G. MURRY SNOW, District Judge.
Pending before the Court are cross-motions for summary judgment. (Docs. 64, 67). For the reasons stated below, both motions are denied.
In 1995, Plaintiffs formed the Dorrance 1995 Legacy Trust (the "Trust"), which in turn purchased five life insurance policies in 1996. (Doc. 67-1 ¶¶ 16, 17). The policies were purchased with The Prudential Insurance Company of America ("Prudential"), Sun Life Assurance Company of Canada ("SunLife"), Phoenix Home Life Mutual Insurance Company ("Phoenix"), Principal Life Insurance Company ("Principal"), and Metropolitan Life Insurance Company ("MetLife"). (Doc. 65 ¶ 1). In the aggregate, the policies provided $87,775,000.00 in coverage. (Doc. 67-1 ¶¶ 19-23). The Trust purchased the policies in the anticipation that the benefits would provide liquidity to pay Plaintiffs' estate taxes upon their death, so that Plaintiffs' heirs would not need to liquidate the family stock portfolio to pay such taxes. (Doc. 67-1 ¶ 17).
All of the policies were purchased with mutual insurance companies. In a mutual insurance company, the policyholders have an interest in the company itself in addition to holding a policy. This interest provides the policyholder with certain rights, including the right to vote on corporate decisions and the right to receive the mutual company's surplus should the company liquidate. (Doc. 65 ¶ 7; Doc. 67-1 ¶ 6).
The five mutual life insurance companies demutualized through processes that began in 1998, 1999, and 2000, and culminated in 2000 or 2001. (Doc. 65 ¶¶ 32-38). In the process of demutualization, a mutual company changes its corporate structure into that of a stock company, often through a procedure governed by state statute. (Doc. 67-1 ¶ 39; Doc. 65 ¶ 24). Policyholders must vote to approve a demutualization before the process can proceed. (Doc. 67-1 ¶ 40).
When the Trust received its IRS Form 1099-B, the form listed the basis in the Trust's stock as zero, consistent with IRS policy that policyholders have no basis in stock received by a policyholder during demutualization of a life insurance company. (Doc. 67-1 ¶ 66). Plaintiffs paid the taxes thereby owed, and subsequently filed this claim for relief.
Defendant has filed a motion for summary judgment, arguing that no part of Plaintiffs' periodic payments for their original insurance policies was paid to acquire the mutual rights under the policy, and that all of the premium was paid to purchase the policy. As a result, under this theory, Plaintiffs would have had no basis in the stock that was provided in exchange for those rights. (Doc. 64).
Plaintiffs likewise have filed a motion for summary judgment, arguing that the demutualization should be governed by the open transaction doctrine, which is employed in circumstances where the basis in property that is split cannot be allocated to the resulting assets. Under this theory, all of the proceeds from Plaintiffs' sale of stock would be considered return of capital from their premiums, and they would thereby owe no tax. (Doc. 67).
I. Legal Standard
Summary judgment is appropriate if the evidence, viewed in the light most favorable to the nonmoving party, shows "that there is no genuine issue as to any material fact and that the movant is entitled to judgment as a matter of law." FED. R. CIV. P. 56(c). Only disputes over facts that might affect the outcome of the suit will preclude the entry of summary judgment, and the disputed evidence must be "such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986). "[A] party seeking summary judgment always bears the initial responsibility of informing the district court of the basis for its motion, and identifying those portions of [the record] which it believes demonstrate the absence of a genuine issue of material fact." Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986).
Defendant claims that Plaintiff has not met its burden of establishing that it paid anything for the mutual rights at all.
A. The Burden of Proving Basis in Property
Under the Internal Revenue Code, gross income includes "[g]ains derived from dealings in property." 26 U.S.C. § 61(a)(3) (2006). The gains derived from property are defined as "the excess of the amount realized therefrom over the adjusted basis." 26 U.S.C. § 1001(a). The basis of property is defined by regulation as "the cost of such property." 26 U.S.C. § 1012(a). The burden of establishing a basis in property "rest[s] on the taxpayer." Coloman v. C.I.R., 540 F.2d 427, 429 (9th Cir.1976).
When a taxpayer offers only an "unverified statement that he had contributed property ... to the partnership," he has not met his burden of showing he invested in the underlying asset. Coloman, 540 F.2d at 427. On the other hand, when a taxpayer has shown that he made some investment into property, but cannot establish the value of that investment, his basis should not be declared zero "on the ground that it [is] impossible to tell how much he had in fact spent." Cohan v. Comm'r of Internal Revenue, 39 F.2d 540, 543 (2d Cir.1930) (Hand, L., J.). In such cases, the government "should make as close an approximation as it can" to the actual basis, "bearing heavily if it chooses upon the taxpayer whose inexactitude is of his own making." Id. at 544. More recent decisions of the Ninth Circuit have continued to rely on Cohan, noting that if "it is clear that the taxpayer is entitled to some deduction, but he cannot establish the full amount claimed, it is improper to deny the deduction in its entirety." United States v. Marabelles, 724 F.2d 1374, 1383 (9th Cir.1984).
Plaintiffs have met their burden of showing they paid something for the mutual rights by proving that they paid premiums for policies that included the policy rights and the mutual rights. Defendant's motion for summary judgment is therefore denied. The question at issue is how that basis ought to be allocated between the two assets that were created when the companies demutualized.
B. The Open Transaction Doctrine
The open transaction doctrine allows a taxpayer to apply gains received from the sale of a portion of a piece of property to the entire original basis without apportioning the basis between the property that was sold and the property that was retained; the doctrine is available only in "rare and exceptional" circumstances. Fisher, 82 Fed. Cl. at 795. The doctrine was announced by the Supreme Court in Burnet v. Logan, 283 U.S. 404, 51 S.Ct. 550, 75 L.Ed. 1143 (1931), and although subsequent regulations have narrowed its scope, Logan remains the core authority for the open transactions doctrine. See, e.g., Ebert v. United States, 66 Fed. Cl. 287, 292 (Fed.Cl.2005) ("[Logan] addressed the question of whether a transaction whose value was contingent on future events could, in effect, be treated as a closed transaction."); Inaja Land Co., Ltd.
The taxpayer in Logan owned a share of an iron company which in turn owned 12% of an ore company. Logan, 283 U.S. at 409, 51 S.Ct. 550. The ore company apportioned the value of the ore it extracted to its shareholders, including the iron company in which the taxpayer held an interest. Id. In 1916, the iron company was sold to Youngstown Sheet and Tube Company; Youngstown paid the shareholders $2,200,000 in cash and agreed to pay 60 cents for every ton of ore extracted by the ore company. Id. Thus, the taxpayer received, in exchange for the shares she owned, both a lump sum and an income stream that depended on the continued success of the ore company. The Commissioner originally discounted the income stream to an estimated present value, and then apportioned the taxpayer's original basis in the fixed portion of the asset and the income stream according to the same ratio that they had to each other at the time of distribution. Id. at 411, 51 S.Ct. 550. The Supreme Court ruled that the taxpayer had not received two assets in exchange for her stock; instead she had received cash and "the promise of future money payments wholly contingent upon facts and circumstances not possible to foretell with anything like fair certainty." Id. at 413, 51 S.Ct. 550. It held that the value of the income stream could not be estimated, because it "had no ascertainable fair market value." Id. It therefore allowed the taxpayer to apply the entire basis of the original stock purchase to the cash portion of the transaction; as a result she realized no gain at the time, but would only do so were the ore payments to exceed her remaining capital investment. Id.
At its core, the Logan Court held that the basis in the stock could not be allocated between the income stream and the cash payment because the value of the income stream was too uncertain. Id. at 413, 51 S.Ct. 550. Had the Court accepted the Commissioner's allocation and the ore company subsequently seen better-than-expected production, or had it sputtered, the original basis allocation would have been incorrect. The Court did not address whether the relative cost of the income stream and the cash portion of the stock could have been determined when the stock was originally purchased; its focus was solely on the value of the separate portions of the asset at the time they were split. Id.
The open transaction doctrine has periodically been invoked by both the Government and taxpayers. The Government successfully urged application of the doctrine in Pierce v. United States, 49 F.Supp. 324 (Ct.Cl.1943). There, a bank had created a security company in which its shareholders were given an interest based on their interest in the original company, without paying anything more. After a federal law mandated dissolution of the security company, a taxpayer claimed that his original basis in the stock should be allocated between his remaining bank stock and the dissolution proceeds, which he claimed represented a loss. Id. at 329-30. The Court found that apportionment was inappropriate because "the exact answer to the question of profit or loss may be obtained by waiting till the bank stock is sold." Id. at 330.
A taxpayer successfully invoked the doctrine in Inaja Land Co., Ltd. v. C.I.R., 9 T.C. 727 (Tax Ct.1947). There, a company purchased land by the Owens River, near Los Angeles, for $61,000 to start a fishing club and to rent some of the property for livestock grazing. The City of Los Angeles,
In all of these cases, the basis a taxpayer had in the original asset could not be allocated when the asset was split because the value of the asset that the taxholder kept was "impossible to determine with fair certainty." Logan, 283 U.S. at 412, 51 S.Ct. 550. Because of this uncertainty, it was not clear whether the taxpayer had, or would eventually experience, a gain or a loss on the transaction as a whole, and it was determined that a taxpayer should not "be charged with gain on pure conjecture unsupported by any foundation in ascertainable fact." Inaja Land, 9 T.C. at 736. Regulations have replaced at least part of the open transactions doctrine, in particular with regards to contingent payments; there are now regulations allocating basis in any transaction that "provides for one or more payments due more than 1 year after the date of the sale or exchange." 26 C.F.R. § 1.483-1(a)(1).
In 2008, the Court of Federal Claims applied the open transaction doctrine in a case where a taxpayer had received a cash payment in exchange for his mutual rights during the demutalization of a life insurance company. Fisher v. United States, 82 Fed. Cl. 780, 795 (Fed.Cl.2008). After taking what it described as a "tour d'horizon" of the relevant caselaw, statutes, and regulations, the Fisher court noted that the open transaction doctrine remained "a viable, albeit limited, exception to the general rule enunciated" by 26 C.F.R. § 1.61-6(a). Fisher, 82 Fed. Cl. at 791. Writing after a trial in which the Government had argued that the mutual rights were worth nothing while the taxpayer had asserted that valuing the rights was impossible, the Court sided with the taxpayer, noting that "the ownership rights were, at the outset, inextricably tied to the underlying insurance policy and were not separately sellable." Id. at 795. It thus applied the open transaction doctrine, allowing the taxpayer to treat all of the premium payments he had made during the course of the policy as capital investment, and deferring any payment on the proceeds that the taxpayer had received in exchange for his rights. Id. at 799. The Federal Circuit affirmed without opinion. Fisher v. United States, 333 Fed.Appx. 572 (2009).
Other courts have not yet had the opportunity to consider whether application of the open transactions doctrine was appropriate in Fisher. See, e.g., Cadrecha v. United States, 104 Fed.Cl. 296 (2012) (declining to apply Fisher when the taxpayer's claim was untimely). Practitioners, however, quickly noted significant factual distinctions between historical open transaction
Another commenter pointed out that the arguments advanced by the parties in Fisher may have made it appear more difficult to allocate basis under the regulations than it actually was. The government had only put forward expert witnesses stating that the taxpayer had paid nothing for the rights, while the taxpayer had put forward only experts claiming that calculating the cost of the rights was impossible-neither party addressed "how use of the doctrine could be avoided altogether by applying reasonable alternative basis apportionment methods." Paul Galindo, Revisiting the "Open Transaction" Doctrine: Exploring Gain Potential and the Importance of Categorizing Amounts Realized, 63 Tax Lawyer 221, 234 (2009). Noting that the value of the stock and the value of the policy on the secondary market were both ascertainable at the time of demutualization, and a ratio from which to apportion basis could be calculated, the commenter wrote that apportionment "through the use of current and readily ascertainable relative fair market value data seems reasonable." Id. at 244.
Plaintiffs have failed to show that allocating basis between the mutual rights and the stock is so difficult that this case requires applying the open transactions doctrine. Despite disagreement as to what Plaintiffs may have paid for their mutual rights, there is no question that at the time of demutualization, both the value of the stock and the market value of the policy itself could be calculated. The open transactions doctrine prevents the government from forcing a taxpayer to apportion basis in transactions where only through waiting can "the exact answer to the question of profit or loss" be found. Pierce, 49 F.Supp. at 330. In Inaja Land, the rights ceded to Los Angeles were so uncertain that there remained a genuine question as to whether the land retained any value at all, because, depending on how much the city continued to pollute the river, the easement may have rendered the land worthless, and the company may have in fact sold its investment at a loss. Inaja Land, 9 T.C. at 736.
Since the value of both the mutual rights and the policy itself at the time of demutualization can be determined, there is no concern here that the taxpayer will be forced to pay tax on a transaction that is later proven to show a loss. The Ninth Circuit has confirmed that "taxation of an `open' transaction is deferred only to the extent that consideration received by the seller consists of property having no ascertainable fair market value in the year of sale." In re Steen, 509 F.2d 1398, 1404-05 (9th Cir.1975) (emphasis added). Here, Plaintiffs received stock, and retained a
The Court does not lightly disagree with another federal district court, and relies in some degree on arguments that do not appear to have been made before the Fisher court. But given the limited arguments at trial, it is not surprising that the Fisher court found that it was limited to deciding only whether "
The facts particular to this case show that applying the open transaction doctrine would be inequitable here. In Fisher, the plaintiff opted for the "cash election" upon demutualization, and thereby received an immediate payment in exchange for his mutual rights. Fisher, 82 Fed. Cl. at 783. Here, Plaintiffs received stock, held it for years, and sold it for $454,035 more than its market value at the time of demutualization. (Doc. 67-1 ¶ 65). The open transactions doctrine would therefore allow Plaintiffs to apply this gain to basis accrued through policy payments made before mutualization, even though the increase in value took place entirely after the rights were split. At the same time, since the open transaction doctrine would not recognize any separate bases in the policy and the stock, policy payments made after the companies demutualized would increase the total basis towards which the stock sale would be applied, even though these payments were not made to obtain the mutual rights or the stock.
The First Circuit conducted a sophisticated analysis of the treatment of distributions after a demutualization from the perspective of the insurer in UNUM Corp. v. United States, 130 F.3d 501 (1st Cir.1997). There, the insurance company claimed that the distributions to policyholders should be interpreted as a "policyholder dividend," and therefore should be deductible for the insurance company. Id. at 517; see 26 U.S.C. § 808(a). The court found that although UNUM had made a colorable argument based on the language of the statute, the court had an obligation to consider the statutory language in the context of the "basic policies and structure of the Code," and that "when the language is read against the background of the statutory structure, it becomes untenable." UNUM, 130 F.3d at 517 (quoting Colonial American Life Ins. Co. v. C.I.R., 491 U.S. 244, 257, 109 S.Ct. 2408, 105 L.Ed.2d 199 (1989)). So here, while the difficulty in pricing the mutual rights at the time the policies were purchased bears some surface resemblance to similar difficulties in open transaction cases, applying a doctrine that would permit Plaintiffs to realize untaxed gain of nearly a half a million dollars that post-dated demutualization, and to avoid taxation entirely should they hold their insurance policy until their death, does not comport with the background and basic policies of the tax code. Colonial American, 491 U.S. at 257, 109 S.Ct. 2408.
This Court need not opine on the continued viability of the open transaction doctrine, or speculate on what circumstances may trigger its application. Given the undisputed facts of this case, it need only note that the doctrine does not apply here. Summary judgment is denied to Plaintiffs.
C. Calculating Basis in Divided Property
When a taxpayer sells only one part of a piece of property, the entire cost of the property "shall be equitably apportioned among the several parts." 26 C.F.R. § 1.61-6(a). There is no single accepted method for apportioning basis equitably. The Ninth Circuit has suggested that one method for apportioning the basis to a certain property right that a taxpayer had sold while maintaining other rights would be to compare the price of the property, at the time it was originally purchased, to the market prices of similar properties without the right in question. Gladden v. C.I.R., 262 F.3d 851, 856 (9th Cir.2001) (returning the case to the district court and suggesting that "it may be possible to determine the premium price paid for the potential water rights by comparing the price of the land purchased by the partnership to prices of similar land without" such potential rights). Other circuits have suggested that basis can be equitably apportioned by comparing the fair market value of the two pieces of property at the time of division, and applying that ratio to the original cost. See Byram v. C.I.R., 555 F.2d 1234, 1236 (5th Cir.1977) ("What appellants should have shown, and never did, was the fair market value of the tract."); see also Urbanek v. United States, 731 F.2d 870, 873 (Fed.Cir.1984) (holding that allocating basis "in proportion to fair market value of the interests sold and retained" is "in accord with correct accounting practice").
Defendant argues that Plaintiffs did not pay a "premium" for the mutual rights by noting that Plaintiffs did not pay higher premiums after demutualization and that the mutual companies did not consider the mutual rights when calculating the prices of the policies. As noted above, at least one of the companies promised the policyholders that premiums would not rise under demutualization, perhaps to secure the votes of its policyholders. The comparison between the price of the policies pre- and post-mutualization would therefore not necessarily capture any actual premium paid by Plaintiffs for their policies relative to other polices available without mutual rights when Plaintiffs first acquired their polices.
In Gladden, the taxpayer had purchased a piece of property in which rights were anticipated but had not vested; the question for the court was how to assign basis to the potential rights when the land was purchased. 262 F.3d at 854. The Ninth Circuit suggested that the district court may calculate the premium paid for such rights by comparing the price of land with such potential rights to the price of comparable land without such expectations. Id. at 856. Under this method, the proper comparison here would be between the periodic premiums that Plaintiffs paid in order to purchase and retain their policies and the premiums that would have been required for equivalent polices offered over the same period that did not offer mutual rights.
True, the Gladden court was dealing with land that had the potential to gain rights, not land on which rights already existed. It did find, however, that the regulation on allocating property by its value "would be easy to apply ... if the water rights had already been vested when the partnership had purchased the land." Id. at 853.
Such a comparison is not possible from the current record. Defendant has only compared the cost of Plaintiff's policy before and after demutualization; it has not provided any evidence comparing the cost of Plaintiff's policy at the time it was purchased to similar policies lacking mutual rights. See Douglas P. Faucette & Timothy S. Farber, National Insurance Act of 2007 & Demutualization of Insurers: The Devil is in the Details, FDCC Quarterly 109, 123 n. 44 ("[A] sophisticated policyholder might have been willing to pay more for his policy, after incorporating the small probability that his mutual would liquidate or convert, and thereby owe him a portion of its otherwise-withheld surplus."). Moreover, parties have not had the opportunity to argue that using the method suggested by Gladden would be more equitable than comparing the value of the rights and the policy at the time of demutualization.
Neither party has yet presented evidence from which the Court could equitably apportion the premiums paid before demutualization as basis in the mutual rights and basis in the policies themselves. The Court has noted that previous Ninth Circuit caselaw suggests that the best method for such apportionment would be to compare the cost of Plaintiffs' policies to the cost of comparable policies issued by non-mutual insurance companies at the time of issuance. Gladden, 262 F.3d at 856. On the other hand, commenters writing specifically about the issue of applying basis to mutual rights have suggested that comparing the market value of the policy and the stock at the time of demutualization, and applying that ratio to the premium payments, would be more appropriate.
The Court need not address, at summary judgment, which method of apportionment is appropriate. Plaintiffs have shown that they may have paid something for the mutual rights. The open transactions doctrine does not apply because the facts here do not present "elements of value so speculative in character as to prohibit any reasonably based projection of worth." Campbell v. United States, 661 F.2d 209, 215 (Ct.Cl.1981), The regulation requires basis to be apportioned equitably. 26 C.F.R. § 1.61-6(a). The Court reminds the parties that, as in Fisher, the trial will be to the bench. See Galloway v. United States, 319 U.S. 372, 388, 63 S.Ct. 1077, 87 L.Ed. 1458 (1943) (holding that the Seventh Amendment right to a jury trial does not apply in suits against the United States because it "hardly can be maintained that under the common law in 1791 jury trial was a matter of right for persons asserting claims against the sovereign"). Parties will not bring forward arguments that have been rejected in this order, but are free to argue that either method, or some other equitable method of allocating basis, is appropriate.
1. Defendant's Motion for Summary Judgment (Doc. 64) is
2. Plaintiffs' Motion for Summary Judgment (Doc. 67) is
3. The Court has determined that Plaintiffs have demonstrated that they may have had some basis in the mutual rights, and that the open transaction doctrine does not apply in this case. The basis in the life insurance policies "shall be equitably apportioned among the several parts." 26 C.F.R. § 1.61-6(a).