuur Debevoise & Plimpton

2. Tax Reform for Insurance Companies Recent Developments on Section 163(j) and BEAT

3. 163(j) Overview • Limitation on interest deductions under section 163(j) • Taxpayers can deduct business interest expense up to the sum of (1) their business interest income plus (2) 30% of adjusted taxable income or ATI (similar to EBITDA) • After 2021 ATI flips from EBITDA to EBIT • Bring back the DA movement? • Interest, ATI must be allocable to a trade or business • Exceptions for farming, utilities and electing real estate businesses • Does not include income and expense from investments • Legislative history says that corporations only have business income/expense • For partnerships, the 30% limitation applies at the entity level • No specific rule in statute for consolidated groups • Legislative history says the limitation applies at the consolidated return level

4. What’s New? – Proposed Regulations • Proposed regulations released in November 2018 confirm that all income/expense of a corporation is business income/expense • As a practical matter insurance companies generally should not be 163(j) limited on their U.S. interest expense, which can be offset against interest income from their bond portfolios • Regulations significantly expand scope of “interest” compared to traditional tax law concepts • Includes other amounts that involve time value element, such as bond premium, capitalized debt issuance costs, substitute interest • Anti-avoidance rule covers payments for use of funds if predominantly incurred in consideration of the time value of money • Regulations confirm that consolidated groups have a single 163(j) limitation • Separate limitation for non-life companies if life insurance subsidiary is waiting out 5-year period for life/nonlife consolidation • Regulations extend 30% limitation to foreign subsidiaries (CFCs) • Extraordinarily complex – is the game worth the candle?

5. Entity-level Approach for Partnerships • Entity-level approach creates potential for leakage on partnership investments: • Partnership has its own 163(j) limitation for its business interest expense • Partners cannot use their own business interest income or ATI to unlock excess business interest deductions that cannot be used by the partnership • Proposed regulations • Partnership investment income/expense allocable to a corporate partner treated as business income/expense of such partner – 163(j) limitation applies at partner level • For partnerships, business interest income/expense and ATI determinations are made at the partnership level • Basis increase on disposition • Allows economic cost of lost interest deductions to be recaptured on disposition • What of partial dispositions? • Partnership rules include 11-step allocation rule (!?!)

6. Base Erosion and Anti-Abuse Tax (“BEAT”) • The BEAT generally limits the ability of in-scope U.S. corporations to reduce their U.S. tax bill by making deductible payments to foreign affiliates (“BEAT Payments”) • Minimum tax approach: • Increase taxable income by BEAT Payments • Multiply by BEAT tax rate for the year – currently 10% (12.5% beginning 2026) • BEAT tax = excess of (2) over regular 21% corporate tax • In general, corporations can use BEAT Payments to reduce their effective tax rate by approximately 50% (21% to 10%) • Less favorable after the 2026 rate increase

7. What’s New? – Proposed Regulations Approach to Reinsurance • Proposed regulations released in December 2018 do not provide relief for reinsurance to foreign affiliates • Regulations say that premiums and other consideration paid by a U.S. ceding company to a foreign affiliate are not reduced by or netted against other amounts owed to the taxpayer from the foreign affiliate (no netting approach) • Reverse BEAT situations? • IRS explanation to proposed regulations says that U.S. P&C companies should not be subject to BEAT on claims that they pay to foreign affiliated ceding companies • For P&C companies, claims payments reduce gross income • Explanation notes that, for life insurance companies, claims payments are deductible and are potentially within the scope of BEAT • No policy reason for difference – Treasury has requested comments

8. Post-BEAT Affiliate Transactions • Proposed regulations would respect (non-insurance) transactions where otherwise applicable law provides that a deduction is computed on a net basis • May be possible to use transactions that have tax-netted payment streams under regular tax rules (e.g. notional principal contracts) • Excess of loss reinsurance • Proposed regulations would not count reinsurance to a U.S. branch of a foreign affiliate as a BEAT Payment • Can obtain capital relief with U.S. net-basis tax rather than BEAT gross-basis tax • Similar strategies apply to with respect to Section 953(d) companies

9. Federal Legislative ProposalsAffecting Life Insurance Products

10. Bipartisan Effort House Ways & Means Committee Chair and Ranking Member • Richard Neal (D-MA)House W&M • Kevin Brady (R-TX)House W&M Senate Finance Committee Chair and Ranking Member • Chuck Grasley (R-IA)Senate Finance • Ron Wyden (D-OR)Senate Finance 10

11. Bipartisan Ideas Encouraging lifetime income products Encouraging and preserving savings Encouraging small businesses to have a 401(k) plan • Move RMD age to 72 • Allow IRA contributions after age 70½ • Coverage for long-term part time employees • Fiduciary protection for employers • Lifetime income disclosure on 401(k) statements • Enhanced portability of in-plan annuities • “Open” multiple employer plans • Increased start-up business credits 11

12. Two Similar Bills: • SECURE Act (H.R. 1994, 116th Congress) • Setting Every Community Up for Retirement Enhancement Act • RESA (S. 972, 116th Congress) • Retirement Enhancement and Savings Act 12

13. Fiduciary Safe Harbor for Selecting Annuity Providers Current Law SECURE Act / RESA • New statutory safe harbor: • Reliance on representations about state law status for insurers’ financial capabilities; • Not required to select lowest-cost provider; • Not required to review after purchase for a participant or beneficiary; and • Allow reliance on annual representations from insurers • ERISA imposes fiduciary requirements on plan sponsors when making decisions affecting a plan • DOL regulations provide a safe harbor to satisfy those requirements when selecting an annuity provider for the plan • But the existing safe harbor is widely viewed as insufficient, so many plan sponsors are reluctant to offer in-plan annuity options 13

14. In-Plan Annuity Portability Current Law SECURE Act / RESA • Create an exception to the withdrawal restrictions for lifetime income investments • Directly roll the investment to an IRA or another plan, or a plan-distributed annuity • Only if the lifetime income investment is no longer authorized to be held under the plan • Retirement plans are subject to in-service withdrawal restrictions • Plan investment options, including those with lifetime income features, can change • If participants must liquidate a plan investment because the plan changes its options, they may not be able to preserve their lifetime income features through a rollover or otherwise 14

15. Lifetime Income Disclosure Current Law SECURE Act / RESA • Require DC plan statements to include a lifetime income disclosure annually • Disclosure would illustrate monthly payments if the participant’s total benefits were used to provide a single life annuity and a QJSA • No ERISA liability solely for providing the disclosure if certain rules are met and certain assumptions are used • DC plans must provide participants with benefit statements that include account balance, vesting, and investment information • The statements must be provided each calendar quarter or each calendar year, depending on whether the participant has the right to direct investments 15

16. Changes to Required Beginning Date (“RBD”) Current Law SECURE Act (but not RESA) • Increases RBD to April 1 of the year following • The year in which the individual reaches age 72, or • For plans, the year the individual retires (except for 5% or more owners) • Would apply to distributions required to be made after December 31, 2019, with respect to individuals who attain age 70½ after such date • IRA and qualified plan distributions must begin by April 1 the year following: • The year in which the individual reaches age 70 1/2, or • For plans, the year the individual retires (except for 5% or more owners) 16

17. Contributions to Traditional IRAs Current Law SECURE Act / RESA • No age limit for contributions to Traditional IRAs • Must still have compensation (generally from work) • No contributions after age 70 ½, even if still working • Contributions to Roth IRAs still allowed, if otherwise eligible 17

18. “Stretch” RMDs Current Law SECURE Act / RESA • Require distributions within 10 years of death • Exception for spouse, disabled and chronically ill, beneficiary within 10 years of decedent, minors until age of majority • Applies to deaths in 2020 and later • Senate RESA package uses five years, but includes $400,000 per beneficiary exception • After-death RMD regulations permit a beneficiary to draw down the remaining plan or IRA benefits over the beneficiary’s life expectancy 18

19. “Open” Multiple Employer Plans • Allows completely unrelated employers to participate in a single MEP, a “pooled employer plan” • Must use a “pooled plan provider” that serves as the fiduciary • Considered new opportunity to offer 401(k) plans to small businesses • SECURE Act and RESA have similar provisions 19

20. Additional Provisions (among many) • Allow plan withdrawals for birth or adoption (SECURE Act only) • Increase or eliminate cap on automatic enrollment contributions • Reform rules for safe harbor 401(k) plans • Increase start-up credit for small employer plans • New credit for small employers adopting automatic enrollment • Treat plan loans through credit cards as distributions • Clarify rules for terminating 403(b)(7) custodial accounts • Clarify rules for 403(b)(9) church plans • Require plans to allow certain long-term part-time employees to participate • Expand 529 plans 20

21. Retirement Plan Simplification & Enhancement Act • Richard Neal (D-MA)House W&M • Relief from the minimum income threshold test (MITT) • Treas. Reg. § 1.401(a)(9)-6, Q&A-14(c) • For any annuity with “increasing” payments, the total future expected payments must exceed the amount being annuitized, using certain limiting assumptions • The bill would exempt the following from the MITT: • Annuity payments that increase by less than 5% per year • Commutations determined in good faith using reasonable actuarial methods and assumptions • Certain accelerations of payments • Payments from participating annuities determined reasonably • Return of premium death benefits 21

22. Retirement Plan Simplification & Enhancement Act (cont.) • Qualifying longevity annuity contracts (QLACs) • Treas. Reg. § 1.401(a)(9)-6, Q&A-17 • Repeal the 25% limit on QLAC premiums • Increase the dollar limit to $200,000, indexed • Post-issuance divorce will not affect permissibility of purchased QLAC benefits if a QDRO or divorce / separation instrument: • Provides that the former spouse is entitled to the survivor benefits, • Does not modify the treatment of the former spouse as the contract beneficiary, or • Does not modify the treatment of the former spouse as the measuring life for the survivor benefits under the contract • Many other helpful provisions 22

23. Emerging Leaders on Retirement (Again) • Rob Portman (R-OH) • Ben Cardin (D-MD) 23

24. Portman-Cardin Bill • Portman-Cardin Ideas • The Retirement Security and Savings Act was introduced on 12/19/18 • Contains 56 sections – all Finance Committee jurisdiction • Many proposals from previously introduced bills • Adds new provisions • Reintroduction mid 2019 for 116th Congress • Wyden • Draft • Neal Bills • New • Ideas Portman-Cardin The Retirement Security and Savings Act 24

25. Portman-Cardin Bill • Create parity for annuities in RMD rules: Annuity distributions in excess of the distributions required from an individual account could be applied to reduce the RMD that otherwise would be required from the account. • Annuity distribution options: Facilitate plan distribution options such as annuity contract investments, GLWBs, and managed payout funds. • Update RMD life expectancy tables: Update to reflect mortality improvements (see also Executive Order 13847). • Expand EPCRS: Facilitate more self-correction for plan loan and other errors, extend program to IRAs, etc. • Expand 403(b)(7) custodial accounts: Allow them to invest in collective investment trusts. 25

26. Portman-Cardin Bill (cont.) • Many other helpful provisions, including some overlap with other bills: • MITT and QLAC issues in RMD regulations • Annuity portability in qualified plans • 403(b) plan terminations • Increase RMD start age • Exempt small balances from RMD rules 26

27. Missing Participants 27

28. State Law Overview • Insurers must report abandoned property to the state • Personal property is deemed abandoned if no contact with the owner throughout a “dormancy” period • Period normally begins when amount is payable • E.g., for an IRA, when a distribution was “attempted” or when a tax penalty would arise absent a distribution (RMDs) • Dormancy period normally lasts 3 years • Insurers then must pay the contract value to the state • Certain notice requirements for insurer and state • State assumes custody of the proceeds 28

29. Common Scenarios for Insurers • Death • Plan participant, IRA owner, or non-qualified annuity owner dies • Insurer sends a check to the beneficiary of record • Check is returned or never cashed • Lifetime payments • Non-qualified deferred annuity reaches its maturity date • Required minimum distributions commence pursuant to tax law • Insurer sends check to the owner • Check is returned or never cashed • No taxpayer ID number or address for a beneficiary 29

30. State Collection Efforts • States have stepped up efforts to collect in recent years • They can use the funds until claimed by the owner • They often have retained third party firms to help collect • Conduct audits of life insurers (and others) • Insurers may have withholding obligation to IRS • States would prefer the gross proceeds • Catch 22 for the insurer? 30

31. Internal Revenue Code • IRC § 3405 – tax withholding for designated distributions • Generally any distribution or payment from or under a qualified plan, IRA, or commercial annuity (including life insurance) • Exception if the “individual” elects out, but cannot elect out in the case of any “eligible rollover distribution” from a qualified plan • Exception if “reasonable to believe … not includible in gross income,” but this exception is unavailable for traditional IRAs • IRC § 6047(d) – tax reporting for designated distributions • Apply to any plan or contract from which designated distributions may be made • IRC § 408(i) – general reporting requirement for IRAs 31

32. GAO Report on Unclaimed 401(k) Accounts Recommendations to IRS Recommendations to DOL “Federal Action Needed to Clarify Tax Treatment of Unclaimed 401(k) Plan Savings Transferred to States” Requested by Sen. Ron Wyden (D-WA) • Consider clarifying reporting and withholding requirements • Consider extending 60-day rollover deadline for savings escheated from terminating DC plans Specify when uncashed checks from active planscan be transferred to the states 32

33. Legislation? • Retirement Savings Lost and Found Act (S. 2474) introduced by Sen. Warren (D-MA) and Sen. Daines (R-ID) • Would create public pension registry; modified reporting by plans for terminated employees • Increases cash-out to $6000 • Modifies rules for investment of cash-out (TDF, small uncashed checks go to federal government) • The Retirement Plan Modernization Act (H.R. 4158) was introduced by Chairman Walberg (R-MI) and Ranking Member Sablan (D-Northern Mariana Island). • Would increase the existing $5,000 cash-out limit to $7,600 for participants who have terminated employment. • Builds in an inflation index going forward. 33

34. Regulatory Guidance • IRS, DOL & PBGC are coordinating • Concerns raised with IRS • Withholding and reporting on payments to state unclaimed property funds or bank accounts • Search standards • Uncashed checks • Memoranda for Employee Plans (EP) Examinations Employees • Directs EP Examiners not to challenge a qualified plan or 403(b) plan for failures to make RMDs to a missing participant or beneficiary • Plan must take certain steps to attempt to locate the participant or beneficiary • Does not apply to IRAs • Guidance item on Priority Guidance Plan 34

35. Rev. Rul. 2018-17: Traditional IRAs • Facts • Individual is a U.S. person and has an “interest” in a traditional IRA • Individual made no withholding election under IRC § 3405(b)(2) • Issuer must pay Individual’s interest to state unclaimed property fund • Conclusion #1: Withholding required under IRC § 3405 • The exception for “reasonable to believe is not includible in gross income” does not apply to traditional IRAs (flush language) • Thus, the payment is a designated distribution • No election out, so 10% withholding applies (nonperiodic distribution) • Conclusion #2: Reporting required IRC § 408(i) • Report on Form 1099-R, showing the Individual as recipient of payment 35

36. Rev. Rul. 2018-17 (cont.) • Roth IRAs not addressed • SEP IRAs, SIMPLE IRAs & deemed IRAs not addressed • Ruling does not apply to payments made before the earlier of January 1, 2020, or the date it “becomes reasonably practicable” for the payor to comply earlier (as modified by Notice 2018-90) 36

37. Rev. Rul. 2018-17 (cont.) • Situations where the flush language does not apply (i.e., amounts are not presumed to be includible in gross income) • Roth IRAs • Qualified plans and IRC § 403(b) plans • DOL: ERISA preempts transfers mandated under state unclaimed property laws • DOL has approved sending assets of missing participants to a state in connection with a terminated DC plan • Implications for non-qualified annuity contracts • Similar withholding rules apply (except flush language) • Reporting under IRC § 6047(d), not IRC § 408(i) 37

38. Taxation in the Digital Economy

39. OECD Report on Tax Challenges of Digitalization • Consultation document released on 2/13/2019 that describes and requests comment on various options for implementing a two-pillared approach to addressing the tax challenges of digitalization and “remaining BEPS [base erosion and profit sharing] issues” • Changes to the profit allocation and nexus rules and expanding the tax rights of user and market jurisdictions • Global anti-base erosion proposal with a minimum tax and a fallback proposal targeting related party, base eroding payments

40. South Dakota v. Wayfair, Inc. • US Supreme Court decision upends the Quill decision from 25 years ago on the question of nexus • The issue at the heart of the decision was whether online retailers have to collect sales (or use) tax for online purchases • Quill focused on a bright-line physical presence requirement – “[A] bright-line rule in the area of sales and use taxes also encourages settled expectations and, in doing so, fosters investment by businesses and individuals.” • In Wayfair, the Court concluded that “the physical presence rule of Quill is unsound and incorrect.” • Implications beyond the online retail industry