2. DHG Dealerships Portfolio
Robert Davis and Ryan Hanlon
Changes to F&I Insurance/Reinsurance Taxation After the Tax Cuts and Jobs Acts

3. Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. This guidance concerning ASC 740 is preliminary and based on our current understanding of the indicated tax law provisions. Certain tax law provisions may be clarified through issuance of guidance by Treasury, regulations or future technical corrections. We will update our views as such further information becomes available. DHG does not provide legal advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for legal advice. You should consult your own legal advisors before engaging in any transaction.

4. Part 1: Changes and Analysis of Taxation within Various Reinsurance Structures

5. Changes to Affiliated Reinsurance Companies (ARC)
ARC – A CFC which makes the §953(d) election and is no longer considered a foreign entity.
Generally makes an §831(b) election for companies which have annual premium flow of less than $2.3 million.
Previous tax on Investment Income ranged from 15-34%.
New tax rate is a flat 21% on Investment Income.
Breakeven Point is $90,384 in Investment Income annually.
Less than $90,384 in annual Investment Income is a slight tax increase.
More than $90,384 in annual Investment Income is a slight tax decrease.
Dividends Received Deductions Provision has been reduced from 70% to 50%
Omnibus Spending Bill clarified and affirmed the look thru principle the addition of §831(b)(2)(D).

6. Changes to Dealer Owned Warranty Company (DOWC)
Like any other C Corporation, Dealer Owned Warranty Companies (DOWC) are affected by the corporate rate change to a flat 21%.
Net operating loss (NOL) rules were revised under the new law, but not for property and casualty insurance companies. NOL’s of DOWCs may continue to be carried back two years and carried forward 20 years to offset 100% of taxable income.
For most companies, losses arising in tax years after 2017 are limited to 80% of taxable income and carried forward indefinitely.

7. Changes to DOWC (cont’d)
The tax efficiency of DOWCs rely upon the generation of NOLs in their early years. Eventually a DOWC will generate taxable income. This generally occurs when the DOWC’s growth rate decreases and the NOL carryovers become fully utilized.
Most administrators will still make a §831(b) election at this time so that the DOWC pays tax only on the investment income.
The ceded premiums need to be below the annual threshold, currently $2.3 Million, to allow this election to occur. This strategy is unchanged by the new law.

8. Retrospective Commission Plans / Overrides to a Dealership
Payments made to the dealership benefit from new rules – the new flat 21% rate if the dealer is a C corporation, or the 20% deduction for qualified business income under §199A if the dealership is a pass-through entity or sole proprietorship.
Payments made to directly to an individual would be taxed at that individual’s new rate and generally not benefit from the provisions of §199A.

9. Changes to Self-Insured Plans
Owner will benefit from the new rules - 21% effective rate if the dealer is a C corporation, or 20% deduction for qualified business income under §199A as the activity related to this activity is a part of the dealership entity.

10. Changes to Non-Controlled Foreign Companies (NCFC)
The Passive Foreign Investment Company (PFIC) problem
Generally not new law – PFIC tax law originated in 1986
Effectively eliminates the US tax deferral previously afforded NCFC-PFICs
CFC-PFICs are taxed as CFCs, not PFICs
Tax Reform added the “applicable insurance liabilities” (AIL) 25% test to continue to get a “pass” from PFIC taxation
AIL has to exceed 25% of the NCFC assets in order to pass the test and unearned premiums are specifically excluded from AILs.
The test uses the insurance company’s financial statements for the test based upon a hierarchy of financial statements available to use

11. Changes to NCFC (cont’d)
The PFIC Tax Regime
NCFC’s earnings can be taxed at the highest marginal rate under certain circumstances
PFIC Taxation occurs annually when earned or when a distribution occurs
Annual taxation is afforded those US shareholders making a Qualified Electing Fund (QEF) election
QEF elected in first PFIC year…this is VERY IMPORTANT
Preserves capital gain treatment on stock redemptions
If via dividend, pre-PFIC earnings are distributed first

12. Changes to NCFC (cont’d)
Taxation when distributions occur is afforded to those US Shareholders not making a QEF election
Conversion of pre-PFIC potential capital gain to ordinary income for undistributed surplus as of 12/31/17.
“Excess Distributions” are seen as being distributed from all years of earnings instead of oldest earnings first.
Interest is added to taxes paid currently that are attributed to PFIC earnings from prior years

13. Changes to Controlled Foreign Companies (CFC)
US Shareholder definition change to 10% of vote or value
Some NCFCs may become CFCs on January 1, 2018
Repatriation Tax generally not applicable
The company has to be a CFC as of December 31, 2017.

14. Part 2: What is the Best Use of Each Structure?

15. ARC
Ideally suited for those companies with annual ceded premium less than $2.3 million annually.
Subject to state premium taxes but not state income taxes currently
Multiple company structures are common and typically tax efficient.
Tax efficiency is reduced if the multiple companies are part of a controlled group where the total premium ceded is in excess of $2.3 million annually.
Causes underwriting income to be subject to tax as earned.

16. DOWC
Can be used without concern for the $2.3 million annually premium limit to achieve tax efficiency initially.
Ideally suited for those NCFCs that have become PFICs under tax reform that have ceded premium in excess of the $2.3 million annual limit.
The annual limit for a DOWC is utilized based upon on the customer sales price, not the net premium ceded.
Additional tax efficiency is achieved over a §831(b) ARC when the underwriting NOLs are utilized to offset the investment income until the NOLs are fully utilized.
With mature DOWC structures, multiple company structures are common and typically tax efficient. The older DOWCs typically make a §831(b) election.
The same cautions occur here as with ARCs regarding the tax efficiency of multiple company structures.

17. DOWC (cont’d)
A business purpose needs to be present if additional companies are formed in the future
Not subject to premium tax
Can be subject to state income tax after the state NOLs are fully utilized
The state income tax can be imposed on underwriting income if the state does not recognize a §831(b) election.
Some states impose capitalization requirements

18. Retrospective Arrangements
This structure is suited for higher risk business in conjunction with the other arrangements.
Dealers funding an ARC or a DOWC may consider these arrangements for high mileage vehicles as an example.
This structure is also highly suited for those companies writing minimal contracts monthly.
The breakover point for this vs. other structures is typically seen at approximately VSCs monthly.

19. Self-Insured Arrangements
Typically not frequently seen in the marketplace as a stand alone arrangement anymore.
Attractive for its typically extremely low costs to administer.
Provides for maximum cash up front but tax inefficiencies vs. other arrangements have made this arrangement unfavorable in general.

20. NCFC
Given the current changes to PFIC rules, this arrangement is not being seen as favorable.
Most NCFC arrangements are currently examining their options thus forcing their shareholders to consider the other options available to them for future ceded premium.
Further guidance by the IRS will ultimately determine the fate of these arrangements and whether they re-enter the marketplace as a viable option for those large dealer groups ceding large amounts of premium annually.

21. CFC
These arrangements typically are a result of unintended consequences during the formation of an NCFC or an ARC.
They are not recommended.
However, CFC taxation is less onerous than PFIC taxation.
Most NCFC arrangements are currently examining their options thus forcing their shareholders to consider the other options available to them for future ceded premium.
Further guidance by the IRS will ultimately determine the fate of these arrangements and whether they re-enter the marketplace as a viable option for those large dealer groups ceding large amounts of premium annually.

22. Questions?

23. Contact Us Robert Davis Partner DHG Dealerships Direct – 901.684.5646
Cell –
Ryan Hanlon Managing Director Portfolio Co. Direct – Cell –