taxes

When policyholders become shareholders

George SaenzQuestionDear Tax Talk,
My question is: Do we have to claim the full amount we received when we cashed in our demutualization shares?
-- Carole

AnswerDear Carole,
It doesn't happen often, but every now and then a taxpayer prevails and wins one against the Internal Revenue Service. A mutual insurer is an insurance company that is basically owned by its policyholders. When it demutualizes, the policyholders become shareholders, converting the company to a traditional stock company. This usually occurs in the course of the mutual insurer going public. The policyholders usually can opt to receive the shares or have the shares converted to cash.

The IRS contended that the policyholders have no basis in the shares received and therefore if they sold their shares, the full amount would be taxable capital gain. As of 2010, the Schedule D instructions maintain this as the IRS position.

In a Court of Claims case that was upheld on appeal, the court held that the IRS position was not appropriate in these circumstances and that the taxpayers had met their burden in proving the proceeds were a return of premiums previously paid. While the facts in this case may not be the same for all taxpayers, an opportunity exists for legally avoiding the taxation of the demutualization proceeds. Before filing your tax return, I recommend that you seek professional advice on this matter.

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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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