[Code of Federal Regulations]
[Title 26, Volume 8]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.818-3]

[Page 680-682]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
Determination of Tax Liability--Table of Contents
 
Sec. 1.818-3  Amortization of premium and accrual of discount.

    (a) In general. Section 818(b) provides that the appropriate items 
of income, deductions, and adjustments under part I, subchapter L, 
chapter 1 of the Code, shall be adjusted to reflect the appropriate 
amortization of premium and the appropriate accrual of discount on 
bonds, notes, debentures, or other evidences of indebtedness held by a 
life insurance company. Such adjustments are limited to the amount of 
appropriate amortization or accrual attributable to the taxable year 
with respect to such securities which are not in default as to principal 
or interest and which are amply secured. The question of ample security 
will be resolved according to the rules laid down from

[[Page 681]]

time to time by the National Association of Insurance Commissioners. The 
adjustment for amortization of premium decreases the gross investment 
income, the exclusion and reduction for wholly tax-exempt interest, the 
exclusion and deduction for partially tax-exempt interest, and the basis 
or adjusted basis of such securities. The adjustment for accrual of 
discount increases the gross investment income, the exclusion and 
reduction for wholly tax-exempt interest, the exclusion and deduction 
for partially tax-exempt interest, and the basis or adjusted basis of 
such securities. However, for taxable years beginning after May 31, 
1960, only the accrual of discount relating to issue discount will 
increase the exclusion and reduction for wholly tax-exempt interest. See 
section 103.
    (b) Acquisitions before January 1, 1958. (1) In the case of any such 
security acquired before January 1, 1958, the premium is the excess of 
its acquisition value over its maturity value and the discount is the 
excess of its maturity value over its acquisition value. The acquisition 
value of any such security is its cost (including buying commissions or 
brokerage but excluding any amounts paid for accrued interest) if 
purchased for cash, or if not purchased for cash, its then fair market 
value. The maturity value of any such security is the amount payable 
thereunder either at the maturity date or an earlier call date. The 
earlier call date of any such security may be the earliest interest 
payment date if it is callable or payable at such date, the earliest 
date at which it is callable at par, or such other call or payment date, 
prior to maturity, specified in the security as may be selected by the 
life insurance company. A life insurance company which adjusts 
amortization of premium or accrual of discount with reference to a 
particular call or payment date must make the adjustments with reference 
to the value on such date and may not, after selecting such date, use a 
different call or payment date, or value, in the calculation of such 
amortization or discount with respect to such security unless the 
security was not in fact called or paid on such selected date.
    (2) The adjustments for amortization of premium and accrual of 
discount will be determined:
    (i) According to the method regularly employed by the company, if 
such method is reasonable, or
    (ii) According to the method prescribed by this section.

A method of amortization of premium or accrual of discount will be 
deemed ``regularly employed'' by a life insurance company if the method 
was consistently followed in prior taxable years, or if, in the case of 
a company which has never before made such adjustments, the company 
initiates in the first taxable year for which the adjustments are made a 
reasonable method of amortization of premium or accrual of discount and 
consistently follows such method thereafter. Ordinarily, a company 
regularly employs a method in accordance with the statute of some State, 
Territory, or the District of Columbia, in which it operates.
    (3) The method of amortization and accrual prescribed by this 
section is as follows:
    (i) The premium (or discount) shall be determined in accordance with 
this section; and
    (ii) The appropriate amortization of premium (or accrual of 
discount) attributable to the taxable year shall be an amount which 
bears the same ratio to the premium (or discount) as the number of 
months in the taxable year during which the security was owned by the 
life insurance company bears to the number of months between the date of 
acquisition of the security and its maturity or earlier call date, 
determined in accordance with this section. For purposes of this 
section, a fractional part of a month shall be disregarded unless it 
amounts to more than half a month, in which case it shall be considered 
a month.
    (c) Acquisitions after December 31, 1957. (1) In the case of:
    (i) Any bond, as defined in section 171(d), acquired after December 
31, 1957, the amount of the premium and the amortizable premium for the 
taxable year, shall be determined under section 171(b) and the 
regulations thereunder, as if the election set forth in section 171(c) 
had been made, and

[[Page 682]]

    (ii) Any bond, note, debenture, or other evidence of indebtedness 
not described in subdivision (i) of this subparagraph and acquired after 
December 31, 1957, the amount of the premium and the amortizable premium 
for the taxable year, shall be determined under paragraph (b) of this 
section.
    (2) In the case of any bond, note, debenture, or other evidence of 
indebtedness acquired after December 31, 1957, the amount of the 
discount and the accrual of discount attributable to the taxable year 
shall be determined under paragraph (b) of this section.
    (d) Convertible evidences of indebtedness. Section 818(b)(2)(B) 
provides that in no case shall the amount of premium on a convertible 
evidence of indebtedness (including any bond, note, or debenture) 
include any amount attributable to the conversion features of the 
evidence of indebtedness. This provision is the same as the one 
contained in section 171(b), and the rules prescribed in paragraph (c) 
of Sec. 1.171-2 shall be applicable for purposes of section 
818(b)(2)(B). This provision is to be applied without regard to the date 
upon which the evidence of indebtedness was acquired. Thus, where a 
convertible evidence of indebtedness was acquired before January 1, 
1958, and a portion or all of the premium attributable to the conversion 
features of the evidence of indebtedness has been amortized for taxable 
years beginning before January 1, 1958, no adjustment for such 
amortization will be required by reason of section 818(b)(2)(B). Such 
amortization will, however, require an adjustment to the basis of the 
evidence of indebtedness under section 1016(a)(17). For taxable years 
beginning after December 31, 1957, no further amortization of the 
premium attributable to the conversion features of such an evidence of 
indebtedness will be taken into account.
    (e) Adjustments to basis. Section 1016(a)(17) (relating to 
adjustments to basis) provides that in the case of any evidence of 
indebtedness referred to in section 818(b) and this section, the basis 
shall be adjusted to the extent of the adjustments required under 
section 818(b) (or the corresponding provisions of prior income tax 
laws) for the taxable year and all prior taxable years. The basis of any 
evidence of indebtedness shall be reduced by the amount of the 
adjustment required under section 818(b) (or the corresponding provision 
of prior income tax laws) on account of amortizable premium and shall be 
increased by the amount of the adjustment required under section 818(b) 
on account of accruable discounts.
    (f) Denial of double inclusion. Any amount which is includible in 
gross investment income by reason of section 818(b) and paragraph (a) of 
this section shall not be includible in gross income under section 
1232(a) (relating to the taxation of bonds and other evidences of 
indebtedness). See section 1232(a)(2)(C) and the regulations thereunder.

[T.D. 6558, 26 FR 2786, Apr. 4, 1961]