Source: https://appellatetax.com/tag/policyholder-dividends/
Timestamp: 2019-04-19 05:10:17+00:00

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The government has now filed its reply brief in MassMutual. The brief begins by asserting that the taxpayer has abandoned on appeal an argument that had persuaded the trial court — namely, “reliance on its annual-dividend obligation to individual policyholders to establish the fact of its liability under the dividend guarantees.” In the government’s view, that “about-face is fatal to its case.” The reply brief then addresses the taxpayer’s reliance on the Washington Post case. See our previous report here. It argues that, “unlike the group obligations in Washington Post, the alleged group obligations in this case were not otherwise fixed as to liability in the years in which the dividend guarantees were adopted” for reasons unconnected to the indeterminate membership of the group. The rest of the brief hews more closely to the topics discussed in the government’s opening brief, including the Supreme Court’s decision in Hughes Properties and the Second Circuit’s decision in New York Life. See our previous report here. The reply brief also argues again that its economic performance regulation is entitled to Auer deference.
The Federal Circuit has not yet announced a date for oral argument.
The government has filed its opening brief in MassMutual contesting the Court of Federal Claims’ conclusion that the taxpayer could accrue the amount of certain policyholder dividends in the year before they were paid. See our prior post on this case and the New York Life case here. The government’s brief raises three distinct objections to the decision.
The primary argument is that the liability to pay the dividends was not “fixed” under the all-events test. The government contends that no individual obligation was fixed at the close of the year, even if all the premiums had been paid, because the dividend would not be paid unless the policy remained in force on the anniversary date. This is the same argument that was accepted by the Second Circuit in New York Life, and the government’s brief here argues that the cases are indistinguishable (asserting that the Second Circuit’s effort to distinguish them was based on a misperception of the facts in MassMutual).
The brief argues that the case “clearly fits the General Dynamics fact pattern,” which it describes as one where the “potential obligee has taken some action that renders him preliminarily eligible to receive the payment, subject only to some other condition that is within his exclusive control” – here, “forgoing the right to surrender the policy for its cash value prior to the next anniversary date.” It rejects the proposition argued by the taxpayer that this alleged final condition is not a genuine “event,” but rather just a continuation of the status quo. The government points to a comment in the Restatement (Second) of Contracts stating that “a duty may be conditioned upon the failure of something to happen . . ., and in that case its failure to happen is the event” that constitutes a condition precedent. And it rejects the contrary suggestion in Burnham Corp. v. Commissioner, 878 F.2d 86 (2d Cir. 1989), as misguided. Finally, the brief argues that the taxpayer’s all-events-test interpretation proves too much because its logical implication is that the amount of the dividend could be accrued even if the company had not passed a board resolution in the taxable year guaranteeing an aggregate dividend – a position that the taxpayer has not argued.
Second, the government argues that the dividend guarantees did not even give rise to an obligation, fixed or otherwise, because they were not communicated to the persons who were to benefit from them. Thus, the government argues, the taxpayer could have walked away from the guarantees at any time. In addition, the government argues, the guarantees were not a meaningful “substantive undertaking” because, based on the historical data, the guaranteed payments were “already virtually certain to occur in the ordinary course of the companies’ business operations, independent of any ‘guarantee’ to that effect.” There is some degree of irony in this argument; on its face, certainty that the amounts will be paid would appear to be an argument in favor of accrual, not against it. But the certainty of which the government speaks refers to the aggregate amount of payment; it is not a concession with respect to an individual obligation being fixed.
Third, the government contests the Court of Federal Claims’ holding that the dividends fell within the “recurring item” exception. The government’s primary point here is that this determination turns on the meaning of “rebate, refund, or similar payment” in Treas. Reg. § 1.461-4(g)(3), and therefore the court should have deferred to the IRS’s interpretation of that regulation – even if that interpretation did not conclusively emerge until this litigation and is at odds with some earlier internal guidance on the regulation’s meaning. The general principle of so-called Auer or Seminole Rock deference to an agency’s interpretation of its own regulations has come under fire recently, with Justice Scalia stating that it should be abandoned and Chief Justice Roberts and Justice Alito indicating that they are at least open to reconsidering it. See Decker v. Northwest Environmental Defense Center, No. 11-338 (Mar. 20, 2013). So it will be interesting to see how the Federal Circuit responds to this argument, which presents a relatively weak case for deference because the claimed agency interpretation is just based on its litigation position.
The taxpayer’s brief is due April 4.
First, a quick refresher course. The “all events test” is described as the “touchstone” for determining when a liability has been incurred and a deduction can be accrued. Dating back to United States v. Anderson, 269 U.S. 422, 441 (1926), and now codified at I.R.C. § 461(h)(4), it originally provided for accrual when “all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy.” In the mid-1980s, litigation over the application of this two-pronged test yielded two Supreme Court decisions in rapid succession, with the taxpayer prevailing in the first one and the government prevailing in the second.
In United States v. Hughes Properties, Inc., 476 U.S. 593 (1986), the Court held that a casino could treat as a fixed liability the amounts shown on the jackpot meters of its progressive slot machines at the close of the taxable year. In United States v. General Dynamics Corp., 481 U.S. 239 (1987), the Court held that a self-insuring employer could not accrue amounts that it had reserved for payment of employee medical claims not yet filed for services already performed, even assuming that the amount of the liability had been determined with reasonable accuracy. The Court held that the fact of liability was not established until the employee filed a claim for reimbursement, which it termed a “condition precedent” to the establishment of liability that was not “a mere technicality” or a mere “ministerial” act. Id. at 242-45 & nn.4-5. Three dissenters argued that the case was essentially indistinguishable from Hughes Properties, where the Court had rejected the government’s argument that the fact of liability did not arise until the winning patron pulled the handle because until then it was possible that the jackpot would never be paid – for example, if the casino went out of business or declared bankruptcy. Id. at 248-49. The majority, by contrast, held that failing to file a claim was not “the type of ‘extremely remote and speculative possibility’” that was found in Hughes Properties not to “render an otherwise fixed liability contingent.” Id. at 244-45.
In 1984, Congress codified the traditional all events test in Code section 461(h)(4) and added a third prong for future years by enacting section 461(h)(1), which provides that generally “the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.” The Code, however, contains an exception from the economic performance requirement for “certain recurring items” if economic performance occurs within a reasonable period after the close of the taxable year and certain other conditions are met. I.R.C. § 461(h)(3). In the case of policyholder dividends issued by mutual insurance companies, the taxpayers have contended that the section 461(h)(3) exception is satisfied and therefore that their right to accrue those dividend payments turns on whether the original two-pronged all events test has been satisfied.
The insurer in MassMutual adopted Board Resolutions before the close of the taxable year guaranteeing an aggregate amount of policyholder dividends that would be paid in the upcoming year on each individual policyholder’s anniversary date. The government argued that the all events test was not satisfied until the year in which the dividends were paid because the Board Resolution could be revoked (though government counsel apparently characterized this as a “weak argument” at oral argument) and also because no precise dividend amounts could be allocated at the time of the resolution to an identifiable policyholder, since any individual policy might not still be in force on the anniversary date.
After a trial, the Court of Federal Claims rejected these arguments and allowed the taxpayer to accrue the amount of the dividends in the year before they were paid. Citing to Hughes Properties, the court said that it was not necessary that the identity of the individual recipients be known at the time of accrual. The court also stated that, “[a]lthough a condition precedent can prevent a liability from being fixed, if the only event(s) still to occur are the passage of time and/or the payment, the liability is considered fixed.” The court added that “the group of policyholders with paid-up policies were not at risk for their policies lapsing,” so the company “had an unconditional obligation” to those policyholders “to pay the guaranteed amounts of policyholder dividends.” The court then ruled that the dividends were “rebates” or “refunds” falling within the “recurring item” exception of section 461(h)(3), and therefore “economic performance” was not required before the expenses could be accrued.
After the Court of Federal Claims decision issued, but before it was ripe for appeal, the Second Circuit came to the opposite conclusion in a case involving policyholder dividends accrued by New York Life. That mutual insurance company also paid annual dividends on the anniversary date, but only if the policy was still in force and fully paid up (payment was required a month in advance). The taxpayer sought to accrue dividend payments due in January of the following year, since those policies had been fully paid up in December. The Second Circuit, however, ruled that the all events test was not satisfied for the January anniversary date policies, because of the possibility that the policyholder might choose to cash in the policy in January before the anniversary date and thus the policy would no longer be in force when the dividend came due.
The petition’s main contention is that the Second Circuit’s decision cannot be squared with Hughes Properties. Because MassMutual is just a trial court decision, the cert petition rests its claim of a circuit conflict primarily on older cases that predate General Dynamics, arguing that the Second Circuit’s decision “recreates a multi-circuit conflict resolved by this Court in Hughes Properties.” The timing of the respective decisions is such that MassMutual is not likely to provide much help in this regard; the Supreme Court can be expected to act on the cert petition by the end of May at the latest, well before a Federal Circuit decision is likely in MassMutual.
The government’s opening brief in MassMutual is due February 20. Its opposition to the petition for certiorari in New York Life is due, after one extension, on March 20.

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