114 F.2d 314 (1st Cir. 1940), 3470, Commissioner of Internal Revenue v. Monarch Life Ins. Co.

Docket Nº:3470, 3475.
Citation:114 F.2d 314
Party Name:COMMISSIONER OF INTERNAL REVENUE v. MONARCH LIFE INS. CO. MONARCH LIFE INS. CO. v. COMMISSIONER OF INTERNAL REVENUE.
Case Date:August 15, 1940
Court:United States Courts of Appeals, Court of Appeals for the First Circuit
 
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114 F.2d 314 (1st Cir. 1940)

COMMISSIONER OF INTERNAL REVENUE

v.

MONARCH LIFE INS. CO.

MONARCH LIFE INS. CO.

v.

COMMISSIONER OF INTERNAL REVENUE.

Nos. 3470, 3475.

United States Court of Appeals, First Circuit.

August 15, 1940

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[Copyrighted Material Omitted]

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[Copyrighted Material Omitted]

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Edward H. Horton, Sp. Asst. to the Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, Sp. Asst. to the Atty. Gen., on the brief), for Commissioner of Internal Revenue.

Abbot P. Mills, of Washington, D.C. (Frederick A. Ballard, of Washington, D.C., Gurdin W. Gordon, of Springfield, Mass., and Underwood, Mills & Kilpatrick, of Washington, D.C., on the brief), for Monarch Life Ins. Co.

Paul F. Myers and James Craig Peacock, both of Washington, D.C., amici curiae.

Before MAGRUDER and MAHONEY, Circuit Judges, and FORD, District Judge.

MAHONEY, Circuit Judge.

This is a petition to review a decision of the Board of Tax Appeals reported in 1938, 38 B.T.A. 716 and is before this court on a petition filed by the Commissioner of Internal Revenue, and upon a cross-petition filed by the Monarch Life Insurance Company. The controversy relates to income taxes for the calendar years 1933 and 1934.

The question involved in the Commissioner's petition for review is whether

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certain reserve funds held by the taxpayer pursuant to state law were 'reserve funds required by law' within the meaning of Section 203(a)(2) 1 of the Revenue Acts of 1932 and 1934, 47 Stat. 224, 48 Stat. 732, 26 U.S.C.A.Internal Revenue Acts, pages 547, 730, entitling the taxpayer to a deduction from gross income. Although the reserves in question are admittedly set aside as reserves and required by the various state laws, the Supreme Court has held that in order to come within the meaning of 'reserve funds required by law' as used in Section 203(a)(2) the reserves must pertain to insurance in contradistinction to 'solvency' or ordinary business reserves. Helvering v. Illinois Life Insurance Co., 1936, 299 U.S. 88, 57 S.Ct. 63, 81 L.Ed. 56; Helvering v. Inter-Mountain Life Insurance Co., 1935, 294 U.S. 686, 55 S.Ct. 572, 79 L.Ed. 1227; Maryland Casualty Co. v. United States, 1920, 251 U.S. 342, 40 S.Ct. 155, 64 L.Ed. 297. The reserves in the instant case must satisfy this restricted meaning in order to be deductible.

The taxpayer's petition presents the question whether the Board was in error in determining that the discount allowed by the taxpayer on premiums on life insurance paid in advance of their due dates does not constitute interest paid on indebtedness within the meaning of Section 203(a)(8) 2 of the Revenue Acts of 1932 and 1934, 26 U.S.C.A.Int.Rev.Acts, pages 548, 732. The pertinent provisions of both of these acts, though of different years, are identical in terms, and the questions raised under each act are identical, only the amounts in controversy being different.

The facts were stipulated and the Board found as follows:

The monarch Life Insurance Company, taxpayer herein, is a corporation organized and existing under the laws of the State of Massachusetts, having its home office in Springfield, Massachusetts. It was organized December 31, 1931, to take over the business of the Monarch Accident Insurance Company, which was organized in 1921, and the Monarch Life Insurance Company, which was organized in 1926, both under the laws of the State of Massachusetts. The taxpayer was licensed to write life, accident and health insurance contracts, and was so engaged during 1933 and 1934, the taxable years herein involved, in the State of Massachusetts as well as in 23 other states and the District of Columbia.

More than 50 per cent of taxpayer's total reserve funds held during the taxable years were held for the fulfillment of life insurance contracts, and taxpayer was held to be taxable as a life insurance company, as defined in Section 201(a) of the respective Acts, 26 U.S.C.A.pages 546, 729.

For the taxable years the taxpayer filed separate statements for its life insurance business and for its accident and health insurance business, with the Commissioner of Insurance for the State of Massachusetts. These reports were required by chapter 175, section 25, of the General Laws of Massachusetts, and they were in the form adopted by the National Convention of Insurance Commissioners.

During the taxable years taxpayer maintained the following reserves which it

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claims were insurance reserves required by law, but which the Commissioner asserts were not insurance reserves within the meaning of Section 203(a)(2) of the Revenue Acts of 1932 and 1934, respectively:

1933
Dec. 31, Dec. 31,
Life Statement 1932 1933
Page 5, item 9--Reserve for incurred disability benefits ................... 3,843.00 4,467.00
Page 5, item 36--Reserve for nondeduction of deferred fractional premiums ................... 3,050.00 3,600.00
Accident and Health Statement
Page 5, item 25--Unearned premium reserve on accident and health policies ................. 395,800.00 350,519.14
Page 5, item 25 1/2--Additional reserve on noncancellable accident and health policies ........ 123,000.00 124,700.00
Page 5, item 19--Reserve for unpaid and unresisted claims ........ 264,632.00 180,539.23
----------
790,325.00 663,825.37
790,325.00
----------
1,454,150.37
----------
Mean of reserves disallowed ......................... 727,075.19
3 3/4% of mean, deducted on return but disallowed by respondent ....................... 27,265.32
1934
Dec. 31, Dec. 31,
Life Statement 1933 1934
Page 5, item 9--Reserve for incurred disability benefits .......... 4,467.00 7,102.00
Page 5, item 36--Reserve for non-deduction of deferred fractional premiums ................... 3,600.00 4,430.00
Accident and Health Statement
Page 5, item 25--Unearned premium reserve on accident and health policies ................. 350,519.14 365,819.00
Page 5, item 25 1/2--Additional reserve on noncancellable accident and health policies ................. 124,700.00 131,492.00
Page 5, item 19--Reserve for unpaid and unresisted claims ........ 180,539.23 213,839.39
----------
663,825.37 722,682.39
663,825.37

1,386,507.76
693,253.88
Mean of reserves disallowed...
3 3/4% of mean, deducted on return but disallowed by respondent ....................... 25,997.02
During the years in question, the taxpayer maintained the above-described reserves as insurance reserves required by law. The Commissioner contends that they are not insurance reserves within the meaning of Section 203(a)(2) of the Revenue Acts of 1932 and 1934, and refused to allow the taxpayer to deduct 3 3/4 per cent of the mean of these reserve funds according to Section 203(a)(2). The Board of Tax Appeals held that these reserve funds were within the meaning of Section 203(a)(2) and reversed the action of the Commissioner in disallowing the deductions. The Commissioner has petitioned for review. The parties have agreed that the reserve funds involved were required by state law, and they have also stipulated the amounts of the funds held by the taxpayer at the beginning and end of the taxable years, and for what purposes they were held. The questions remaining on the petition of the Commissioner are only two: Are these reserves technical insurance reserves? Must reserves be technical life insurance reserves in order to come within the deduction allowed by Section 203(a)(2)? The first question is whether the reserves are technical insurance reserves. The cases which discuss the question of reserves, under various forms of insurance, set up definite requirements for a technical insurance reserve. It must pertain directly to insurance and be calculated upon the basis of an experience or actuarial table applicable to the nature of the risk involved, with an interest assumption involved in the calculation. It must be set up and maintained out of premiums and earnings from the investment thereof, and be maintained for the purpose of maturing and liquidating, either by payment or re-insurance with other companies, future, unaccrued and contingent claims. Helvering v. Inter-Mountain Life Insurance Co., supra; United States v. Boston Insurance Co., 1925, 269 U.S. 197, 46 S.Ct. 97, 70 L.Ed. 232; Maryland Casualty Co. v. United States, supra; McCoach v. Insurance Co. of North America, 1917, 244 U.S. 585, 37 S.Ct. 709, 61 L.Ed. 1333; Continental Assurance Co. v. United States, Ct. Cls., 1934, 8 F.Supp. 474; Minnesota Mutual Life Insurance Co. v. United States, 1928, 66 Ct.Cls. 481, certiorari denied, 1929, 279 U.S. 856, 49 S.Ct. 352, 73 L.Ed. 998. It is stipulated that the reserve funds in the instant case were computed upon the basis of experience or actuarial tables; that an interest assumption was involved; and that the reserves were set up and maintained out of premiums. Though the stipulated facts in regard to the additional Page 320 reserve for noncancellable health and accident policies are slightly ambiguous on these points, it is clear that the reserve is set up from premiums and based on experience tables with an assumed rate of interest. See Massachusetts Protective Association, Inc. v. United States, 1 Cir., August 6, 1940, 114 F.2d 304. All that remains to make these reserve funds technical insurance reserves is to show that they directly pertain to insurance, and were set aside and maintained for the purpose of maturing and liquidating either by payment or reinsurance with other companies, future, unaccrued and contingent claims. Reserve for Incurred Disability Benefits.-- Taxpayer's life insurance policies during the taxable year contained a provision that taxpayer shall waive the payment of premiums by a...

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