IRS Code Section 846 requires property and casualty insurance companies to discount their unpaid loss reserves to present value before deducting them, rather than writing off the full face amount of claims they expect to pay in future years. The calculation uses three inputs the IRS publishes: an applicable interest rate, a loss payment pattern for each line of business, and the undiscounted reserve itself. For the 2025 accident year, the applicable rate is 3.57 percent, compounded semiannually.1Internal Revenue Service. Rev. Proc. 2026-13 Getting it wrong shifts taxable income and exposes the company to accuracy-related penalties.
Who the Rule Applies To
Section 846 governs property and casualty insurers filing Form 1120-PC, the federal income tax return for insurance companies other than life insurance companies.2Internal Revenue Service. About Form 1120-PC That covers writers of auto, professional liability, workers’ compensation, property, and similar coverages. Every such insurer carries reserves for reported-but-unpaid claims and for claims that have been incurred but not yet reported (IBNR). Both categories go into the undiscounted figure before Section 846 is applied.
Life insurers are outside this framework entirely. Their reserve deductions run through Section 807, which handles the actuarial mechanics of life and annuity contracts. The two regimes do not overlap.
The Small Insurer Boundary
Not every P&C company runs the full discounting exercise. Under Section 831(b), a qualifying small insurance company can elect to be taxed only on investment income, taking premium income out of the tax base. The premium threshold for 2026 is $2,900,000. Companies under that line often find the 831(b) election simpler than running discounted loss computations, though the election carries its own diversification and ownership requirements.
Why Reserves Have to Be Discounted
The rationale is the time value of money. If an insurer knows it will pay a $1 million claim three years from now, deducting the full $1 million today overstates what that obligation actually costs. The reserve can be invested in the meantime, so a dollar paid three years out is worth less than a dollar today. Section 846 pushes the deduction down to present value, which reflects the economic cost more accurately.3Office of the Law Revision Counsel. 26 U.S. Code 846 – Discounted Unpaid Losses Defined
The computation runs separately for each line of business and each accident year. Insurers cannot substitute their own actuarial assumptions or current market rates for the IRS-published factors.3Office of the Law Revision Counsel. 26 U.S. Code 846 – Discounted Unpaid Losses Defined
The Applicable Interest Rate
Since tax years beginning after December 31, 2017, the applicable rate has been based on the corporate bond yield curve defined in Section 430(h)(2)(D)(i), calculated over a 60-month lookback. The Tax Cuts and Jobs Act replaced the earlier method, which drew on the federal mid-term rates under Section 1274(d). The longer lookback smooths short-term rate swings and prevents insurers from timing deductions around a volatile market.3Office of the Law Revision Counsel. 26 U.S. Code 846 – Discounted Unpaid Losses Defined
The IRS publishes the rate annually in a revenue procedure. The same revenue procedure includes the actual discount factor tables, so insurers apply the published factors directly rather than building present-value models from scratch. For the 2025 accident year, that rate is 3.57 percent, compounded semiannually.1Internal Revenue Service. Rev. Proc. 2026-13
Loss Payment Patterns by Line of Business
The payment pattern tells the calculation how quickly claims in a given line are expected to settle. The IRS derives these patterns from aggregate industry data reported on annual statements. The statute splits lines into two categories:
- Short-tail lines. All losses are assumed paid during the accident year and the three following calendar years, with losses paid after the first year treated as split equally between the second and third years. Property damage and inland marine sit here.
- Long-tail lines. Auto liability, other liability, medical malpractice, workers’ compensation, and multiple peril use a longer window across the accident year and ten following calendar years, with a statutory extension for any losses still unpaid at the end of that period.3Office of the Law Revision Counsel. 26 U.S. Code 846 – Discounted Unpaid Losses Defined
The distinction matters. A workers’ compensation claim paid over 15 years takes a much deeper discount than a property claim closing in 18 months. Two insurers with the same undiscounted reserves can end up with very different current deductions depending on their mix of business.
Company-Specific Patterns No Longer Allowed
Section 846(e) previously let an insurer elect its own historical payment pattern in place of the industry-wide one. The TCJA repealed that election for tax years beginning after December 31, 2017. All P&C insurers now use the same IRS-published patterns, and any company still applying a pre-2018 election is relying on a rule that no longer exists.
Salvage and Subrogation Sit Outside Section 846
Expected recoveries through salvage (selling damaged property the insurer has taken title to) or subrogation (pursuing a responsible third party) affect the tax calculation, but the mechanics come from Section 832(b)(5), not Section 846. Section 832(b)(5) defines “losses incurred” and requires insurers to add estimated salvage and reinsurance recoverable as of the end of the prior year, then subtract those amounts as of the end of the current year.4Office of the Law Revision Counsel. 26 USC 832 – Insurance Company Taxable Income
Estimated salvage recoverable must also be discounted, using salvage discount factors the IRS publishes in the same annual revenue procedure as the loss discount factors.1Internal Revenue Service. Rev. Proc. 2026-13 The regulation at 26 CFR 1.846-1 addresses a common trap: if unpaid losses on the annual statement already reflect a reduction for estimated salvage, the unpaid losses should be determined without that reduction so the salvage discount can be applied on its own.5eCFR. 26 CFR 1.846-1 – Application of Discount Factors Both losses and expected recoveries end up discounted, through separate mechanisms. Double-counting the salvage reduction is one of the more common preparation errors.
Where the Number Lands on Form 1120-PC
Discounted unpaid losses are reported on Schedule F of Form 1120-PC, “Losses Incurred.” Lines 2b and 4b of Schedule F call for the discounted amounts as defined in Section 846.6Internal Revenue Service. Instructions for Form 1120-PC The instructions repeat that the calculation runs separately by line of business and accident year, using the three statutory inputs.
One point of confusion worth clearing up: Schedule P, which insurers use in NAIC annual statement filings to analyze unpaid losses and loss adjustment expenses, is a state regulatory document. Data from Schedule P feeds the tax calculation, but IRS reporting happens on Schedule F and the other Form 1120-PC schedules.
The Effect on Taxable Income
The net discounted figure flows into “losses incurred” under Section 832 and reduces the insurer’s taxable income. A deeper discount produces a smaller current deduction, which means higher taxable income now and a larger current tax bill, with the deferred portion recognized as claims are actually paid. Section 846 shifts the timing of the deduction; it does not eliminate any of it.
Long-tail carriers feel this most. A workers’ compensation insurer with reserves stretching across two decades sees a meaningful gap between undiscounted reserves and the current deduction. A short-tail property writer sees a much smaller gap. Both will ultimately deduct the full amount of claims paid.
Penalty Exposure for Errors
Because the discounting calculation feeds directly into taxable income, mistakes can trigger the accuracy-related penalty under Section 6662. A substantial understatement of income tax carries a penalty of 20 percent of the underpayment attributable to the understatement.7Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments For a large insurer sitting on billions in reserves, even a small percentage error in the factors used can produce a material understatement.
The safest approach is mechanical. Use the discount factors from the current revenue procedure exactly as published. Apply them to the correct line of business and accident year. Keep salvage discounting on its own track under Section 832. Companies that substitute internal actuarial estimates or apply stale patterns from an earlier determination year create exactly the mismatch the IRS looks for on audit.