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Dear Tax Talk,
Is there any thing new with respect to demutualization? I still have my Prudential shares from when it
demutualized. If I remember right, it was the IRS conclusion that there was no cost associated with the
shares and that if I sold, 100 percent of the selling price is gain.
-- Alina
Dear Alina,
It looks like there is good news for shareholders who have hung onto their shares of an insurer that converted
from mutual ownership to a stock company.
In a mutual insurer, the policyholders were considered the owners of the insurer. The insurance
company was, in effect, a private company without stock trading on any exchange.
In the late 1990s and early part of this decade, many mutual insurers converted to stock companies.
The initial owners of the demutualized insurer were the policyholders. Many policyholders delighted in the found
money from the conversion and cashed in their shares in the IPO of the insurer, later finding out that the IRS'
position was that the sale was all gain.
The IRS reasoned that because the insured continued to own their insurance policy before and after
the demutualization, the policy owner in affect lost nothing and therefore the stock was without cost. It was, in
effect, a windfall. The IRS did not consider the insured's loss of voting and liquidation rights as an asset that
would allow cost (from the policy premiums) to be allocated to the shares.
The Federal Claims Court considered the IRS position and concluded that it was illogical. The Court
found that the IRS' own regulations consider all assets to have some value:
The regulations presume these values are obtainable, stating that "only in rare and extraordinary
cases will property be considered to have no fair market value." Treas. Reg. § 1.1001-1(a).
The court concluded that there was value given up by the policyholders in the demutualization. The
court agreed that it was impossible to assign a value to the relinquished rights and determined that the value of the
shares received should be applied to reduce the policyholder's cost basis in the insurance policy. To the extent that
the policyholder's basis in the insurance policy was less than the value of the shares received in the demutualization,
he or she would have gain.
In a life insurance policy, the cost of the policyholder is only relevant if the policy is surrendered
for its cash value. If the insured died, the amount received for the stock would not be considered a gain, but rather
part of the tax-free insurance benefit.
The court case may have come too late for many. The statute of limitations would preclude an affected
taxpayer from amending a return filed more than three years ago. If you filed an affected return from 2004 or later
less than three years ago, you can file a claim to request a refund. Because the appropriate presentation of a claim is
vital to your obtaining a refund, I recommend you find a CPA familiar with the law to assist in obtaining your refund.
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