What Was IRS Code 820 and Why Was It Repealed?

Internal Revenue Code Section 820 was a repealed provision that governed the optional tax treatment of specific reinsurance agreements between domestic and foreign insurance companies. Through a joint election filed with the IRS, a U.S. insurance company and a foreign reinsurer could agree to consolidate the taxable income from the reinsured policies onto the U.S. company’s tax return. The primary consequence was that the domestic company would not deduct the reinsurance premiums it paid to its foreign partner. Instead, it would report all investment income and underwriting gains from those policies, an arrangement particularly relevant for modified coinsurance contracts.

The Function of the Reinsurance Election

Under Section 820, the domestic company forwent the deduction for premiums paid to its foreign partner. In its place, the U.S. firm was required to include in its own gross income all the revenue generated by the assets held by the foreign reinsurer to support the reinsured policies. This included investment income, such as interest, dividends, and rents, as well as any underwriting profits.

This treatment effectively treated the foreign reinsurer as an extension of the domestic company for tax reporting purposes on the specific block of business under the election. The U.S. company was responsible for calculating and reporting this income on its annual tax return, Form 1120-L for life insurance companies or Form 1120-PC for property and casualty companies. This required the foreign reinsurer to provide detailed financial information to its U.S. partner, including asset balances, investment yields, and claims paid.

To substantiate this arrangement, the companies had to maintain meticulous records. The domestic insurer needed to track the flow of funds and the investment performance of the assets held by the foreign entity. This created a significant compliance burden, as it necessitated a transparent and continuous exchange of detailed financial data across international borders.

Rationale for Enactment and Repeal

The original enactment of Section 820 was intended to enhance the competitiveness of U.S. insurance companies in the global marketplace. It allowed them to enter into certain types of reinsurance agreements without the immediate tax disadvantages that would otherwise arise. By permitting the U.S. company to retain the tax liability on the reinsured business, it could better manage its overall tax position and offer more competitive terms to policyholders.

Over time, the provision came to be viewed by lawmakers and the Treasury Department as a tax loophole. The structure of the election was exploited, leading to significant tax deferral and, in some cases, permanent tax avoidance. Arrangements were often structured with reinsurers located in jurisdictions with low or no income taxes, which allowed investment income to accumulate offshore under the election without being repatriated to the U.S.

The primary concern was that the election facilitated the transfer of profitable business to foreign affiliates in tax havens, where investment income could grow tax-free, while the U.S. parent company managed the tax consequences. This created an imbalance and was seen as eroding the U.S. tax base. The ability to selectively use the election for certain contracts gave companies a tool to artificially lower their effective tax rate.

Congress acted to eliminate this perceived loophole. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) included the repeal of Section 820 as part of a broader legislative effort to close tax shelters and increase federal revenue. The repeal was effective for tax years beginning after December 31, 1981, reflecting a policy decision that the potential for tax avoidance outweighed the provision’s original benefits.

Tax Treatment After Repeal

Following the repeal of Section 820, the tax treatment of reinsurance premiums paid to foreign entities reverted to a standard framework. A U.S. insurance company paying premiums to a foreign reinsurer can deduct those premiums as a business expense. This shifts the income associated with the reinsured policies to the foreign jurisdiction where the reinsurer is domiciled.

The income earned by the foreign reinsurer is not subject to U.S. income tax, provided the company is not considered to be “engaged in a U.S. trade or business.” If the foreign reinsurer’s activities are limited to accepting risks from abroad and it does not maintain an office or agents in the United States, its underwriting and investment income is outside the reach of U.S. taxation.

To counteract the complete avoidance of U.S. tax on this income, a federal excise tax is imposed on insurance premiums paid to foreign insurers for the coverage of U.S. risks. The tax rate is 4% for casualty insurance and indemnity bonds, and 1% for life insurance and reinsurance premiums. This tax is paid by the U.S. ceding company or broker and is reported on Form 720, Quarterly Federal Excise Tax Return. This excise tax can be waived or reduced if the foreign reinsurer is located in a country that has an income tax treaty with the United States.

The tax landscape for these transactions was significantly altered by the Tax Cuts and Jobs Act of 2017. This legislation introduced the Base Erosion and Anti-Abuse Tax (BEAT), a provision that can affect reinsurance premiums paid to foreign affiliates. BEAT functions as a type of corporate minimum tax that can limit the deductibility of certain payments to foreign affiliates, including reinsurance premiums, potentially subjecting them to U.S. tax.