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Regulation and Compliance > Federal Regulation > IRS

IRS Sued Over Taxation Of Demutualization Payouts

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IRS Sued Over Taxation Of Demutualization Payouts


A lawsuit has been filed against the Internal Revenue Service in Federal Claims Court in Washington, D.C., seeking a refund for taxes paid on stock and cash distributions received when mutual insurers converted to stock companies.

The suit is the latest step in a controversy between the IRS and a group of CPAs and lawyers on the issue of whether a policyholder has a claim to more than the value of his policy when an insurer converts from mutual to stock status.

According to C.D. Ulrich, a Baxter, Minn., CPA, if the suit is successful, policyholders who received the distributions as far back as 1986 would not have to pay taxes when they sold the stock. But the suit only cites taxes paid for the year 2000 and beyond because a statute of limitations applies. Ulrich did say he was suggesting to potential class members that they should file for a refund if they had sold the stock recently to protect their position. The suit cites distributions to policyholders of 22 mutual insurers that converted to stock status, starting with Unum in 1986.

The suit was filed on behalf of an irrevocable trust created by a Rockville, Md., man. The plaintiff seeks a refund of the $5,725 in federal income taxes paid for the year ended Dec. 31, 2000. The tax was the result of the sale of stock distributed by Sun Life Assurance Company of Canada, when it demutualized in 2000.

But the plaintiff also seeks class-action status for the lawsuit. “The potential members of the class number is in the millions,” the suit said, adding that “the names of most of the class members are unknown to the identified plaintiff, but are known to, or ascertainable by, defendant, since the claims involved have all been filed with defendant [the IRS].”

It argues that the “the prosecution of separate actions by individual class members not only would be prohibitively expensive for both the class members involved and the defendant but also would create the risk of inconsistent or varying adjudications and the resulting prolongation of the resolution of the technical tax issues involved in this matter.”

It was filed in Federal Claims Court Dec. 1 and assigned to Judge George W. Miller. The IRS has 60 days from the filing date to respond to the suit.

The IRS claims the distributions are all taxable because, among other reasons, there is no way to determine the value of a policyholders relationship to a mutual insurer besides the benefits he receives from his policy.

But the lawyers and accountants representing policyholders maintain that the tax basis is a portion of the total premiums that have been paid on the underlying life insurance policy. “The position of plaintiff and of the other class members is that part of that part of the cost of the life insurance policy from which the stock is derived becomes the tax basis of the stock,” the plaintiff says in the suit.

In his comments, Ulrich said, “Anyone who has reported gain based upon the IRS advice that such cash or stock had a zero tax basis should consider filing a refund claim in order that the statute of limitations not be allowed to run on their potential refund prior to the ultimate disposition” of the suit.

The suit was filed by Burgess J.W. Raby of Tempe, Ariz.

Reproduced from National Underwriter Edition, December 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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