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SOCIAL SECURITY ADMINISTRATION

DEPARTMENT OF THE TREASURY

20 CFR Part 405

Internal Revenue Service

RIN 0960–AG31

26 CFR Parts 1 and 602

Administrative Review Process for
Adjudicating Initial Disability Claims;
Correction
AGENCY:
ACTION:

Social Security Administration.

Effective August 1, 2006.

FOR FURTHER INFORMATION CONTACT:

Richard Bresnick, Social Insurance
Specialist, Office of Regulations, Social
Security Administration, 100 Altmeyer
Building, 6401 Security Boulevard,
Baltimore, MD 21235–6401, (410) 965–
1758 or TTY (410) 966–5609 for
information about this notice. For
information on eligibility or filing for
benefits, call our national toll-free
number, 1–800–772–1213 or TTY 1–
800–325–0778, or visit our Internet site,
Social Security Online, at http://
www.socialsecurity.gov.
In FR Doc.
06–3011 appearing on page 16424 in the
Federal Register of Friday, March 31,
2006, the following correction is made:

SUPPLEMENTARY INFORMATION:

§ 405.601

[Corrected]

On page 16456, in the third column,
in § 405.601, in paragraph (b),
‘‘§§ 404.989(a)(1) and 416.989(a)(1)’’ is
corrected to read ‘‘§§ 404.989(a)(1) and
416.1489(a)(1)’’.

■

Dated: April 4, 2006.
Gregory Zwitch,
Social Security Regulations Officer.
[FR Doc. 06–3388 Filed 4–7–06; 8:45 am]

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BILLING CODE 4191–02–P

RIN 1545–AY49

Application of Section 338 to
Insurance Companies
Internal Revenue Service (IRS),
Treasury.
ACTION: Final and temporary
regulations.
AGENCY:

Final rule; correction.

SUMMARY: The Social Security
Administration is correcting a final rule
that appeared in the Federal Register on
March 31, 2006 (71 FR 16424). The
document amends our administrative
review process for applications for
benefits that are based on whether you
are disabled under title II of the Social
Security Act (the Act), or applications
for supplemental security income (SSI)
payments that are based on whether you
are disabled or blind under title XVI of
the Act.
DATES:

[TD 9257]

SUMMARY: This document contains final
regulations that apply to a deemed sale
or acquisition of an insurance
company’s assets pursuant to an
election under section 338 of the
Internal Revenue Code, to a sale or
acquisition of an insurance trade or
business subject to section 1060, and to
the acquisition of insurance contracts
through assumption reinsurance. It also
contains final regulations under section
381 concerning the effect of certain
corporate liquidations and
reorganizations on certain tax attributes
of insurance companies. This document
also contains temporary regulations
under section 197 relating to the
determination of adjusted basis of
amortizable section 197 intangibles with
respect to insurance contracts, section
338 relating to increases in reserves after
a deemed asset sale and sections 338
and 846 relating to the effect of a section
338 election on a section 846(e)
election. The text of the temporary
regulations also serves as the text of the
proposed regulations set forth in the
notice of proposed rulemaking on this
subject in the Proposed Rules section in
this issue of the Federal Register. The
final and temporary regulations apply to
insurance companies.
DATES: Effective Date: The final and
temporary regulations are effective on
April 10, 2006.
Applicability Dates: For dates of
applicability of these regulations, see
§§ 1.197–2(g)(5)(iv), 1.338(i)–1(c), and
1.1060–1(a)(2). The applicability of
§§ 1.197–2T(g)(5)(ii), 1.338–11T(d), and
1.338–11T(e) will expire on April 7,
2009.
FOR FURTHER INFORMATION CONTACT:
Mark Weiss, (202) 622–7790 (not a tollfree number).
SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act
The collection of information in these
final regulations was not proposed in
the preceding notice of proposed
rulemaking. The collection of

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information has been reviewed in
accordance with the Paperwork
Reduction Act (44 U.S.C. 3507) and,
pending receipt and evaluation of
public comments, approved by the
Office of Management and Budget under
control number 1545–1990.
The collection of information is in
§§ 1.338–11T(e)(2), 1.338(i)–1(c),
1.381(c)(22)–1(c), 1.1060–1(a)(2). This
information is required by the IRS to
allow an insurance company permission
to cease using its historical loss
payment pattern and to allow parties to
a transaction under section 338, to an
applicable asset acquisition under
section 1060, or to a distribution or
reorganization to which section 381
applies to file a retroactive election to
apply these regulations to transactions
completed before the effective dates of
these regulations. The likely
recordkeepers are business or other forprofit institutions.
The estimated burden is as follows:
Estimated total annual reporting and/
or recordkeeping burden: 12 hours.
Estimated average annual burden per
respondent: 1 hour.
Estimated number of respondents: 12.
Estimated annual frequency of
responses: once.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Office of Management and Budget,
Attn: Desk Officer for the Department of
the Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503, with copies to the Internal
Revenue Service, Attn: IRS Reports
Clearance Officer,
SE:W:CAR:MP:T:T:SP, Washington, DC
20224. Any such comments should be
submitted not later than June 9, 2006.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid control number
assigned by the Office of Management
and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background and Explanation of
Provisions
On March 8, 2002, the IRS and the
Department of Treasury published a
notice of proposed rulemaking in the
Federal Register (REG–118861–00,
2002–1 C.B. 651 [67 FR 10640]) (the
proposed regulations) that sets forth

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rules applying to taxable acquisitions
and dispositions of insurance
businesses, including those that are
deemed to occur when an election
under section 338 of the Internal
Revenue Code (Code) is made.
The proposed regulations generally
treat the transfer of insurance or annuity
contracts and the assumption of related
reserve liabilities that are deemed to
occur when an election under section
338 is made consistently with the
treatment of assumption reinsurance
transactions entered into in the ordinary
course of business under § 1.817–4(d)
(and other provisions of subchapter L of
chapter 1, subtitle A of the Code and the
regulations promulgated thereunder).
The proposed regulations provide
similar rules for acquisitions of
insurance businesses governed by
section 1060, whether effected through
assumption or indemnity reinsurance.
Thus, in the case of both a deemed and
an actual transfer of an insurance
business, the proposed regulations
provide that the ceding company (in the
case of a section 338 election, old target)
is treated as having income in the
amount of the reduction in its reserves
and having a deduction for the
consideration paid for the reinsurer’s
assumption of those liabilities, and the
reinsurer (in the case of a section 338
election, new target) is treated as
receiving premium income for its
assumption of reserve liabilities and
having a deduction for its increase in
reserves (the latter usually offsetting in
amount the former). The proposed
regulations also provide that the
consideration allocated to the value of
the insurance contracts acquired in the
assumption reinsurance transaction is
treated as an amount paid by the
reinsurer to purchase intangible assets
and as ordinary income to the ceding
company.
The proposed regulations depart from
the rules governing assumption
reinsurance transactions effected in the
ordinary course of business in some
circumstances to account for differences
that occur because the assumption
reinsurance transaction occurs as part of
a larger acquisitive transaction. In an
assumption reinsurance transaction
effected in the ordinary course of
business, the total consideration paid
for the transfer of insurance contracts
and assumption of related liabilities is
known. Furthermore, the rules in
§ 1.817–4(d) assume that the only
intangible asset transferred in such an
assumption reinsurance transaction is
the insurance in force which can then
be valued using the residual method.
Thus, if premiums and ceding
commissions are not separately stated,

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they can be extrapolated from the
known elements with a reasonable
degree of accuracy. However, when the
assumption reinsurance transaction
occurs as part of a larger acquisitive
transaction, the total consideration paid
by the purchaser is not solely for the
acquisition of insurance contracts and
the liabilities assumed are not solely for
the risk on the insurance contracts. In
these circumstances, the extrapolated
values would not accurately reflect the
amount of the items. Accordingly, the
proposed regulations modify the general
rules for assumption reinsurance
transactions to account for these
differences.
Written comments were received in
response to the proposed regulations,
and a public hearing was held on
September 18, 2002. Two commentators
requested to speak at the hearing. After
consideration of all the comments, the
proposed regulations are adopted as
amended by this Treasury decision. In
general, the final regulations follow the
approach of the proposed regulations
with some revisions. The more
significant comments and revisions are
discussed in the order in which they
appear in the regulations. In addition to
the revisions discussed, the final
regulations revise the language of the
proposed regulations in some places to
clarify the intent of the IRS and
Treasury Department or to make the
regulations better conform to the
terminology and usage of the general
section 338 regulations.
A. Determination of Adjusted Basis of
Amortizable Section 197 Intangibles
With Respect to Insurance Contracts
Under Section 197(f)(5)
Section 197(f)(5) provides that, in the
case of any amortizable section 197
intangible resulting from an assumption
reinsurance transaction, the amount
taken into account as the adjusted basis
of such intangible is the excess of (A)
the amount paid or incurred by the
acquirer under the assumption
reinsurance transaction over (B) the
amount required to be capitalized under
section 848 in connection with the
transaction. Under section 848, an
insurance company is required to
capitalize an amount of otherwise
deductible expenses equal to a
percentage of the net premiums for the
taxable year for certain categories of
insurance contracts. The capitalized
amounts, commonly referred to as
deferred acquisition costs, or ‘‘DAC,’’
are amortized on a straight-line basis
over 120 months.
Section 197(f)(5) is designed to ensure
that the DAC amounts attributable to an
assumption reinsurance transaction are

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amortized over the period specified by
section 848 rather than the longer
period under section 197. To achieve
this result, the adjusted basis of the
amortizable section 197 intangible
resulting from an assumption
reinsurance transaction is recognized
only to the extent that the amount paid
or incurred by the acquirer for the
relevant contracts exceeds the DAC
taken into account under section 848 as
a result of the transaction.
The proposed regulations provide
rules to determine the amounts paid or
incurred for amortizable section 197
intangibles with respect to contracts
acquired as a result of assumption
reinsurance transactions occurring as
part of transactions governed by section
1060 or section 338. The proposed
regulations also provide rules for
purposes of determining the DAC
amounts for the transactions. See
proposed § 1.197–2(g)(5).
Under the proposed regulations, the
amount paid or incurred by the acquirer
under the assumption reinsurance
transaction in a transaction governed by
section 338 or 1060 is the amount of
adjusted grossed up basis (AGUB) or
consideration allocable to the insurance
contracts under the residual method.
The amount required to be capitalized
under section 848 in connection with
the assumption reinsurance transaction
is determined by multiplying the
acquirer’s specified policy acquisition
expenses for the taxable year by a
fraction, the numerator of which is the
total tentative positive capitalization
amount for the relevant group of
acquired insurance contracts and the
denominator of which is the total
tentative required capitalization amount
for the taxable year for all specified
insurance contracts. The tentative
positive capitalization amount for the
relevant group of acquired insurance
contracts is the net positive
consideration received for the contracts
in the assumption reinsurance
transaction multiplied by the percentage
factor applicable to the contracts under
section 848(c).
An insurance company’s DAC amount
may not exceed the company’s general
deductions for the taxable year. See
section 848(c). The amortization of
intangibles under section 197 is a
general deduction relevant in
computing DAC. However, the amount
of amortization under section 197
cannot be calculated until section
197(f)(5) is applied. To avoid complex
calculations, for purposes of calculating
the basis of amortization, the proposed
regulations presume that one-half of the
consideration allocated to the insurance
contracts is amortizable under section

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197. See proposed § 1.197–
2(g)(5)(i)(D)(2). Comments were
requested regarding alternative
approaches to calculating the basis for
DAC amounts and section 197
amortization.
A number of comments were received
relating to the proposed regulations
under section 197(f)(5). Commentators
requested that the final regulations
clarify that section 197(f)(5) applies only
to assumption reinsurance transactions,
and not to indemnity reinsurance
transactions. Commentators asked that
the final regulations clarify that the full
amount of consideration allocable to the
reinsured contracts is currently
deductible under section 848(g) when
the provisions of section 848 apply to an
indemnity reinsurance transaction that
occurs as part of a section 1060
acquisition of an insurance business.
Commentators also expressed concern
that the proposed regulations could
cause an acquirer’s DAC under section
848 to be subject to the general
deductions cap in section 848(c) despite
the existence of a substantial ceding
commission. Commentators requested
that the final regulations clarify that the
election under § 1.848–2(g)(8) is
available to allow old target and new
target in a deemed asset sale governed
by section 338(h)(10) to determine the
amount of DAC attributable to the
transaction without regard to the general
deductions limitation.
The temporary and proposed
regulations generally follow the
proposed rules under section 197(f)(5),
subject to several modifications. In
particular, the temporary and proposed
rules build on the method under
§ 1.848–2(g) of the existing regulations
for determining the amounts capitalized
under section 848 for a reinsurance
agreement. Under the temporary and
proposed rules, the amount of expenses
capitalized under section 848 as a result
of an assumption reinsurance
transaction equals the lesser of (A) the
required capitalization amount for the
transaction, or (B) the amount of general
deductions allocable to the transaction.
The temporary and proposed rules also
clarify that in the event that the acquirer
purchases more than one category of
specified insurance contracts, the
determination of the amount capitalized
under section 848 is made as if each
category were transferred in a separate
assumption reinsurance transaction.
The temporary and proposed
regulations also modify the special rule
in the proposed regulations with respect
to the interplay between section
197(f)(5) and section 848 as regards the
determination of the acquirer’s general
deductions under section 848(c)(2).

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Under the temporary and proposed
rules, an acquirer will determine its
general deductions as if the entire
amount paid or incurred for the
acquired contracts were allocable to an
amortizable section 197 intangible.
If the acquirer has a capitalization
shortfall (i.e., the amount of general
deductions allocable to the assumption
reinsurance transaction is less than the
required capitalization amount for the
transaction), the temporary and
proposed regulations permit the
acquirer and the ceding company to
elect under § 1.848–2(g)(8) to determine
the amount capitalized under section
848 without regard to the general
deductions limitation. The additional
amounts capitalized by the acquirer as
a result of the election are treated as first
reducing the adjusted basis of the
amortizable section 197 intangible with
regard to the insurance contracts
acquired in the assumption reinsurance
transaction, before reducing the
acquirer’s otherwise deductible
expenses. The temporary and proposed
rules generally allow the acquirer to
amortize a larger amount over the
period specified by section 848 as
compared to the proposed regulations.
The temporary and proposed
regulations generally apply, on a cut-off
basis, to acquisitions and dispositions
on or after April 10, 2006. Thus, there
is no adjustment under section 481(a).
Taxpayers must make the change on
their income tax return and should not
file a Form 3115, Application for
Change in Accounting Method.
Taxpayers are permitted, however, to
apply the regulations to acquisitions
before that date on a transaction-bytransaction basis, with an adjustment
under section 481(a). The temporary
and proposed regulations provide a
procedure for taxpayers to obtain
automatic consent of the Commissioner
to do so.
B. Recovery of Basis on Dispositions of
Acquired Insurance Contracts
Proposed § 1.197–2(g)(5)(ii)(A)(2)
provides that basis recovery with
respect to a section 197(f)(5) intangible
transferred through indemnity
reinsurance is permitted when sufficient
economic rights relating to the
insurance contracts that gave rise to the
section 197(f)(5) intangible have been
transferred. Sufficient economic rights
are treated as transferred when the
ceding company transfers the right to
future income on the contracts. The
proposed regulations also provide rules
governing the amount of loss recognized
on the disposition of a section 197(f)(5)
intangible. The proposed regulations
requested comments whether additional

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guidance should address other
situations or issues.
Several commentators requested that
the final regulations clarify when
sufficient economic rights in a section
197(f)(5) intangible are transferred
through indemnity reinsurance as well
as additional examples to address
situations relating to transfers through
indemnity reinsurance of less than 100
percent of the insurance contracts that
gave rise to the section 197(f)(5)
intangible. The IRS and Treasury
Department continue to believe that the
rules contained in these regulations
should refer to general tax principles,
and will as needed, address these issues
in future published guidance.
C. Reserve Increases by New Target
After the Deemed Asset Sale
When a section 338 election is made
for an insurance company, § 1.338–11(d)
of the proposed regulations provides
that new target must capitalize its
increases in reserves for any acquired
contracts in the deemed asset sale.
Similar principles apply for an
applicable asset acquisition of an
insurance business under section 1060.
The proposed regulations generally
require capitalization of increases in
reserves for the acquired contracts in
excess of cumulative annual increases of
two percent per year from the
acquisition date reserves. However, the
proposed regulations do not require
capitalization to the extent the increases
in reserves reflect the time value of
money, to the extent the increases in
reserves occur while new target is under
state receivership, or to the extent the
deduction for the increases in reserves
is spread over the 10 succeeding taxable
years under section 807(f).
Many commentators objected to the
rule requiring capitalization for
increases in reserves after the
transaction date. They questioned the
justification for the rule, stating that the
rule was inconsistent with, and
overrode, principles established under
subchapter L for determining losses
incurred. Commentators argued that,
under subchapter L principles, reserve
liabilities are not treated like contingent
liabilities and that it was inappropriate
to treat the reserves as contingent
liabilities even for the limited purposes
of the regulation. Commentators also
requested that the application of the
rule be restricted to cases of abuse
because the ceding company’s reserves
assumed in the transaction are fair and
reasonable estimates under Subchapter
L as of the transaction date.
The commentators’ objections largely
ignore the fact that the proposed
regulations blend elements of the asset

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purchase model common to most
taxpayers that dispose of or acquire
assets for consideration that includes
the discharge of liabilities and the
services model that generally applies to
insurance companies. Treating increases
in reserves for acquired contracts
similarly to contingent liabilities under
the asset purchase model is just one
aspect of that amalgam.
Under the asset purchase model,
assumed contingent liabilities are an
element of the consideration for which
a buyer acquires assets. Thus, a buyer
includes the contingent liability in its
cost for the acquired assets. However, a
buyer may not include the contingent
liability in its cost until the liability is
incurred for Federal income tax
purposes. The buyer must capitalize the
liability in the cost of the acquired
assets even if the buyer could have
currently deducted the liability had it
arisen in the buyer’s historic business.
Under the asset purchase model, the
buyer does not realize any income for
the assumption of the contingent
liability; the buyer merely has bought
assets. See Commissioner v. Oxford
Paper, 194 F.2d 190 (2d Cir. 1951).
Under the services model, the seller
(or ceding company) is treated as paying
a premium to the buyer (or reinsurer) to
assume the risk on its insurance
contracts. The reinsurer includes in
income the receipt of the premium and
has a deduction for its increase in
reserves for the additional risks
assumed in the transaction. The amount
of the premium income is generally
equal to the consideration paid by the
ceding company, that is, the fair market
value of the assets that the ceding
company transfers to the reinsurer in
the transaction (though it may not be
less than the amount of the reinsurer’s
increase in tax reserves, see § 1.817–
4(d)(2)(iii)). Thus, when the fair market
value of the assets that the ceding
company transfers exceeds the
reinsurer’s increase in tax reserves for
the additional risks assumed in the
transaction, the reinsurer has net
income. See § 1.817–4(d)(3) Example 4.
Under the services model, no liabilities
are treated as contingent liabilities. The
reserve rules effectively treat increases
to reserves for new risks as fixed
liabilities and increases to reserves for
existing risks as period expenses
(similar to interest).
The proposed regulations blend the
asset purchase model and the services
model by—
(1) Using the residual method of
sections 338 and 1060 to determine the
value of goodwill and going concern
value (which assumes that the value of
all assets other than goodwill and going

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concern value is readily determinable)
rather than the residual method of
§ 1.817–4(d) to determine the value of
insurance in force (which assumes that
the value of all assets other than
insurance in force is readily
determinable);
(2) Treating the amount of old target’s
tax reserves as a fixed liability as of the
close of the acquisition date that is
taken into account in determining the
seller’s aggregate deemed sales price
(ADSP) under § 1.338–4 and the buyer’s
AGUB under § 1.338–5;
(3) Treating certain of new target’s
increases in reserves for any insurance
contracts acquired in the deemed asset
sale as a contingent liability as of the
close of the acquisition date that
becomes fixed when new target
increases its reserves;
(4) Assuming that the amount of
reinsurance premium is equal to the
amount of old target’s tax reserves, even
though the ceding company would have
to pay the reinsuring company an
amount greater than the tax reserves in
an arm’s length reinsurance transaction.
This rule ensures that the acquirer of an
insurance business will not have
immediate net taxable income merely as
a result of the acquisition; and
(5) Not requiring capitalization for
new target’s increases in reserves due to
the time value of money for any
insurance contracts acquired in the
deemed asset sale.
The proposed regulations generally
treat an insurance company’s
assumption of contingent liabilities
related to insurance contracts more
favorably than a noninsurance
company’s assumption of a similar
contingent liability. The proposed
regulations also treat an insurance
company’s assumption of contingent
liabilities related to insurance contracts
more favorably than subchapter L does.
As discussed previously, under
subchapter L, a reinsurer may have net
income when entering into an
assumption reinsurance transaction.
The amount of the income is the amount
of the bargain, that is, the excess of fair
market value of the assets the seller
transfers over the amount of the
consideration the buyer pays at closing
(in an assumption reinsurance
transaction, the latter measured by the
reinsurer’s increase in tax reserves for
the risks assumed in the transaction).
The proposed regulations, unlike
subchapter L, require income to be
recognized if there is an increase in
certain reserves for the acquired
insurance contracts.
The IRS and Treasury Department
believe that a rule requiring
capitalization of increases to reserves is

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a necessary corollary to the rule in the
proposed regulations linking the
amount of reinsurance deemed paid to
the amount of old target’s tax reserves
at the time of the assumption
reinsurance transaction (with the
concomitant result that new target has
no income). The logical implication of
the commentators’ arguments would be
that the buyer should have premium
income in a bargain purchase. In
addition, without requiring
capitalization of at least some increases
to reserves, there is an incentive for
sellers to defer increases in reserves.
This incentive results from the fact that
while the seller is generally indifferent
to an increase in reserves (the
immediate deduction to the seller
would be offset by a corresponding
increase in amount realized of ADSP in
the sale), a buyer would be entitled to
an immediate deduction rather than
increased basis from an increase in the
seller’s reserves.
In response to comments, the IRS and
Treasury Department have decided to
issue temporary regulations with these
final regulations that continue to require
capitalization (and concomitant
treatment as premium) of certain reserve
increases, but further limit the
capitalization rule of the proposed
regulations in a manner consistent with
the application of subchapter L
principles. See § 1.338–11T(d). After the
deemed asset sale, the temporary
regulations apply subchapter L
principles to new target. Under the
temporary regulations, capitalization is
required only for increases in reserves
that clearly reflect a so called ‘‘bargain
purchase’’ (that is, when the application
of the residual method clearly indicates
the initial understatement of the
reserve). The amount of the bargain
purchase is the amount of income the
reinsurer would have otherwise
recognized under § 1.817–4(d) if the
final regulations (and proposed
regulations) had not adopted the
convention that the reinsurance
premium paid by the seller to the buyer
is deemed to equal the seller’s closing
tax reserves, and were it not necessary
to employ a residual method to account
for the presence of non-insurance
intangible assets.
Under the temporary regulations, new
target is required to capitalize any
increases in reserves for acquired
contracts if the AGUB allocated to assets
in Class I through Class V is less than
the fair market value of the assets in
those classes. Any deductions would
continue to be capitalized until the basis
of the assets in Class I through Class V
is equal to their fair market value. This
mechanism avoids the problem of

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valuing Class VI and Class VII
intangibles. The approach of the
temporary regulations essentially treats
the ceding company as transferring no
Class VI or Class VII assets to the
reinsurer for the reinsurer’s assumption
of the liabilities on the acquired
contracts. Because the temporary
regulations limit the total amount of
capitalization for increases in reserves
for acquired contracts, the IRS and
Treasury Department believe that it is
no longer necessary to provide a time
limit on when increases in reserves for
acquired contracts are to be capitalized
or to provide a floor below which
increases in reserves are not capitalized.
However the temporary regulations
retain the other limits on capitalization
in the proposed regulations.
D. Allocation of ADSP and AGUB to
Specific Insurance Contracts
Proposed § 1.338–11(b)(2) provides a
rule that for purposes of allocating
AGUB and ADSP, the fair market value
of a specific insurance contract or group
of insurance contracts is the amount of
the ceding commission a willing
reinsurer would pay a willing ceding
company in an arm’s length transaction
for the reinsurance of the contracts if the
gross reinsurance premium for the
contracts were equal to old target’s tax
reserves for the contracts.
Commentators questioned the reliance
of the proposed regulations upon tax
reserves as a basis for valuing the
contracts and asked that the value of the
contracts be based on GAAP or statutory
reserves, or an amount upon which the
parties agree. The IRS and Treasury
Department believe that using tax
reserves as a basis for valuing the
contracts is consistent with other areas
in which tax reserves, not GAAP or
statutory reserves, are used to compute
taxable income. See, e.g., section 807
(prescribing rules for taking life
insurance reserves and certain other
reserves into account for purposes of
computing life insurance company
taxable income); section 846
(prescribing a methodology for
discounting unpaid loss reserves for
purposes of computing insurance
company taxable income); and Rev.
Proc. 90–36, (1990–2 C.B. 357)
(computing up-front ceding commission
paid by a reinsurer as the increase in the
reinsurer’s tax reserve liabilities
resulting from the reinsurance
transaction, minus the value of the net
assets received, for purposes of
capitalizing ceding commissions to
comply with the Supreme Court
decision in Colonial American Life
Insurance Company v. Commissioner,
491 U.S. 244 (1989), (1989–2 C.B. 110,

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Ct. D. 2045). Moreover, in the context of
a transaction governed by section 338 or
1060, the use of old target’s tax reserves
as a means of valuing the contracts is
consistent with both (i) the treatment of
old target’s closing tax reserves as a
liability in the computation of the
seller’s ADSP and the buyer’s AGUB,
and (ii) the general rule of § 1.817–
4(d)(2)(iii), which treats the assuming
company in an assumption reinsurance
transaction as receiving premium
income equal to at least the increase in
its reserves.
E. Effect of Section 338 Election on
Section 846(e) Election by Old Target
The proposed regulations do not
provide any special rules under section
846 for new target to apply old target’s
historical loss payment pattern as a
result of a section 846(e) election made
by old target because new target is
generally treated as a new corporation
that may adopt its own accounting
methods without regard to the methods
used by old target. See § 1.338–1(b).
Commentators believed that this
result was inconsistent with the purpose
of allowing a company to make a section
846(e) election. Commentators noted
that a section 846(e) election is made for
all eligible lines of business, determined
by reference to the accident years for the
line of business shown on the insurance
company’s annual statement.
Additionally, commentators noted that
the availability of the election should
not depend upon the tax identity of new
target after the section 338 election
because the historical loss payment
pattern is not a tax account, the pattern
is determined by reference to nontax
factors, and new target continues to
operate in the same manner and legal
form as old target.
In response to these comments, the
temporary regulations contain a new
rule that treats new target and old target
as the same corporation for purposes of
a section 846(e) election to use an
insurance company’s historical loss
payment pattern. See § 1.338–
1T(b)(2)(vii). Therefore, if old target has
a section 846(e) election in effect, new
target will continue to use the historical
loss payment pattern of old target to
discount unpaid losses, unless new
target chooses to revoke the election. If
new target revokes old target’s section
846(e) election, new target will use the
industry-wide factors determined by the
Secretary to discount unpaid losses
incurred in accident years beginning on
or after the acquisition date. See
§ 1.338–11T(e)(2).

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F. Treatment of Shareholders Surplus
Accounts, Policyholders Surplus
Accounts (PSA), and Other Accounts in
Transactions to Which Section 381
Applies
Section 1.381(c)(22)–1(b)(7)(i) of the
proposed regulations provides that if
one corporation distributes or transfers
a substantial portion (50 percent or
more) of an insurance business to
another corporation in a transaction to
which section 381 applies, then the
acquiring corporation succeeds to the
distributor or transferor corporation’s
shareholders surplus account,
policyholders surplus account, and
other accounts. However, under
§ 1.381(c)(22)–1(b)(7)(ii) of the proposed
regulations, if an acquiring corporation
in the section 381 transaction acquires
less than 50 percent of the distributor or
transferor corporation’s insurance
business, then the acquiring corporation
succeeds only to a ratable portion
(determined by reference to reserves) of
the distributor or transferor
corporation’s shareholders surplus
account, policyholders surplus account,
and other accounts.
Commentators questioned whether
the IRS and Treasury Department have
the authority to relate the carryover of
PSA to the percentage of business that
was transferred to the acquiring
corporation in a section 381 transaction.
The IRS and Treasury Department
believe that the rule in the proposed
regulations is appropriate and that there
is sufficient authority for the proposed
rule. The legislative history to the 1984
Tax Reform Act indicates that the term
indirect distribution is to be interpreted
broadly to include any use of PSA funds
for the indirect benefit of shareholders.
H.R. Rep. No. 432, pt. 2, 98th Cong., 2d
Sess. at 1410–11; Staff of the Joint
Committee on Taxation, 98th Cong., 2d
Sess., General Explanation of the
Revenue Provisions of the Tax Reform
Act of 1984, at 594 (1984), as well as
Bankers Life and Casualty Co. v. United
States, 79 AFTR2d (RIA) 1726 (N.D. Ill.
1996), aff’d on other grounds, 142 F.3d
973 (7th Cir. 1998), cert denied, 525
U.S. 961 (1998) (section 338(g)
transaction results in an indirect
distribution of old target’s PSA).
Accordingly, the final regulations adopt
the rule as proposed in §§ 1.338–11(f)
and 1.381(c)(22)–1(b)(7).
G. Treatment of DAC in Transactions to
Which Section 381 Applies
Section 1.381(c)(22)–1(b)(13) of the
proposed regulations provides that any
remaining balances of DAC or excess
negative DAC carry over to a successor
insurance company in a section 381

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transaction. One commentator
questioned whether a nonlife insurance
company may succeed to DAC attributes
under § 1.381(c)(22)–1. Another
commentator believed positive DAC
should not be carried over to a successor
corporation in a section 381 transaction.
The IRS and Treasury Department
believe that in a section 381 transaction,
positive DAC, like negative DAC, is an
attribute that is carried over to the
acquiring corporation. Thus, the final
regulations retain the rule in the
proposed regulations that the remaining
balances of DAC or excess negative DAC
carry over to a successor insurance
company in a section 381 transaction.
See § 1.381(c)(22)–1(b)(13). However,
the IRS and Treasury Department
believe that a proportionality rule
similar to the one the final regulations
adopt at § 1.381(c)(22)–1(b)(7) for
policyholder surplus accounts is
appropriate because DAC is a tax
accounting convention that relates to a
line of business. Thus, the final
regulations provide that when the
acquiring corporation acquires 50
percent or more of the distributor or
transferor corporation’s insurance
business (measured by its reserves for
all of its contracts immediately before
the earlier of the distribution or transfer
or the adoption of the plan of
liquidation or reorganization), the
acquiring corporation will succeed to
the distributor or transferor
corporation’s entire positive or negative
DAC amount. To the extent an acquiring
corporation in the section 381
transaction acquires less than 50 percent
of the distributor or transferor
corporation’s insurance business, then
only that percentage of positive or
negative DAC remains. In addition,
because some attributes under section
381(c)(22) and § 1.381(c)(22)–1 are
equally relevant for life and nonlife
insurance companies, the final
regulations clarify that, except as
otherwise provided, the rules in
§ 1.381(c)(22)–1 apply to any insurance
company, whether a life or a nonlife
company.
H. Effective Date of Regulations
The final and temporary regulations
are effective for transactions on or after
April 10, 2006. Commentators asked for
an election to apply the final regulations
to transactions completed before April
10, 2006. The IRS and Treasury
Department believe that the elective
retroactivity of the final regulations is
warranted and administrable. Thus, the
final regulations permit new target and
old target an election to apply the final
regulations, in whole, to qualified stock
purchases occurring before April 10,

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2006 if all taxable years for which the
consequences of the section 338 election
affect the computation of tax are open.
In the case of a section 338 election for
which a section 338(h)(10) election is
made (or a section 338 election for a
foreign target), new target’s ability to
elect to retroactively apply the final
regulations does not depend upon old
target making the election. Similarly,
old target’s ability to elect to
retroactively apply the final regulations
does not depend upon new target
making the election. However, in the
case of a section 338 election for a
domestic target for which no section
338(h)(10) election is made, the
purchasing corporation generally
controls both the filing of new target’s
returns and old target’s final return.
Accordingly, when no section
338(h)(10) election is made and the
target is a domestic corporation, new
target and old target must both elect to
retroactively apply the final regulations.
If one of new target or old target cannot
make the election, the other is not
permitted to make the election. See
§ 1.338(i)–1(c).
Special Analyses
It has been determined that the final
regulations issued with respect to
section 197 and section 338 are not a
significant regulatory action as defined
in Executive Order 12866. Therefore, a
regulatory assessment is not required. It
is hereby certified that the collection of
information requirement in these
regulations will not have a significant
economic impact on a substantial
number of small entities. This
certification is based on the fact that
these regulations do not have a
substantial economic impact because
they merely provide guidance about the
operation of the tax law in the context
of acquisitions of insurance companies
and businesses. Moreover, they are
expected to apply predominantly to
transactions involving larger businesses.
In addition, the collection of
information requirement merely
requires a taxpayer to prepare a written
representation that contains minimal
information relating to the making of an
election. Therefore, a Regulatory
Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Under section
7805(f) of the Code, the notice of
proposed rulemaking preceding this
regulation was submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business. The
Chief Counsel for Advocacy did not
submit any comments on the
regulations.

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It has been determined that the
temporary regulations issued with
respect to sections 197 and 338 are not
a significant regulatory action as defined
in Executive Order 12866. Therefore a
regulatory assessment is not required.
These regulations provide guidance
relating to the taxable acquisition and
disposition of insurance companies.
Additionally, these regulations provide
rules by which a party to the transaction
may elect to apply these rules to
transactions which occur prior to April
10, 2006. Based on these considerations,
it is determined that these temporary
regulations will provide taxpayers with
the necessary guidance and authority to
ensure equitable administration of the
tax laws. Because of the need for
immediate guidance, notice and public
procedure are impracticable and
contrary to the public interest pursuant
to 5 U.S.C. 533(b) and the delayed
effective date is not required pursuant to
5 U.S.C. 553(d). For applicability of the
Regulatory Flexibility Act to these
temporary regulations, please refer to
the cross-reference notice of proposed
rulemaking published elsewhere in this
Federal Register. Pursuant to section
7805(f) of the Code, these temporary
regulations will be submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment
on their impact on small business.
It has been determined that the final
regulations issued with respect to
sections 381, 846 and 1060 are not a
significant regulatory action as defined
in Executive Order 12866. Therefore, a
regulatory assessment is not required. It
has also 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. Therefore, a
Regulatory Flexibility Analysis under
the Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Under section
7805(f) of the Code, the notice of
proposed rulemaking preceding this
regulation was submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on its impact on small business. The
Chief Counsel for Advocacy did not
submit any comments on the
regulations.
Drafting Information
The principal author of the final
regulations is Mark J. Weiss, Office of
Chief Counsel (Corporate), IRS.
However, other personnel from the IRS
and Treasury Department participated
in their development.

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations
§ 1.197–2T Amortization of goodwill and
certain other intangibles (temporary).

List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:

■

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

■

Authority: 26 U.S.C. 7805 * * *
Section 1.197–2 also issued under 26
U.S.C. 197.
Section 1.197–2T also issued under 26
U.S.C. 197.* * *
Section 1.338–11 also issued under 26
U.S.C. 338.
Section 1.338–11T also issued under 26
U.S.C. 338.* * *
Section 1.846–2(d) is also issued under 26
U.S.C. 846.* * *

Par. 2. In § 1.197–0, the entries in the
table of contents for § 1.197–2,
paragraph (g)(5) are revised and § 1.197–
2T is added to read as follows:

■

§ 1.197–0

This section lists the headings that
appear in §§ 1.197–2 and 1.197–2T.
§ 1.197–2 Amortization of goodwill and
certain other intangibles.

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*

*
*
*
*
(g) * * *
(5) Treatment of certain insurance
contracts acquired in an assumption
reinsurance transaction.
(i) In general.
(ii) Determination of adjusted basis of
amortizable section 197 intangible
resulting from an assumption
reinsurance transaction.
(iii) Application of loss disallowance
rule upon a disposition of an insurance
contract acquired in an assumption
reinsurance transaction.
(A) Disposition.
(1) In general.
(2) Treatment of indemnity
reinsurance transactions.
(B) Loss.
(C) Examples.
(iv) Effective dates.
(A) In general.
(B) Application to pre-effective date
acquisitions and dispositions.
(C) Change in method of accounting.
(1) In general.
(2) Acquisitions and dispositions on
or after effective date.
(3) Acquisitions and dispositions
before the effective date.
*
*
*
*
*

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§ 1.197–2 Amortization of goodwill and
certain other intangibles.

*

Table of contents.

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(a) through (g)(5)(i) [Reserved].
(ii) Determination of adjusted basis of
amortizable section 197 intangible
resulting from an assumption
reinsurance transaction.
(A) In general.
(B) Amount paid or incurred by
acquirer (reinsurer) under the
assumption reinsurance transaction.
(C) Amount required to be capitalized
under section 848 in connection with
the transaction.
(1) In general.
(2) Required capitalization amount.
(3) General deductions allocable to
the assumption reinsurance transaction.
(4) Treatment of a capitalization
shortfall allocable to the reinsurance
agreement.
(i) In general.
(ii) Treatment of additional
capitalized amounts as the result of an
election under § 1.848–2(g)(8).
(5) Cross references and special rules.
(D) Examples.
(E) Effective date.
(g)(5) (iii) through (l) [Reserved].
■ Par. 3. Section 1.197–2 is amended by
revising paragraph (g)(5) to read as
follows:

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*
*
*
*
(g) * * *
(5) Treatment of certain insurance
contracts acquired in an assumption
reinsurance transaction—(i) In general.
Section 197 generally applies to
insurance and annuity contracts
acquired from another person through
an assumption reinsurance transaction.
See § 1.809–5(a)(7)(ii) for the definition
of assumption reinsurance. The transfer
of insurance or annuity contracts and
the assumption of related liabilities
deemed to occur by reason of a section
338 election for a target insurance
company is treated as an assumption
reinsurance transaction. The transfer of
a reinsurance contract by a reinsurer
(transferor) to another reinsurer
(acquirer) is treated as an assumption
reinsurance transaction if the
transferor’s obligations are extinguished
as a result of the transaction.
(ii) Determination of adjusted basis of
amortizable section 197 intangible
resulting from an assumption
reinsurance transaction. For further
guidance, see § 1.197–2T(g)(5)(ii).
(iii) Application of loss disallowance
rule upon a disposition of an insurance
contract acquired in an assumption
reinsurance transaction. The following
rules apply for purposes of applying the
loss disallowance rules of section
197(f)(1)(A) to the disposition of a

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section 197(f)(5) intangible. For this
purpose, a section 197(f)(5) intangible is
an amortizable section 197 intangible
the basis of which is determined under
section 197(f)(5).
(A) Disposition—(1) In general. A
disposition of a section 197 intangible is
any event as a result of which, absent
section 197, recovery of basis is
otherwise allowed for Federal income
tax purposes.
(2) Treatment of indemnity
reinsurance transactions. The transfer
through indemnity reinsurance of the
right to the future income from the
insurance contracts to which a section
197(f)(5) intangible relates does not
preclude the recovery of basis by the
ceding company, provided that
sufficient economic rights relating to the
reinsured contracts are transferred to the
reinsurer. However, the ceding company
is not permitted to recover basis in an
indemnity reinsurance transaction if it
has a right to experience refunds
reflecting a significant portion of the
future profits on the reinsured contracts,
or if it retains an option to reacquire a
significant portion of the future profits
on the reinsured contracts through the
exercise of a recapture provision. In
addition, the ceding company is not
permitted to recover basis in an
indemnity reinsurance transaction if the
reinsurer assumes only a limited portion
of the ceding company’s risk relating to
the reinsured contracts (excess loss
reinsurance).
(B) Loss. The loss, if any, recognized
by a taxpayer on the disposition of a
section 197(f)(5) intangible equals the
amount by which the taxpayer’s
adjusted basis in the section 197(f)(5)
intangible immediately before the
disposition exceeds the amount, if any,
that the taxpayer receives from another
person for the future income right from
the insurance contracts to which the
section 197(f)(5) intangible relates. In
determining the amount of the
taxpayer’s loss on the disposition of a
section 197(f)(5) intangible through a
reinsurance transaction, any effect of the
transaction on the amounts capitalized
by the taxpayer as specified policy
acquisition expenses under section 848
is disregarded.
(C) Examples. The following
examples illustrate the principles of this
paragraph (g)(5)(iii):
Example 1. (i) Facts. In a prior taxable year,
as a result of a section 338 election with
respect to T, new T was treated as purchasing
all of old T’s insurance contracts that were

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations
in force on the acquisition date in an
assumption reinsurance transaction. Under
§§ 1.338–6 and 1.338–11(b)(2), the amount of
AGUB allocable to the future income right
from the purchased insurance contracts was
$15, net of the amounts required to be
capitalized under section 848 as a result of
the assumption reinsurance transaction. At
the beginning of the current taxable year, as
a result of amortization deductions allowed
by section 197(a), new T’s adjusted basis in
the section 197(f)(5) intangible resulting from
the assumption reinsurance transaction is
$12. During the current taxable year, new T
enters into an indemnity reinsurance
agreement with R, another insurance
company, in which R assumes 100 percent of
the risk relating to the insurance contracts to
which the section 197(f)(5) intangible relates.
In the indemnity reinsurance transaction, R
agrees to pay new T a ceding commission of
$10 in exchange for the future profits on the
underlying reinsured policies. Under the
indemnity reinsurance agreement, new T
continues to administer the reinsured
policies, but transfers investment assets equal
to the required reserves for the reinsured
policies together with all future premiums to
R. The indemnity reinsurance agreement
does not contain an experience refund
provision or a provision allowing new T to
terminate the reinsurance agreement at its
sole option. New T retains the insurance
licenses and other amortizable section 197
intangibles acquired in the deemed asset sale
and continues to underwrite and issue new
insurance contracts.
(ii) Analysis. The indemnity reinsurance
agreement constitutes a disposition of the
section 197(f)(5) intangible because it
involves the transfer of sufficient economic
rights attributable to the insurance contracts
to which the section 197(f)(5) intangible
relates such that recovery of basis is allowed.
For purposes of applying the loss
disallowance rules of section 197(f)(1) and
paragraph (g) of this section, new T’s loss is
$2 (new T’s adjusted basis in the section
197(f)(5) intangible immediately before the
disposition ($12) less the ceding commission
($10)). Therefore, new T applies $10 of the
adjusted basis in the section 197(f)(5)
intangible against the amount received from
R for the future income right on the reinsured
policies and increases its basis in the
amortizable section 197 intangibles that it
acquired and retained from the deemed asset
sale by $2, the amount of the disallowed loss.
The amount of new T’s disallowed loss under
section 197(f)(1)(A) is determined without
regard to the effect of the indemnity
reinsurance transaction on the amounts
capitalized by new T as specified policy
acquisition expenses under section 848.
Example 2. (i) Facts. Assume the same
facts as in Example 1, except that under the
indemnity reinsurance agreement R agrees to
pay new T a ceding commission of $5 with
respect to the underlying reinsured contracts.
In addition, under the indemnity reinsurance
agreement, new T is entitled to an experience
refund equal to any future profits on the
reinsured contracts in excess of the ceding
commission plus an annual risk charge. New
T also has a right to recapture the business
at any time after R has recovered an amount
equal to the ceding commission.

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(ii) Analysis. The indemnity reinsurance
agreement between new T and R does not
represent a disposition because it does not
involve the transfer of sufficient economic
rights with respect to the future income on
the reinsured contracts. Therefore, new T
may not recover its basis in the section
197(f)(5) intangible to which the contracts
relate and must continue to amortize ratably
the adjusted basis of the section 197(f)(5)
intangible over the remainder of the 15-year
recovery period and cannot apply any
portion of this adjusted basis to offset the
ceding commission received from R in the
indemnity reinsurance transaction.

(iv) Effective dates—(A) In general—
This paragraph (g)(5) applies to
acquisitions and dispositions on or after
April 10, 2006. For rules applicable to
acquisitions and dispositions before that
date, see § 1.197–2 in effect before that
date (see 26 CFR part 1, revised April 1,
2001).
(B) Application to pre-effective date
acquisitions and dispositions. A
taxpayer may choose, on a transactionby-transaction basis, to apply the
provisions of this paragraph (g)(5) to
property acquired and disposed of
before April 10, 2006.
(C) Change in method of accounting—
(1) In general—A change in a taxpayer’s
treatment of all property acquired and
disposed under paragraph (g)(5) is a
change in method of accounting to
which the provisions of sections 446
and 481 and the regulations thereunder
apply.
(2) Acquisitions and dispositions on
or after effective date. A Taxpayer is
granted the consent of the
Commissioner under section 446(e) to
change its method of accounting to
comply with this paragraph (g)(5) for
acquisitions and dispositions on or after
April 10, 2006. The change must be
made on a cut-off basis with no section
481(a) adjustment. Notwithstanding
§ 1.446–1(e)(3), a taxpayer should not
file a Form 3115, ‘‘Application for
Change in Accounting Method,’’ to
obtain the consent of the Commissioner
to change its method of accounting
under this paragraph (g)(5)(iv)(C)(2).
Instead, a taxpayer must make the
change by using the new method on its
federal income tax returns.
(3) Acquisitions and dispositions
before the effective date. For the first
taxable year ending after April 10, 2006,
a taxpayer is granted consent of the
Commissioner to change its method of
accounting for all property acquired in
transactions described in paragraph
(g)(5)(iv)(B) to comply with this
paragraph (g)(5) unless the proper
treatment of any such property is an
issue under consideration in an
examination, before an Appeals office,
or before a Federal Court. (For the

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definition of when an issue is under
consideration, see, Rev. Proc. 97–27
(1997–1 C.B. 680); and, § 601.601(d)(2)
of this chapter). A taxpayer changing its
method of accounting in accordance
with this paragraph (g)(5)(iv)(C)(3) must
follow the applicable administrative
procedures for obtaining the
Commissioner’s automatic consent to a
change in method of accounting (for
further guidance, see, for example, Rev.
Proc. 2002–9 (2002–1 C.B. 327) as
modified and clarified by
Announcement 2002–17 (2002–1 C.B.
561), modified and amplified by Rev.
Proc. 2002–19 (2002–1 C.B. 696), and
amplified, clarified and modified by
Rev. Proc. 2002–54 (2002–2 C.B. 432);
and, § 601.601(d)(2) of this chapter),
except, for purposes of this paragraph
(g)(5)(iv)(C)(3), any limitations in such
administrative procedures for obtaining
the automatic consent of the
Commissioner shall not apply.
However, if the taxpayer is under
examination, before an appeals office, or
before a Federal court, the taxpayer
must provide a copy of the application
to the examining agent(s), appeals
officer, or counsel for the government,
as appropriate, at the same time that it
files the copy of the application with the
National Office. The application must
contain the name(s) and telephone
number(s) of the examining agent(s),
appeals officer, or counsel for the
government, as appropriate. For
purposes of From 3115, ‘‘Application
for Change in Accounting Method,’’ the
designated number for the automatic
accounting method change authorized
by this paragraph (g)(5)(iv)(C)(3) is ‘‘98.’’
A change in method of accounting in
accordance with this paragraph
(g)(5)(iv)(C)(3) requires an adjustment
under section 481(a).
*
*
*
*
*
■ Par. 4. Section 1.197–2T is added to
read as follows:
§ 1.197–2T Amortization of goodwill and
certain other intangibles (temporary).

(a) through (g)(5)(i) [Reserved]. For
further guidance, see § 1.197–2(a)
through (g)(5)(i).
(g)(5)(ii) Determination of adjusted
basis of amortizable section 197
intangible resulting from an assumption
reinsurance transaction—(A) In general.
Section 197(f)(5) determines the basis of
an amortizable section 197 intangible
for insurance or annuity contracts
acquired in an assumption reinsurance
transaction. The basis of such intangible
is the excess, if any, of—
(1) The amount paid or incurred by
the acquirer (reinsurer) under the
assumption reinsurance transaction;
over

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(2) The amount, if any, required to be
capitalized under section 848 in
connection with such transaction.
(B) Amount paid or incurred by
acquirer (reinsurer) under the
assumption reinsurance transaction.
The amount paid or incurred by the
acquirer (reinsurer) under the
assumption reinsurance transaction is—
(1) In a deemed asset sale resulting
from an election under section 338, the
amount of the AGUB allocable thereto
(see §§ 1.338–6 and 1.338–11(b)(2));
(2) In an applicable asset acquisition
within the meaning of section 1060, the
amount of the consideration allocable
thereto (see §§ 1.338–6, 1.338–11(b)(2),
and 1.1060–1(c)(5)); and
(3) In any other transaction, the excess
of the increase in the reinsurer’s tax
reserves resulting from the transaction
(computed in accordance with sections
807, 832(b)(4)(B), and 846) over the
value of the net assets received from the
ceding company in the transaction.
(C) Amount required to be capitalized
under section 848 in connection with
the transaction—(1) In general. The
amount required to be capitalized under
section 848 for specified insurance
contracts (as defined in section 848(e))
acquired in an assumption reinsurance
transaction is the lesser of—
(i) The reinsurer’s required
capitalization amount for the
assumption reinsurance transaction; or
(ii) The reinsurer’s general deductions
(as defined in section 848(c)(2))
allocable to the transaction.
(2) Required capitalization amount.
The reinsurer determines the required
capitalization amount for an assumption
reinsurance transaction by multiplying
the net positive or net negative
consideration for the transaction by the
applicable percentage set forth in
section 848(c)(1) for the category of
specified insurance contracts acquired
in the transaction. See § 1.848–2(g)(5). If
more than one category of specified
insurance contracts is acquired in an
assumption reinsurance transaction, the
required capitalization amount for each
category is determined as if the transfer
of the contracts in that category were
made under a separate assumption
reinsurance transaction. See § 1.848–
2(f)(7).
(3) General deductions allocable to
the assumption reinsurance transaction.
The reinsurer determines the general
deductions allocable to the assumption
reinsurance transaction in accordance
with the procedure set forth in § 1.848–
2(g)(6). Accordingly, the reinsurer must
allocate its general deductions to the
amount required under section 848(c)(1)
on specified insurance contracts that the
reinsurer has issued directly before

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determining the general deductions
allocable to the assumption reinsurance
transaction. For purposes of allocating
its general deductions under § 1.848–
2(g)(6), the reinsurer includes premiums
received on the acquired specified
insurance contracts after the assumption
reinsurance transaction in determining
the amount required under section
848(c)(1) on specified insurance
contracts that the reinsurer has issued
directly. If the reinsurer has entered into
multiple reinsurance agreements during
the taxable year, the reinsurer
determines the general deductions
allocable to each reinsurance agreement
(including the assumption reinsurance
transaction) by allocating the general
deductions allocable to reinsurance
agreements under § 1.848–2(g)(6) to
each reinsurance agreement with a
positive required capitalization amount.
(4) Treatment of a capitalization
shortfall allocable to the reinsurance
agreement—(i) In general. The reinsurer
determines any capitalization shortfall
allocable to the assumption reinsurance
transaction in the manner provided in
§§ 1.848–2(g)(4) and 1.848–2(g)(7). If the
reinsurer has a capitalization shortfall
allocable to the assumption reinsurance
transaction, the ceding company must
reduce the net negative consideration
(as determined under § 1.848–2(f)(2)) for
the transaction by the amount described
in § 1.848–2(g)(3) unless the parties
make the election provided in § 1.848–
2(g)(8) to determine the amounts
capitalized under section 848 in
connection with the transaction without
regard to the general deductions
limitation of section 848(c)(2).
(ii) Treatment of additional
capitalized amounts as the result of an
election under § 1.848–2(g)(8). The
additional amounts capitalized by the
reinsurer as the result of the election
under § 1.848–2(g)(8) reduce the
adjusted basis of any amortizable
section 197 intangible with respect to
specified insurance contracts acquired
in the assumption reinsurance
transaction. If the additional capitalized
amounts exceed the adjusted basis of
the amortizable section 197 intangible,
the reinsurer must reduce its deductions
under section 805 or section 832 by the
amount of such excess. The additional
capitalized amounts are treated as
specified policy acquisition expenses
attributable to the premiums and other
consideration on the assumption
reinsurance transaction and are
deducted ratably over a 120-month
period as provided under section
848(a)(2).
(5) Cross references and special rules.
In general, for rules applicable to the
determination of specified policy

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acquisition expenses, net premiums,
and net consideration, see section 848(c)
and (d), and § 1.848–2(a) and (f).
However, the following special rules
apply for purposes of this paragraph
(g)(5)(ii)(C)—
(i) The amount required to be
capitalized under section 848 in
connection with the assumption
reinsurance transaction cannot be less
than zero;
(ii) For purposes of determining the
company’s general deductions under
section 848(c)(2) for the taxable year of
the assumption reinsurance transaction,
the reinsurer takes into account a
tentative amortization deduction under
section 197(a) as if the entire amount
paid or incurred by the reinsurer for the
specified insurance contracts were
allocated to an amortizable section 197
intangible with respect to insurance
contracts acquired in an assumption
reinsurance transaction; and
(iii) Any reduction of specified policy
acquisition expenses pursuant to an
election under § 1.848–2(i)(4) (relating
to an assumption reinsurance
transaction with an insolvent insurance
company) is disregarded.
(D) Examples. The following
examples illustrate the principles of this
paragraph (g)(5)(ii):
Example 1. (i) Facts. On January 15, 2006,
P acquires all of the stock of T, an insurance
company, in a qualified stock purchase and
makes a section 338 election for T. T issues
individual life insurance contracts which are
specified insurance contracts as defined in
section 848(e)(1). P and new T are calendar
year taxpayers. Under §§ 1.338–6 and 1.338–
11(b)(2), the amount of AGUB allocated to
old T’s individual life insurance contracts is
$300,000. On the acquisition date, the tax
reserves for old T’s individual life insurance
contracts are $2,000,000. After the
acquisition date, new T receives $1,000,000
of net premiums with respect to new and
renewal individual life insurance contracts
and incurs $100,000 of general deductions
under 848(c)(2) through December 31, 2006.
New T engages in no other reinsurance
transactions other than the assumption
reinsurance transaction treated as occurring
by reason of the section 338 election.
(ii) Analysis. The transfer of insurance
contracts and the assumption of related
liabilities deemed to occur by reason of the
election under section 338 is treated as an
assumption reinsurance transaction. New T
determines the adjusted basis under section
197(f)(5) for the life insurance contracts
acquired in the assumption reinsurance
transaction as follows. The amount paid or
incurred for the individual life insurance
contracts is $300,000. To determine the
amount required to be capitalized under
section 848 in connection with the
assumption reinsurance transaction, new T
compares the required capitalization amount
for the assumption reinsurance transaction
with the general deductions allocable to the

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transaction. The required capitalization
amount for the assumption reinsurance
transaction is $130,900, which is determining
by multiplying the $1,700,000 net positive
consideration for the transaction ($2,000,000
reinsurance premium less $300,000 ceding
commission) by the applicable percentage
under section 848(c)(1) for the acquired
individual life insurance contracts (7.7%). To
determine its general deductions, new T
takes into account a tentative amortization
deduction under section 197(a) as if the
entire amount paid or incurred for old T’s
individual life insurance contracts ($300,000)
were allocable to an amortizable section 197
intangible with respect to insurance contracts
acquired in the assumption reinsurance
transaction. Accordingly, for the year of the
assumption reinsurance transaction, new T is
treated as having general deductions under
section 848(c)(2) of $120,000 ($100,000 +
$300,000/15). Under § 1.848–2(g)(6), these
general deductions are first allocated to the
$77,000 capitalization requirement for new
T’s directly written business ($1,000,000 ×
.077). Thus, $43,000 ($120,000¥$77,000) of
the general deductions are allocable to the
assumption reinsurance transaction. Because
the general deductions allocable to the
assumption reinsurance transaction ($43,000)
are less than the required capitalization
amount for the transaction ($130,900), new T
has a capitalization shortfall of $87,900
($130,900¥$43,000) with regard to the
transaction. Under § 1.848–2(g), this
capitalization shortfall would cause old T to
reduce the net negative consideration taken
into account with respect to the assumption
reinsurance transaction by $1,141,558
($87,900÷.077) unless the parties make the
election under § 1.848–2(g)(8) to capitalize
specified policy acquisition expenses in
connection with the assumption reinsurance
transaction without regard to the general
deductions limitation. If the parties make the
election, the amount capitalized by new T
under section 848 in connection with the
assumption reinsurance transaction would be
$130,900. The $130,900 capitalized by new T
under section 848 would reduce new T’s
adjusted basis of the amortizable section 197
intangible with respect to the specified
insurance contracts acquired in the
assumption reinsurance transaction.
Accordingly, new T would have an adjusted
basis under section 197(f)(5) with respect to
the individual life insurance contracts
acquired from old T of $169,100 ($300,000 ¥
130,900). New T’s actual amortization
deduction under section 197(a) with respect
to the amortizable section 197 intangible for
insurance contracts acquired in the
assumption reinsurance transaction would be
$11,273 ($169,100÷15).
Example 2. (i) Facts. The facts are the same
as Example 1, except that T only issues
accident and health insurance contracts that
are qualified long-term care contracts under
section 7702B. Under section 7702B(a)(5), T’s
qualified long-term care insurance contracts
are treated as guaranteed renewable accident
and health insurance contracts, and,
therefore, are considered specified insurance
contracts under section 848(e)(1). Under
§§ 1.338–6 and 1.338–11(b)(2), the amount of
AGUB allocable to T’s qualified long-term

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care insurance contracts is $250,000. The
amount of T’s tax reserves for the qualified
long-term care contracts on the acquisition
date is $7,750,000. Following the acquisition,
new T’s receives net premiums of $500,000
with respect to qualified long-term care
contracts and incurs general deductions of
$75,000 through December 31, 2006.
(ii) Analysis. The transfer of insurance
contracts and the assumption of related
liabilities deemed to occur by reason of the
election under section 338 is treated as an
assumption reinsurance transaction. New T
determines the adjusted basis under section
197(f)(5) for the insurance contracts acquired
in the assumption reinsurance transaction as
follows. The amount paid or incurred for the
insurance contracts is $250,000. To
determine the amount required to be
capitalized under section 848 in connection
with the assumption reinsurance transaction,
new T compares the required capitalization
amount for the assumption reinsurance
transaction with the general deductions
allocable to the transaction. The required
capitalization amount for the assumption
reinsurance transaction is $577,500, which is
determining by multiplying the $7,500,000
net positive consideration for the transaction
($7,750,000 reinsurance premium less
$250,000 ceding commission) by the
applicable percentage under section 848(c)(1)
for the acquired insurance contracts (7.7%).
To determine its general deductions, new T
takes into account a tentative amortization
deduction under section 197(a) as if the
entire amount paid or incurred for old T’s
insurance contracts ($250,000) were allocable
to an amortizable section 197 intangible with
respect to insurance contracts acquired in the
assumption reinsurance transaction.
Accordingly, for the year of the assumption
reinsurance transaction, new T is treated as
having general deductions under section
848(c)(2) of $91,667 ($75,000 + $250,000/15).
Under § 1.848–2(g)(6), these general
deductions are first allocated to the $38,500
capitalization requirement for new T’s
directly written business ($500,000 × .077).
Thus, $53,167 ($91,667¥$38,500) of general
deductions are allocable to the assumption
reinsurance transaction. Because the general
deductions allocable to the assumption
reinsurance transaction ($53,167) are less
than the required capitalization amount for
the transaction ($577,500), new T has a
capitalization shortfall of $524,333
($577,500¥$53,167) with regard to the
transaction. Under § 1.848–2(g), this
capitalization shortfall would cause old T to
reduce the net negative consideration taken
into account with respect to the assumption
reinsurance transaction by $6,809,519
($524,333÷.077) unless the parties make the
election under § 1.848–2(g)(8) to capitalize
specified policy acquisition expenses in
connection with the assumption reinsurance
transaction without regard to the general
deductions limitation. If the parties make the
election, the amount capitalized by new T
under section 848 in connection with the
assumption reinsurance transaction would
increase from $53,167 to $577,500. Pursuant
to § 1.197–2(g)(5)(ii)(C)(4), the additional
$524,333 ($577,500¥$53,167) capitalized by
new T under section 848 would reduce new

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17999

T’s adjusted basis of the amortizable section
197 intangible with respect to the insurance
contracts acquired in the assumption
reinsurance transaction. Accordingly, new
T’s adjusted basis of the section 197
intangible with regard to the insurance
contracts is reduced from $196,833
($250,000¥$53,167) to $0. Because the
additional $524,333 capitalized pursuant to
the § 1.848–2(g)(8) election exceeds the
$196,833 adjusted basis of the section 197
intangible before the reduction, new T is
required to reduce its deductions under
section 805 by the $327,500 ($524,333–
196,833).

(E) Effective date. This section applies
to acquisitions and dispositions of
insurance contracts on or after April 10,
2006. The applicability of this section
expires on or before April 7, 2009.
(g)(5)(iii) through (l) [Reserved]. For
further guidance, see § 1.197–2(g)(5)(iii)
through (l).
■ Par. 5. Section 1.338–0 is amended by
adding entries to the outline of topics
for § 1.338–11, § 1.338–11T and
§ 1.338(i)–1 to read as follows:
§ 1.338–0

*

*

Outline of topics.

*

*

*

§ 1.338–11 Effect of section 338 election
on insurance company targets.

(a) In general.
(b) Computation of ADSP and AGUB.
(1) Reserves taken into account as a
liability.
(2) Allocation of ADSP and AGUB to
specific insurance contracts.
(c) Application of assumption
reinsurance principles.
(1) In general.
(2) Reinsurance premium.
(3) Ceding commission.
(4) Examples.
(d) Reserve increases by new target
after the deemed asset sale.
(e) Effect of section 338 election on
section 846(e) election.
(f) Effect of section 338 election on
old target’s capitalization amounts
under section 848.
(1) Determination of net consideration
for specified insurance contracts.
(2) Determination of capitalization
amount.
(3) Section 381 transactions.
(g) Effect of section 338 election on
policyholders surplus account.
(h) Effect of section 338 election on
section 847 special estimated tax
payments.
§ 1.338–11T Effect of section 338 election
on insurance company targets (temporary).

(a) through (c) [Reserved].
(d) Reserve increases by new target
after the deemed asset sale.
(1) In general.
(2) Exceptions.

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(3) Amount of additional premium.
(i) In general.
(ii) Increases in unpaid loss reserves.
(iii) Increases in other reserves.
(4) Limitation on additional premium.
(5) Treatment of additional premium
under section 848.
(6) Examples.
(7) Effective dates.
(i) In general.
(ii) Application to pre-effective date
increases to reserves.
(e) Effect of section 338 election on
section 846(e) election.
(1) In general.
(2) Revocation of existing section
846(e) election.
(f ) through (h) [Reserved].
§ 1.338(i)–1

Effective dates.

(a) In general.
(b) Section 338(h)(10) elections for S
corporation targets.
(c) Section 338 elections for insurance
company targets.
(1) In general.
(2) New target election for retroactive
election.
(i) Availability of election.
(ii) Time and manner of making the
election for new target.
(3) Old target election for retroactive
election.
(i) Availability of election.
(ii) Time and manner of making the
election for old target.
■ Par. 6. Section 1.338–1 is amended
by:
■ 1. Revising the last two sentences of
paragraph (a)(2).
■ 2. Adding a sentence before the last
sentence of paragraph (a)(3).
■ 3. Redesignating existing paragraph
(b)(2)(vii) as paragraph (b)(2)(viii) and
adding new paragraph (b)(2)(vii).
The revisions read as follows:

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§ 1.338–1 General principles; status of old
target and new target.

(a) * * *
(2) * * * For example, if the target is
an insurance company for which a
section 338 election is made, the
deemed asset sale results in an
assumption reinsurance transaction for
the insurance contracts deemed
transferred from old target to new target.
See, generally, § 1.817–4(d), and for
special rules regarding the acquisition of
insurance company targets, § 1.338–11.
(3) * * * Section 1.338–11 provides
special rules for insurance company
targets. * * *
*
*
*
*
*
(b) * * *
(2) * * *
(vii) [Reserved]
*
*
*
*
*
■ Par. 7. Section 1.338–1T is added to
read as follows:

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§ 1.338–1T General principles; status of
old target and new target (temporary).

(a) through (b)(2)(vi) [Reserved]. For
further guidance, see § 1.338–1(a)
through (b)(2)(vi).
(b)(2)(vii) Section 846(e) (relating to
an election to use an insurance
company’s historical loss payment
pattern).
■ Par. 8. Section 1.338–11 is added to
read as follows:
§ 1.338–11 Effect of section 338 election
on insurance company targets.

(a) In general. This section provides
rules that apply when an election under
section 338 is made for a target that is
an insurance company. The rules in this
section apply in addition to those
generally applicable upon the making of
an election under section 338. In the
case of a conflict between the provisions
of this section and other provisions of
the Internal Revenue Code or
regulations, the rules set forth in this
section determine the Federal income
tax treatment of the parties and the
transaction when a section 338 election
is made for an insurance company
target.
(b) Computation of ADSP and
AGUB—(1) Reserves taken into account
as a liability. Old target’s tax reserves
are the reserves for Federal income tax
purposes for any insurance, annuity,
and reinsurance contracts deemed sold
by old target to new target in the
deemed asset sale. The amount of old
target’s tax reserves is the amount that
is properly taken into account by old
target for the contracts at the close of the
taxable year that includes the deemed
sale tax consequences (before giving
effect to the deemed asset sale and
assumption reinsurance transaction).
Old target’s tax reserves are a liability of
old target taken into account in
determining ADSP under § 1.338–4 and
a liability of new target taken into
account in determining AGUB under
§ 1.338–5.
(2) Allocation of ADSP and AGUB to
specific insurance contracts. For
purposes of allocating AGUB and ADSP
under §§ 1.338–6 and 1.338–7, the fair
market value of a specific insurance,
reinsurance or annuity contract or group
of insurance, reinsurance or annuity
contracts (insurance contracts) is the
amount of the ceding commission a
willing reinsurer would pay a willing
ceding company in an arm’s length
transaction for the reinsurance of the
contracts if the gross reinsurance
premium for the contracts were equal to
old target’s tax reserves for the
contracts. See § 1.197–2(g)(5) for rules
concerning the treatment of the amount

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allocable to insurance contracts
acquired in the deemed asset sale.
(c) Application of assumption
reinsurance principles—(1) In general. If
a target is an insurance company, the
deemed sale of insurance contracts is
treated for Federal income tax purposes
as an assumption reinsurance
transaction between old target, as the
reinsured or ceding company, and new
target, as the reinsurer or acquiring
company, at the close of the acquisition
date. The Federal income tax treatment
of the assumption reinsurance
transaction is determined under the
applicable provisions of subchapter L,
chapter 1, subtitle A of the Internal
Revenue Code, as modified by the rules
set forth in this section.
(2) Reinsurance premium. Old target
is deemed to pay a gross amount of
premium in the assumption reinsurance
transaction equal to the amount of old
target’s tax reserves for the insurance
contracts that are acquisition date assets
(acquired contracts). New target is
deemed to receive a reinsurance
premium in the amount of old target’s
tax reserves for the acquired contracts.
See paragraph (d) of this section for
circumstances in which new target is
deemed to receive additional premium.
See § 1.817–4(d)(2) for old target’s and
new target’s treatment of the premium.
(3) Ceding commission. Old target is
deemed to receive a ceding commission
in an amount equal to the amount of
ADSP allocated to the acquired
contracts, as determined under
§§ 1.338–6 and 1.338–7 and paragraph
(b) of this section. New target is deemed
to pay a ceding commission in an
amount equal to the amount of AGUB
allocated to the acquired contracts, as
determined under §§ 1.338–6 and
1.338–7 and paragraph (b) of this
section. See § 1.817–4(d)(2) for old
target’s and new target’s treatment of the
ceding commission.
(4) Examples. The following examples
illustrate this paragraph (c):
Example 1. (i) Facts. On January 1, 2003,
T, an insurance company, has the following
assets with the following fair market values:
$10 cash, $30 of securities, $10 of equipment,
a life insurance contract having a value,
under paragraph (b)(2) of this section, of $17,
and goodwill and going concern value. T has
tax reserves of $50 and no other liabilities.
On January 1, 2003, P purchases all of the
stock of T for $16 and makes a section 338
election for T. For purposes of the
capitalization requirements of section 848,
assume new T has $20 of general deductions
in its first taxable year ending on December
31, 2003, and earns no other premiums
during the year.
(ii) Analysis. (A) For Federal income tax
purposes, the section 338 election results in
a deemed sale of the assets of old T to new

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T. Old T’s ADSP is $66 ($16 amount realized
for the T stock plus $50 liabilities). New T’s
AGUB also is $66 ($16 basis for the T stock
plus $50 liabilities). See paragraph (b)(1) of
this section. Each of the AGUB and ADSP is
allocated under the residual method of
§ 1.338–6 to determine the purchase or sale
price of each asset transferred. Each of the
AGUB and ADSP is allocated as follows: $10
to cash (Class I), $30 to the securities (Class
II), $10 to equipment (Class V), $16 to the life
insurance contract (Class VI), and $0 to
goodwill and going concern value (Class VII).
(B) Under section 1001, old T’s amount
realized for the securities is $30 and for the
equipment is $10. As a result of the deemed
asset sale, there is an assumption reinsurance
transaction between old T (as ceding
company) and new T (as reinsurer) at the
close of the acquisition date for the life
insurance contract issued by old T. See
paragraph (c)(1) of this section. Although the
assumption reinsurance transaction results in
a $50 decrease in old T’s reserves, which is
taxable income to old T, the reinsurance
premium paid by old T is deductible by old
T. Under paragraph (c)(2) of this section, old
T is deemed to pay a reinsurance premium
equal to the reserve for the life insurance
contract immediately before the deemed asset
sale ($50) and is deemed to receive a ceding
commission from new T. Under paragraph
(c)(3) of this section, the portion of the ADSP
allocated to the life insurance contract is $16;
thus, the ceding commission is $16. Old T,
therefore, is deemed to pay new T a
reinsurance premium of $34 ($50 ¥ $16 =
$34). Old T also has $34 of net negative
consideration for purposes of section 848.
See paragraph (f) of this section for rules
relating to the effect of a section 338 election
on the capitalization of amounts under
section 848.
(C) New T obtains an initial basis of $30
in the securities and $10 in the equipment.
New T is deemed to receive a reinsurance
premium from old T in an amount equal to
the $50 of reserves for the life insurance
contract and to pay old T a $16 ceding
commission for the contract. See paragraphs
(c)(2) and (3) of this section. Accordingly,
new T includes $50 of premium in income
and deducts $50 for its increase in reserves.
For purposes of section 848, new T has $34
of net positive consideration for the deemed
assumption reinsurance transaction. Because
the only contract involved in the deemed
assumption reinsurance transaction is a life
insurance contract, new T must capitalize
$2.62 ($34 × 7.7% = $2.62) under section
848. New T will amortize the $2.62 as
provided under section 848. New T’s
adjusted basis in the life insurance contract,
which is an amortizable section 197
intangible, is $13.38, the excess of the $16
ceding commission over the $2.62 capitalized
under section 848. See section 197 and
§ 1.197–2(g)(5). New T deducts the $2.62 of
the ceding commission that is not
amortizable under section 197 because it is
reflected in the amount capitalized under
section 848 and also deducts the remaining
$17.38 of its general deductions.
Example 2. (i) Facts. Assume the same
facts as in Example 1, except the life
insurance contract has a value of $0 and the

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fair market value of T’s securities are $60.
Thus, to reinsure the contract in an arm’s
length transaction, T would have to pay the
reinsurer a reinsurance premium in excess of
T’s $50 of tax reserves for the contract.
(ii) Analysis. (A) For Federal income tax
purposes, the section 338 election results in
a deemed sale of the assets of old T to new
T. Old T’s ADSP is $66 ($16 amount realized
for the T stock plus $50 liabilities). New T’s
AGUB also is $66 ($16 basis for the T stock
plus $50 liabilities). See paragraph (b)(1) of
this section. Each of the AGUB and ADSP is
allocated under the residual method of
§ 1.338–6 to determine the purchase or sale
price of each asset transferred. Each of the
AGUB and ADSP is allocated as follows: $10
to cash (Class I), $56 to the securities (Class
II), $0 to the equipment (Class V), $0 to the
life insurance contract (Class VI), and $0 to
goodwill and going concern value (Class VII).
(B) Under section 1001, old T’s amount
realized for the securities is $56 and for the
equipment is $0. As a result of the deemed
asset sale, there is an assumption reinsurance
transaction between old T (as ceding
company) and new T (as reinsurer) at the
close of the acquisition date for the life
insurance contract issued by old T. See
paragraph (c)(1) of this section. Although the
assumption reinsurance transaction results in
a $50 decrease in old T’s reserves, which is
taxable income to old T, the reinsurance
premium deemed paid by old T to new T is
deductible by old T. Under paragraph (c)(2)
of this section, old T is deemed to pay a
reinsurance premium equal to the reserve for
the life insurance contract immediately
before the deemed asset sale ($50), and is
deemed to receive from new T a ceding
commission equal to the amount of AGUB
allocated to the life insurance contract ($0),
as provided in paragraph (c)(3) of this
section. Old T also has $50 of net negative
consideration for purposes of section 848.
See paragraph (f) of this section for rules
relating to the effect of a section 338 election
on capitalization amounts under section 848.
(C) New T obtains an initial basis of $56
in the securities (with a fair market value of
$60) and $0 in the equipment (with a fair
market value of $10). New T is deemed to
receive a reinsurance premium from old T in
an amount equal to the $50 of reserves for the
life insurance contract. Accordingly, new T
includes $50 of premium in income and
deducts $50 for its increase in reserves. For
purposes of section 848, new T has $50 of net
positive consideration for the deemed
assumption reinsurance transaction. Because
the only contract involved in the assumption
reinsurance transaction is a life insurance
contract, new T must capitalize $3.85 ($50 ×
7.7%) under section 848 from the transaction
and deducts the remaining $16.15 of its
general deductions. Because new T allocates
$0 of the AGUB to the insurance contract, no
amount is amortizable under section 197
with respect to the insurance contract. See
§ 1.338–11T(d) for rules on adjustments
required if new T increases its reserves for,
or reinsures at a loss, the acquired life
insurance contract.

(d) Reserve increases by new target
after the deemed asset sale. For further
guidance, see § 1.338–11T(d).

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(e) Effect of section 338 election on
section 846(e) election. For further
guidance, see § 1.338–11T(e)
(f) Effect of section 338 election on old
target’s capitalization amounts under
section 848—(1) Determination of net
consideration for specified insurance
contracts. For purposes of applying
section 848 and § 1.848–2(f) to the
deemed assumption reinsurance
transaction, old target’s net
consideration (either positive or
negative) for each category of specified
insurance contracts is an amount equal
to—
(i) The allocable portion of the ceding
commission (if any) relating to contracts
in that category; less
(ii) The amount by which old target’s
tax reserves for contracts in that
category has been reduced as a result of
the deemed assumption reinsurance
transaction.
(2) Determination of capitalization
amount. Except as provided in
§ 1.381(c)(22)–1(b)(13)—
(i) If, after the deemed asset sale, old
target has an amount otherwise required
to be capitalized under section 848 for
the taxable year or an unamortized
balance of specified policy acquisition
expenses from prior taxable years, then
old target deducts such remaining
amount or unamortized balance as an
expense incurred in the taxable year
that includes the deemed sale tax
consequences; and
(ii) If, after the deemed asset sale, the
negative capitalization amount resulting
from the reinsurance transaction
exceeds the amount that old target can
deduct under section 848(f)(1), then old
target’s capitalization amount is treated
as zero at the close of the taxable year
that includes the deemed sale tax
consequences.
(3) Section 381 transactions. For
transactions described in section 381,
see § 1.381(c)(22)–1(b)(13).
(g) Effect of section 338 election on
policyholders surplus account. Except
as specifically provided in
§ 1.381(c)(22)–1(b)(7), the deemed asset
sale effects a distribution of old target’s
policyholders surplus account to the
extent the grossed-up amount realized
on the sale to the purchasing
corporation of the purchasing
corporation’s recently purchased target
stock (as defined in § 1.338–4(c))
exceeds old target’s shareholders
surplus account under section 815(c).
(h) Effect of section 338 election on
section 847 special estimated tax
payments. If old target had elected to
claim an additional deduction under
section 847 for the taxable year that
includes the deemed sale tax
consequences or any earlier years, the

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amount remaining in old target’s special
loss discount account under section
847(3) must be reduced to the extent it
relates to contracts transferred to new
target and the amount of such reduction
must be included in old target’s gross
income for the taxable year that
includes the deemed sale tax
consequences. Old target may apply the
balance of its special estimated tax
account as a credit against any tax
resulting from such inclusion in gross
income. Any special estimated tax
payments remaining after this credit are
voided and, therefore, are not available
for credit or refund. Under section
847(1), new target is permitted to claim
a section 847 deduction for losses
incurred before the deemed asset sale,
subject to the general requirement that
new target makes timely special
estimated tax payments equal to the tax
benefit resulting from this deduction.
See § 1.381(c)(22)–1(c)(14) regarding the
carryover of the special loss discount
account attributable to contracts
transferred in a section 381 transaction.
■ Par. 9. Section 1.338–11T is added to
read as follows:

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§ 1.338–11T Effect of section 338 election
on insurance company targets (temporary).

(a) through (c) [Reserved]. For further
guidance, see § 1.338–11(a) through (c).
(d) Reserve increases by new target
after the deemed asset sale—(1) In
general. If in new target’s first taxable
year or any subsequent year, new target
increases its reserves for any acquired
contracts, new target is treated as
receiving an additional premium, which
is computed under paragraph (d)(3), in
the assumption reinsurance transaction
described in § 1.338–11(c)(1). New
target includes the additional premium
in gross income for the taxable year in
which new target increases its reserves
for acquired contracts. New target’s
increase in reserves for the insurance
contracts acquired in the deemed asset
sale is a liability of new target not
originally taken into account in
determining AGUB that is subsequently
taken into account. Thus, AGUB is
increased by the amount of the
additional premium included in new
target’s gross income. See §§ 1.338–
5(b)(2)(ii) and 1.338–7. Old target has no
deduction under this paragraph (d) and
makes no adjustments under §§ 1.338–
4(b)(2)(ii) and 1.338–7.
(2) Exceptions. New target is not
treated as receiving additional premium
under paragraph (d)(1) if—
(i) It is under state receivership as of
the close of the taxable year for which
the increase in reserves occurs; or

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(ii) It is required by section 807(f) to
spread the reserve increase over the 10
succeeding taxable years.
(3) Amount of additional premium—
(i) In general. The additional premium
taken into account under this paragraph
(d) is an amount equal to the sum of the
positive amounts described in
paragraphs (d)(3)(ii) and (d)(3)(iii).
However, the additional premium
cannot exceed the limitation described
in paragraph (d)(4).
(ii) Increases in unpaid loss reserves.
The positive amount with respect to
unpaid loss reserves is computed using
the formula A/B x (C¥[D + E]) where—
(1) A equals old target’s discounted
unpaid losses (determined under
section 846) included in AGUB under
§ 1.338–11(b)(1);
(2) B equals old target’s undiscounted
unpaid losses (determined section
846(b)(1) as of the close of the
acquisition date;
(3) C equals new target’s
undiscounted unpaid losses
(determined under section 846(b)(1) at
the end of the taxable year that are
attributable to losses incurred by old
target on or before the acquisition date;
and
(4) D (which may be a negative
number) equals old target’s
undiscounted unpaid losses as of the
close of the acquisition date, reduced by
the cumulative amount of losses, loss
adjustment expenses, and reinsurance
premiums paid by new target through
the end of the taxable year for losses
incurred by old target on or before the
acquisition date; and
(5) E equals the amount obtained by
dividing the cumulative amount of
reserve increases taken into account
under this paragraph (d) in prior taxable
years by A/B.
(iii) Increases in other reserves. The
positive amount with respect to reserves
other than discounted unpaid loss
reserves is the net increase of those
reserves due to changes in estimate,
methodology, or other assumptions used
to compute the reserves (including the
adoption by new target of a
methodology or assumptions different
from those used by old target).
(4) Limitation on additional premium.
The additional premium taken into
account by new target under paragraph
(d)(1) is limited to the excess, if any,
of—
(i) The fair market value of old target’s
assets acquired by new target in the
deemed asset sale (other than Class VI
and Class VII assets), over
(ii) The AGUB allocated to those
assets (including increases in AGUB
allocated to those assets as the result of

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reserve increases by new target in prior
taxable years).
(5) Treatment of additional premium
under section 848. If a portion of the
positive amounts described in
paragraphs (d)(3)(ii) and (iii) are
attributable to an increase in reserves for
specified insurance contracts (as
defined in section 848(e)), new target
takes an allocable portion of the
additional premium in determining its
specified policy acquisition expenses
under section 848(c) for the taxable year
of the reserve increase.
(6) Examples. The following examples
illustrate this paragraph (d):
Example 1. (i) Facts On January 1, 2006, P
purchases all of the stock of T, a non-life
insurance company, for $120 and makes a
section 338 election for T. On the acquisition
date, old T has total reserve liabilities under
state law of $725, consisting of undiscounted
unpaid losses of $625 and unearned
premiums of $100. Old T’s tax reserves on
the acquisition date are $580, which consist
of discounted unpaid losses (as defined in
section 846) of $500 and unearned premiums
(as computed under section 832(b)(4)(B)) of
$80. Old T has Class I through Class V assets
with a fair market value of $800. Old T also
has a Class VI asset with a fair market value
of $75, consisting of the future profit stream
of certain insurance contracts. During 2006,
new T makes loss and loss adjustment
expense payments of $200 with respect to the
unpaid losses incurred by old T before the
acquisition date. As of December 31, 2006,
new T reports undiscounted unpaid losses of
$475 attributable to losses incurred before the
acquisition date. The related amount of
discounted unpaid losses (as defined in
section 846) for those losses is $390.
(ii) Computation and allocation of AGUB.
Under § 1.338–5 and § 1.338–11(b)(1), as of
the acquisition date, AGUB is $700, reflecting
the sum of the amount paid for old T’s stock
($120) and the tax reserves assumed by new
T in the transaction ($580). The fair market
value of old T’s Class I through V assets is
$800, whereas the AGUB available for such
assets under § 1.338–6 is $700. There is no
AGUB available for old T’s Class VI assets,
even though such assets have a fair market
value of $75 on the acquisition date.
(iii) Adjustments for increases in reserves
for unpaid losses. Under paragraph (d) of this
section, new T must determine whether there
are any amounts by which it increased its
unpaid loss reserves that will be treated as
an additional premium and an increase in
AGUB. New T applies the formula of
paragraph (d)(3) of this section, where A
equals $500, B equals $625, C equals $475,
D equals $425 ($625–$200), and E equals $0.
Under this formula, new T is treated as
having increased its reserves for discounted
unpaid losses attributable to losses incurred
by old T by $40 ($500/$625 x ($475
¥[$425+0]). The limitation under paragraph
(d)(5) based on the difference between the
fair market value of old T’s Class I through
Class V assets and the AGUB allocated to
such assets is $100. Accordingly, new T
includes an additional premium of $40 in

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gross income for 2006, and increases the
AGUB allocated to old T’s Class I through
Class V assets to reflect this additional
premium.
Example 2. (i) Facts. Assume the same
facts as in Example 1. Further assume that
during 2007 new T deducts total loss and
loss expense payments of $375 with respect
to losses incurred by old T before the
acquisition date. On December 31, 2007, new
T reports undiscounted unpaid losses of $150
with respect to losses incurred before the
acquisition date. The related amount of
discounted unpaid losses (as defined in
section 846) for those unpaid losses is $125.
(ii) Analysis. New T must determine
whether any amounts by which it increased
its unpaid losses during 2007 will be treated
as an additional premium under paragraph
(d)(3) of this section. New T applies the
formula under paragraph (d)(3) of this
section, where A equals $500, B equals $625,
C equals $150, D equals $50 ($625–$575),
and E equals $50 ($40 divided by .8). Under
paragraph (d)(3) of this section, new T is
treated as increasing its reserves for
discounted unpaid losses by $40 during 2007
with respect to losses incurred by old T
($500/$625 x ($150 ¥ [$50 + $50]). New T
determines the limitation of paragraph (d)(5)
of this section by comparing the $800 fair
market value of the Class I through V assets
on the acquisition date to the $740 AGUB
allocated to such assets (which includes the
$40 addition to AGUB included during
2006). Thus, new T recognizes $40 of
additional premium as a result of the
increase in reserves during 2007, and adjusts
the AGUB allocable to the Class I through V
assets acquired from old T to reflect such
additional premium.
Example 3. (i) Facts. The facts are the same
as Example 2, except that on January 1, 2008,
new T reinsures the outstanding liability
with respect to losses incurred by old T
before the acquisition date through a
portfolio reinsurance transaction with R,
another non-life insurance company. R agrees
to assume any remaining liability relating to
losses incurred by old T before the
acquisition date in exchange for a
reinsurance premium of $200. Accordingly,
as of December 31, 2008, new T reports no
undiscounted unpaid losses with respect to
losses incurred by old T before the
acquisition date.
(ii) Analysis. New T must determine
whether any amount by which it increased
its unpaid loss reserves will be treated as an
additional premium under paragraph (d) of
this section. New T applies the formula of
paragraph (d)(3) of this section, where A
equals $500, B equals $625, C equals $0, and
D equals-$150 ($625 ¥ ($575 + $200), and E
equals $100 ($80 divided by .8). Thus, new
T is treated as having increased its
discounted unpaid losses by $40 in 2008
with respect to losses incurred by old T
before the acquisition date ($500/$625 × (0 ¥
[¥$150 + $100]). New T includes this
positive amount in gross income, subject to
the limitation of paragraph (d)(4). The
limitation of paragraph (d)(4) equals $20,
which is computed by comparing the $800
fair market value of the Class I through V
assets acquired from old T with the $780

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AGUB allocated to such assets (which
includes the $40 addition to AGUB in 2006
and the $40 addition to AGUB in 2007).
Thus, New T includes $20 in additional
premium, and increases the AGUB allocated
to the Class I through V assets acquired from
old T by $20. As a result of these
adjustments, the limitation under paragraph
(d)(4) is reduced to zero.

(7) Effective dates—(i) In general. This
section applies to increases to reserves
made by new target after a deemed asset
sale occurring on or after April 10, 2006.
The applicability of the section expires
on or before April 7, 2009.
(ii) Application to pre-effective date
increases to reserves. If either new target
makes an election under § 1.338(i)–
1(c)(2) or old target makes an election
under § 1.338(i)–1(c)(3) to apply the
rules of § 1.338–11, in whole, to a
qualified stock purchase occurring
before April 10, 2006 then the rules
contained in this section shall apply in
whole to the qualified stock purchase.
(e) Effect of section 338 election on
section 846(e) election—(1) In general.
New target and old target are treated as
the same corporation for purposes of an
election by old target to use its historical
loss payment pattern under section
846(e). See § 1.338–1T(b)(2)(vii).
Therefore, if old target has a section
846(e) election in effect on the
acquisition date, new target will
continue to use the historical loss
payment pattern of old target to
discount unpaid losses incurred in
accident years covered by the election,
unless new target elects to revoke the
section 846(e) election. In addition, new
target may consider old target’s
historical loss payment pattern when
determining whether to make the
section 846(e) election for a
determination year that includes or is
subsequent to the acquisition date.
(2) Revocation of existing section
846(e) election. New target may revoke
old target’s section 846(e) election to use
its historical loss payment pattern to
discount unpaid losses. If new target
elects to revoke old target’s section
846(e) election, new target will use the
industry-wide patterns determined by
the Secretary to discount unpaid losses
incurred in accident years beginning on
or after the acquisition date through the
subsequent determination year. New
target may revoke old target’s section
846(e) election by attaching a statement
to new target’s original tax return for its
first taxable year.
(f) through (h) [Reserved]. For further
guidance, see § 1.338–11(f) through (h).
■ Par. 10. Section 1.338(i)–1 is amended
by adding new paragraph (c) to read as
follows:

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§ 1.338(i)–1

*

18003

Effective dates.

*
*
*
*
(c) Section 338 elections for insurance
company targets—(1) In general. The
rules of § 1.338–11 apply to qualified
stock purchases occurring on or after
April 10, 2006.
(2) New target election for retroactive
application—(i) Availability of election.
New target may make an irrevocable
election to apply the rules in §§ 1.338–
11 and 1.338–11T(d) (including the
applicable provisions in §§ 1.197–
2(g)(5), 1.197–2T(g)(5)(ii), 381(c)(22)–1,
and 846) in whole, but not in part, to a
qualified stock purchase occurring
before April 10, 2006 for which a
section 338 election is made, provided
that new target’s first taxable year and
all subsequent affected taxable years are
years for which an assessment of
deficiency or a refund for overpayment
is not prevented by any law or rule of
law. In the case of a section 338 election
for which a section 338(h)(10) election
is made (or a section 338 election for a
foreign target), new target may make the
election to apply the regulations
retroactively without regard to whether
old target makes the election. In the case
of a section 338 election for a domestic
target for which no section 338(h)(10)
election is made, new target may make
the election to apply the regulations
retroactively only if old target also
makes the election. Paragraph (c)(2)(ii)
of this section prescribes the time and
manner of the election for new target.
(ii) Time and manner of making the
election for new target. New target may
make an election described in paragraph
(c)(2)(i) of this section by attaching a
statement to its original or amended
income tax return for its first taxable
year. The statement must be entitled
‘‘Election to Retroactively Apply the
Rules in §§ 1.338–11 and 1.338–11T(d)
(including the applicable provisions in
§§ 1.197–2(g)(5), 1.197–2T(g)(5)(ii),
1.381(c)(22)–1 and 846) in whole to a
transaction completed before April 10,
2006’’ and must include the following
information—
(A) The name and E.I.N. for new
target; and
(b) The following declaration (or a
substantially similar declaration): New
target has amended its income tax
returns for its first taxable year and for
all affected subsequent years to reflect
the rules in §§ 1.338–11 and 1.338–
11T(d) (including the applicable
provisions in §§ 197–2(g)(5), 1.197–
2t(g)(5)(ii), 1.381(c)(22)–1 and 846). All
other parties whose income tax
liabilities are affected by new target’s
election have amended their income tax
returns for all affected years to reflect
the rules in §§ 1.338–11 and 1.338–

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11T(d) (including the applicable
provisions in §§ 1.197–2(g)(5), 1.197–
2T(g)(5)(ii), 1.381(c)(22)–1 and 846).
(3) Old target election for retroactive
application—(i) Availability of election.
Old target may make an irrevocable
election to apply the rules in §§ 1.338–
11 and 1.338–11T(d) (including the
applicable provisions in §§ 1.197–
2(g)(5), 1.197–2T(g)(5)(ii), 1.381(c)(22)–1
and 846) in whole, but not in part, to a
qualified stock purchase occurring
before April 10, 2006 for which a
section 338 election is made, provided
that old target’s taxable year that
includes the deemed sale tax
consequences and all subsequent
affected taxable years are years for
which an assessment of deficiency or a
refund for overpayment is not prevented
by any law or rule of law. In the case
of a section 338 election for which a
section 338(h)(10) election is made (or
a section 338 election for a foreign
target), old target may make the election
to apply the regulations retroactively
without regard to whether new target
makes the election. In the case of a
section 338 election for a domestic
target for which no section 338(h)(10)
election is made, old target may make
the election to apply the regulations
retroactively only if new target also
makes the election. Paragraph (c)(3)(ii)
of this section prescribes the time and
manner of the election for old target.
(ii) Time and manner of making the
election for old target. Old target may
make an election described in paragraph
(c)(3)(i) of this section by attaching a
statement to each affected party’s
original or amended income tax return
for the taxable year that includes the
deemed sale tax consequences. The
statement must be entitled ‘‘Election to
Retroactively Apply the Rules in
§§ 1.338–11 and 1.338–11T(d)
(including the applicable provisions in
§§ 1.197–2(g)(5), 1.197–2T(g)(5)(ii),
1.381(c)(22)–1 and 846) to a transaction
completed before April 10, 2006’’ and
must include the following
information—
(A) The name and E.I.N. for old target;
and
(B) The following declaration (or a
substantially similar declaration): Old
target has amended its income tax
returns for the taxable year that includes
the deemed sale tax consequences and
for all affected subsequent years to
reflect the rules in §§ 1.338–11 and
1.338–11T(d) (including the applicable
provisions in §§ 1.197–2(g)(5), 1.197–
2T(g)(5)(ii), 1.381(c)(22)–1 and 846). All
other parties whose income tax
liabilities are affected by old target’s
election have amended their income tax
returns for all affected years to reflect

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the rules in §§ 1.338–11 and 1.338–
11Td) (including the applicable
provisions in §§ 1.197–2(g)(5), 1.197–
2T(g)(5)(ii), 1.381(c)(22)–1 and 846).
■ Par. 11. Section 1.381(c)(22)–1 is
amended by:
■ 1. Revising the first sentence of
paragraph (a).
■ 2. Adding a sentence to the end of
paragraph (b)(7)(i).
■ 3. Redesignating existing (b)(7)(ii) as
paragraph (b)(7)(iv) and adding new
paragraphs (b)(7)(ii) and (b)(7)(iii).
■ 4. Adding paragraphs (b)(7)(v), (b)(13),
(b)(14), and (c).
The revisions read as follows:
§ 1.381(c)(22)-1
company.

Successor insurance

(a) Carryover requirement. If in a
taxable year beginning after December
31, 1957, a distributor or transferor
corporation which is an insurance
company is acquired by a corporation
which is an insurance company in a
transaction to which section 381(a)
applies, section 381(c)(22) provides that
the acquiring corporation shall take into
account the appropriate items which the
distributor or transferor corporation was
required to take into account for
purposes of part I, subchapter L, chapter
1 of the Internal Revenue Code. * * *
(b) * * *
(7)(i) * * * However, any amounts
attributable to money or other property
not permitted to be received without the
recognition of gain (i.e., boot)
distributed to a person other than the
acquiring corporation under section
381(a) shall be treated as a distribution
under section 815.
(ii) Notwithstanding paragraph
(b)(7)(i) of this section, if the distributor
or transferor corporation distributes or
transfers less than 50 percent of its
insurance business to the acquiring
corporation, then the acquiring
corporation shall succeed to a ratable
portion of the dollar balances in the
distributor’s or transferor’s shareholders
surplus account, policyholders surplus
account, and other accounts. The
percentage of the accounts to which the
acquiring corporation succeeds is
determined by the ratio of the
distributor’s or transferor’s insurance
reserves for the contracts transferred to
the acquiring corporation, as maintained
under section 816(b), to the distributor’s
or transferor’s reserves for all of its
contracts maintained under section
816(b) immediately before the earlier of
the distribution or transfer or the
adoption of the plan of liquidation or
reorganization. For transactions in
which the distributor liquidates
pursuant to an election under section
338(h)(10), see § 1.338–11(f) for the

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treatment of its remaining policyholders
surplus account. For all other
transactions subject to this paragraph,
the distributor or transferor must take
into account as income its remaining
policyholders surplus account to the
extent the fair market value of its assets
(net of liabilities) distributed or
transferred to the acquiring corporation
or to the transferor’s shareholders
pursuant to the plan of liquidation or
reorganization exceeds the distributor’s
or transferor’s remaining shareholders
surplus account.
(iii) If, pursuant to a plan in existence
at the time of the liquidation or
reorganization, the acquiring
corporation transfers any insurance or
annuity contract it received in the
liquidation or reorganization to another
person, then, for purposes of paragraph
(b)(7)(ii) of this section, that contract
shall be deemed to have been
transferred by the transferor to that
other person after the adoption of the
plan of liquidation or reorganization. If
the transferor is an old target within the
meaning of § 1.338(h)(10)-1(d)(2), any
transfer by the acquiring corporation to
the purchasing corporation (as defined
in § 1.338–2(c)(11)) or to any person
related to the purchasing corporation
within the meaning of section
197(f)(9)(C) within two years of the
transfer described in section 381(a) will
be presumed to have been pursuant to
a plan in existence at the time of the
liquidation or reorganization.
*
*
*
*
*
(v) The provisions of this paragraph
(b)(7) are illustrated by the following
examples:
Example 1. P buys the stock of insurance
company target, T, from S for $16, and P and
S make a section 338(h)(10) election for T. T
transfers no insurance contracts to S, or any
related party, in connection with the
transaction. Further, assume that T had $10
in its policyholders surplus account and no
balance in its shareholders surplus account
or other accounts. Immediately before the
deemed asset sale, old T is required to
include as ordinary income the $10 in the
policyholders surplus account.
Example 2. Assume the same facts as in
Example 1, except that T holds a block of life
insurance contracts P does not wish to
acquire, and, immediately before the sale of
T stock, S causes T to distribute the
unwanted block of insurance contracts to S.
Further, assume that S is an insurance
company, that the distribution of contracts is
one of series of distributions in complete
cancellation or redemption of all of its stock
(the others occurring under § 1.338(h)(10)1(d)(4)(i)) that qualifies as a complete
liquidation under section 332, and that old
T’s tax reserves with respect to the
distributed contracts represent one-tenth of
old T’s tax reserves with respect to all of its
life insurance contracts. Because T transfers

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations
less than 50 percent of its life insurance
business to S in a transaction to which
section 381(a) applies, S succeeds to a ratable
portion of old T’s policyholders surplus
account ($1), and old T includes as ordinary
income the remaining $9 of that account.
Example 3. Assume the same facts as in
Example 2, except that 14 months after the
deemed asset sale, S and X, a person related
to new T under section 197(f)(9)(C), engage
in an indemnity reinsurance transaction
involving the contracts transferred to S from
old T. Because X is related to the purchasing
corporation (P) under section 197(f)(9)(C),
and X receives contracts from the acquiring
corporation (S) that S acquired from old T
within two years of the transfer from old T
to S, the contracts are presumed to have been
transferred pursuant to a plan in existence at
the time of old T’s liquidation. If S cannot
establish otherwise, old T is treated as having
distributed the remainder of its policyholders
surplus account. In that case, in the taxable
year of the indemnity reinsurance
transaction, S takes into account as ordinary
income the portion of old T’s accounts ($9)
that old T or S has not previously taken into
account as income.

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*

*
*
*
*
(13)(i) The transferor’s unamortized
policy acquisition expenses or positive
or negative capitalization requirements
on its specified insurance contracts.
(ii) Notwithstanding paragraph
(b)(13)(i) of this section, if the
distributor or transferor corporation
transfers less than 50 percent of its
insurance business to the acquiring
corporation, then the acquiring
corporation shall succeed to a ratable
portion of the transferor’s unamortized
policy acquisition expenses or positive
or negative capitalization requirements
on its specified insurance contracts. The
percentage of such acquisition expenses
or positive or negative capitalization
requirements to which the acquiring
corporation succeeds is determined by
the ratio of the distributor’s or
transferor’s insurance reserves for the
contracts transferred to the acquiring
corporation, as maintained under
section 816(b), to the distributor’s or
transferor’s reserves for all of its
contracts maintained under section
816(b) immediately before the earlier of
the distribution or transfer or the
adoption of the plan of liquidation or
reorganization. For amounts of the
distributor’s or transferor’s unamortized
policy acquisition expenses or positive
or negative capitalization requirements
on its specified insurance contracts to
which the acquirer does not succeed to
under this paragraph, and, for
transactions in which the transferor
liquidates pursuant to an election under
section 338(h)(10), see § 1.338–11(f) for
the treatment of its capitalized amounts
under section 848.
(iii) If, pursuant to a plan in existence
at the time of the liquidation or

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reorganization, the acquiring
corporation transfers any insurance or
annuity contract it received in the
liquidation or reorganization to another
person, then, for purposes of paragraph
(b)(13)(ii) of this section, that contract
shall be deemed to have been
transferred by the transferor to that
other person after the adoption of the
plan of liquidation or reorganization. If
the transferor is an old target within the
meaning of § 1.338(h)(10)–1(d)(2), any
transfer by the acquiring corporation to
the purchasing corporation (as defined
in § 1.338–2(c)(11)) or to any person
related to the purchasing corporation
within the meaning of section
197(f)(9)(C) within two years of the
transfer described in section 381(a) will
be presumed to have been pursuant to
a plan in existence at the time of the
liquidation or reorganization.
(14) The special loss discount
account, provided, however, that the
acquiring corporation will succeed to
the special loss discount account only to
the extent that it is attributable to the
portion of the transferor’s insurance
business acquired by the acquiring
corporation in the section 381
transaction.
(c) Effective dates—(1) In general.
This section applies to the acquisition of
assets of an insurance company by
another insurance company in a
transaction to which section 381 applies
for taxable years beginning after
December 31, 1957.
(2) Special rules for section 381
transactions. Paragraphs (a), (b)(7),
(b)(13), and (b)(14) of this section apply
to the acquisition of assets of an
insurance company by another
insurance company in a transaction to
which section 381 applies on or after
April 10, 2006.
(3) Joint retroactive election. The
distributor or transferor and the
acquiring corporation may jointly make
an irrevocable election to apply
paragraphs (a), (b)(7), (b)(13), and (b)(14)
of this section to a transaction to which
section 381 applies occurring before
April 10, 2006 provided that the taxable
year that includes the acquisition and
all subsequent affected taxable years of
both the distributor or transferor and the
acquiring corporation are years for
which an assessment of deficiency or a
refund for overpayment is not prevented
by any law or rule of law.
(4) Time and manner of making the
joint election. The distributor or
transferor and the acquiring corporation
may make an election described in
paragraph (c)(2) of this section by each
attaching a statement to its original or
amended income tax return for the
taxable year that includes the

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18005

acquisition of assets in a transaction to
which section 381 applies. The
statement must be entitled ‘‘Election to
retroactively apply the rules of section
1.381(c)(22)–1 to a transaction
completed before April 10, 2006’’ and
must include the following
information—
(i) The name and EIN of the
distributor or transferor and the
acquiring corporation; and
(ii) The following declaration (or a
substantially similar declaration): The
distributor or transferor and the
acquiring corporation have each
amended its income tax returns for the
taxable year that includes the
acquisition of assets in a transaction to
which section 381 applies and for all
affected subsequent years to reflect the
rules in paragraphs (a), (b)(7), (b)(13),
and (b)(14) of section 1.381(c)(22)–1.
*
*
*
*
*
■ Par. 12. Section 1.846–0 is amended
by:
■ 1. Adding a new entry in the table of
contents for § 1.846–2(d).
■ 2. Revising the entry in the table of
contents for § 1.846–4.
■ 3. Adding a new entry in the table of
contents for § 1.846–4T.
The revisions and additions read as
follows:
§ 1.846–0

*

*

Outline of provisions.

*

*

*

§ 1.846–2 Election by taxpayer to use its
own historical loss payment pattern.

*

*
*
*
*
(d) Effect of section 338 election on
section 846(e) election.
§ 1.846–2T Election by taxpayer to use its
own historical loss payment pattern
(temporary).

(a) through (c) [Reserved].
(d) Effect of section 338 election on
section 846(e) election.
*
*
*
*
*
§ 1.846–4

Effective dates.

(a) In general.
(b) Section 338 election.
§ 1.846–4T

Effective dates (temporary).

(a) [Reserved].
(b) Section 338 election.
*
*
*
*
*
■ Par. 13. Section 1.846–2 is amended
by adding paragraph (d) to read as
follows:
§ 1.846–2 Election by taxpayer to use its
own historical loss payment pattern.

*

*
*
*
*
(d) Effect of section 338 election on
section 846(e) election. [Reserved]. For
further guidance, see § 1.846–2T(d).
*
*
*
*
*

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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations

Par. 14. Section 1.846–2T is added to
read as follows:

■

§ 1.846–2T Election by taxpayer to use its
own historical loss payment pattern
(temporary).

(a) through (c) [Reserved]. For further
guidance, see § 1.846–2(a) through (c).
(d) Effect of section 338 election on
section 846(e) election. For rules
regarding qualified stock purchases
occurring on or after April 10, 2006, see
§§ 1.338–1(b)(2)(vii) and 1.338–11T(e).
*
*
*
*
*
■ Par. 15. Section 1.846–4 is revised to
read as follows:
§ 1.846–4

Effective dates.

(a) In general. Sections 1.846–1
through 1.846–3 apply to taxable years
beginning after December 31, 1986.
(b) Section 338 election. [Reserved].
For further guidance, see § 1.846–2T(d).
■ Par. 16. Section 1.846–4T is added to
read as follows:
§ 1.846–4T

Effective dates (temporary).

(a) [Reserved]. For further guidance,
see § 1.846–2(a).
(b) Section 338 election. Section
1.846–2(d) applies to section 846(e)
elections made with regard to a
qualified stock purchase made on or
after April 10, 2006.
*
*
*
*
*
■ Par. 17. Section 1060–1 is amended
by:
■ 1. Revising paragraph (a)(2).
■ 2. Adding new entries in paragraph
(a)(3) in the outline of topics for
paragraphs (b)(9) and (c)(5).
■ 3. Adding new paragraphs (b)(9) and
(c)(5).
The revision and additions read as
follows:

rwilkins on PROD1PC63 with RULES

§ 1.1060–1 Special allocation rules for
certain asset acquisitions.

(a) * * *
(2) Effective dates—(i) In general. The
provisions of this section apply to any
asset acquisition occurring after March
15, 2001. However, paragraphs (b)(9)
and (c)(5) of this section apply only to
applicable asset acquisitions occurring
on or after April 10, 2006. A purchaser
or a seller may make an irrevocable
election to apply the rules in §§ 1.338–
11 and 1.338–11T(d) (including the
applicable provisions in §§ 1.197–
2(g)(5), 1.197–2T(g)(5)(ii), 1.381(c)(22)–
1, 846 and 1060) to an applicable asset
acquisition occurring before April 10,
2006. Paragraph (a)(2)(ii) of this section
describes the time and manner of the
election for the purchaser and paragraph
(a)(2)(iii) of this section prescribes the
time and manner of the election for the
seller. The seller may make the election

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to apply the regulations retroactively
without regard to whether the purchaser
also makes the election. For rules
applicable to asset acquisitions on or
before March 15, 2001, see § 1.1060–1T
in effect before March 16, 2001 (see 26
CFR part 1 revised April 1, 2000).
(ii) Time and manner of making the
election for the purchaser. The
purchaser may make an election
described in this paragraph (a)(2) by
attaching a statement to its original or
amended income tax return for the
taxable year that includes the applicable
asset sale. The statement must be
entitled ‘‘Election to Retroactively
Apply the Rules in §§ 1.338–11 and
1.338–11T(d) (Including the Applicable
Provisions in §§ 1.197–2(g)(5), 1.197–
2T(g)(5)(ii), 1.381(c)(22)–1, 846 and
1060) to an Applicable Asset
Acquisition Completed Before April 10,
2006’’ and must include the following
information—
(A) The name and E.I.N. for the
purchaser; and
(B) The following declaration (or a
substantially similar declaration): The
purchaser has amended its income tax
returns for the taxable year that includes
the applicable asset acquisition and for
all affected subsequent years to reflect
the rules in §§ 1.338–11 and 1.338–
11T(d) (Including the Applicable
Provisions in §§ 1.197–2(g)(5), 1.197–
2T(g)(5)(ii), 1.381(c)(22)–1,846 and
1060).
(iii) Time and manner of making the
election for the seller. The seller may
make an election described in this
paragraph (a)(2) by attaching a statement
to its original or amended income tax
return for the taxable year that includes
the applicable asset sale. The statement
must be entitled ‘‘Election to
retroactively apply the rules in
§§ 1.338–11 and 1.338–11T(d)
(including the applicable provisions in
§§ 1.197–2(g)(5), 1.197–2T(g)(5)(ii),
1.381(c)(22)–1, 846 and 1060) to an
applicable asset acquisition completed
before April 10, 2006’’ and must include
the following information—
(A) The name and E.I.N. for the seller;
and
(B) The following declaration (or a
substantially similar declaration): The
seller has amended its income tax
returns for the taxable year that includes
the applicable asset acquisition and for
all affected subsequent years to reflect
the rules in §§ 1.338–11 and 1.338–
11T(d) (including the applicable
provisions in §§ 1.197–2(g)(5), 1.197–
2T(g)(5)(ii), 1.381(c)(22)–1, 846 and
1060).
(3) * * *
*
*
*
*
*

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(b) * * *
(9) Insurance Business.
(c) * * *
(5) Insurance Business.
*
*
*
*
*
(b) * * *
(9) Insurance business. The mere
reinsurance of insurance contracts by an
insurance company is not an applicable
asset acquisition, even if it enables the
reinsurer to establish a customer
relationship with the owners of the
reinsured contracts. However, a transfer
of an insurance business is an
applicable asset acquisition if the
purchaser acquires significant business
assets, in addition to insurance
contracts, to which goodwill and going
concern value could attach. For rules
regarding the treatment of an applicable
asset acquisition of an insurance
business, see paragraph (c)(5) of this
section.
(c) * * *
(5) Insurance business. If the trade or
business transferred is an insurance
business, the rules of this paragraph (c)
are modified by the principles of
§ 1.338–11(a) through (d). However, in
transactions governed by section 1060,
such principles apply even if the
transfer of the trade or business is
effected in whole or in part through
indemnity reinsurance rather than
assumption reinsurance, and, for the
insurer or reinsurer, an insurance
contract (including an annuity or
reinsurance contract) is a Class VI asset
regardless of whether it is a section 197
intangible. In addition, the principles of
§ 1.338–11(f) through (h) apply if the
transfer occurs in connection with the
complete liquidation of the transferor.
*
*
*
*
*
PART 602—OMB CONTROL NUMBERS
UNDER PAPERWORK REDUCTION
ACT
Par. 18. The authority citation for part
602 continues to read as follows:

■

Authority: 26 U.S.C. 7805. * * *

Par. 19. In § 602.101, paragraph (b) is
amended by revising the entry for
‘‘1.1060–1’’ and adding the following
entries in numerical order to the table
to read as follows:

■

§ 602.101

*

OMB Control numbers.

*
*
(b) * * *

*

*

CFR part or section where
identified and described
*
*
*
1.338–11T .............................

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control No.
*

*
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Federal Register / Vol. 71, No. 68 / Monday, April 10, 2006 / Rules and Regulations
CFR part or section where
identified and described

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*
1.338(i)–1 ..............................

Current OMB
control No.
*

*
1545–1990

FOR FURTHER INFORMATION CONTACT:

J.

William Leonard, Director, ISOO, at
202–357–5250.

The
proposed rule was published in the
January 27, 2006, Federal Register (71
*
*
*
*
*
1.381(c)(22)–1 ......................
1545–1990 FR 4541) for a 45-day public comment
period. NARA received no comments on
*
*
*
*
*
the proposed rule. The final rule is
1.1060–1 ...............................
1545–1658 published without change.
1545–1990
This final rule is being issued
pursuant to the provisions of section
*
*
*
*
*
102(b)(1) of Executive Order 12829,
January 6, 2003 (58 FR 3479), as
Mark E. Matthews,
amended by Executive Order 12885,
Deputy Commissioner for Services and
December 14, 1993, (58 FR 65863). The
Enforcement.
purpose of this Directive is to assist in
Approved: March 7, 2006.
implementing the Order; users of the
Eric Solomon,
Directive shall refer concurrently to that
Acting Deputy Assistant Secretary of the
Order for guidance. As of November 17,
Treasury (Tax Policy).
1995, ISOO became a part of NARA. The
[FR Doc. 06–3320 Filed 4–7–06; 8:45 am]
drafting, coordination, and issuance of
BILLING CODE 4830–01–P
this Directive fulfills one of the
responsibilities of the implementation
delegated to the ISOO Director. ISOO
maintains oversight over Executive
NATIONAL ARCHIVES AND RECORDS Order 12958, as amended, and policy
ADMINISTRATION
oversight over Executive Order 12829,
as amended. Nothing in this directive
Information Security Oversight Office
shall be construed to supersede the
authority of the Secretary of Energy or
32 CFR Part 2004
the Nuclear Regulatory Commission
under the Atomic Energy Act of 1954,
RIN 3095–AB34
as amended (42 U.S.C. 2011 et seq.), or
the authority of the Director of Central
National Industrial Security Program
Intelligence under the National Security
Directive No. 1
Act of 1947, as amended, or Executive
Order No. 12333 of December 8, 1981,
AGENCY: Information Security Oversight
or the authority of the Director of
Office (ISOO), National Archives and
National Intelligence under the
Records Administration (NARA).
Intelligence Reform and Terrorism
ACTION: Final rule.
Prevention Act of 2004. Requirements of
the latter Act will necessitate additional
SUMMARY: The Information Security
future changes to Executive Order 12829
Oversight Office (ISOO), National
and this implementing Directive. The
Archives and Records Administration
interpretive guidance contained in this
(NARA), is publishing this Directive
rule will assist agencies in
pursuant to section 102(b)(1) of
implementing Executive Order 12829,
Executive Order 12829, as amended,
as amended.
relating to the National Industrial
This rule is not a significant
Security Program. This order establishes
regulatory action for the purposes of
a National Industrial Security Program
(NISP) to safeguard Federal Government Executive Order 12866. The rule is not
classified information that is released to a major rule as defined in 5 U.S.C.
Chapter 8, Congressional Review of
contractors, licensees, and grantees of
Agency Rulemaking. As required by the
the United States Government.
Redundant, overlapping, or unnecessary Regulatory Flexibility Act, we certify
that this rule will not have a significant
requirements impede those interests.
Therefore, the NISP serves as the single, impact on a substantial number of small
entities because it applies only to
integrated, cohesive industrial security
Federal agencies.
program to protect classified
information and to preserve our
List of Subjects in 32 CFR Part 2004
Nation’s economic and technological
Classified information.
interests. This Directive sets forth
guidance to agencies to set uniform
■ 1. For the reasons set forth in the
standards throughout the NISP that
preamble, NARA amends Title 32 of the
promote these objectives.
Code of Federal Regulations to add part
DATED: Effective Date: May 10, 2006.
2004 as follows:

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SUPPLEMENTARY INFORMATION:

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18007

PART 2004—NATIONAL INDUSTRIAL
SECURITY PROGRAM DIRECTIVE NO.
1
Subpart A—Implementation and Oversight
Sec.
2004.10 Responsibilities of the Director,
Information Security Oversight Office
(ISOO) [102(b)].
2004.11 Agency Implementing Regulations,
Internal Rules, or Guidelines [102(b)(3)].
2004.12 Reviews by ISOO [102(b)(4)].
Subpart B—Operations
2004.20 National Industrial Security
Program Operating Manual (NISPOM)
[201(a)].
2004.21 Protection of Classified Information
[201(e)].
2004.22 Operational Responsibilities
[202(a)].
2004.23 Cost Reports [203(d)].
2004.24 Definitions.
Authority: Section 102(b)(1) of Executive
Order 12829, January 6, 2003, 58 FR 3479, as
amended by Executive Order 12885,
December 14, 1993, 58 FR 65863.

Subpart A—Implementation and
Oversight
§ 2004.10 Responsibilities of the Director,
Information Security Oversight Office
(ISOO) [102(b)].1

The Director ISOO shall:
(a) Implement EO 12829, as amended.
(b) Ensure that the NISP is operated
as a single, integrated program across
the Executive Branch of the Federal
Government; i.e., that the Executive
Branch departments and agencies
adhere to NISP principles.
(c) Ensure that each contractor’s
implementation of the NISP is overseen
by a single Cognizant Security Authority
(CSA), based on a preponderance of
classified contracts per agreement by the
CSAs.
(d) Ensure that all Executive Branch
departments and agencies that contract
for classified work have included the
Security Requirements clause, 52.204–2,
from the Federal Acquisition Regulation
(FAR), or an equivalent clause, in such
contract.
(e) Ensure that those Executive
Branch departments and agencies for
which the Department of Defense (DoD)
serves as the CSA have entered into
agreements with the DoD that establish
the terms of the Secretary’s
responsibilities on behalf of those
agency heads.
§ 2004.11 Agency Implementing
Regulations, Internal Rules, or Guidelines
[102(b)(3)].

(a) Reviews and Updates. All
implementing regulations, internal
1 Bracketed references pertain to related sections
of Executive Order 12829, as amended by E.O.
12885.

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