[Federal Register Volume 68, Number 88 (Wednesday, May 7, 2003)]
[Rules and Regulations]
[Pages 24349-24351]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-11211]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9058]
RIN 1545-AY48


Guidance Under Section 817A Regarding Modified Guaranteed 
Contracts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations affecting insurance 
companies that define the interest rate to be used with respect to 
certain insurance contracts that guarantee higher returns for an 
initial, temporary period. Specifically, the final regulations define 
the appropriate interest rate to be used in the determination of tax 
reserves and required interest for certain modified guaranteed 
contracts. The final regulations also address how temporary guarantee 
periods that extend past the end of a taxable year are to be taken into 
account.

DATES: Effective Date: These regulations are effective as of May 7, 
2003.
    Applicability Date: For dates of applicability, see Sec.  1.817A-
1(d).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Ann H. 
Logan, 202-622-3970 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On June 3, 2002, the Treasury Department and the IRS published a 
notice of proposed rulemaking (REG-248110-96) under section 817A of the 
Internal Revenue Code (Code) in the Federal Register (67 FR 38214). The 
notice was corrected in the Federal Register (67 FR 41653) on June 19, 
2002. The proposed regulations were designed, in part, to reflect the 
addition of section 817A to the Code by section 1612 of the Small 
Business Job Protection Act of 1996, Public Law 104-188 (110 Stat. 
1755). No one requested to speak at the public hearing scheduled for 
August 27, 2002. Accordingly, the public hearing was canceled on August 
15, 2002 (67 FR 53327). Comments in response to the notice of proposed 
rulemaking were received and are addressed in the following Explanation 
and Summary of Comments. After consideration of all the comments, this 
document adopts the proposed regulations as revised by this Treasury 
decision. In addition, previous guidance under section 817A is revoked.

Explanation and Summary of Comments

    Two comments were filed with the Office of the Chief Counsel of the 
Internal Revenue Service. Both commentators generally agreed with the 
decisions incorporated in the proposed regulations. However, both 
commentators raised concern as to the interaction of the interest rates 
to be used for the reserve computations for modified guaranteed 
contracts (MGCs) with the reserve computation rules of section 811(d). 
That provision imposes an additional reserve computation rule for 
contracts that guarantee beyond the end of the taxable year payment or 
crediting of amounts in the nature of interest in excess of the greater 
of the prevailing state assumed interest rate or the applicable Federal 
interest rate. In those circumstances, section 811(d) requires that the 
contract's future guaranteed benefits be determined as though the 
interest in excess of the greater of the prevailing state assumed 
interest rate or the applicable Federal rate were guaranteed only to 
the end of the taxable year.
    Material was submitted as to the possible distortion of taxable 
income with respect to MGCs in declining interest rate environments. 
Notably, in cases where the interest rate required to be used under the 
regulations as proposed falls below the contract crediting rate during 
the guarantee period, section 811(d) will operate in a manner that does 
not match taxable income to actual income. As section 811(d) precludes 
taking future guaranteed interest amounts into account, examples showed 
that income distortion could occur under this fact pattern.
    After review of the comments, the proposed regulations have been 
amended to waive section 811(d) throughout the guarantee period of non-
equity-indexed MGCs.

Effect on Other Documents

    Notice 97-32 is revoked as of May 7, 2003. Accordingly, the notice 
may continue to be used by taxpayers if they wish through the effective 
date of these final regulations.

[[Page 24350]]

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking were submitted to the Small Business Administration for 
comment on the regulations' impact on small business.

Drafting Information

    The principal author of these proposed regulations is Ann H. Logan, 
Office of the Associate Chief Counsel (Financial Institutions and 
Products), Office of Chief Counsel, Internal Revenue Service. However, 
personnel from other offices of the IRS and the Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part I

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAX

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.807-2 also issued under 26 U.S.C. 817A(e) * * *
    Section 1.811-3 also issued under 26 U.S.C. 817A(e) * * *
    Section 1.812-9 also issued under 26 U.S.C. 817A(e) * * *
    Section 1.817A-1 also issued under 26 U.S.C. 817A(e) * * *

0
Par. 2. Section 1.807-2 is added to read as follows:


Sec.  1.807-2  Cross-reference.

    For special rules regarding the treatment of modified guaranteed 
contracts (as defined in section 817A and Sec.  1.817A-1(a)(1)), see 
Sec.  1.817A-1.

0
Par. 3. Section 1.811-3 is added to read as follows:


Sec.  1.811-3  Cross-reference.

    For special rules regarding the treatment of modified guaranteed 
contracts (as defined in section 817A and Sec.  1.817A-1(a)(1)), see 
Sec.  1.817A-1.


0
Par. 4. Section ``1.812-9 is added to read as follows:


Sec.  1.812-9  Cross-reference.

    For special rules regarding the treatment of modified guaranteed 
contracts (as defined in section 817A and Sec.  1.817A-1(a)(1)), see 
Sec.  1.817A-1.


0
Par. 5. Sections Sec.  1.817A-0 and Sec.  1.817A-1 are added to read as 
follows:


Sec.  1.817A-0  Table of contents.

    This section lists the captions that appear in section Sec.  
1.817A-1:


Sec.  1.817A-1  Certain modified guaranteed contracts.

(a) Definitions.
    (1) Modified guaranteed contract.
    (2) Temporary guarantee period.
    (3) Equity-indexed modified guaranteed contract.
    (4) Non-equity-indexed modified guaranteed contract.
    (5) Current market rate for non-equity-indexed modified 
guaranteed contract.
    (6) Current market rate for equity-indexed modified guaranteed 
contract. [Reserved.]
(b) Applicable interest rates for non-equity-indexed modified 
guaranteed contracts.
    (1) Tax reserves during temporary guarantee period.
    (2) Required interest during temporary guarantee period.
    (3) Application of section 811(d).
    (4) Periods after the end of the temporary guarantee period.
    (5) Examples.
(c) Applicable interest rates for equity-indexed modified guaranteed 
contracts. [Reserved.]
(d) Effective date.


Sec.  1.817A-1  Certain modified guaranteed contracts.

    (a) Definitions--(1) Modified guaranteed contract. The term 
modified guaranteed contract (MGC) is defined in section 817A(d) as an 
annuity, life insurance, or pension plan contract (other than a 
variable contract described in section 817) under which all or parts of 
the amounts received under the contract are allocated to a segregated 
account. Assets and reserves in this segregated account must be valued 
from time to time with reference to market values for annual statement 
purposes. Further, an MGC must provide either for a net surrender value 
or for a policyholder's fund (as defined in section 807(e)(1)). If only 
a portion of a contract is not described in section 817, such portion 
is treated as a separate contract for purposes of applying section 
817A.
    (2) Temporary guarantee period. An MGC may temporarily guarantee a 
return other than the permanently guaranteed crediting rate for a 
period specified in the contract (the temporary guarantee period). 
During the temporary guarantee period, the amount paid to the 
policyholder upon surrender is usually increased or decreased by a 
market value adjustment, which is determined by a formula set forth 
under the terms of the MGC.
    (3) Equity-indexed modified guaranteed contract. An equity-indexed 
MGC is an MGC, as defined in paragraph (a)(1) of this section, that 
provides a return during or at the end of the temporary guarantee 
period based on the performance of stocks, other equity instruments, or 
equity-based derivatives.
    (4) Non-equity-indexed modified guaranteed contract. A non-equity-
indexed MGC is an MGC, as defined in paragraph (a)(1) of this section, 
that provides a return during or at the end of the temporary guarantee 
period not based on the performance of stocks, other equity 
instruments, or equity-based derivatives.
    (5) Current market rate for non-equity-indexed modified guaranteed 
contracts. The current market rate for a non-equity-indexed MGC issued 
by an insurer (whether issued in that tax year or a previous one) is 
the appropriate Treasury constant maturity interest rate published by 
the Board of Governors of the Federal Reserve System for the month 
containing the last day of the insurer's taxable year. The appropriate 
rate is that rate published for Treasury securities with the shortest 
published maturity that is greater than (or equal to) the remaining 
duration of the current temporary guarantee period under the MGC.
    (6) Current market rate for equity-indexed modified guaranteed 
contracts. [Reserved]
    (b) Applicable interest rates for non-equity-indexed modified 
guaranteed contracts--(1) Tax reserves during temporary guarantee 
period. An insurance company is required to determine the tax reserves 
for an MGC under sections 807(c)(3) or (d)(2). During a non-equity-
indexed MGC's temporary guarantee period, the applicable interest rate 
to be used under sections 807(c)(3) and (d)(2)(B) is the current market 
rate, as defined in paragraph (a)(5) of this section.
    (2) Required interest during temporary guarantee period. During the 
temporary guarantee period of a non-equity-indexed MGC, the applicable 
interest rate to be used to determine required interest under section 
812(b)(2)(A) is the same current market rate, defined in paragraph 
(a)(5) of this section, that applies for that period for purposes of 
sections 807(c)(3) or (d)(2)(B).

[[Page 24351]]

    (3) Application of section 811(d). An additional reserve 
computation rule applies under section 811(d) for contracts that 
guarantee certain interest payments beyond the end of the taxable year. 
Section 811(d) is waived for non-equity-indexed MGCs.
    (4) Periods after the end of the temporary guarantee period. For 
periods after the end of the temporary guarantee period, sections 
807(c)(3), 807(d)(2)(B), 811(d) and 812(b)(2)(A) are not modified when 
applied to non-equity-indexed MGCs. None of these sections are affected 
by the definition of current market rate contained in paragraph (a)(5) 
of this section once the temporary guarantee period has expired.
    (5) Examples. The following examples illustrate this paragraph (b):

    Example 1. (i) IC, a life insurance company as defined in 
section 816, issues a MGC (the Contract) on August 1 of 1996. The 
Contract is an annuity contract that gives rise to life insurance 
reserves, as defined in section 816(b). IC is a calendar year 
taxpayer. The Contract guarantees that interest will be credited at 
8 percent per year for the first 8 contract years and 4 percent per 
year thereafter. During the 8-year temporary guarantee period, the 
Contract provides for a market value adjustment based on changes in 
a published bond index and not on the performance of stocks, other 
equity instruments or equity based derivatives. IC has chosen to 
avail itself of the provisions of these regulations for 1996 and 
taxable years thereafter. The 10-year Treasury constant maturity 
interest rate published for December of 1996 was 6.30 percent. The 
next shortest maturity published for Treasury constant maturity 
interest rates is 7 years. As of the end of 1996, the remaining 
duration of the temporary guarantee period for the Contract was 7 
years and 7 months.
    (ii) To determine under section 807(d)(2) the end of 1996 
reserves for the Contract, IC must use a discount interest rate of 
6.30 percent for the temporary guarantee period. The interest rate 
to be used in computing required interest under section 812(b)(2)(A) 
for 1996 reserves is also 6.30 percent.
    (iii) The discount rate applicable to periods outside the 8-year 
temporary guarantee period is determined under sections 807(c)(3), 
807(d)(2)(B), 811(d) and 812(b)(2)(A) without regard to the current 
market rate.
    Example 2. Assume the same facts as in Example 1 except that it 
is now the last day of 1998. The remaining duration of the temporary 
guarantee period under the Contract is now 5 years and 7 months. The 
7-year Treasury constant maturity interest rate published for 
December of 1998 was 4.65 percent. The next shortest duration 
published for Treasury constant maturity interest rates is 5 years. 
A discount rate of 4.65 percent is used for the remaining duration 
of the temporary guarantee period for the purpose of determining a 
reserve under section 807(d) and for the purpose of determining 
required interest under section 812(b)(2)(A).
    Example 3. Assume the same facts as in Example 1 except that it 
is now the last day of 2001. The remaining duration of the temporary 
guarantee period under the Contract is now 2 years and 7 months. The 
3-year Treasury constant maturity interest rate published for 
December of 2001 was 3.62 percent. The next shortest duration 
published for Treasury constant maturity interest rates is 2 years. 
A discount rate of 3.62 percent is used for the remaining duration 
of the temporary guarantee period for the purpose of determining a 
reserve under section 807(d) and for the purpose of determining 
required interest under section 812(b)(2)(A).

    (c) Applicable interest rates for equity-indexed modified 
guaranteed contracts. [Reserved.]
    (d) Effective date. Paragraphs (a), (b) and (d) of this section are 
effective on May 7, 2003. However, pursuant to section 7805(b)(7), 
taxpayers may elect to apply those paragraphs retroactively for all 
taxable years beginning after December 31, 1995, the effective date of 
section 817A.

David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
    Approved: April 25, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-11211 Filed 5-6-03; 8:45 am]
BILLING CODE 4830-01-P