The Section 847 Special Deduction for Insurers

Section 847 was a former provision in the U.S. tax code that offered a special deduction to certain insurance companies. The Tax Cuts and Jobs Act of 2017 (TCJA) repealed Section 847 for all taxable years beginning after December 31, 2017, making the deduction unavailable. The repeal required companies that had previously used this provision to take specific final actions to close out their related accounts.

Eligibility for the Special Deduction

The Section 847 deduction was not available to all insurance companies. Its use was limited to insurers required by tax law to discount their unpaid loss reserves, a rule that predominantly affects property and casualty insurance companies. These companies deal with lines of business such as workers’ compensation and medical malpractice where claims may be reported but not fully paid for many years.

The election was applicable to specific lines of business that involved these “long-tail” claims, including certain accident and health insurance lines. Eligibility was tied directly to the requirement under Internal Revenue Code Section 846, which mandates the discounting of unpaid losses to reflect the time value of money. An insurer’s qualification for the Section 847 election depended on the nature of the policies it wrote.

Calculating the Deduction Amount

The calculation of the special deduction began with the requirement for property and casualty insurers to discount their reserves for unpaid losses. This meant they could not deduct the full face value of estimated future claim payments in the current year. Instead, they had to calculate the present value of those future payments using an interest rate and payment pattern prescribed by the IRS.

The Section 847 deduction was based on the difference between two figures. The first was the insurer’s “undiscounted unpaid losses,” which represented the full amount of estimated future payments. The second figure was the “discounted unpaid losses,” which was the lower, present-value amount. The special deduction allowed an eligible insurer to deduct an amount up to the difference between these two figures.

For example, if an insurer had undiscounted unpaid losses of $100 million and discounted unpaid losses of $90 million, the difference is $10 million. The company could then claim an additional deduction of up to $10 million. This mechanism was a timing benefit, not a permanent reduction of tax, effectively allowing the insurer to deduct the full, undiscounted amount of its loss reserves.

The Election and Special Estimated Tax Payments

An insurer had to make a formal election with a timely filed tax return for the year it was to take effect. A company could not go back and amend prior year returns to claim the deduction if it had not been properly elected. This election was a year-by-year choice, and a company could choose to stop claiming the deduction in a subsequent year without needing special permission from the IRS.

A condition for the deduction was the requirement to make “special estimated tax payments” (SETPs). The amount of these payments had to equal the tax benefit the company received from taking the special deduction. These payments were due on or before the original due date of the tax return, not including extensions. The funds were held by the U.S. Treasury in a “Special Loss Discount Account” for the company.

Subsequent Year Income Inclusion

The Section 847 deduction was a tool for managing the timing of tax payments, as the benefit was reversed, or “recaptured,” in subsequent years. As the insurer paid out claims related to the previously deducted reserves, the amount of the discount would decrease. This decrease was then subtracted from the company’s Special Loss Discount Account and included in its gross income for that year, increasing its tax liability.

The Tax Cuts and Jobs Act repealed Section 847 for tax years starting after December 31, 2017. As a result, any insurance company with a remaining balance in its Special Loss Discount Account was required to include the entire balance in its income for the first taxable year beginning after that date, which for most was the 2018 tax year.

To prevent a sudden tax burden, the law provided a mechanism to use the accumulated special estimated tax payments. The entire amount of existing SETPs was applied against the additional tax liability from the income inclusion. If the SETPs exceeded the tax owed, the excess was treated as a regular estimated tax payment for the first quarter of its 2018 tax year, which could then be applied to other tax liabilities or refunded.