Overview of Tax Court Representative Cases:

Litigating Insurance Tax Cases Overview of Tax Court Representative Cases: A View from The Bench with Judges Mark V. Holmes and Albert G. Lauber May 11, 2018 Susan Seabrook Partner, (US) LLP 2018 (US) LLP

Selected Cases for Discussion Avrahami v. Commissioner, 149 T.C. No. 7 (2017) R.V.I. Guaranty Co. v. Commissioner, 145 T.C. 209 (2015) Webber v. Commissioner, 144 T.C. 324 (2015) Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1 (2014) Securitas Holdings, Inc. v. Commissioner, T.C. Memo. 2014-225 Acuity v. Commissioner, T.C. Memo. 2013-209 State Farm Mutual Automobile Ins. Co. v. Commissioner, 135 T.C. 543 (2010), aff d in part, rev d in part, 678 F.3d 357 (7th Cir. 2012) Cigna Corp. v. Commissioner, T.C. Memo. 2012-266 Minnesota Lawyers Mutual Ins. Co. v. Commissioner, T.C. Memo. 2000-203, aff d, 285 F.3d 1086 (8th Cir. 2002) Utah Medical Ins. Ass n v. Commissioner, T.C. Memo. 1998-458 3

Avrahami v. Commissioner Question presented: Whether captive insurance company s elections to be treated as a small insurance company and to be taxed as a domestic corporation were invalid Taxpayer position: Amounts paid qualified as insurance premiums for Federal income tax purposes Government position: Amounts transferred out of captive insurance company were distributions Tax Court: Taxpayers did not enter into a valid insurance transaction No risk distribution Not insurance in its commonly accepted sense Apparently, premiums not otherwise deductible as a section 162 deduction No penalties on the insurance transaction Foreign-domiciled captive lost its elections, but parties agreed to no U.S. income 4

R.V.I. v. Commissioner Question presented: Whether residual value insurance policies were contracts of insurance for Federal income tax purposes Taxpayer position: Contracts insuring against the risk that the actual value of an asset upon termination of a lease would be significantly lower than the expected value are contracts of insurance Government position: The protection purchased by the lessors covered investment risk rather than insurance risk Tax Court: The risks incurred by the policies sold cover an insurance risk and, therefore, the policies constitute contracts of insurance for Federal income tax purposes 5

Webber v. Commissioner Question presented: Whether the income earned by investment accounts managed through private placement variable life insurance was taxable to the owner of the policy Taxpayer position: Neither the Investor Control doctrine nor the Constructive Receipt doctrine applied to tax income earned through these investment accounts Government position: Mr. Webber retained sufficient control and incidents of ownership over the assets in the separate accounts to be treated as their owner for Federal income tax purposes Tax Court: The IRS pronouncements enunciating the Investor Control doctrine are entitled to deference and weight Mr. Webber retained control and incidents of ownership over the assets held in the private placement-related investment account; he was therefore taxable on the income earned on those assets during the taxable years at issue 6

Rent-A-Center v. Commissioner Question presented: Whether payments to a subsidiary insurance company were deductible, pursuant to section 162, as insurance expenses Taxpayer position: The subsidiary was a bona fide insurance company, and the arrangement between the parties constituted insurance in the commonly accepted sense Government position: The subsidiary was created primarily as a tax shelter for the parent company and, in any event, there was no risk shifting Tax Court: Premiums paid by a parent company to a subsidiary insurance company on behalf of other wholly-owned subsidiaries were properly deductible as insurance premiums 7

Securitas v. Commissioner Question presented: Whether taxpayer is entitled to deduct premiums paid through captive insurance arrangement established by its parent corporation Taxpayer position: Captive insurance arrangement was insurance for Federal income tax purposes Government position: Parental guarantee blocked any actual risk shifting Tax Court: Payments made to a brother-sister insurance company were properly deductible as insurance premiums because the arrangement shifted risks, distributed risks, and constituted insurance in the commonly accepted sense 8

Acuity v. Commissioner Question presented: Whether the taxpayer s yearend carried loss reserves, as used in computing losses incurred, are a fair and reasonable estimate and represent only actual unpaid losses Taxpayer position: Reserves determined by professional actuaries through accepted actuarial methodologies and reported on the NAIC annual statement in accordance with NAIC statutory accounting guidance should be respected Government position: Relationship between the annual statement and section 832 does not prove that the carried loss reserves are fair and reasonable; the annual statement controls for what is includible in the reserve but not for the amount of the reserve Tax Court: Loss reserves based on NAIC and ASOP standards were fair and reasonable and represented only actual unpaid losses 9

State Farm v. Commissioner Question presented: Whether extracontractual amounts for bad faith damages are included in unpaid losses Taxpayer position: The Annual Statement method of accounting controls; amounts were properly included under those rules Government position: Annual Statement accounting does not control tax accounting for extracontractual losses; amounts properly accounted for as business expense under section 832(c) Tax Court: Not convinced that section 832(b) was intended to have the Annual Statement accounting control tax treatment of extracontractual losses; Sears not controlling 7th Circuit: Sears controlling; Annual Statement accounting controlling; NAIC has spoken to compensatory damages but not punitive 10

Cigna v. Commissioner Question presented: Whether Cigna may use AG 34 to compute its tax reserves for MGDB reinsurance Taxpayer position: There was no prescribed CARVM method in effect covering MGDB reinsurance on the date the contracts were issued, thus Cigna is required to use a method consistent with CARVM Government position: AG 34 did not exist and thus was not the method in effect on the date the contracts were issued, therefore Cigna may not use AG 34 Tax Court: IRS conceded the deficiency; parties stipulated that Cigna s tax reserves correctly computed [T]he tax reserve issue is a discrete legal issue involving a specific insurance product Not convinced that resolving the legal issue will alleviate the uncertainty for thousands of taxpayers Respondent represented he will not challenge petitioner or other taxpayers that used AG 34 to compute tax reserves for MGDB reserves Declined to decide the discrete legal issue 11

Minnesota Lawyers versus Utah Medical Minnesota Lawyers Question presented: Whether the taxpayer s reserves as reported were fair and reasonable Taxpayer position: Unpaid loss reserves set by internal departments should be sufficient for Federal income tax purposes Government position: The unpaid loss reserves were not fair and reasonable because they did not represent actual unpaid losses as accurately as possible Utah Medical Whether the taxpayer s reserves as reported were fair and reasonable Statutory reserves, although at the high end, were certified by a third-party actuary and should be OK for Federal income taxes Only the midpoint or tax equipoise of an actuarial range is the fair and reasonable estimate required by the regulations Tax Court: Reduced the insurance company s unpaid loss reserves to a courtdetermined fair and reasonable amount Although the reserve estimate was high, the actuary complied with actuarial standards; the estimate was upheld 12

Lessons Learned Precedent matters Know your audience Amicus can be influential Facts matter 13

Views from the Bench Practitioners commonly assume we should: Anticipate follow-up questions from the bench Use trial time wisely Tell a cohesive story Little details can make a difference 14