Posts Tagged ‘demutualization’

Tax Roundup, 12/10/15: No basis for you! 9th Circuit rules against taxpayer in demutualization case.

Thursday, December 10th, 2015 by Joe Kristan

VLUU L310 W / Samsung L310 W

Demutualization debacle. A favorable decision for taxpayers who have received insurance company shares in demutualizations was overturned yesterday. A divided three-judge panel in the Ninth Circuit ruled that a taxpayer had no basis to shares of five mutual insurance companies that converted to stock companies. That means all proceeds from a sale of the shares is treated as capital gain.

Principal Mutual in Des Moines demutualized in 2001.

The court held that the taxpayers, a Mr. and Mrs. Dorrance, paid nothing for their shares:

Treating the premiums as payment for membership rights would be inconsistent with the Code’s provisions related to insurance premiums. For example, gross premiums paid to purchase a policy are allocated as income to the insurance company; no portion is carved out as a capital contribution. See I.R.C. §§ 803(a)(1), 118. On the flip side, the policyholder is allowed to deduct the “aggregate amount of premiums” paid upon receipt of a dividend or cash-surrender value. I.R.C. § 72(e). No amount is carved out as an investment in membership rights. The taxpayer can’t have it both ways — a tax-free exchange with zero basis and then an increased basis upon sale of the stock.

The district court skipped a critical step by examining the value of the mutual rights without evidence of whether the Dorrances paid anything to first acquire them. The basis inquiry is concerned with the latter question. The district court also erred when it estimated basis by using the stock price at the time of demutualization rather than calculating basis at the time the policies were acquired. The stock value post-demutualization is not the same as the cost at purchase…

This analysis brings us back to the Dorrances’ burden and the economic realities of this case. Because the Dorrances offer nothing to show payment for their stake in the membership rights, as opposed to premium payments for the underlying insurance coverage, the IRS properly rejected their refund claim.

The Ninth Circuit ruling creates a conflict among different appellate courts on the proper treatment of shares of demutualized insurers.   A 2008 Federal Circuit decision upheld a Claims Court ruling that basis should be assigned to demutualized shares under an “open transaction” approach. That sets up a possible Supreme Court decision to resolve the split.

For now, expect the many pending refund claims for gains arising from demutualization transactions to remain unpaid indefinitely.

Cite: Dorrance, CA-9, No. 13-16548.

Background: Roger McEowen, Tax Impact of Demutualization – The Saga Continues


VLUU L310 W / Samsung L310 W


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Jeremy Scott, How Congress Keeps Saving the Tax System From Treasury and the IRS (Tax Analysts Blog). “In fact, too often in the last few years, it’s been Congress saving the fisc from bizarre administrative decisions from Treasury or the Service that have wounded the tax system.”

Frank Yan, The “Google tax”: What it is, and Why We Should Be Cautious (Tax Policy Blog). “Broadly speaking, the Google tax imposes a penalty on large companies that shift income abroad through certain transactions and corporate structures.”

TaxProf, The IRS Scandal, Day 945

Peter Reilly, National Organization For Marriage Denied Attorney Fees In IRS Lawsuit. “It looks like the National Organization for Marriage has come to the end of the line in its hope for a big payday from the IRS for the unauthorized disclosure of the Schedule B (donor list) attached to its 2008 Form 990.” Too bad. If a CPA firm made such an egregious “accidental” disclosure of tax information, it would be sued to a crisp. It’s good to be king.




Robert D. Flach, THE 2015 PNC CHRISTMAS PRICE INDEX. “The increase in the Partridge is due to the growing popularity as a gourmet food and in backyard farming.”

Programming note: The site was down as a result of technical difficulties this morning, accounting for the brevity of today’s update. Order has been restored; apologies for the inconvenience.



Taxpayer gets basis of 60% of IPO price in demutualized shares in Arizona case

Thursday, March 21st, 2013 by Joe Kristan


VLUU L310 W  / Samsung L310 WLast year a Federal judge in Arizona dampened the hopes of recipients of stock in insurance company demutualizations by ruling that the “open transaction” rule didn’t apply.  That rule, first used in the Fisher case, would make all IPO gain go away for some taxpayers receiving stock when insurance companies go from “mutual” to “stock” format.

Cheer up, stockholders.  The same judge this week determined that mutual policyholders still get a much better result than the IRS “zero basis” rule.  The IRS rule gives shareholders no basis in their mutual shares, making all proceeds taxable.

The plaintiffs in this case sold the shares of a number of insurance companies, including Des Moines-based Principal Financial Group; apparently they were wonderful insurance policy customers.   The judge looked to how the insurance companies determined demutualization IPO values and applied their analysis to determine the basis of the shares issued.

When determining how many shares of stock to give policyholders, the Companies calculated (1) a fixed component for the loss of voting rights, since each policyholder was entitled to one vote, and (2) a variable component for the loss of other rights, measured by the policyholder’s past and projected future contributions to the company’s surplus. Of the variable component, 60% was an estimate of each policyholder’s past contributions to surplus as of the calculation date while the remaining 40% was an estimate of future contributions.

     The Companies allocated shares to Plaintiffs based on (1) the value of voting rights, (2) past contributions to surplus, and (3) projected future contributions to surplus. Effectively, Plaintiffs paid for shares of stock in the demutualized Companies by relinquishing voting rights and making contributions to surplus. However, projected future contributions to surplus are a portion of premiums which Plaintiffs had not actually paid before receiving shares and cannot be considered as a part of basis.

      Therefore, Plaintiffs’ basis is equal to the combination of the IPO value of shares allocated to Plaintiffs for (1) the fixed component representing compensation for relinquished voting rights (“fixed shares”) and (2) 60% of the variable component representing past contributions to surplus (“variable shares”).

In short, the shareholders got a little more than 60% of the IPO value as share basis.

While this is a defeat for the IRS, it is not as taxpayer-favorable as the Fisher case.  If this new case is upheld on appeal, there will be a conflict among the circuits as to which rule applies.  Whether the IRS will continue to litigate or will settle based on this case is anyone’s guess.  In the meantime, if you have demutualized shares, or sold them in an open year, be sure you have a refund claim in to preserve your refund rights.


Cite: Dorrance, DC-AZ No. 2:09-cv-01284 (3/19/2013)

Prior coverage:

Arizona court shoots down “open transaction” rule for demutualization gains




Arizona court shoots down “open transaction” rule for demutualization gains

Wednesday, July 11th, 2012 by Joe Kristan

The happy fun times may be ending for recipients of insurance company stock when mutual companies go public.  A U.S. district court in Arizona has ruled that the “open transaction” rule is not the right way to tax sale of stock received in  a demutualization transaction.  He instead said that the cost of insurance policies needs to be allocated between the stock and the insurance policy value, and he ordered a trial to be held on how that should be done.

When a mutual insurance company becomes a stock company — usually so it can go public — its policyholders receive shares of the company based on their policy and business history with the mutual company — which they own as mutual policyholders.  Des Moines’ Principal Financial Group, for example, demutualized in 2001.  The IRS has long argued that taxpayers should receive no basis in stock received when mutual insurance companies convert to stock companies.  That would require taxpayers receiving such stock to pay capital gain taxes on 100% of proceeds received when demutualization stock is sold. 

A Minnesota CPA has long argued against this treatment, and his position won out when the Court of Claims in Washington, D.C. ruled in Fisher that the “open transaction” rule applied to demutualizations.  This position was upheld on appeal by the Court of Appeals for the Federal Circuit.  Under this rule all policy premiums paid could be considered to apply to the stock, and the reported gain would normally be zero.   Because most life insurance proceeds are non-taxable, there would be no gain on the insurance policies either.

The Arizona court held that neither the IRS approach or the Open Transaction approach were proper in the case under consideration:

The Court does not lightly disagree with another federal district court, and relies in some degree on arguments that do not appear to have been made before the Fisher court. But given the limited arguments at trial, it is not surprising that the Fisher court found that it was limited to deciding only whether “none of the basis of the originally-acquired property is allocable to the part disposed of or that all of it is allocable thereto until exhausted?” Id. at 784 (double emphasis in original). At summary judgment, this Court is not so limited, and finds neither argument convincing.

The judge said that there is no good reason the amount paid over the years in policy premiums can’t be allocated between the policies and the shares:

Since the value of both the mutual rights and the policy itself at the time of demutualization can be determined, there is no concern here that the taxpayer will be forced to pay tax on a transaction that is later proven to show a loss. The Ninth Circuit has confirmed that “taxation of an ‘open’ transaction is deferred only to the extent that consideration received by the seller consists of property having no ascertainable fair market value in the year of sale.”

The court ruling was a “summary judgment” holding that the taxpayer cannot rely on the Open Transaction rule.  There will now be a trial to determine how the basis will be allocated:

Neither party has yet presented evidence from which the Court could equitably apportion the premiums paid before demutualization as basis in the mutual rights and basis in the policies themselves. The Court has noted that previous Ninth Circuit caselaw suggests that the best method for such apportionment would be to compare the cost of Plaintiffs’ policies to the cost of comparable policies issued by non-mutual insurance companies at the time of issuance. Gladden, 262 F.3d at 856. On the other hand, commenters writing specifically about the issue of applying basis to mutual rights have suggested that comparing the market value of the policy and the stock at the time of demutualization, and applying that ratio to the premium payments, would be more appropriate.

The Court need not address, at summary judgment, which method of apportionment is appropriate. Plaintiffs have shown that they may have paid something for the mutual rights. The open transactions doctrine does not apply because the facts here do not present “elements of value so speculative in character as to prohibit any reasonably based projection of worth.”

Whatever the district court decides can be appealed to the Ninth Circuit Court of Appeals.  If it upholds the ruling against Open Transaction treatment, the stage may be set for a Supreme Court resolution of a conflict between the D.C  Circuit and the Ninth Circuit.

What should taxpayers do?  Right now the Arizona ruling is only law in that district.  Taxpayers can continue to file based on the Fisher Open Transaction holding.  Because they are filing in opposition to a long-standing IRS position, they should disclose their position on Form 8275.  Meanwhile, taxpayers who filed refund claims based on the Open Transaction rule can expect a long wait now before they can hope to get any cash.

Cite: Order on Summary Judgement, 7/9/12: Bennett Dorrance et ux. v. United States; USDC-AZ No. 2:09-cv-01284

Prior coverage:

IRS fighting demutualization holding in another venue


Demutualization: what to do now?


IRS fighting demutualization holding in another venue

Thursday, January 20th, 2011 by Joe Kristan

The switch by many mutual insurers to stockholder ownership in recent years has provided a windfall to many policyholders. The IRS has long argued that insurance company shares received in demutualizations had zero basis. In 2009 the Federal Circuit upheld a Court of Claims decision (Fisher) against the IRS that allowed taxpayers to consider premiums paid as stock basis, reducing their gain when the stock is sold.
The IRS is now litigating the issue in another forum. We are informed that the IRS Office of Chief Counsel has authorized this letter to taxpayers claiming refunds based on the prior Claims Court decision:

Your protective claim for refund in the amount of $______________ for the year____________ is currently held in suspense by this office. As you may be aware, there was a recent decision concerning the basis of stock received in a demutualization, which was affirmed in an unpublished and non-precedential opinion. (Eugene A. Fisher, Trustee, Seymour P. Nagan Irrevocable Trust v. United States, 82 Fed.Cl. 780, 102 A.F.T.R.2d 2008-5608, 2008-2 USTC P 50,481, affirmed Fed. Cir. 2009-5001.) The United States is actively litigating the demutualization issue in another Court (Dorrance v. US, Civil Action No. 09-cv1284-PHX-ROS (D. Arizona)). Once the law on taxpayers’ basis in stock received in a demutualization becomes well defined, we will act on your claim for refund. If you are not willing to wait for a final resolution of that issue, you can bring a refund suit after your claim has been pending for six months without the Internal Revenue Service taking action. See Page 2 of Publication 5. We would encourage you to wait until the issue is finally resolved. If it is determined that you are entitled to a refund, you will receive the refund plus interest.

So the demutualization battle continues, and shareholders of insurers like Principal, Prudential and Sun who have filed for refund claims will have to keep waiting.