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.”