IRS Code 846: Discount Rate, Loss Patterns, and Salvage

IRS Code Section 846 requires property and casualty insurance companies to discount their unpaid loss reserves to present value before deducting them for federal income tax purposes. Rather than letting an insurer deduct the full face amount of a claim it will not pay for years, the statute forces the reserve down to what that future payout is worth in today’s dollars, using an interest rate and payment pattern the IRS publishes each year. For the 2025 accident year, the applicable interest rate is 3.57 percent, compounded semiannually.¹

Who the Rule Applies To

Section 846 governs property and casualty insurers that file Form 1120-PC, the federal return for insurance companies other than life insurers.² If a company writes auto, professional liability, workers’ compensation, property damage, or similar coverage, its reserves fall under this regime. That includes both reported-but-unpaid claims and claims incurred but not yet reported, often called IBNR. Both go into the undiscounted figure before any discounting is applied.

Life insurers are not in scope. Their reserve deductions sit under Section 807, which runs on a separate framework for life and annuity contracts.

The Small Company Election

A qualifying small P&C insurer can skip the Section 846 machinery entirely by electing under Section 831(b) to be taxed only on investment income. The 2026 premium threshold for that election is $2,900,000. Below the line, the election is often simpler than running discounted loss computations, though it carries its own requirements on risk diversification and ownership.

The Three Inputs to the Calculation

Every Section 846 computation uses the same three ingredients: the undiscounted amount of unpaid losses, an applicable interest rate, and a loss payment pattern. The IRS supplies the rate and the patterns. Insurers are not permitted to swap in their own actuarial assumptions or current market rates.³ The calculation runs separately for each line of business and each accident year.

The economic logic is straightforward. If a claim will be paid three years out, deducting its full face value today overstates the real cost, because the reserve can be invested in the meantime. Discounting pulls the deduction back to present value. The deferred portion is not lost; it is deducted in later years as the claims are actually paid.

The Applicable Interest Rate After the TCJA

Before the Tax Cuts and Jobs Act, the discount rate came from an average of federal mid-term rates under Section 1274(d). For tax years beginning after December 31, 2017, the rate shifted to the corporate bond yield curve defined in Section 430(h)(2)(D)(i), calculated over a 60-month lookback rather than the 24-month window Section 430 normally uses.³ The longer lookback smooths rate volatility and limits timing games around a shifting rate environment.

The rate itself arrives each year through an IRS revenue procedure. The same revenue procedure publishes the actual discount factor tables, so insurers apply ready-made factors to their undiscounted reserves rather than building their own present-value models.¹

Loss Payment Patterns

The payment pattern tells the calculation how fast claims in a given line of business are expected to be paid out. The IRS builds these patterns from aggregate industry data in annual statements. A pattern is fixed in a “determination year” and then governs that year and the four accident years that follow. Determination years started in 1987 and recur every five years.³

Lines of business fall into two statutory groups:

Short-tail lines assume all losses are paid during the accident year and the three calendar years that follow. Losses paid after the first year are treated as split equally between the second and third years. Property damage and inland marine sit here.
Long-tail lines, including auto liability, other liability, medical malpractice, workers’ compensation, and multiple peril coverage, use a payout window stretching across the accident year and ten following calendar years. If claims remain unpaid after year ten, the pattern extends further, with any remaining losses treated as paid no later than the 24th year after the accident year.³

The split matters. A workers’ compensation claim paid over 15 years absorbs a far deeper discount than a property claim settled in 18 months. Two insurers with identical undiscounted reserves can land in very different deduction positions depending on which lines dominate their book.

No More Company-Specific Pattern Elections

Section 846(e) once let an insurer elect its own historical payment pattern instead of the IRS industry pattern. The TCJA repealed that election for tax years beginning after December 31, 2017. All P&C insurers now use the IRS-published patterns. Any company still working from a pre-2018 election is applying a rule that is gone.

Salvage and Subrogation Sit Under Section 832

Expected recoveries from salvage (sale of damaged property the insurer has taken) and subrogation (pursuing a responsible third party) do affect the tax calculation, but the mechanism is not in Section 846. It is in Section 832(b)(5), which defines “losses incurred” for P&C companies and requires adding estimated salvage and reinsurance recoverable at the end of the prior year and subtracting those estimates at the end of the current year.⁴

Section 832(b)(5) also requires estimated salvage recoverable to be determined on a discounted basis using IRS procedures. The salvage discount factors appear alongside the unpaid loss factors in the same annual revenue procedure.¹ The regulation at 26 CFR 1.846-1 adds that if unpaid losses on the annual statement already reflect a reduction for estimated salvage recoverable, those unpaid losses should be computed without that reduction so the salvage discount can be run separately.⁵ Losses and expected recoveries both get discounted, but through distinct provisions. Double-counting the salvage reduction is one of the more common preparation errors.

Where It Lands on the Return

Discounted unpaid losses are reported on Schedule F of Form 1120-PC, “Losses Incurred,” on lines 2b and 4b, which call for all discounted unpaid losses as defined in Section 846.⁶ The instructions repeat the rule that the calculation must be performed separately by line of business and accident year, using the three statutory inputs.

From Schedule F, the figure flows into the losses incurred computation under Section 832 and reduces taxable income. A deeper discount means a smaller current-year deduction, higher current taxable income, and a larger current tax bill, with the deferred piece recognized when claims are actually paid. Section 846 shifts the timing of the deduction, not its ultimate size.

What Errors Cost

Because the discount calculation directly sets 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.⁷ For a large insurer with billions in reserves, even a small percentage error in the factors can push a return into material understatement territory.

The safest path is narrow: use the IRS discount factors from the current revenue procedure exactly as published, apply them to the correct line of business and accident year, and keep the salvage discounting on its own Section 832 track. Substituting internal actuarial estimates, carrying forward stale payment patterns from an earlier determination year, or folding salvage into the loss discount creates precisely the mismatch an examiner is positioned to find.

1
Internal Revenue Service. Rev. Proc. 2026-13
2
Internal Revenue Service. About Form 1120-PC
3
Office of the Law Revision Counsel. 26 U.S. Code 846 – Discounted Unpaid Losses Defined
4
Office of the Law Revision Counsel. 26 USC 832 – Insurance Company Taxable Income
5
eCFR. 26 CFR 1.846-1 – Application of Discount Factors
6
Internal Revenue Service. Instructions for Form 1120-PC
7
Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments