Demutualization Soup: Another Ruling

July 25, 2012
By Kaye A. Thomas

Nearly four years after the first ruling in a demutualization case we have another one—and it’s inconsistent with the first one. At issue is the proper treatment of taxpayers who receive shares of stock when a mutual insurance company that issued policies to them converts into a regular corporation. The IRS has long taken the position that these shares have zero basis, so that when they are sold, the entire proceeds must be reported as capital gain. The Court of Federal Claims rejected that position in 2008, and in addition found that the open transaction doctrine applied, so that the selling shareholders would report zero gain on the sale.

The open transaction doctrine stems from Burnet v. Logan, a famous tax case in the U.S. Supreme Court. In essence it says that if we won’t know whether a transaction produced a gain until some later event occurs, the taxpayer will not have to report gain until that later event. However, this doctrine is to be used only in “rare and exceptional” circumstances.

The IRS disagreed with the ruling and continued to fight the issue in other courts. A new ruling involves a trust established by Bennett and Jacquelynn Dorrance to hold life insurance policies acquired for estate planning purposes. (Forbes lists Bennett Dorrance among the wealthiest Americans, with a fortune derived from Campbell Soup.) As in the previous case, the court rejected the position of the IRS that the shares have zero basis. However, the court also rejected the notion that the open transaction doctrine should apply. (In an odd coincidence, for this ruling the court cited a case called Campbell v. United States, involving a corporation called Campbell Chain Company, apparently unrelated to Campbell Soup.)

As a result, the court said further proceedings would be necessary to determine the basis of the shares. In making this ruling, the court noted that there is more than one possible way to measure basis, and said it would determine later which one is appropriate. As a result, we now have two decisions with differing methodology, one of which doesn’t even tell us at this point what methodology is appropriate. The only thing they agree on is rejection of the position of the IRS, that the shares have zero basis.


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