In recent years, many mutual insurance companies, which are owned by their policy holders, have converted to corporations owned by stockholders. In the conversion process, known as demutualization, these companies issued shares of stock to their policyholders. The IRS has taken the position that these shares of stock had zero basis. According to that view, when the shares are sold, the entire proceeds must be reported as capital gain. Some taxpayers have challenged that view, arguing that they acquired these shares as a result of paying insurance premiums, so a portion of the insurance premiums should be considered basis for the shares. Last week, a United States District Court ruling in the Central District of California, Timothy D. Reuben v. United States, disagreed with other courts that have considered the question and held in favor of the IRS, finding that the shares had zero basis.
The courts have now taken three distinct approaches to this issue. The Fisher case applied the open transaction doctrine, so that no gain would be recognized on a sale of the shares. The Dorrance case refused to apply the open transaction doctrine but found that the shares have basis. The Reuben case completes the sandwich, finding that the shares have zero basis.