Originally published in the November/December 2008 issue of South Carolina CPA Report, below check out an article discussing the tax implications of insurance company demutualization:
Millions of people and entities own insurance policies in one form or another. And if you owned a policy in the late 1990s or the early 2000s, your ownership may entitle you to a tax refund.
In the not so distant past, many insurance companies were owned by the policy holders who were entitled to receive company dividends and vote. These were called "mutual insurance companies.” USAA, for example, retains this current corporate structure. But many of these mutual insurance companies restructured themselves from policy holder owned to stockholder owned in the late 1990s and the early 2000s.
As part of the restructuring, individuals who owned policies were distributed new stock in the insurance companies when it transformed to a publicly owned company. This transformation from policy holder owned into publicly owned is called "demutualization.”
In the past, the IRS required that taxpayers, who received stock as part of a demutualization, pay capital gains tax on the 100 percent of the value of the stock when it was sold. But a recent court decision shot down the IRS's position and, in fact, said that the taxpayer owed no tax at all. This decision has widespread ramifications for individuals, professional associations and business entities that owned insurance policies.
Some of the largest insurance companies - in America demutualized in the last decade, including MetLife Inc. and Prudential Financial Inc. Between MetLife and Prudential alone, there were approximately 22 million policyholders at the time oftheir demutualization that occurred in 2000 and 2001, respectively. Indeed, when this tax treatment issue was shared with a South Carolina accountant, he advised that the one of the largest malpractice coverage providers in South Carolina for accountants was Prudential. No doubt, millions of individuals and entities received stock in insurance companies as a result of demutualization. More importantly, if the stock was sold, these individuals and entities paid tax on the sale. As it turns out, it appears that no tax was owed.
In August 2008, the Court of Federal Claims issued a decision in Fisher v. United States. The court held that tax is only owed on the sale of the demutualization stock to the extent that the sale proceeds exceed the cost basis in the taxpayer's policy. Because the stock was sold for $31,759 and the taxpayer had paid over $194,000 in premiums, the cost basis in the policy far exceeded the proceeds from the sale of the stock. As such, no taxable event occurred, and no tax was owed.
Let us review certain issues that could, affect a taxpayer's ability to receive the benefits of this decision. The ability to claim refunds by filing amended returns is limited to those claims filed within three years of filing the income tax return for the year in which the sale of the stock occurred, or two years after payment of the tax—whichever is longer.
If a taxpayer timely filed and paid, they are effectively limited to filing claims for refund for the 2005 to 2007 tax years, unless an agreement to extend the statue of limitations was entered into. If enough money is at issue, the taxpayer may consider bringing an action under the Tucker Act that provides for a six year statute of limitations. Please note that South Carolina follows the Federal Law for timely filing claims for refund, and refunds for South Carolina income tax should be available as well. As Certified Public Accountants whether practicing in public or private practice, this ruling has potential for great refunds. No need to make unintended gifts to the IRS.
NOTE: The opinion in Fisher was subsequently affirmed on appeal. See 333 Fed. Appx. 572 (Fed. Cir. Oct 09, 2009).
By Lindsey W. Cooper Jr., Esq. and Robert Baldwin, CPA, PFS, AEP.
Both authors work in Charleston, SC, at the Law Offices of L.W. Cooper Jr., LLC, and Baldwin and Associates LLC, respectively. Robert Baldwin is a former president of SCACPA.
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