Up until recently, I’ve always advised clients that they had zero basis in stocks they received from the demutualization of companies. Some of the companies include John Hancock, Anthem, Sun Life, Prudential, Met Life, Mutual of NY and Principal, just to name a few. The company frequently offered a cash option instead of the stock. In all cases, if the policyholder opted for cash or took stock and sold it within the first year, they paid the highest tax bracket applicable to their income on the entire gain. If they sold the stock after 12 months, they paid long term capital gain on the amount. That has all changed.
In 2006, Eugene Fisher, trustee for the Seymour P. Nagan Irrevocable trust sued the United States government for a refund of taxes from the sale of stocks received as a matter of demutualization. The case went through several trials and finally there was a ruling in favor of Fisher in 2009 and the trust received the tax paid and interest.
What This Means to Taxpayers
Prior to the ruling, taxpayers used the receipt of the stock as the day of ownership and zero basis paid for the stock. That meant that if they received stock or a cash option, they paid full taxation. On a $5000 transaction, that might mean as much as $1667. Since the ruling, the potential exists for zero tax owed. I use the term potential because the judge never said what the basis should be. Most tax experts agree that the value of the shares at issue is the basis. They also agree that the day you bought the policy is the date of “purchase” for the stocks.
What to Do for Previous Tax Years
If you’ve paid taxes on the entire gain from stock sold previously, you should file an amendment using tax form 1040X, using the policy issue date as your purchase date and the price per share of the stock the day it was issued. If you accepted a cash option, that’s your basis. While this isn’t a guarantee that the IRS will recognize your claim, it can’t hurt. Nobody knows what the IRS is going to do at this point, but you have a sound argument in the court findings. The worse that can happen is that you’ll receive no refund.
Be aware that you only have three years from the filing date for amended returns that receive a refund. For 2007 taxes, the final date for filing an amendment is April 15, 2011 since the filing date was April 15, 2008. Once that date passes, kiss your refund good-bye and congratulate yourself on helping to reduce the national debt.
Filing for That Year’s Taxes
Use the date of policy issue as your purchase date and the price of the shares the date the company issued them as your basis. Any proceeds from the sale are normally long term capital gain, since you use the policy issue date, not the stock issue date. Even though the law is not set in stone, you have good reason to believe it’s true. In this case, if you file using the stock price at issue as your basis, the worst thing that can happen is that the IRS charges you the taxes you’d pay anyhow if you hadn’t and interest. There is no penalty because you had reason to believe you were correct.
In doing this article, I came across a site by a CPA that states he was part of the Fisher case and will file your 1040X for 1/3 of the refund and $50 handling fee. Be aware that even though he may have been part of the case, as is well documented by the site, you can hire someone to do the 1040X for approximately $50 and keep the entire refund yourself.
Federal Claims Court: Fisher v United States
Kiplinger: Finding Basis for Demutualized Stock
Iowa State CALT: Court Says IRS Wrong on Taxation of Insurance Company Demutualization
List of Demutualized Insurance Companies