Placing a value on insurance stock

Over the last two years, your client has sold some of the stock and now is contemplating selling more.

What is the cost basis of the stock used to compute the capital gains for the last two years?

Solution

A mutual insurance company is one that is owned by participating policyholders (“members”) who possess ownership rights, such as voting and distribution rights, including the right to share in the insurance company’s residual value if it is being wound up.

Since the 1930s, more than 200 mutual insurance companies have converted into publicly traded stock companies.

As a part of this demutualization, existing members are typically awarded shares in the newly formed publicly traded entity to compensate them for the loss of voting control and the right to share in the insurance company’s residual value if it is wound up.

So how does one determine the basis of the shares received via demutualization?

The IRS position is that the basis of a policyholder’s membership is zero, and thus, the basis of stock received in exchange for a membership interest is also zero.

In a recent case (Fisher, 102 AFTR 2d 2008-5608), the Court of Federal Claims disagreed.

It stated that no gain should be realized upon the sale of stock received as a part of demutualization until the entire basis of the life insurance policy is recovered.

The IRS has not decided on whether to appeal the case.

For now, your client should discuss with his or her accountant the possibility of filing amended returns for prior open tax years since the client did not apply any basis against the proceeds.

Your client should be cautioned that the Fisher case may be overturned if appealed, and that other courts, including the Tax Court, may disagree with the Court of Federal Claims.

Tax INsight is prepared by experts who are active members of the American Institute of Certified Public Accountants. Tax INsight appears on the web and in IN Daily every Tuesday. Comments are welcome at IN_Editor@InvestmentNews.com.

Michael M. Eisenberg

Michelle Musacchio

Vinu Satchit

Keneth Straus

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