b'Taxconversion that section 1297(b)(2)(B) preserved forinvestment contracts, structured settlements, or life insurance companies. The Internal Revenue Serviceinsurance or annuity contracts the payments of issued a notice 2in 2003 warning taxpayers thatwhich do not depend on the life expectancy of any these arrangements often do not generate theone or more individuals. Unearned premium claimed Federal tax benefit and that The Servicereserves for P&C companies are also excluded from will challenge the claimed tax treatment in appro- applicable insurance liabilities.priate cases. We do not know if the ServiceThe proposed regulations address the use of financial audited any investors in a hedge fund re schemestatement which include assets or liabilities of an in that era. We do know that there are no reportedentity other than the entity being tested for qualify-court cases dealing with section 1297(b)(2)(B). ing insurance company status, a matter not Congress finally responded to the hedge fund readdressed in the 2019 proposals. The December phenomenon by revising section 1297(b)(2)(B) in theproposed regulations allow reducing the assets on an Tax Cuts and Jobs Act of 2017. 3That law retained theapplicable financial statement by the amount of amorphous active conduct of an insurance businessliabilities on the financial statement that represent test, but added a second requirement that theamounts recoverable from other parties through insurance business must be conducted by a qualify- reinsurance, whether the reinsurer is related or not. ing insurance corporation as defined in new sectionThe Preamble to the 2020 proposed regulations 1297(f). In the summer of 2019 the Service and theindicates that this rule is intended to adjust for Treasury proposed regulations defining these terms. 4 financial statements that report reinsurance recover-In December 2020, the Service and the Treasuryable as assets on the balance sheet. The Preamble finalized some of those regulations and re-proposedalso indicates that a corresponding reduction to total some. 5The December, 2020 regulations take a clearliabilities would also be allowed to take into account step toward limiting the hedge fund re phenomenon. the amount of any asset reduction under this rule.Most of the new final regulations deal with theThe proposed regulations allow adjustments to a definition of a qualifying insurance company. Mostcorporations applicable financial statement pre-of the re-proposed regulations deal with the termpared on a consolidated basis. The allowed active conduct of insurance business. adjustment is that the assets of the corporation whose qualifying insurance corporation status is Qualifying Insurance Company being tested may be reduced by the applicable Section 1297(f) requires a qualifying insuranceinsurance liabilities of another entity that are company to have applicable insurance liabilitiesreported on the applicable financial statement.which constitute more than 25% of its total assets,The preamble also suggests that reserves for determined on the basis of the corporations appli- modified coinsurance are insurance liabilities of the cable financial statement. Section 1297(f)(2) allows aceding company and not the reinsurer. Accordingly, shareholder in a foreign corporation to elect a 10%a foreign reinsurer could not include liabilities test if the insurers failure to meet the 25% test isreinsured on a modified coinsurance basis to meet due solely to runoff related circumstances orthe applicable insurance liability test.rating-related circumstances.The final regulations continue the rule of the pro-The final regulations expressly exclude from appli- posed regulations limiting the availability of the cable insurance liabilities reserves for depositalternative 10% test for runoff-related circum-liabilities such as funding agreements, guaranteedstances to a corporation in the process of MAYER BROWN 105'