More On Legal & Compliancefrom The Advisor's Professional Library
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
A recent federal court decision ruled against the IRS's stance that policyholders who receive stock in a mutual-to-stock conversion of an insurance company--known as a demutualization--must pay taxes on the proceeds when the stock is sold.
In the case, Fisher vs. U.S., decided August 6, Judge Francis Allegra of the U.S. Court of Claims said such insurance company conversions are akin to an "open transaction," in which the court cannot distinguish between the value of the life insurance policy to the policyholder and the value of the policyholder's interest in the insurance company.
Ted Groom, a partner with the Groom Law Group in Washington, says the ruling may have far-reaching implications, but, he says, the "ruling is not necessarily advantageous to every policyholder." At this point, he says, "there are all sorts of questions and implications about this [ruling]." Groom does believe, however, that the IRS will appeal the ruling.
In the facts of the case, the plaintiff, Eugene Fisher, trustee for the Seymour Nagan irrevocable trust, had paid about $200,000 (an estimate, according to Groom) in premiums for his insurance policy to Sun Life, which afterwards demutualized. After the demutualization, "it appears that he continued to hold his policy and instead of receiving stock he elected to receive cash equal to approximately $32,000," Groom says. "The IRS's position has been that in demutualization transactions, you don't have any cost basis in the stock you receive so that the entire amount that you receive for your stock is taxable income. So the entire $32,000 is taxable income."
Groom notes that the plaintiff argued, however, that "of the $200,000 that I paid under the insurance policy, some part of that was allocable to the stock, therefore I have a cost basis in the stock and I shouldn't be taxed."
The court had several options: it could have agreed with the IRS, Groom says, or it could have tried "to figure out how much of the $200,000 that was paid in the policy should be allocated to the stock. But the court didn't do that either; it just said something of substantial value was paid for the stock so we don't agree with the IRS and we're going to follow this approach--the open transaction approach--in which we're not going to determine the tax consequences until we know how much is received into the policy and how much is received into the stock."
As it stands now, the starting question for most policyholders, Groom says, is whether the three-year statute of limitations has run out, considering that most companies that demutualized did so several years ago. "So the statute of limitations would have run out on the tax returns; but it may still be open for some people. If it's been more than three years since you filed your tax return for the year in question, generally the policyholder can't do anything about it, and neither can the IRS."
There are instances, though, in which policyholders would rather stick with the IRS's position, he notes. "For example, a policyholder both sold the stock that they got in the demutualization and then they terminated their policy. The sale of the stock would ordinarily be a capital gain and the policy income would be ordinary income, so some policyholders would rather have the IRS position." Also, if a policyholder got stock and also held onto, say, a life insurance policy, and if he then holds it until death, there would be no taxes on the proceeds, Groom says. "So a policyholder who holds onto the policy would like to have some or all of their basis allocated to the stock because that will reduce their tax on that transaction and they won't have any tax on the policy."