District Court Refuses to Apply Open Transaction Doctrine to Insurance Company Demutualization
Joe Kristan over at Roth & Co. has the full details, but this is certainly a case that warrants attention and may carry some interesting implications. We don’t want to step on Joe’s toes with the write-up, so we’ll just touch on why the decision is important and you can head over to Roth & Co. for the details.
In the early 2000’s, demutualizations were all the rage. In a demutualization, a so called “mutual insurance companies” — called such because policyholders own not only their insurance policy, but also an interest in the company such as the right to vote on corporate decisions or to receive corporate surplus upon liquidation– converts to a stock issuing company prior to going public.
When the mutual insurance company converts, policyholders continue to hold their insurance policies, but are also granted stock in thenew corporation to replace their former “ownership” rights.
An issue has always been how the policyholder determines his basis in the corporate stock received. On one side, the IRS has long maintained that the policyholder takes a zero basis in the stock, so that any subsequent sale will generate pure gain.
To the contrary, taxpayers have argued that the “open transaction doctrine” should apply to the demutualization. Become, taxpayer’s argue, the premiums they paid cannot be allocated between their dual interests after the conversion of policyholder and stock holder, all of the taxpayers premiums should be applied against any proceeds subsequently received upon the sale of the stock in determining gain.
The open transaction doctrine for demutualizationswas blessed in 2008 by the Court of Claims in D.C. in Fisher , and approved by the Court of Appeals.
On Monday, however, an Arizona District Court challenged the use of the open transaction doctrine in demutualizations, arguing that the policyholder’spremiums could be allocated between the stock received and continuing interest in the insurance policy, giving the policyholder a “basis” in each interest. Only the basis allocated to the stock received could be used against subsequent sales proceeds in computing gain or loss.
The District Court did not determine the proper methodology for allocating basis among the stock and policy; instead, the case will head for trial and a methodology will be established.
Check out Joe’s write-up for the details.
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