Source: https://docs.justia.com/cases/federal/district-courts/arizona/azdce/2:2009cv01284/450218/121
Timestamp: 2017-07-23 15:36:03
Document Index: 422179146

Matched Legal Cases: ['§\n7312', '§ 1346', '§ 7422', '§ 1391', '§ 61', '§ 1001', '§ 1', '§ 1012', '§ 1', '§ 1', '§ 1']

FINDINGS OF FACT AND CONCLUSIONS OF LAW AND JUDGMENT re Plaintiffs are entitled to a refund of taxes in the amount of $161,719 for Dorrance, et al v. United States of America :: Justia Dockets & Filings Log In
Bennett and Jacquelynn Dorrance,
No. CV-09-1284-PHX-GMS
On December 18 and 19, 2012, this matter was tried to the Court without a jury.
(Doc. 114, 115.) This Order constitutes the Court’s findings of fact and conclusions of
law under Federal Rule of Civil Procedure 52(a).1
In 1996, Bennett and Jacquelynn Dorrance (“Plaintiffs”) purchased several life
insurance policies from mutual companies. Along with insurance benefits, those policies
granted Plaintiffs mutual ownership rights in the companies (“mutual rights”) for as long
as they paid premiums. These mutual companies later demutualized and converted into
stock-based companies. In 2000 and 2001, the mutual companies compensated Plaintiffs
During trial, at the conclusion of Plaintiffs’ case, Defendant moved for partial
judgment pursuant to Federal Rule of Civil Procedure 52(c). Defendant argued that
Plaintiffs failed to meet their burden of proof. Defendant contended that Plaintiffs had not
provided an equitable method to apportion cost basis between their mutual rights and
insurance benefits. Furthermore, Plaintiffs did not offer evidence that they had a realistic
expectation of demutualization and that they paid an additional amount for mutual rights.
See Gladden v. Comm’r, 262 F.3d 851, 854-55 (9th Cir. 2001). The Court denied
for the loss of their mutual rights with shares of stock valued at $1,794,771. On June 23,
2003, Plaintiffs sold those shares for an aggregate amount of $2,248,806. Consistent with
IRS policy that policyholders have no basis in stock received during demutualization of a
life insurance company, Plaintiffs listed a zero cost basis when reporting their proceeds
for the tax year ending on December 31, 2003 and paid taxes on the full amount. On
October 15, 2007, Plaintiffs filed a claim for a refund, arguing that they did not owe tax
on their proceeds. Because the IRS did not issue a final determination regarding the
refund, Plaintiffs filed suit in this Court to affirm their claim on June 15, 2009.2
On July 9, 2012, this Court issued an Order ruling on the Parties’ cross-motions
for summary judgment. (Doc. 88.) Defendant argued that Plaintiffs paid premiums to
acquire insurance benefits, not to obtain mutual rights under the policy. Accordingly,
Plaintiffs had no basis in the stock that was provided in exchange for those mutual rights.
However, this Court held that Plaintiffs had met their burden of showing they paid
something for the mutual rights because they paid premiums for policies that included
both policy rights and mutual rights.
Plaintiffs contended that the demutualization should be governed by the “open
transaction doctrine” which is employed when the basis in property that is split cannot be
allocated to the resulting assets because it is not clear how much each asset cost. See
Fisher v. United States, 82 Fed. Cl. 780, 795 (Fed. Cl. 2008) (aff’d without opinion by
Fisher v. United States, 333 Fed. App’x. 572 (2009)). For example, under this doctrine,
proceeds from Plaintiffs’ sale of stock would be considered return of capital from their
premiums, and they would thereby owe no tax. This Court held that the doctrine did not
apply because Plaintiffs’ mutual rights were not “elements of value so speculative in
Plaintiffs Bennett and Jacquelynn Dorrance originally sought a refund in the
amount of $2,678,411.10 for the taxable years ending December 31, 2002, 2003, and
2004 on three unrelated and distinct bases. (Doc. 1 at 1-2.) They sought a refund of
penalties and interest the IRS assessed against them for participation in an allegedly
illegal tax shelter. On October 10, 2011, Plaintiffs abandoned that portion of their
Complaint. (Doc. 64 at 2.) Plaintiffs also sought to recover an overpayment of taxes due
to the miscalculation of their investment interest expense deduction. That issue was
settled with Defendant. (Id.)
character as to prohibit any reasonably based projection of worth.” Campbell v. United
States, 661 F.2d 209, 215 (Ct. Cl. 1981).
The remaining issue for trial was to determine an equitable method to allocate the
premiums paid by Plaintiffs before demutualization and apply that amount as a cost basis
to calculate the taxable gain, if any, on their sale of stock.
In 1995, Plaintiffs formed the Dorrance 1995 Legacy Trust (the “Trust”)
and retained a financial consulting firm to assemble a pool of survivor coverage for their
heirs. Through that Trust, Plaintiffs purchased the life insurance policies at issue as part
of an estate plan. They purchased policies with the Prudential Insurance Company of
America (“Prudential”), Sun Life Assurance Company of Canada (“Sun Life”), Phoenix
Home Life Mutual Insurance Company (“Phoenix”), Principal Life Insurance Company
(“Principal”), and Metropolitan Life Insurance Company (“MetLife”) (collectively, the
“Companies”). At that time, all of the Companies were mutual insurance companies.
On April 28, 1996, Plaintiffs purchased the Principal policy with a face
value of $10,000,000 and annual premiums of $124,450. On April 30, 1996, Plaintiffs
purchased the Phoenix policy with a face value of $8,000,000 and annual premiums of
$106,355. On June 1, 1996, Plaintiffs purchased the Prudential policy, which provides the
bulk of their coverage, with a face value of $50,000,000 and fluctuating premiums. On
June 10, 1996, Plaintiffs purchased the MetLife policy with a face value of $17,500,000
and annual premiums of $254,350. On August 20, 1996, Plaintiffs purchased the Sun
Life policy with a face value of $2,275,000 and annual premiums of $33,259.
Mutual insurance companies issue no stock and have no shareholders.
Instead, initial capital requirements come from premiums paid by policyholders.
Policyholders are the owners of mutual companies which operate for their benefit and
seek to offer reliable insurance at a low cost.
A typical purchaser of a life insurance policy from a mutual company
understands that, by virtue of buying a policy, he or she becomes an owner of the
company. The possession of mutual rights was a typical selling point to potential
A stock-based life insurance company is organized and operated for the
purpose of making a profit for its shareholders. Policyholders may also be shareholders
if they purchase stock, but otherwise policyholders have no equity interest in the
company and no voting rights. If a stock-based insurance company has surplus, it is
distributed to the shareholders, not the policyholders.
Mutual rights include the right to share in company profits, to vote, and to a
preferred position in the event of liquidation. Each policyholder has one vote regardless
of how many policies the policyholder owns and of the size of each policy. These rights
arise by operation of state law and under corporate charters. See, e.g., NY Ins. Law §
7312(a)(3) (mutual rights defined as “including, but not limited to, the rights to vote and
to participate in any distribution of surplus whether or not incident to a liquidation of the
mutual life insurer.”). The Companies expressly defined their policyholders’ mutual
rights in their plans of demutualization.
Prior to demutualization, mutual rights were not separable from ownership
of the life insurance policy. A policyholder could not sell or transfer mutual rights
regardless of whether he retained the underlying policy to which they were inextricably
Plaintiffs paid premiums to the Companies which secured life insurance
and mutual rights. However, the Companies did not allocate premiums or assign an
independent cost to the mutual rights. Some of the Companies stated that policyholders’
mutual rights could not be valued prior to demutualization.
If an underlying policy was terminated, either because of missed payments
or because the death benefit came due, the mutual rights would also be terminated. For
Plaintiffs, no such divestiture occurred prior to the five demutualizations in this case.
The Companies demutualized into stock companies by exchanging the
policyholders’ mutual rights for shares of stock through processes that culminated in
2000 and 2001. They demutualized to raise additional capital through an initial public
offering (“IPO”) which occurred at the same time as the demutualization.
The demutualizations went through several levels of approval. First, the
Companies’ boards of directors investigated and voted to approve demutualization. This
investigation involved the opinions of independent actuaries and investment banks
regarding the fairness of the compensation to be given to policyholders. Second, state
insurance commissioners approved the plans. Third, the plans were submitted to
policyholders, who approved them by significant majority votes.
MetLife’s board unanimously approved its Plan of Reorganization on
September 28, 1999. Following approval by the New York state insurance commissioner,
a public hearing, and an approval vote by policyholders, MetLife’s IPO and
demutualization took place on April 4, 2000.
On December 18, 2000, Phoenix’s board of directors unanimously
approved its Plan of Reorganization. Following approval by the New York state
insurance commissioner, a public hearing, and an approval vote by policyholders,
Phoenix’s IPO and demutualization took place on June 19, 2001.
On March 31, 2001, Principal’s board of directors unanimously approved
its Plan of Conversion. Following approval by the Iowa state insurance commissioner, a
public hearing, and an approval vote by Principal’s policyholders, Principal’s IPO and
demutualization took place on October 22, 2001.
On December 15, 2000, Prudential’s board of directors unanimously
approved a Plan of Reorganization. Following approval by the New Jersey state
insurance department, a public hearing, and an approval vote by policyholders,
Prudential’s IPO and demutualization took place on December 12, 2001.
On September 28, 1999, Sun Life’s board unanimously approved its plan of
demutualization. Following approval by the Canadian insurance superintendent and the
Michigan state insurance commissioner, and an approval vote by Sun Life’s
policyholders, Sun Life’s IPO and demutualization took place on March 23, 2000.
After the Companies demutualized, Plaintiffs retained their policies and
continued to pay premiums but no longer had mutual rights. In exchange for relinquished
mutual rights, the Companies provided Plaintiffs with stock compensation.
When determining how many shares of stock to give policyholders, the
Companies calculated (1) a fixed component for the loss of voting rights, since each
policyholder was entitled to one vote, and (2) a variable component for the loss of other
rights, measured by the policyholder’s past and projected future contributions to the
company’s surplus.3 Of the variable component, 60% was an estimate of each
policyholder’s past contributions to surplus as of the calculation date while the remaining
40% was an estimate of future contributions.
Although the Companies used different methods to measure policyholders’
contribution to surplus, all obtained independent actuarial opinions that the share
allocation methods were sound and that the stock compensation was “fair and equitable.”
The Companies also obtained opinions from investment banks, concluding that the
compensation was fair to the group as a whole.
The Companies informed policyholders that their mutual rights were being
“exchanged” for stock. (Doc. 70-3 at 12; Doc. 71-1 at 11; Doc. 68-7 at 11; Doc. 69-1 at
20; Doc. 69-3 at 12.) In 2000 and 2001, Principal and Sun Life represented to the IRS
that the fair market value of the stock policyholders would receive during
demutualization approximately equaled the fair market value of mutual rights that
policyholders surrendered. (Doc. 24 at 3); I.R.S. Priv. Ltr. Rul. 200020048 at 6 (Feb. 22,
2000) (representation (g)) (Sun Life Private Letter Ruling).
The aggregate IPO value of the shares that the Companies granted to
Plaintiffs during demutualization was $1,794,771. At the time of the IPOs, Plaintiffs had
paid $15,265,608 in premiums on the five life insurance policies.
Plaintiffs received 2,721 shares in MetLife’s demutualization. The IPO
“Surplus” is the book value or equity of the insurance company. It is equal to the
company’s assets reduced by its liabilities.
stock price on April 4, 2000 was $14.25 per share. The IPO value of the shares Plaintiffs
received was $38,774. At the time of MetLife’s IPO, Plaintiffs had paid $1,017,400 in
Plaintiffs received 1,601 shares in Phoenix’s demutualization. The IPO
stock price on June 19, 2001 was $17.50 per share. The IPO value of the shares Plaintiffs
received was $28,018. At the time of Phoenix’s IPO, Plaintiffs had paid $638,130 in
Plaintiffs received 5,039 shares in Principal’s demutualization. The IPO
stock price on October 22, 2001 was $18.50 per share. The IPO value of the shares
Plaintiffs received was $93,222. At the time of Principal’s IPO, Plaintiffs had paid
$746,700 in premiums.
Plaintiffs received 58,455 shares in Prudential’s demutualization. The IPO
stock price on December 12, 2001 was $27.50 per share. The IPO value of the shares
Plaintiffs received was $1,607,513. At the time of Prudential’s IPO, Plaintiffs had paid
$12,730,342 in premiums.
Plaintiffs received 3,209 shares in Sun Life’s demutualization. The IPO
stock price on March 23, 2000 was $8.49 per share. The IPO value of the shares
Plaintiffs received was $27,244. At the time of Sun Life’s IPO, Plaintiffs had paid
$133,036 in premiums.
Plaintiffs sold all of their shares on June 23, 2003, for an aggregate value of
$2,248,806. The MetLife stock sold with proceeds of $76,953. The Phoenix stock sold
with proceeds of $15,289. The Principal stock sold with proceeds of $164,603. The
Prudential stock sold with proceeds of $1,925,797. The Sun Life stock sold with proceeds
of $66,164.
This is an action for the refund of federal income taxes in the amount of
$2,248,806 for the taxable year ending December 31, 2003. This Court has jurisdiction
by reason of 28 U.S.C. § 1346(a)(1) and 26 U.S.C. § 7422.
Venue is proper in this District under 28 U.S.C. § 1391(e) because
Plaintiffs reside in this District and because a substantial part of the events giving rise to
this claim took place in this District.
Taxpayers are required to report “[g]ains derived from dealings in
property” in their gross income under I.R.C. § 61(a)(3). In general, the amount of gain or
loss recognized upon the sale of property is the difference between the adjusted basis of
the property sold and the amount realized from the sale. I.R.C. § 1001(a), (c); Treas.
Reg. §§ 1.61-6(a), 1.1001-1(a).
A taxpayer’s basis in property is equal to the cost of that property to the
taxpayer. I.R.C. § 1012. A taxpayer must prove what he actually paid for property to
establish a basis in that property. See Gladden, 262 F.2d at 855. However, if “it is clear
that the taxpayer is entitled to some deduction, but he cannot establish the full amount
claimed, it is improper to deny the deduction in its entirety.” United States v. Marabelles,
724 F.2d 1374, 1383 (9th Cir. 1984).
“[W]hen property is acquired in a lump-sum purchase but then divided and
sold off in parts,” Treas. Reg. § 1.61-6(a) requires that “the cost basis of the property
should generally be allocated over the several parts.” Gladden, 262 F.3d at 853. Thus,
the default rule calls for the taxpayer to “equitably apportion[]” the basis of the property
among its elements when those elements are sold. Treas. Reg. § 1.61-6(a).
Taxpayers must prove their bases in property by a preponderance of the
evidence and substantiate the amount of the refund they seek. See Coloman v. Comm’r,
540 F.2d 427, 429 (9th Cir. 1976); United States v. Janis, 428 U.S. 433 (1976). The fact
that basis may be difficult to establish does not relieve a taxpayer from his burden.
Coloman, 540 F.2d at 430. Plaintiffs must prove that there is an equitable method of
estimating the amount they paid for mutual rights at the time they purchased insurance
policies and paid premiums.
Defendant contends that Plaintiffs did not pay an additional amount for
mutual rights and did not have a realistic expectation of demutualization. Therefore,
Plaintiffs should not be allocated any basis from the premium payments. See Gladden,
262 F.3d at 855. The Gladden Court addressed a situation where taxpayers did not own
the asset at issue at the time of a land purchase but rather, obtained unvested water rights
contingent on the execution of a government irrigation project. Id. In contrast, Plaintiffs
obtained vested mutual rights when they bought insurance policies. At the time of
purchase, Plaintiffs had voting rights and the ability to participate in any distribution of
the company’s surplus, whether or not that distribution was triggered by a
demutualization. Therefore, the Gladden “expectation test” is not applicable to these
facts. The correct question is how to allocate cost between mutual rights and policy rights
under Treas. Reg. § 1.61-6(a).
Although Plaintiffs’ mutual rights contributed to the insurance policies’
value from the time the policies were purchased, the cost of the mutual rights could not
be determined prior to demutualization. The mutual rights were not separable from the
policy rights and could not be sold. Therefore, the cost associated with acquiring mutual
rights cannot be established exclusively through Plaintiffs’ payment of premiums.
The first valuation of what Plaintiffs paid for mutual rights was the IPO
price of the shares they received pursuant to demutualization. The Companies determined
that the fair market value of the shares were equivalent to the value of the mutual rights.
Furthermore, the shares were allocated in exchange for mutual rights in a fair and
equitable manner, as determined by the Companies, actuaries, and state insurance
The Companies allocated shares to Plaintiffs based on (1) the value of
voting rights, (2) past contributions to surplus, and (3) projected future contributions to
surplus. Effectively, Plaintiffs paid for shares of stock in the demutualized Companies by
relinquishing voting rights and making contributions to surplus. However, projected
future contributions to surplus are a portion of premiums which Plaintiffs had not actually
paid before receiving shares and cannot be considered as a part of basis.
Therefore, Plaintiffs’ basis is equal to the combination of the IPO value of
shares allocated to Plaintiffs for (1) the fixed component representing compensation for
relinquished voting rights (“fixed shares”) and (2) 60% of the variable component
representing past contributions to surplus (“variable shares”).
The following is the calculation, by insurer, of the IPO value of the fixed
shares. For the MetLife policy, Plaintiffs were allocated 10 fixed shares amounting to an
IPO value of $143. (Doc. 70-3 at 23.) For the Phoenix policy, Plaintiffs were allocated 18
fixed shares amounting to an IPO value of $315. (Doc. 75-6 at 2.) For the Principal
policy, Plaintiffs were allocated 100 fixed shares amounting to an IPO value of $1,850.
(Doc. 68-7 at 29.) For the Prudential policy, Plaintiffs were allocated 8 fixed shares
amounting to an IPO value of $220. (Doc. 69-11 at 33.) For the Sun Life policy, Plaintiffs
were allocated 75 fixed shares amounting to an IPO value of $637. (Doc. 69-3 at 31.) The
aggregate IPO value of the fixed shares was $3,164.
The following are the calculations, by insurer, of the IPO value of the
variable shares.4 For the MetLife policy, Plaintiffs were allocated 2,711 variable shares
amounting to a value of $38,632. For the Phoenix policy, Plaintiffs were allocated 1,583
variable shares amounting to a value of $27,703. For the Principal policy, Plaintiffs were
allocated 4,939 variable shares amounting to a value of $91,372. For the Prudential
policy, Plaintiffs were allocated 58,447 variable shares amounting to a value of
$1,607,293. For the Sun Life policy, Plaintiffs were allocated 3,134 variable shares
amounting to a value of $26,608. The aggregate IPO value of the variable shares is
$1,791,606. Plaintiffs’ past contributions to surplus is equal to 60% of the aggregate IPO
value, amounting to $1,074,964.
Accordingly, Plaintiffs’ basis is equal to the IPO value of the fixed shares
($3,164) combined with 60% of IPO value of the variable shares ($1,074,964). That
amounts to a basis of $1,078,128 applicable to Plaintiffs’ sales proceeds of $2,248,806.5
The amounts of variable shares, by insurer, are calculated by deducting the
amount of fixed shares from the aggregate amount of shares allocated to Plaintiffs.
Plaintiffs offer a method to account for additional contributions made to surplus
After selling their shares in 2003, Plaintiffs paid tax on that basis at a 15% capital gains
tax rate. Thus, they are entitled to a refund of $161,719.20.
Any conclusion of law deemed a finding of fact is so adopted.
Plaintiffs paid for shares of stock in the demutualized Companies by contributing
to the Companies’ surplus and by relinquishing voting rights in exchange for the shares.
Accordingly, they had a cost basis in the shares of $1,078,128. Plaintiffs are entitled to a
refund of taxes in the amount of $161,719.20.
IT IS THEREFORE ORDERED that Plaintiffs’ request for a refund of taxes is
IT IS FURTHER ORDERED directing the Clerk of Court to terminate this
between the calculation date for share allocation and the IPO date, as an element of basis
in shares. (Doc. 119 at 5-6.) Plaintiffs provide this methodology for the first time in posttrial briefing. Their failure to provide this methodology at trial has waived it for purposes
of calculating additional contributions to surplus as an element of basis. See Air
Separation, Inc. v. William H. Cauley Ins., Inc., 967 F.2d 583 (9th Cir. 1992); Northwest
Acceptance Corp. v. Lynnwood Equipment, Inc., 841 F.2d 918, 924 (9th Cir. 1988).