First, a little background: life insurance companies come in (essentially) two flavors, stock and mutual. Stock companies are owned by (wait for it...) stockholders, who may or may not own policies issued by a given carrier. Any dividends accruing from the stock are distributed to the folks who own shares.
Mutual companies are owned (primarily) by their policyholders; buying a policy automatically makes you a part owner. Dividends from these companies generally flow back to their insureds. Dividends on these policies can be used to pay premiums, or provide additional insurance, or paid directly in cash. As with any such arrangement, dividends are not guaranteed.
But the focus here really isn't on dividends, but ownership itself. What does that really mean? It's not as if the president of the company calls up each policyholder for suggestions or ideas. From a practical standpoint, there are really only two benefits: one is, of course, the aforementioned dividends. The other is the potential for a nice settlement if (when?) a mutual company "demutualizes." That's not as scary as it sounds; it just means the carrier decides it doesn't want to be a mutual company anymore, and goes through a (lengthy) process to convert itself into a stock company.
That's all well and good, but let's remember that the "owners" are the policyholders, and they're entitled to "a piece of the action." So when a company demutualizes, it essentially "cashes out" the policyholders' ownership, and sends everyone a check representing their fair share. This can amount to a nice little windfall, but it can also mean tax problems. After all, what's the basis for the value? Is this a capital gains situation? Ordinary income? Or something else entirely?
For a long, long time, the IRS has taken the position that policyholders "hadn't paid anything for the shares and owed taxes on the full amount when the shares were sold. Cash distributions also were fully taxable."
Could that be right?
Well, for the past 7 years, Minnesota-based accountant Charles Ulrich has said "no." His thinking is that folks "had paid for their ownership rights through their premiums so the distributions should have been tax-free." In other words, he took the underlying insurance principle and applied it to the tax law. Pretty cool.
And now, pretty successful:
"A federal court recently agreed with his interpretation."
And this is no small victory: Ulrich thinks that there are some 30 million policyholders who've received such distributions. MetLife alone settled with 11 million insureds back in 2000, to the tune of $7 billion. That's a lot of dec pages.
Of course, the IRS wasn't exactly a big fan of Ulrich's efforts, and accused him of "promoting abusive tax shelters." They even demanded his client list, which he refused to turn over. Eventually, the Feds gave up on that tack.
Of course, the IRS has virtually unlimited funds and resources, and could appeal this decision. They could also fight future such claims, hoping for a different result. So the story's not completely over.
But it sure has a happy ending for Mr Ulrich, his clients, and a host of folks who may get a nice refund check from the Feds.