Circuit Court Addresses Proper Year of Deduction for Mutual Insurance Company Dividends
On April 9, 2015, the Court of Appeals for the Federal Circuit issued its opinion in Mass. Mutual Life Ins. Co. v. United States. The case considers the proper year for the deduction of dividends paid by MassMutual to certain of its policyholders. In reaching its decision in favor of the taxpayer, the Court of Appeals for the Federal Circuit distinguishes the recent decision of the Second Circuit in New York Life Insurance Company v. United States, which also considered the proper year for the deduction of various dividends paid by that company to its policyholders.
MassMutual is a mutual life insurance company based in Massachusetts that uses the accrual method of accounting. Life insurance companies often run surpluses because they make conservative assumptions about the level of premiums necessary to cover the company’s operating expenses and liabilities to policyholders for the year. Owners of participating life insurance policies issued by MassMutual are eligible to receive a portion of any distribution of the company’s surplus for the year.
In 1995, MassMutual adopted a policy of guaranteeing a minimum quantum of dividends that it would pay in the following year to eligible policyholders. This dividend was payable to the entire class of eligible policyholders on a pro rata basis. For purposes of determining its taxable income, MassMutual deducted, in the year that the dividend was guaranteed, the portion of the dividend that was payable by September 15 of the following year. The IRS disallowed MassMutual a deduction in the year of the guarantee arguing that, for various reasons, the dividend was not deductible until the year in which it was paid. In support of its position, the government relied upon the 2013 opinion of the Second Circuit in New York Life, which had considered a similar question.
The deduction for policyholder dividends is allowed by section 808 of the Internal Revenue Code, a provision specific to insurance companies. The deduction is allowed for policyholder dividends "paid or accrued" during the taxable year.
In general, a liability, such as an obligation to pay a dividend, must satisfy the “all events test” in order to be taken into account for U.S. federal income tax purposes. In addition, in many cases, a liability may not be taken into account before the year in which “economic performance” occurs with respect to the liability. For certain recurring liabilities, however, the liability may be taken into account prior to the year in which economic performance occurs, provided (i) the all-events test is satisfied, (ii) the item is not material, (iii) a “matching” requirement is satisfied and (iv) economic performance occurs within the shorter of (a) a reasonable period after the close of the taxable year in which the other requirements are satisfied, (b) 8-1/2 months after the close of such taxable year, or the item is recurring in nature and the taxpayer consistently treats items of such kind as incurred in the taxable year in which the requirements of all events test are satisfied.
The Parties’ Disputes
In claiming its deduction in the year the guaranteed dividend was determined, MassMutual relied on the exception to the economic performance rule for recurring items. The company argued that it had satisfied the all events test, the guaranteed dividends were not material, the matching requirement was satisfied because the dividends were “rebates,” and the guaranteed dividends were paid within a reasonable period after the close of the taxable year in which the amount the dividends were determined.
The government made several arguments in support of its position that MassMutual should be denied a deduction for the guaranteed dividend in the year the amount of the dividend was determined. The government relied on New York Life to support its positions that MassMutual had no obligation to pay the guaranteed dividends until the year they were paid and that MassMutual did not satisfy the all events test until the year in which the dividends were paid. The government also argued that the guaranteed dividends were not “rebates” within the meaning of section 461. Finally, the government argued that its interpretation of Reg. § 1.461-4(g)(3) concerning rebates and refunds was due judicial deference.
The Circuit Court’s Analysis
Relying on New York Life, the government argued that MassMutual had no obligation to pay the guaranteed dividends until its board approved a resolution to pay the dividends. The circuit court distinguishes New York Life on the grounds that MassMutual had a contractual obligation to pay a guaranteed dividend out of surplus once it was determined, while in New York Life the dividend would not be paid by the company unless certain other conditions were satisfied. It also was relevant to the circuit court that state regulators had the authority to enforce payment of MassMutual’s guaranteed dividend.
Similarly, the government argued that MassMutual’s liability was not fixed and the all events test was not satisfied because a condition precedent to the payment of the guaranteed dividend was that the policy remain in effect in the year of payment. The circuit court found, however, that MassMutual had an obligation to pay the guaranteed dividend to the entire class of policyholders on a pro rata basis. The lower court also had found, as a matter of fact, that some policyholders had paid-up premiums for their policies so that there were some policyholders who were certain to receive the dividend in the year the dividend was payable. By contrast, in New York Life, that company’s obligation to pay was determined individually with respect to each policyholder so it was critical that the particular policyholder’s policy was in effect in the year of payment.
With respect to the definition of “rebate,” the Court of Federal Claims had determined that there was no general definition of the term in the regulations. The circuit court therefore used basic rules of statutory interpretation to determine the meaning of the term. The circuit court concluded, referring to the 1992 definition of “rebate” in Black’s Law Dictionary, that the guaranteed dividend was a rebate. The circuit court also concluded that deference to the government’s definition of “rebate” was not warranted in this situation. The IRS had issued several Field Service Advice Memoranda (“FSAs”) that were cited by the government. The circuit court found the positions set out in the FSAs were not entitled to deference because they did not reflect the agency’s considered position, but were merely the views of litigating counsel.
 Fed. Cir. No. 14-05019 (April 9, 2015). 724 F.3d 256 (2d Cir. 2013) (“New York Life”). Mutual insurance companies are owned entirely by their policyholders. Generally, under an accrual method, income is to be included for the taxable year when all the events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy. Section 461(h)(4). Section 461(h)(1). For example, in the case of a liability of a taxpayer to provide services or property to another person, economic performance occurs as the taxpayer incurs costs in connection with the satisfaction of the liability. The provision is intended to prevent the accelerated deduction of liabilities that satisfy the all events test. Section 461(h)(3). See Reg. § 1.461-5(b)(5)(ii). For example, a policyholder was eligible for a certain dividends only if the policyholder kept the policy in effect through the policy's anniversary date.KEYWORD: Tax Accounting
Tax Insights Blog