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Court shoots down $100 million refund for New York Life

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The U.S. Court of Appeals for the Second Circuit has affirmed a district court’s decision that, with respect to two tax deductions claimed by New York Life, “all events” had not yet occurred to fix the insurer’s liability in the tax years in which it had taken the deductions. Because the insurer’s liability for the dividends was contingent, the circuit court held, it did not satisfy the regulatory requirements for deduction of an accrued expense.

The case

From 1990 through 1995, New York Life Insurance Company, a mutual life insurance company organized under New York law that was a calendar-year, accrual-basis taxpayer, distributed policyholder dividends to policyholders both at set periods and upon the occurrence of certain events, such as the death of the insured, as applicable New York law permitted it to do. Because the Internal Revenue Code (IRC) allows life insurance companies to deduct from gross income “an amount equal to the policyholder dividends paid or accrued during the taxable year,” 26 U.S.C. § 808(c), the insurer deducted the amount of these dividends.

The Internal Revenue Service (IRS) disallowed the deductions, ruling that the insurer could not deduct these dividend amounts until the tax year of payment. In the IRS’ view, the deductions did not satisfy the “all-events” test, which governs the deductibility of accrued but unpaid expenses. See Treas. Reg. § 1.461–1(a)(2)(i). 

New York Life contested the ruling, paid the taxes owed, and challenged the IRS’ determination by filing a refund claim for approximately $99.66 million (its calculation of the alleged overpayment) plus interest in the U.S. District Court for the Southern District of New York. The district court granted the IRS’ motion to dismiss the complaint, concluding that New York Life had failed to (and could not) allege that for the tax years in which they were deducted, the liabilities satisfied the “all-events” test.

The insurer appealed.

The deductions

In compliance with N.Y. Ins. Law § 4231 and the terms of its policies, New York Life paid certain of its whole life policyholders an annual dividend on the relevant policy’s anniversary date. The annual dividend comprised the policyholder’s share of the insurer’s surplus. 

The timing of the distribution of the annual dividend to eligible policyholders depended on the policy’s anniversary date and the schedule for the policyholder’s premium payments. The insurer’s practice in the relevant period was to credit a policyholder’s account with the amount of the annual dividend on a credit date that was before, but not more than 30 days before, the policy’s anniversary date. The credit would occur if, as of the credit date, the policyholder had paid all premiums necessary to keep the policy in force through its anniversary date. New York Life did not actually pay the dividend, however, until the credited policy’s anniversary date.

See also: New York Life’s dividends to policyholders to rise 8% in 2013

For most policies — those with anniversary dates falling from Feb. 1 through Dec. 31 — the credit date fell within the same calendar year as the anniversary date. For policies with January anniversary dates, however, the credit date and the anniversary date typically fell in different calendar (and thus tax) years. 

The insurer deducted from its gross income for tax year 1990 the cumulative annual dividends on policies that had credit dates in December 1990 and anniversary dates in January 1991. It did the same for tax years 1991 through 1995 (the deduction for the “annual dividend for January policies”). 

In addition, certain policies eligible for the annual dividend also were eligible, under New York Life’s practices, to receive an amount it called a termination dividend. This was a share of the insurer’s surplus that it paid the policyholder or beneficiary upon the policy’s termination, whether the termination occurred because the policy matured, the policyholder died, or the policyholder surrendered the policy to obtain its cash value. Although the termination dividend, like the annual dividend, was drawn from the insurer’s surplus, the two dividends were calculated on different bases. 

New York Life’s accrual and payment methods for the termination dividend were as follows. In each December from 1990 through 1995, the insurer calculated the annual dividends and termination dividends it expected to pay in the following year to eligible policyholders. It then determined, on a policy-by-policy basis, the lesser of the two amounts. It claimed the aggregate of those amounts on its returns for 1990 through 1995 as a deduction for an accrued dividend under IRC Section 808.

The tax law

IRC Section 808(c) permits life insurance companies to deduct from gross income “an amount equal to the policyholder dividends paid or accrued during the taxable year.”

Treasury Regulation § 1.461–1(a)(2)(i) provides that, for such taxpayers “a liability … is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which [1] all the events have occurred that establish the fact of the liability, [2] the amount of the liability can be determined with reasonable accuracy, and [3] economic performance has occurred with respect to the liability.”

The circuit court’s decision 

The Second Circuit affirmed the district court’s decision, finding that, with respect to the two claimed deductions — relating to two categories of policyholder dividends: (1) the insurer’s annual dividend for January policies, and (2) its termination dividend  — “all events” had not yet occurred to fix the insurer’s liability in the tax years in which it had taken the deductions. The circuit court stated that because the insurer’s liability for the dividends was contingent, it did not satisfy the regulatory requirements for deduction of an accrued expense.

The circuit court held that the IRS had properly disallowed New York Life’s deduction for the annual dividend for January policies, ruling that the insurer’s allegations did not support an inference that, as of the credit date, all events had occurred that had established “the fact of the liability” for that dividend as provided in Treasury Regulation § 1.461–1(a)(2)(i). In the circuit court’s view, New York Life’s argument overlooked that “the last link in the chain of events creating liability” — the policyholder’s decision to keep his or her policy in force through the policy’s anniversary date — did not occur until January of the following year, and that a policyholder might decide — before the policy’s anniversary date — to forgo the annual dividend and obtain the policy’s cash value.

Then, with respect to termination dividends, the circuit court found that New York Life had failed to allege that it had a contractual, statutory, or other obligation to pay a termination dividend upon surrender. For purposes of the all-events test, the Second Circuit ruled, the relevant inquiry was whether, for the taxable years in question, New York Life was obligated to pay the termination dividend to certain policyholders — and therefore, whether it bore a fixed liability for a minimum liability dividend for the years in which the deduction was claimed. The circuit court concluded that, given the allegations in the complaint, the answer was no.

The case is New York Life Ins. Co. v. U.S., No. 11–2394–cv (2d Cir. Aug. 1, 2013).

FC&S legal comment

The Second Circuit’s decision may be in conflict with the decision by the Court of Claims in Massachusetts Mutual Life Insurance Co. v. United States, 103 Fed. Cl. 111 (2012).

In that case, the Court of Claims permitted deduction of a policyholder dividend in advance of payment where the taxpayer insurance company also required that a policy be “in force as of the anniversary date” to entitle the policyholder to a dividend payment.

The Second Circuit first distinguished that case by noting that, there, the policy was considered “in force” simply “if the premiums for the policy [had been] paid through its anniversary date” but that in its case, New York Life defined eligibility for an annual dividend differently, requiring both that the policyholder have paid all premiums and that the policyholder not have surrendered the policy for cash prior to the policy’s anniversary date.

In any event, the Second Circuit then stated that, to the extent that the reasoning of the Massachusetts Mutual court was “at odds with ours,” it disagreed with that court’s approach.

For more, see:

Court: Insurance company not to blame for wrong beneficiary designation

Ex-Lincoln Memorial Life director guilty of fraud, money laundering

Court: Lapsed life insurance is no life insurance

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