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Regulation and Compliance > Federal Regulation > IRS

Plaintiffs Ask For Conversion Distribution Tax Refunds

By Arthur D. Postal

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Organizers of a new lawsuit want to ease the tax burden on policyholders who have received cash and stock as a result of demutualizations.[@@]

A lawyer has filed the suit against the Internal Revenue Service in Federal Claims Court in Washington. The suit is seeking a refund for taxes paid on distributions received when mutual insurance companies converted to stock.

The suit is the latest volley in a debate between the IRS and a group of accountants and lawyers about the valuation of distributions. IRS officials and some private tax advisors disagree about whether a policyholder has a claim to more than the value of his policy when a policyholder-owned mutual insurer demutualizes.

C.D. Ulrich, a Baxter, Minn., accountant who supports the suit, says a court decision in favor of the plaintiff could mean that policyholders who received the distributions as far back as 1986 would not have to pay taxes when they sold the stock. The suit itself cites only taxes paid for the year 2000 and beyond because a statute of limitations applies, Ulrich says.

Ulrich says he is recommending that potential class members protect their legal position by filing for refunds if they have recently sold insurer stock received through demutualizations.

“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 lawsuit,” Ulrich says.

Burgess J.W. Raby, a Tempe, Ariz., lawyer, filed the suit on behalf of an irrevocable trust created by a Rockville, Md., man. The lead 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 that company demutualized in 2000.

The suit also lists distributions to policyholders of 21 other mutual insurance companies that converted to stock status, and the lawyer who filed the suit is seeking class-action status. “The potential members of the class number is in the millions,” the plaintiffs argue in their petition, 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 [the IRS].”

The plaintiffs argue 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.”

The suit was filed in Federal Claims Court Dec. 1, 2004, and assigned to Judge George W. Miller. The IRS has 60 days from the date of filing to respond to the lawsuit.

The IRS claims the distributions are all taxable because, among other reasons, there is no way to determine the value of a policyholder’s relationship to a mutual insurance company besides looking at the benefits he receives from his policy.

But representatives for the 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 plaintiffs argue in their petition.

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