SELL OF SUN LIFE FINL INC from an insurance policy, what is cost basis?

[nwtaxlady]

What is now the stand on those insurance policies that have issued stock? Basis or no Basis? And if so how do you figure the basis?

My client sold all his and the gross proceeds are $17,532. So it is not a small amount that would get zero capital gain treatment.

Thanks

[Lion]

This may be ongoing. I haven't had one for a long, long time. Basis is said to be FMV on the opening day of stock trading. But that seems so arbitrary. Has anyone been following this issue?

[nwtaxlady]

I first search in the forum to see if there where any recent posts regarding this issue and nothing recent. Ongoing yes, there have been many post clear back to 2005!

I did see they have something in TTB on 6-10 but wasn't sure what the "latest" is. I recall reading something in the Kepplinger Tax Letter a while back but of course I can't remember what it said!

Help! If he gets Zero Cost basis then his tax Liability goes up over $4,000+

[Burke]

This may be ongoing. I haven't had one for a long, long time. Basis is said to be FMV on the opening day of stock trading. But that seems so arbitrary. Has anyone been following this issue?

IRS lost an Appeals Court case on this issue in 2009, but they refuse to honor it so all refund claims on sales of stock in demutualized insurers remain on hold. Now an Arizona court has rejected that stance as well. However, how to determine basis is at issue. The court will hold a trial to come up with a valuation method. (Dorrance, D.C., Ariz.) And so, the saga continues.......

[Roland Slugg]

Despite losing at least two court cases on point, the IRS has continued to steadfastly uphold its position that shares received from the demutualization of insurance companies ... which number about 35 to date ... have a tax basis of zero. Therefore, it continues to hold up all protective claims stemming from this issue. (I'm not sure what it has done in the jurisdictions where the cases were decided against it.)

A source of unknown gravitas, "stockbasis.com," reports on its web site, however, that a California court case handed down in January 2013 ruled in favor of the IRS's position. Unfortunately, that web site offered no link or other reference to the name of the plaintiff or even the name of the court. I, for one, have grave doubt about the voracity of that alleged case. If it were true, there should be dozens of hits for any Google search.

The IRS has published a large number of single-topic articles called "Tax Topics," and Topic 430 deals with this very subject. If you read it carefully, two interesting things become apparent. (1) It does not say that the cost basis of demutualized shares is zero, and (2) it does say this about the sale of such shares: "This may result in capital gain reportable on Form 1040, Schedule D." (Emphasis added) If the IRS was still holding to its assertion that the basis in such shares was zero, wouldn't it say so in Tax Topic 430? And wouldn't that quoted sentence instead read, "This will result in capital gain reportable on Form 1040, Schedule D." Does this signal a change in the IRS's attitude on this issue?

The number of protective claims held in abeyance must be huge. All but one or two of the 35 or so demutualizations took place in 2001 or earlier, and the largest of those, Prudential and Metropolitan, had about 11 million policyholders each. John Hancock was a distant third with about 3 million. If even ten percent of those policyholders/taxpayers filed protective claims, that's 2½ million little time bombs.

This matter seems ripe for a Supreme Court review ... in fact I'm surprised it hasn't found its way there already. In the meantime everyone with a dog in this fight will just have to keep waiting.

[Lion]

Practical Tax Expert:

In the case of stock received in the demutualization of an insurance company, the IRS’s position is that the taxpayer’s basis is zero because what was exchanged was the taxpayer’s equity interest in the insurance company which had a basis of zero. 10 Policyholders of a mutual insurance company have a dual legal relationship under state law—they are policyholders, and as members of the company have an equity interest in the company as a result of their premium payments. The equity interest, however, arises solely as a result of the acquisition of the insurance policy. It cannot be transferred separately from the policy and therefore each policyholder’s basis in their equity interest is zero. Demutualization occurs when a mutual insurance becomes a stock company and each policyholder’s equity interest in the mutual insurance company may be exchanged for shares of stock or cash. The exchange does not cause the insurance policy to change (except for the name of the issuing company). Thus, because the basis of a taxpayer’s equity interest in the mutual company is considered to be zero, his or her basis in the stock received in the exchange is also zero.

Some courts have found that the equity interest in the mutual insurance company does have value because it adds value to the underlying insurance policy. The courts that have addressed the issue, however, differ on how to value the equity interest. For example, one court ruled that while the equity interest had value, it did not have a separate value from the underlying policy and therefore an allocation of the taxpayer’s basis between the equity interest and policy could not be made at the time of demutualization. Fisher v. United States, FedCl, 2008-2 ustc ¶50,481, aff’d, per curiam, CA-FC (unpublished opinion), 2010-1 ustc ¶50,289. As a result, the court applied the open transaction doctrine in Reg. §1.61-6 which provides that a transaction remains open and the recognition of income is postponed until the value of the property can be established. See §16,115. It determined that when the stock was sold, any gain realized by the taxpayer would be a return of capital up to the amount of the cost basis of the insurance policy.

Another court, however, noted that the open transaction doctrine only applies in rare and exceptional circumstances when the value of the property cannot be determined. Dorrance v. United States, D. Ariz., 2012-2 ustc ¶50,463. It ruled that the value of any stock and the market value of the policy could be determined at the time of demutualization as both could be sold or transferred. Thus, the taxpayer was entitled to provide evidence on how to allocate its basis for premiums paid before demutualization between the stock received and the insurance policy.

Footnotes

5 Code Sec. 1012; Rev. Rul. 55-757, 1955-2 CB 557; Rev. Rul. 57-535, 1957-2 CB 513; Philadelphia Park Amusement Co. v. United States, CtCls, 54-2 ustc ¶9697, 130 CtCls 166; Bodell v. Commissioner, CA-1, 46-1 ustc ¶9211, 154 F2d 407.

10 Rev. Rul. 71-233, 1971-1 CB 113; Rev. Rul. 74-277, 1974-1 CB 88; IRS Letter Ruling 200020048.

[taxea]

Despite losing at least two court cases on point, the IRS has continued to steadfastly uphold its position that shares received from the demutualization of insurance companies ... which number about 35 to date ... have a tax basis of zero. Therefore, it continues to hold up all protective claims stemming from this issue. (I'm not sure what it has done in the jurisdictions where the cases were decided against it.)

A source of unknown gravitas, "stockbasis.com," reports on its web site, however, that a California court case handed down in January 2013 ruled in favor of the IRS's position. Unfortunately, that web site offered no link or other reference to the name of the plaintiff or even the name of the court. I, for one, have grave doubt about the voracity of that alleged case. If it were true, there should be dozens of hits for any Google search.

The IRS has published a large number of single-topic articles called "Tax Topics," and Topic 430 deals with this very subject. If you read it carefully, two interesting things become apparent. (1) It does not say that the cost basis of demutualized shares is zero, and (2) it does say this about the sale of such shares: "This may result in capital gain reportable on Form 1040, Schedule D." (Emphasis added) If the IRS was still holding to its assertion that the basis in such shares was zero, wouldn't it say so in Tax Topic 430? And wouldn't that quoted sentence instead read, "This will result in capital gain reportable on Form 1040, Schedule D." Does this signal a change in the IRS's attitude on this issue?

The number of protective claims held in abeyance must be huge. All but one or two of the 35 or so demutualizations took place in 2001 or earlier, and the largest of those, Prudential and Metropolitan, had about 11 million policyholders each. John Hancock was a distant third with about 3 million. If even ten percent of those policyholders/taxpayers filed protective claims, that's 2½ million little time bombs.

This matter seems ripe for a Supreme Court review ... in fact I'm surprised it hasn't found its way there already. In the meantime everyone with a dog in this fight will just have to keep waiting.

http://fairmark.com/another-demutualization-case/

[Burke]

Practical Tax Expert:

In the case of stock received in the demutualization of an insurance company, the IRS’s position is that the taxpayer’s basis is zero because what was exchanged was the taxpayer’s equity interest in the insurance company which had a basis of zero. 10 Policyholders of a mutual insurance company have a dual legal relationship under state law—they are policyholders, and as members of the company have an equity interest in the company as a result of their premium payments. The equity interest, however, arises solely as a result of the acquisition of the insurance policy. It cannot be transferred separately from the policy and therefore each policyholder’s basis in their equity interest is zero. Demutualization occurs when a mutual insurance becomes a stock company and each policyholder’s equity interest in the mutual insurance company may be exchanged for shares of stock or cash. The exchange does not cause the insurance policy to change (except for the name of the issuing company). Thus, because the basis of a taxpayer’s equity interest in the mutual company is considered to be zero, his or her basis in the stock received in the exchange is also zero.

Very good post covering all opinions. In this case, I agree with the above and the IRS. This is based on 32 years experience in the insurance business with one of these companies that demutualized. There is no equity interest because (1) the guaranteed cash values of the underlying policies were not affected (no reduction in basis) at the time of demutualization; and (2) premiums were always based on three things: to wit, mortality, investment income of the company, and expenses. Any amounts over that each year were refunded to the policyowner as "dividends" but, as some of you may remember, were ruled by the IRS as a non-taxable return of premium (i.e, rebate.) So there was nothing in the premium structure nor the policy value to transfer as basis to the stock. The SEC required the issuance of stock as a condition of the demutualization process. IMO, the courts do not understand this process.