Atlantic Mut. Ins. v. Comm'r Internal Revenue

• Decision Date: 21 April 1998
• Docket Number: 97147
• Citation: 118 S.Ct. 1413,523 U.S. 382,140 L.Ed.2d 542
• Parties: ATLANTIC MUTUAL INSURANCE COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE
• Court: U.S. Supreme Court

523 U.S. 382

118 S.Ct. 1413

140 L.Ed.2d 542

ATLANTIC MUTUAL INSURANCE COMPANY, Petitioner,

v COMMISSIONER OF INTERNAL REVENUE.

No. 97-147.

Supreme Court of the United States

Argued March 2, 1998.

Decided April 21, 1998.

Syllabus^*

Before enactment of the Tax Reform Act of 1986, the Internal Revenue Code gave property and casualty (PC) insurers a full deduction for "loss reserves'': estimated amounts of losses reported but not yet paid, losses incurred but not yet reported, and administrative costs of resolving claims. In each taxable year, not only losses paid, but the full amount of the loss reserves, reduced by the amount of the loss reserves claimed for the prior taxable year, were treated as a business expense. Section 1023 of the 1986 Act required PC insurers, beginning with the 1987 taxable year, to discount unpaid losses to present value when claiming them as a deduction. Requiring insurers to subtract undiscounted year-end 1986 reserves from discounted year-end 1987 reserves in computing 1987 losses would produce artificially low deductions, so the Act included a transitional rule requiring insurers to discount 1986 reserves as well. This rule changed the "method of accounting'' for computing taxable income. To avoid requiring PC insurers to recognize as income the difference between undiscounted and discounted year-end 1986 loss reserves, the Act afforded them a "fresh start,'' to-wit, an exclusion from taxable income of the difference between undiscounted and discounted year-end 1986 loss reserves. §1023(e)(3)(A). It foreclosed the possibility that they would inflate reserves to manipulate the "fresh start'' by excepting "reserve strengthening'' from the exclusion. §1023(e)(3)(B). Treasury Regulation §1.846-3(c)(3)(ii) defines "reserve strengthening'' to include any net additions to reserves. Respondent Commissioner determined that petitioner, Atlantic Mutual Insurance Co., and its subsidiary, a PC insurer, made net additions to loss reserves in 1986, reducing the "fresh start'' entitlement and resulting in a tax deficiency. The Tax Court disagreed, holding that "reserve strengthening'' refers to only those increases that result from changes in computation methods or assumptions. In reversing, the Third Circuit concluded that the Treasury regulation's definition of "reserve strengthening'' is based on a permissible statutory construction.

Held: The Treasury regulation represents a reasonable interpretation of the term "reserve strengthening.'' Neither prior legislation nor industry use establishes the plain meaning Atlantic ascribes to that term: reserve increases attributable to changes in methods or assumptions. Since the term is ambiguous, the question is not whether the Treasury regulation represents the best interpretation of the statute, but whether it represents a reasonable one. See Cottage Savings Assn. v. Commissioner, 499 U.S. 554, 560-561, 111 S.Ct. 1503, 1507-1508, 113 L.Ed.2d 589. As a purely linguistic matter, the phrase is broad enough to embrace all increases in the reserve's amount, for whatever reason and from whatever source. The provision at issue is a limitation upon an extraordinary deduction accorded to PC insurers. There was no need for the deduction to be microscopically fair, and the interpretation adopted in the Treasury regulation seems to be a reasonable accommodation of the competing interests of fairness, administrability, and avoidance of abuse. Given the hundreds (or more likely thousands) of claims involved, claims resolved for less than estimated reserves will tend to offset claims that settle for more than estimated reserves. Any discrepancy would not approach the unrealistic proportions claimed by Atlantic. Pp. ____-____.

111 F.3d 1056, affirmed.

SCALIA, J., delivered the opinion for a unanimous Court.

George R. Abramowitz, Washington, DC, for Petitioner.

Kent L. Jones, Washington, DC, for Respondent.

Justice SCALIA delivered the opinion of the Court.

Property and casualty insurance companies maintain accounting reserves for "unpaid losses.'' Under the Tax Reform Act of 1986, increases in loss reserves that constitute "reserve strengthening'' do not qualify for a certain one-time tax benefit. We must decide whether the term "reserve strengthening'' reasonably encompasses any increase in reserves, or only increases that result from changes in the methods or assumptions used to compute them.

I

Atlantic Mutual Insurance Co. is the common parent of an affiliated group of corporations, including Centennial Insurance Co., a property and casualty (PC) insurer. From 1985 to 1993, the two corporations (Atlantic) maintained what insurers call "loss reserves.'' Loss reserves are estimates of amounts insurers will have to pay for losses that have been reported but not yet paid, for losses that have been incurred but not yet reported, and for administrative costs of resolving claims.

Before enactment of the Tax Reform Act of 1986, Pub.L. 99-514, 100 Stat. 2085, the Internal Revenue Code gave PC insurers a full deduction for loss reserves as "losses incurred.'' In each taxable year, not only losses paid, but the full amount of the loss reserves, reduced by the amount of the loss reserves claimed for the prior taxable year, would be treated as a business expense. 26 U.S.C. §832(b)(5) and (c)(4) (1982 ed.). This designation enabled the PC insurer to take, in effect, a current deduction for future loss payments without adjusting for the "time value of money''-the fact that ""[a] dollar today is worth more than a dollar tomorrow,''' D. Herwitz & M. Barrett, Accounting for Lawyers 221 (2d ed.1997). Section 1023 of the 1986 Act amended the Code to require PC insurers, for taxable years beginning after December 31, 1986, to discount unpaid losses to present value when claiming them as a deduction. 100 Stat. 2399, 2404, 26 U.S.C. §§832(b)(5)(A), 846 (1982 ed., Supp. V). Absent a transitional rule, PC insurers would have been left to subtract undiscounted year-end 1986 reserves from discounted year-end 1987 reserves for purposes of computing losses incurred for taxable year 1987-producing artificially low deductions. The 1986 Act softened this consequence by requiring PC insurers, for purposes of that 1987 tax computation, to discount 1986 reserves as well. 100 Stat. 2404, note following 26 U.S.C. §846.

Because the requirement that PC insurers discount 1986 reserves changed the "method of accounting'' for computing taxable income, PC insurers, absent another transitional rule, would have been required to recognize as income the difference between undiscounted and discounted year-end 1986 loss reserves. See 26 U.S.C. §481(a) (1988 ed.). To avoid this consequence, §1023(e)(3)(A) of the 1986 Act afforded PC insurers a "fresh start,'' to-wit, an exclusion from taxable income of the difference between undiscounted and discounted year-end 1986 loss reserves. 100 Stat. 2404, note following 26 U.S.C. §846. Of course the greater the 1986 reserves, the greater the exclusion. Section 1023(e)(3)(B) of the 1986 Act foreclosed the possibility that insurers would inflate reserves to manipulate the "fresh start'' by excepting "reserve strengthening'' from the exclusion:

" (B) Reserve strengthening in years after 1985.- Subparagraph (A) [the fresh-start provision] shall not apply to any reserve strengthening in a taxable year beginning in 1986, and such strengthening shall be treated as occurring in the taxpayer's 1st taxable year beginning after December 31, 1986.'' 100 Stat. 2404, note following 26 U.S.C. §846.

Regulations promulgated by the Treasury Department set forth rules for determining the amount of "reserve strengthening'':

" (1) In general. The amount of reserve strengthening (weakening) is the amount that is determined under paragraph (c)(2) or (3) to have been added to (subtracted from) an unpaid loss reserve in a taxable year beginning in 1986. For purposes of section 1023(e)(3)(B) of the 1986 Act, the amount of reserve strengthening (weakening) must be determined separately for each unpaid loss reserve by applying the rules of this paragraph (c). This determination is made without regard to the reasonableness of the amount of the unpaid loss reserve and without regard to the taxpayer's discretion, or lack thereof, in establishing the amount of the unpaid loss reserve. . . .

.....

" (3) Accident years before 1986 -(i) In general. For each taxable year beginning in 1986, the amount of reserve strengthening (weakening) for an unpaid loss reserve for an accident year before 1986 is the amount by which the reserve at the end of that taxable year exceeds (is less than)-

" (A) The reserve at the end of the immediately preceding taxable year; reduced by

" (B) Claims paid and loss adjustment expenses paid ("loss payments'') in the taxable year beginning in 1986 with respect to losses that are attributable to the reserve . . . .'' Treas.Reg. 1.846-3(c), 26 CFR §1.846-3(c) (1997).

In short, any net additions to reserves (with two exceptions not here at issue, §1.846-3(c)(3)(ii)) constitute "reserve strengthening'' under the regulation.

The Commissioner of Internal Revenue determined that Atlantic made net additions to reserves-"reserve strengthening''-during 1986, reducing the "fresh start'' entitlement by an amount that resulted in a tax deficiency of $519,987. The Tax Court disagreed, holding that Atlantic had not strengthened its reserves. "Reserve strengthening,'' the Tax Court held, refers only to increases in reserves that result from changes in the methods or assumptions used to compute them. (Atlantic's reserve increases, there is no dispute, did not result from any such change.) The United States Court of Appeals for the Third Circuit reversed the Tax Court, concluding that the Treasury regulation's definition of "reserve strengthening'' to include any net additions to reserves is based on a permissible construction of the statute. 111 F.3d 1056 (1997). (It expressly...