Court Opinion

ID: 8904777
Source: CourtListenerOpinion
Date Created: 2022-11-27 01:44:39.399383+00
Date Added: 2024-06-11T17:08:02.878974
License: Public Domain

BARRETT, Circuit Judge,
dissenting:
I respectfully dissent.
As required by law, Western filed in Kansas (just as such companies must in each state they are authorized to do business) the “Annual Statement” of financial condition and the results of operations for the reporting years on forms prescribed by and in accordance with the instructions of the National Association of Insurance Commissioners (NAIC), formerly known as the National Convention of Insurance Commissioners. The “Annual Statement” forms consist of detailed financial accounting under general headings of (a) Assets, (b) Liabilities, Surplus and Other Funds, and (c) Underwriting and Investment Exhibit. The “Annual Statement” is used by various state regulatory agencies or departments as the basis for examination. The instructions for the forms issued by the NAIC permit insurers to use either of two methods to report premiums payable in installment upon policies of insurance which grant the insured the option to pay the stated premium in installments. Some policies were issued for a one-year term, others for three-year terms and, in a few cases, some for five-year terms.
In each calendar year commencing 1954 and continuing through 1969, some of the single-year insurance policies issued by Western provided that the policyholder could pay the premium in installments during the policy year. If the policyholder had elected not to pay the premium when an installment became due, the policy simply lapsed. Those premiums over a policy term which need not be paid, at the option of the policyholder, are referred to as “deferred premium installments.”
Under the instruction forms issued by NAIC dating back to 1954 relating to property and casualty companies, Western chose to report the “deferred premium installments” as “premiums written.” When reported in that manner, the NAIC instructions required that all commissions payable to agents relating to those premiums be included as expenses in the underwriting. Thus, for federal income tax purposes — consistent with the requirements of the NAIC in relation to its reporting instructions— Western reported as “premiums written” the total premium provided for in the policy which, of course, included installments which became due beyond the then federal income tax calendar reporting year. The unpaid premiums were the “deferred premium installments.” When the deferred premiums are thus reported, the NAIC required Western to include the entire amount of commissions payable to its agents relating to those premiums (for the life term of the policy) in its Annual Statement as expenses in underwriting and investments.
In Western’s Annual Statement for calendar years 1967, 1968 and 1969, it booked deferred premium installments when the policies were issued and included the installments in unearned premiums as of the end of the year. Western charged unpaid commissions for the deferred premium installments as expenses of the year in which the policies were issued. Western’s auditors certified that this practice was “in conformity with insurance accounting principles prescribed or permitted under statutory authority,” and that the resulting net income reported in the statements was “ . in conformity with generally accepted accounting principles.” During the three taxable years, Western included deferred premium installments in its respective federal income tax returns in the gross premiums written during the year and in reserves for unearned premiums on outstanding business at the end of the year, and the commission expenses were deducted.
IRS allowed Western a deduction representing the amount of the commissions actually paid during the taxable year. This increased Western’s taxable income by $266,946 for the year 1967 and $311,217 for the year 1968. It decreased Western’s taxable income $241,086 for the year 1969. The amount of these adjustments is the difference between the commissions paid during the year and the commission expense deducted by the taxpayers for the year. The adjustment also represents the *522difference between the taxpayers’ reserve for commissions on deferred premium installments at the end of the taxable year and that reserve at the end of the preceding year.
I agree with Western’s contention that the Tax Court erred in sustaining the IRS position that Western is required, for the taxable years in issue, to change its method of accounting for commissions on deferred premium installments. Western argues that it is entitled to a current (taxable year) deduction, as ordinary and necessary business expenses, for projected future payments of commissions to agents on policies which provide for payment of the premiums in installments.
IRS argues that well-settled tax accounting principles prohibit a deduction of projected commissions prior to the period in which the taxpayer must pay them. Furthermore, IRS contends that nothing in 26 U.S.C.A. §§ 832(b)(6) and (c)(1), infra, authorize the exception urged by Western. § 832(c)(1), supra, allows as deductions “all ordinary and necessary expenses incurred, as provided in section 162 (relating to trade or business expenses) . . . .” § 162, 26 U.S.C.A. simply provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including certain itemized expenses and identifying those which are not to be allowed.
The Tax Court held that Congress intended by § 832(b)(6), supra, that no deduction from underwriting income for an expense incurred was to be allowed unless such deduction would also be allowable under subsection (c), supra, and that a deduction for unpaid commissions on deferred premium installments would not be allowable deductions under § 162, supra, since all of the events necessary to establish the fact of liability giving rise to such deductions had not occurred during the taxable year in which the deductions were claimed. The same proposition is well stated by the IRS: “In other words, the claimed expense must qualify as a deduction under Section 162, without regard for Subsection (b)(6) of Section 832; if it qualifies under Section 162 . and is ‘shown on the annual statement,’ . . . the expense is deducted as an expense incurred in determining underwriting income under Subsection (b)(3) and, through underwriting income, gross income under Subsection (b)(1).” [Brief of Appellee, p. 22.]
Western counters the above IRS contentions and Tax Court holdings on the basis that if an item is of a type allowed as a deduction under § 162, supra, it is then deductible for the year in which it is shown on the Annual Statement. In support thereof, Western argues that it is the intent of Subsection (b)(6) in every instance to defer to the method of accounting of the Annual Statement in determining when such item is deductible. I agree.
Section 832(c)(1) provides:
(c) Deductions allowed. — In computing the taxable income of an insurance company subject to the tax imposed by section 831, there shall be allowed as deductions:
(1) all ordinary and necessary expenses incurred, as provided in section 162 (relating to trade or business expenses);
Section 832(b)(6) provides:
(b) Definitions. — In case of an insurance company subject to the tax imposed by section 831—
* * * * * *
(6) Expenses incurred.- — The term “expenses incurred” means all expenses shown on the annual statement approved by the National Convention of Insurance Commissioners, and shall be computed as follows: To all expenses paid during the taxable year, add expenses unpaid at the end of the taxable year and deduct expenses unpaid at the end of the preceding taxable year. For the purpose of computing the taxable income subject to the tax imposed by section 831, there shall be deducted from expenses incurred (as defined in this paragraph) all expenses incurred which are not allowed as deductions by subsection (c). (Emphasis supplied.)
*523When these two sections are considered together, it seems clear to me that an insurance company may deduct “all ordinary and necessary expenses incurred” as provided in Section 162 under § 832(c)(1) and that under § 832(b)(6) “expenses incurred” is specifically defined to include all expenses shown on the Annual Statement approved by the National Convention of Insurance Commissioners, now NAIC. In Commissioner of Internal Revenue v. Standard Life & Accident Co., No. 75-1771, 433 U.S. 148, 97 S.Ct. 2523, 53 L.Ed.2d 653, 1977, the United States Supreme Court held that the Internal Revenue Code of 1954 requires computations of a life insurance company’s income taxes “in a manner consistent with the manner required for purposes of the annual statement approval by the National Association of Insurance Commissioners” unless the NAIC procedures are inconsistent with accrual accounting rules which require different treatment under the Code. On page 161 of 433 U.S. on page 2531 of 97 S.Ct. supra, the Court, after noting that the accounting approach adopted by the NAIC for purposes of preparing the Annual Statement is firmly anchored to § 818(a) of the Code which establishes a preference for NAIC accounting methods, stated in footnote 24, to-wit:
Evidence of congressional respect of NAIC accounting methods is not limited to the portion of the Code concerning life insurance companies. In defining “gross income” and “expenses incurred” for purposes of taxing certain other insurance companies, Congress expressly requires computations to follow “the annual statement approved by the National Convention of Insurance Commissioners.” 26 U.S.C. § 832(b)(1)(A), (b)(6).
No. 75-1771, p. 161, 97 S.Ct. p. 2531. A similar holding was rendered by the full Tax Court in Bituminous Casualty Corp. v. Commissioner, 57 T.C. 58 (1971), wherein the Court opined:
From the inception of the income tax in 1913 until 1921 insurance company income was computed for tax purposes under rules relating to corporations generally. In 1921, however, that system was recognized to be inappropriate and special rules were adopted. There had evolved in the insurance industry prior to 1921 a uniform format for reporting casualty company income. That format had been devised and developed by the insurance commissioners in the various States acting through an association then known as the National Convention of Insurance Commissioners and now known as the National Association of Insurance Commissioners, or sometimes simply as the NAIC. Thus, when the casualty insurance provisions were adopted in 1921, the statute specifically provided that income would be computed on the basis of “the underwriting and investment exhibit” approved by the National Convention of Insurance Commissioners. The substance of that exhibit, although modified and rearranged in some details, has remained essentially the same from 1921 to present time.
The Annual Statement method of accounting relies extensively on the use of estimated amounts which would be improper under general tax accounting. Thus, for example, instead of taking into income all of the premiums received or accrued, casualty insurance companies take into account only the portion of those premiums which are estimated to be “earned.” Similarly, the major deductions from income are “losses” and “loss adjustment expenses,” which are again estimated amounts. The deduction of these loss and loss adjustment expense items is fundamentally at odds with the “all events” test: The items include amounts for liabilities which are not established, but, on the contrary, vigorously contested; they include, in the case of the loss adjustment items, expenses which will not only be paid in the future, but which are attributable to events which will not even occur until the future, including future overhead; and they are so unsusceptible of accurate estimate that Internal Revenue Service rules applicable in certain contexts provide that estimates will be considered in aggregate amounts *524rather than individually and will not be disturbed if, over a period of years, they are on the average within 15 percent of the final figure.
* * * * * *
Petitioners herein do not contend that the Annual Statement method of accounting is controlling in every respect for tax purposes. However, the Internal Revenue Code clearly adopts the basic approach of the Annual Statement method in computing underwriting income and that basic approach, so far as it concerns income from premiums and losses from claims, is inconsistent with tax accrual rules applicable to commerce generally. (Emphasis supplied.)
57 T.C., at pp. 77, 78.
In Bituminous the Tax Court concluded that the usual principles of tax accounting must give way to the Congressionally preferred NAIC accounting system. The logic of the Bituminous ruling is, I believe, succinctly set forth in the Amicus Brief of NAIC:
For more than half a century, since prior to enactment of the Revenue Act of 1921, it has been recognized that rules of accounting applicable to ordinary businesses distort income when applied to property and casualty insurance companies. This distortion derives from the fact that in general commerce, expenses precede income: a manufacturer must incur the cost of manufacturing his product before he gets paid for it. However, in the insurance industry the reverse is true: the policyholder pays the insurance company in advance and the insurance company’s costs, which are primarily the payment of claims and the expenses related thereto, come afterwards. If the premiums were to be taxed as received and deductions allowed only as they become fixed, the result would be to distort property and casualty insurers’ tax liability by taxing very large sums when in fact such sums will never really become income because they will have to be paid out in settlement of claims, for the expenses of settling those claims, and for other operating expenses. (Emphasis supplied.) Brief of Amici Curiae, p. 2.
I would thus hold that the Tax Court decision is clearly erroneous. I would do so with full recognition of the rule that determinations made by the Commissioner of Internal Revenue are presumptively correct and that the burden rests on the taxpayer to establish error. Merchants National Bank of Topeka v. Commissioner of Internal Revenue, 554 F.2d 412 (10th Cir. 1977); Ruidoso Racing Commission, Inc. v. Commissioner, 476 F.2d 502 (10th Cir. 1973). I believe that the following language from Continental Insurance Company v. United States, 474 F.2d 661, 200 Ct.Cl. 552 (1973), is pertinent to the case at bar:
there is no question of tax avoidance presented here, but merely a question when salvage is to be taken into account for purposes of the federal income tax ... In these circumstances it seems best not to overthrow long-established practice merely to accelerate the receipt of taxes. Such a course of action would cause needless trouble and expense to insurance companies without the realization of any significant offsetting advantage to the government. 474 F.2d, at p. 671.
Valid business reasons have always been considered in the determination of tax consequences. Cravens v. Commissioner of Internal Revenue, 272 F.2d 895 (10th Cir. 1959). I believe that there are valid business reasons why there are no statutory provisions requiring insurance companies subject to the provisions of § 832, supra, to pursue an accrual method of accounting mandated upon life insurance companies under § 818(a) of the Code.
Thus, I would hold that the Tax Court erred in ruling that Western is not entitled to deduct agents’ commissions in respect of installment premiums in the taxable period in which such premiums are reported in the underwriting and investment exhibit of the Annual Statement in accordance with the instruction of NAIC.