Opinion ID: 3014809
Heading Depth: 3
Heading Rank: 2

Heading: Separate values

Text: The Tax Court nonetheless took the reinsurance model as evidence that Capital’s contracts could not be valued individually. It found that, at most, McCarthy had proven the value of the 376contract block sold by Capital, but it had not proven the value of each individual contract: [A]s it must, petitioner does not claim a single loss deduction in 1994 upon the termination of the 376 group contracts. Rather, petitioner claims 376 separate loss deductions relating to the termination of each of the 376 separate group contracts. What is required to support petitioner’s claimed loss deductions under section 165 are valuations of the group contracts that reflect a value for each contract as a separate and discrete contract. . . . [A]ll 4 A fairer analogy might be to odd-lot sales of stock. A shareholder who sells stock in even lots—traditionally, of 100 shares—will usually get a better price and/or pay a lower commission than one who sells “odd lots” of, say, one or six or twenty-three shares. As far as we are aware, shareholders may always value their stock on the assumption that it would be sold in normal market transactions, not in inefficient odd-lot transactions. McCarthy’s method is no more objectionable than this. 23 petitioner has done is establish that the group contracts are capable of being valued in blocks. Petitioner has not, however, established that the group contracts are capable of being valued separately and independently as individual assets. 122 T.C. at 250-51; see also Trigon, 215 F. Supp. 2d at 709 (“[T]he issue is not whether the highest and best use of Trigon’s contracts is as part of an ongoing health insurance company. . . . The issue, instead, is whether specific contracts can be valued separately from the block of contracts to which they belong.”). Capital argues that the contracts can be valued separately, and that McCarthy did in fact value each contract separately. McCarthy testified to this effect, noting that his valuation methodology in this case was consistent with his practice in appraising insurance contracts when advising insurers that are demutualizing: It was consistent, in that it took into account the characteristics of each contract being valued. It was consistent, in that it took into account as the standard of that to be discounted of the emerging stream of expected statutory earnings, and it was consistent, in that they were discounted to present value. He referred to this as a “seriatim or one-at-a-time valuation.” He readily admitted, however, that he calculated the contracts’ value based on an assumption that they would be sold in batches. We think that the Tax Court, and the Commissioner, misunderstood the requirements of separate valuation. As noted above, Newark Morning Ledger, 507 U.S. at 566, requires that a taxpayer wishing to deduct his losses of intangible assets must show that those assets are susceptible of separate valuation. In many cases, this will be impossible, simply because the taxpayer really possesses a single indivisible asset whose whole is incommensurable with the sum of its parts, a single mass “composed of constantly fluctuating components.” Id. at 567. Thus, for instance, a company may not depreciate its “assembled work force,” because new employees are constantly being trained to replace old ones, and because there is no meaningful way to assign 24 distinct values to each member of this workforce. Id. at 560. The value inheres in the “assembly” of the workforce, not in any one individual. Insurance contracts are different. They are valued all the time; indeed, Daniel McCarthy, Capital’s expert, has spent much of his career valuing health and life insurance contracts in order to advise insurers and regulators on the fairness of demutualization transactions. While the Tax Court and the Commissioner have numerous quibbles with Capital’s valuation, they do not persuade us that these contracts do not each have an individual value. As Capital succinctly puts it, “the Tax Court erred because it confused (1) the question of whether an intangible has a value and useful life separate from goodwill . . . , with (2) the question of what the asset’s value is.” The Commissioner cites several pre-Newark Morning News cases for the proposition that taxpayers may not use average values to compute the value of specific accounts. Sunset Fuel, 519 F.2d at 785-86; Skilken v. Comm’r, 420 F.2d 266, 270 (6th Cir. 1969). But the averaging procedures in those cases were far cruder than McCarthy’s sophisticated statistical methods here. McCarthy represented that the 376 contracts lost in 1994 constituted a “fully credible” block of contracts, such that a willing-buyer reinsurer would expect high- and low-value contracts to cancel each other out, and would therefore purchase the community-rated contracts based on average rather than individual experience. Experiencerated contracts were, at all points, valued individually. The evidence is clear that McCarthy’s voluminous, thorough, and professional valuation was meant to determine a value for each individual insurance contract. As part of that individual valuation, McCarthy used various averaging procedures, sometimes to check his work, but sometimes as part of his initial calculations. The undisputed evidence appears to be that such averaging procedures were consistent with industry standards for valuing group insurance contracts for the purposes of reinsurance or demutualization. McCarthy’s use of industry-standard statistical methods does not render his appraisal invalid, or support the Tax Court’s conclusion that Capital’s contracts could not be valued individually. We thus hold that that conclusion was clearly erroneous. 25