MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY, on its own behalf, AND MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY, as successor to CONNECTICUT MUTUAL LIFE INSURANCE COMPANY, Plaintiff-Appellee
UNITED STATES, Defendant-Appellant
Appeal from the United States Court of Federal Claims in No. 1:07-cv-00648-MBH, Judge Marian Blank Horn.
BERNARD JOHN WILLIAMS, JR., Skadden, Arps, Slate, Meagher & Flom LLP, Washington, DC, argued for plaintiff-appellee. Also represented by DAVID W. FOSTER, ALAN J. SWIRSKI, PAUL MCLAUGHLIN.
ARTHUR THOMAS CATTERALL, Tax Division, United States Department of Justice, Washington, DC, argued for defendant-appellant. Also represented by ROBERT WILLIAM METZLER, TAMARA W. ASHFORD.
Before LOURIE, MOORE, and O'MALLEY, Circuit Judges.
O'Malley, Circuit Judge.
The government appeals a judgment of the United States Court of Federal Claims in favor of Massachusetts Mutual Life Insurance
Company (" MassMutual" ) and Connecticut Mutual Life Insurance Company (" ConnMutual" ). The Court of Federal Claims ruled that MassMutual and ConnMutual were legally authorized to deduct policyholder dividends from their 1995, 1996, and 1997 tax returns in the year before the dividends were actually paid. See Mass. Mut. Life Ins. Co. v. United States, 103 Fed.Cl. 111 (2012). The parties agree that both companies may deduct the policyholder dividend payments at some point. They dispute the timing of the deductions, however; they debate whether the deductions may be taken in the year the insurance companies guaranteed the dividends, or may only be taken the following year--when the dividends were actually distributed to the policyholders.
The government contends that, because the liability to pay the dividends at issue is contingent on other events, such as a policyholder's decision to maintain his or her policy through the policy's anniversary date, the liability has not been established in the year the dividends were determined. Because a liability must be fixed before it can be deducted, the government argues that MassMutual and ConnMutual could not deduct their obligations until the following year. Even if the liability was fixed, the government alleges that these payments still could not have been deducted until the year they were actually paid because the dividends did not qualify as rebates or refunds, which would meet the recurring item exception to the requirement that economic performance or payment occur before a deduction may be taken.
Because we find that MassMutual's and ConnMutual's policyholder dividends were fixed in the year the dividends were announced, that the dividends in question are premium adjustments, and that premium adjustments are rebates, thereby satisfying the recurring item exception, we affirm.
Under the tax code, one can elect to recognize revenues and liabilities using different accounting methods, such as the " cash receipts and disbursement method" and the " accrual method." See 26 U.S.C. § 446(c). If a taxpayer uses the accrual method, which life insurance companies usually employ, an expense can be deducted in the year in which the liability is incurred, as opposed to the year in which it is paid. In order to determine if a liability has accrued during a taxable year, one must determine if the liability satisfies the " all events" test and if economic performance or payment of the liability has occurred. 26 U.S.C. § 461(h)(1),(4); see also United States v. Gen. Dynamics Corp., 481 U.S. 239, 243 n.3, 107 S.Ct. 1732, 95 L.Ed.2d 226 (1987). The liability satisfies the " all events" test when " all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy." 26 U.S.C. § 461(h)(4). If all three conditions are satisfied, the expense may be deducted before it is paid.
There are exceptions to this general principle, however. For example, if the liability is " recurring in nature and the taxpayer consistently treats items of such kind as incurred in the taxable year in
which [the all events test is met]," then a taxpayer may deduct it during any taxable year wherein the all events test is met, if the liability " is not a material item, or the accrual of such item in the taxable year in which the requirements of [the all events test] are met results in a more proper match against income than accruing such item in the taxable year in which economic performance occurs." 26 U.S.C. § 461(h)(3). Further, economic performance with respect to that liability must " occur within the shorter of--a reasonable period after the close of such taxable year, or 8 1/2 months after the close of such taxable year." Id. Therefore, if a taxpayer can demonstrate that economic performance will occur within a certain time frame in the next taxable year, that the liability is recurring, and either that the item is immaterial or that the accrual of the liability in a particular taxable year results in a better matching of the deduction with the income to which it relates (" the matching requirement" ), the liability can be treated as incurred during that taxable year. Id. ; 26 C.F.R. § 1.461-5.
Under Treasury Regulations, certain liabilities are deemed to meet the matching requirement without further consideration. These liabilities include rebates and refunds. 26 C.F.R. § 1.461-5(b)(5)(ii) ( " In the case of a liability described in paragraph (g)(3) (rebates and refunds) . . . of § 1.461-4, the matching requirement . . . shall be deemed satisfied." ).
A. Disputed Insurance Policies
MassMutual is a mutual life insurance company based in Massachusetts. In 1996, MassMutual merged with ConnMutual, with MassMutual emerging as the surviving entity. For tax purposes, MassMutual was an accrual basis taxpayer for the relevant tax years of 1995, 1996, and 1997 and, before the merger, ConnMutual was also an accrual basis taxpayer for the 1995 tax year.
Mutual life insurance companies, such as MassMutual, operate for the benefit of their policyholders, and do not have a separate group of shareholders. These companies typically offer policyholders two types of insurance plans: participating and non-participating policies. A participating policy is an insurance policy that is eligible to receive a portion of any distribution of the company's yearly surplus, while a non-participating policy is ineligible to receive such a share.
A mutual insurance company often will conservatively set premiums for its policyholders to ensure that the company will have sufficient funds to pay all benefits, even under extreme circumstances. This amount typically exceeds the funds necessary to cover the company's operating expenses and contractual obligations, resulting in a surplus. At the end of each year, the company will calculate the portion of its total surplus, known as the divisible surplus, which it will return to the participating policyholders in the form of policyholder dividends or a credit towards the policyholder's next insurance premium. This figure is approved by the company's board of directors when set and is then distributed to policyholders the following year.
For most participating plans, including MassMutual's, dividends are only payable to those policyholders whose policies are in force as of the anniversary date of the policy. A policy is considered in force if the premium for the policy has been paid through its anniversary date.
Under the Tax Code, such policyholder dividends are deductible from a life insurance
company's gross income. 26 U.S.C. § 801(b). Specifically, Section 808(c) permits life insurance companies to deduct these payments in " an amount equal to the policyholder dividends paid or accrued during the taxable year." 26 U.S.C. § 808(c). In 1995, MassMutual implemented a policy of guaranteeing a minimum amount of dividends (" guaranteed dividends" ) it would pay the following year to a defined class of eligible policyholders--those with post-1983 policies. The board of directors determined the guaranteed dividend each year, and passed resolutions memorializing this figure. MassMutual believed that this guarantee would fix the expense, such that the dividend would be considered accrued for tax purposes, because so long as there was at least one member of the defined class known by December 31 of the taxable year, it was certain that the entire guaranteed dividend would be paid the following year. In other words, because the guaranteed payment was guaranteed to an entire class of policyholders on a pro rata basis, if even one class member was eligible for receipt of a dividend, that class member would receive the entire guaranteed amount. Because at least one such class member could be identified by December 31 in each year the guarantees were set, MassMutual believed its payment liability was thus established, regardless of the number of policyholders who might ultimately share in that guarantee. ConnMutual adopted a similar policy in 1995.
In light of this new policy, during the relevant tax years of 1995, 1996, and 1997, MassMutual (and ConnMutual for 1995) deducted from its tax refunds the portion of the guaranteed dividend that would be paid by September 15 of the next year in the year the dividend was guaranteed, believing this deduction complied with the Tax Code and Internal Revenue Service (" IRS" ) regulations. See 26 U.S.C. § 461(h)(3)(A)(ii); 26 C.F.R. § 1.461-5(b)(ii) (" Economic performance with respect to the liability occurs on or before the earlier of (A) [t]he date the taxpayer files a timely . . . return for that taxable year; or (B) [t]he 15th day of the 9th calendar month after the close of that taxable year." ).
For example, MassMutual claimed it could deduct $118,975,383 from its 1995 taxes, after it determined in late 1995 that its guaranteed dividend for 1996 would be $185 million. To arrive at this figure, MassMutual first calculated the dividends it expected to pay the class of eligible policyholders, multiplied this amount by 85% to account for the possibility that some policies might lapse, and then determined how much of this figure, i.e., the guaranteed dividend, would be paid by September 15, 1996. Thus, although the guaranteed dividend for 1996, was $185 million, MassMutual only deducted $118,975,383 from its 1995 taxes, instead of waiting to deduct the entire guaranteed dividend from its 1996 taxes.
For each disputed year, MassMutual disclosed to the relevant state regulators that it would pay guaranteed amounts to a class of participating policyholders, and each year the regulators had no objections. MassMutual did not, however, actually disclose the amount of the guarantees to the state insurance regulators and did not disclose the guarantee to its policyholders or its sales force. For its guarantee in 1995,
ConnMutual did disclose the guaranteed dividend in a footnote in its annual statement, but ConnMutual did not disclose the terms of the guarantee or that it would apply only to post-1983 policies. Like MassMutual, ConnMutual also disclosed to the state regulators that it would pay the guarantees and the regulators did not object. For each of the disputed years, the actual payment of dividends exceeded the guaranteed dividend by several million dollars--in 1996, the actual payment for both MassMutual and ConnMutual exceeded the guaranteed amount by $37.8 million; in 1997, the actual payment exceeded the guaranteed amount by $44.7 million; and in 1998, the actual payment exceeded the guaranteed amount by $55.1 million.
B. Court of Federal Claims Proceedings
In September 2007, MassMutual filed an action in the Court of Federal Claims on behalf of itself and ConnMutual to recover funds allegedly overpaid to the IRS for the 1995, 1996, and 1997 tax years. The dispute over the deductions arose after an IRS audit, in connection with which the IRS proposed adjustments to MassMutual's tax returns for 1995, 1996, and 1997 and ConnMutual's 1995 tax return, in part, because it found that MassMutual and ConnMutual could not deduct any portion of the guaranteed dividends in the year before the dividends were paid. These adjustments resulted in an alleged underpayment of taxes for the relevant years. To correct the deficiencies, MassMutual made the necessary payments under protest, and subsequently filed a ...