Read the Second Circuit’s decision [PDF 160 KB]
This case concerns income tax deductions claimed by the taxpayer (a calendar year, accrual basis life insurance company) under section 808 for policyholder dividends paid or accrued during the tax years at issue.
The taxpayer’s practice was to credit a policyholder’s account with the amount of the annual dividend on a date that was before (but not more than 30 days before) the policy’s anniversary date. Thus, for policies with January anniversary dates, the date of credit and the anniversary date typically fell in different calendar (and tax) years.
Certain policies eligible for the annual dividend were also eligible to receive an amount known as a “termination dividend” (i.e., a share of the taxpayer’s surplus that it paid the policyholder or beneficiary upon the policy’s termination, whether the termination occurred because the policy matured, the policyholder died, or the policyholder surrendered the policy to obtain its cash value).
For each year, in December, the taxpayer calculated the annual dividends and termination dividends that it expected to pay in the following year to eligible policyholders. The taxpayer then determined, on a policy-by-policy basis, the lesser of the two amounts, and claimed the aggregate of those amounts on its returns for 1990 through 1995 as a deduction for an accrued policyholder dividend under section 808.
In its income tax returns for tax years 1990 through 1995, the taxpayer thus deducted amounts relating to these two types of policyholder dividends—i.e., the amounts that the taxpayer projected it would pay as policyholder dividends in the following years, but that were in fact not paid until the following years. The taxpayer claimed that its liability for these policyholder dividends had accrued under the deduction-timing rules of Reg. section 1.461-1(a)(2)(i).
The IRS denied the deductions, asserting that the all events and economic performance tests had not been met, and taking a position that the taxpayer could not deduct these amounts until the tax year of payment.
The taxpayer paid the tax assessment in full and then sought a tax refund of approximately $99.66 million, plus interest.
In the refund litigation before a federal district court, the parties agree that the “all-events” test governed and that the taxpayer could claim the deductions in a particular tax year only if “all the events have occurred that establish the fact of the liability” in that tax year.
The district court held that the taxpayer’s complaint failed to state a plausible claim that the all-events test was satisfied as to the two types of dividend-related deductions.
Today, the Second Circuit affirmed the lower court’s decision, finding that, with respect to the two claimed deductions, “all events” had not yet occurred to fix the taxpayer’s liability in the tax years in which the taxpayer claimed the deductions. The Second Circuit concluded that the taxpayer’s liability for the dividends was contingent, so it did not satisfy the regulatory requirements for deduction of an accrued expense.