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Life Insurance Demutualization and Tax Impact
| Posted on May 20, 2020 at 8:48 AM |
In the last twenty or so years, several major life insurance companies,
owned by their policy holders as a group, determined to change the format to
become a shareholder owned business. This process is called a demutualization.
Members receive either a cash payment or shares in the company in exchange for
their voting and liquidation rights, while retaining their life insurance
policies. The receipt of cash or shares will be considered taxable income to the
extent the value received exceeds the former member’s cost basis in the
property – rights – exchanged for the cash or shares. The receipt of cash would
be income at the time received. When a member received shares, that in and of
itself was not a taxable event until the member decided to sell the shares and
thereby realize the income. That is all basic tax law and seems straightforward
enough. The problem, of course, is determining the value of those rights given
up by the member in return for those shares or cash. Not surprisingly, the IRS
has taken the position that the member has a zero tax basis in the cash or
shares received. This disregards the fact that some portion of premiums paid by
a member for insurance was in return for the rights the member held and over
and above the actual cost of insurance itself. Of course, the premium payments themselves
were not broken out into specific aspects reflecting the cost of insurance, the
amount allocated to voting and other rights and any other item. This makes it
more difficult for the member, as taxpayer, to establish a cost basis. In litigation with the IRS, the courts have taken a variety of
viewpoints and results on the cost basis issue. If you, like many other folks,
have been holding onto shares received in a demutualization, it may be helpful
to consult not only with the insurance company itself regarding the issue but
also with a tax professional who may shed light on what your courts are likely
to decide. For some of us, this issue can result in either a large tax saving
or a large tax bill. It is worth looking into to understand the possible
outcome. |
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