Commissioner of Internal Revenue v. Standard Life Accident Insurance Company
| Citation | 53 L.Ed.2d 653,97 S.Ct. 2523,433 U.S. 148 |
| Decision Date | 23 June 1977 |
| Docket Number | No. 75-1771,75-1771 |
| Parties | COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. STANDARD LIFE & ACCIDENT INSURANCE COMPANY |
| Court | United States Supreme Court |
The "net valuation" portion of unpaid life insurance premiums (the portion state law requires a life insurance company to add to its reserves), but not the "loading" portion (the portion to be used to pay salesmen's commissions, other expenses such as state taxes and overhead, and profits), held required to be included in a life insurance company's assets and gross premium income, as well as in its reserves, for purposes of computing its federal income tax liability, notwithstanding such computation necessitates making a fictional assumption that the "net valuation" portion has been paid but that the "loading" portion has not. This treatment of unpaid premiums is in accordance with § 818(a) of the Internal Revenue Code of 1954 (), which requires computations of a life insurance company's income taxes to be made "in a manner consistent with the manner required for purposes of the annual statement approved by the National Association of Insurance Commissioners," unless the NAIC procedures are inconsistent with accrual accounting rules, and to the extent that the Treasury Regulations require different treatment of unpaid premiums they are inconsistent with § 818(a) and therefore invalid. Pp. 152-163.
525 F.2d 786, reversed and remanded.
Vester T. Hughes, Jr., Dallas, Tex., for respondent.
Matthew J. Zinn, Washington, D. C., for American Council of Life Insurance, as amicus curiae, by special leave of Court.
In this case, for the second time this Term, we are required to construe the complex portion of the Internal Revenue Code concerning life insurance companies.1 The issue in this case is the extent to which deferred and uncollected life insurance premiums are includable in "reserves," "assets," and "gross premium income," as those concepts are used in the Life Insurance Company Income Tax Act of 1959.2
Premiums on respondent's policies are often payable in installments. If an installment is not paid when due, the policy will lapse, generally after a grace period. However, there is no legally enforceable duty to pay the premiums. An installment falling due between the end of the tax year and the policy's anniversary date is called a "deferred premium." In 1961, the most recent year in issue, respondent had $1,572,763 of deferred premiums. Pet. for Cert. 4a. An installment which is overdue at the end of the tax year is called an "uncollected premium" if the policy has not yet lapsed. In 1961, respondent had $231,969 of uncollected premiums. Ibid. For convenience, we shall refer to both deferred and uncollected premiums simply as "unpaid premiums."
The amount charged a policyholder the "gross premium" includes two components. Under state law, the company must add part of the premium to its reserves to ensure that it will have sufficient funds to pay death benefits. This amount, the "net valuation premium," is determined under mortality and interest assumptions. The rest of the gross premium is called "loading," and covers profits and expenses such as salesmen's commissions, state taxes and overhead.
Under normal accounting rules, unpaid premiums would simply be ignored. They would not be properly accruable since the company has no legal right to collect them. Nevertheless, for the past century, insurance companies have added an amount equal to the net valuation portion of unpaid premiums to their reserves with an offsetting addition to assets. State law uniformly requires this treatment of unpaid premiums, as does the accounting form issued by the National Association of Insurance Commissioners (NAIC). This national organization of state regulatory officials, which acts on behalf of the various state insurance departments, performs audits on insurance companies like respondent which do business in many States. The NAIC accounting form, known in the industry as the "Annual Statement," is used by respondent for its financial reporting. In effect, in calculating its reserves, the company must treat these premiums to some extent as if they had been paid.
This case involves the tax treatment of respondent's unpaid premiums for the years 1958, 1959, and 1961. In its returns for each of those years, it included the net unpaid premiums in reserves, just as it did in its annual NAIC statement. In 1959 and 1961, it also followed the NAIC statement by including the net premiums in assets and premium income. In 1958, however, it excluded the entire unpaid premium from assets. The Commissioner assessed a deficiency because respondent did not, in any of these years, include the entire unpaid premium loading as well as net premium in calculating assets and income. In his view, if reserves are calculated on the fictional assumption that these premiums have been paid, the same assumption should apply to the calculation of assets and gross premium income. The Tax Court upheld the deficiency; but the Court of Appeals reversed.3 It held that respondent's reserve calculation was correct because it was required by state law. The court further held that in accord with normal accounting practices, the premiums could not be considered as either assets or income before they were actually collected.
The Courts of Appeals have taken varying approaches to this problem. The position taken by the Tenth Circuit in this case conflicts with decisions of four other Circuits.4 For this reason, and because the question is important to the revenue,5 we granted certiorari. 429 U.S. 814, 97 S.Ct. 54, 50 L.Ed.2d 74.
Although the problem is a perplexing one, as indicated by the diversity of opinion among the Circuits, we find guidance in 26 U.S.C. § 818(a), which governs the method of accounting by life insurance companies. In our view, § 818(a) requires deference in this case to the established accounting procedures of the NAIC. In accordance with the NAIC procedures, we therefore hold that the net valuation portion of unpaid premiums, but not the loading, must be included in assets and gross premium income, as well as in reserves.
Resolution of the problem before us requires some understanding of how reserves, assets, and premium income enter into the calculation of a life insurance company's taxable income. We therefore begin with a summary of past legislation and of the method by which the tax is now calculated. We then turn to a discussion of § 818(a) and its application to this case.
Throughout the history of the federal income tax, Congress has taken the view that life insurance companies should not be taxed on the amounts collected for the purpose of paying death benefits. This basic theme has been implemented in different ways.
From 1913 to 1920, life insurance companies, like other companies, were taxed on their entire income, but were allowed a deduction for "the net addition . . . required by law to be made within the year to reserve funds . . . ." 6 In that period the Government first challenged, but then accepted, the industry practice of deducting additions to reserves based on unpaid premiums without taking those premiums into income.7
Beginning with the Revenue Act of 1921, Congress taxed only the investment income of life insurance companies; premium income was not included in their gross income.8 The companies were allowed to deduct a fixed percentage of their total reserves from their total investment income.9 The computation of this deduction was based on the company's entire policy reserves, including the portion attributed to unpaid premiums. This use of this portion of the reserves apparently was not questioned during that period. There was no occasion to consider whether unpaid premiums should be treated as "income" since all premium income was exempt from tax in this period.
The 1959 statute applies to all tax years after 1957. It preserves the basic concept of taxing only that portion of the life insurance company's income which is not required to meet policyholder obligations. It makes two important changes, however, in the method of computing that amount. First, whereas the preceding statutes assumed an industrywide rate of return for the purpose of calculating the reserve deduction, the 1959 Act requires a calculation based on each company's own earnings record. Second, in addition to imposing a tax on investment income, the new Act also taxes a portion of the company's premium income. Although the computations are more complex, the basic approach of the 1959 Act is therefore somewhat comparable to the pre-1921 "total income" concept.
In order to understand the implications of the Commissioner's argument that unpaid premiums should be consistently treated in calculating "assets" and "gross premium income," as well as "reserves," it is necessary to explain how these concepts are employed in the present statute.10
The 1959 Act adds §§ 801 through 820 to the Internal Revenue Code of 1954 (26 U.S.C.). Section 802(b) defines three components of "life insurance company taxable income," of which only the first two are relevant to this case.11 Generally, the taxable income is the sum of (1) the company's "taxable investment income" and (2) 50% of its other income (defined as the difference between its total "gain from operations" and its taxable investment income). 12
A company's total investment income is regarded as including a share for the company, which is taxable, and a "policyholders' share," which is not.13 The policyholders' share is a percentage which is essentially determined by the ratio of the company's reserves to its assets.14 An increase in reserves will therefore reduce the company's taxable investment income,...
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