REVENUE RULING 55-580
1955-2 C.B. 282, amplified in Rev. Rul. 57-279

[IRS Annotation]
An insurance company taxable under the provisions of section 831 of the Internal Revenue Code of 1954 is entitled, under the provisions of section 832(b)(6) of the Code, to a deduction for "expenses incurred" involving estimates of future costs of adjusting claims and similar types of expenses, according to the accounting [283] method adopted by the National Convention of Insurance Commissioners used in filing the company's annual statement. As in the case of determining the "losses incurred" deductible, no corresponding change should be made at the beginning of the year where the taxpayer has obtained substantial tax benefits through the method of determining "loss adjustment expenses" deductible in its returns for prior years, which returns have been finally closed, and upon which the statute of limitation has expired.

Methods required for the computation of "loss adjustment expenses" are not prescribed by the Internal Revenue Service and any reasonable method may be employed, subject to acceptance, upon examination, by the Service.

[Rev. Rul. 55-580]
Advice has been requested as to whether an insurance company, other than a life or mutual company, as defined in section 831 of the Internal Revenue Code of 1954, is entitled to compute its "loss adjustment expenses" on an estimated or reserve basis, and if so what method of computation should be used in determining such expenses.

Some insurance companies taxable under section 831 of the 1954 Code, in addition to claiming deductions for actual allocated "loss adjustment expenses," also claim deductions for the entire amount of unallocated expenses relating to losses which have occurred but have not been examined and settled.

Section 832 of the Code provides, in part, as follows:

(b) Definitions. * * *.

(5) Losses incurred.—The term "losses incurred" means losses incurred during the taxable year on insurance contracts, computed as follows:

(A) To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year.

(B) To the result so obtained, add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year.

(6) Expenses incurred.—* * * means all expenses shown on the annual statement approved by the National Convention of Insurance Commissioners, and shall be computed as follows: To all expenses paid during the taxable year, add expenses unpaid at the end of the taxable year and deduct expenses unpaid at the end of the preceding taxable year. For the purpose of computing the taxable income * * * there shall be deducted from expenses incurred (as defined in this paragraph) all expenses incurred which are not allowed as deductions by subsection (c).

(c) Deductions Allowed.—In computing the taxable income of an insurance company subject to the tax imposed by section 831, there shall be allowed as deductions:

(1) All ordinary and necessary expenses incurred, as provided in section 162 (relating to trade or business expenses); * * *

The reference in section 832 of the Code to the annual statement approved by the National Convention of Insurance Commissioners contemplates that the method of accounting used in preparing that statement should be followed in computing gross income and that the provision in section 832(b)(6) above, which prohibits the deduction of expenses not allowed under subsection (c) of such section, should be construed as meaning that deductions of a type not enumerated in subsection (c) will not be allowed. Therefore, if an expense is of the type which would be allowable as a deduction under section 162(a) of the Code, it should be allowed as a deduction in the year determined on the basis of the accounting method adopted by the National Convention of Insurance Commissioners as reflected in the annual statement. The question here relates to "expenses incurred" [284] involving estimates of future costs of adjusting claims and similar types of expenses but does not include administrative or clerical expenses of a nature that can be actually determined.

Section 832 of the Code does not provide for the deduction of any reserve as such, but it does provide for the deduction of "unpaid losses." Section 39.204-2(b) of Regulations 118, applicable under the 1954 Code by virtue of T.D. 6091, C.B. 1954-2, 47, provides that every insurance company of the type with which this Revenue Ruling is concerned must establish to the satisfaction of the Commissioner of Internal Revenue that the part of the deduction for "losses incurred" which represents "unpaid losses" at the close of the taxable year comprises only actual unpaid losses stated in amounts which, based upon the facts in each case and the company's experience with similar cases, can be said to represent a fair and reasonable estimate of the amount the company will be required to pay.

Accordingly, it is held, in view of the fact that the determination of "loss adjustment expenses" bears a relation to the determination of "unpaid losses," that an insurance company taxable under the provisions of section 831 of the Code is in like manner entitled, under the provisions of section 832(b)(6) of the Code, to a deduction for "expenses incurred" involving estimates of future costs of adjusting claims and similar types of expenses, according to the accounting method adopted by the National Convention of Insurance Commissioners used in filing the company's annual statement. As in the case of determining the "losses incurred" deductible, no corresponding change should be made at the beginning of the year where the taxpayer has obtained substantial tax benefits through the method of determining "loss adjustment expenses" deductible in its returns for prior years, which returns have been finally closed, and upon which the statute of limitation has expired.

Methods required for the computation of "loss adjustment expenses" are not prescribed by the Internal Revenue Service and any reasonable method may be employed, subject to acceptance, upon examination, by the Revenue Service.

Since sections 831 and 832 of the 1954 Code cited and referred to in this Revenue Ruling, in substance, embody the same provisions relating to the taxing of insurance companies (other than life or mutual), mutual marine insurance companies, and mutual fire insurance companies issuing perpetual policies as were contained in section 204 of the Internal Revenue Code of 1939, the discussion and conclusions reached herein would be equally applicable if this same question were considered under the provisions of the 1939 Code.