Farmers Life Insurance Company v. COMMISSIONER OF INTERNAL REVENUE, Docket No. 43317.
| Citation | 27 BTA 423 |
| Decision Date | 22 December 1932 |
| Docket Number | Docket No. 43317. |
| Parties | FARMERS LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
R. W. Colflesh, Esq., and Thomas Watters, Jr., Esq., for the petitioner.
John D. Foley, Esq., and James C. Maddox, Esq., for the respondent.
This proceeding is for the redetermination of deficiencies in income tax asserted by the respondent for the years 1925 and 1926 in the amounts of $479.83 and $31.86, respectively. The following errors are alleged:
1. Failure to allow as a deduction from gross income for each taxable year, 4 per cent of the mean of petitioner's reserves for a guaranteed dividend fund;
2. Failure to allow a like deduction for each year respecting reserves for coupons left with the company at interest;
3. Including as taxable income amounts received in each year as bonus for oil and gas leases;
4. Including as taxable income $1,000 received as the purchase price of an option to buy lands;
5. Failure to allow the full statutory deduction for investment expense for the year 1925;
6. Failure to allow deduction for depreciation on furniture and fixtures at the rate of 10 per cent per annum for each taxable year 7. Failure to allow deduction for depreciation of an automobile at the rate of 33 1/3 per cent per anum for the year 1926.
Some further errors were alleged but were abandoned.
By his amended answer respondent alleges that he erroneously allowed, as a deduction for each year, 4 per cent of the mean of petitioner's reserves for a survivorship fund. Respondent asks that petitioner's taxable income be increased by the amounts so deducted, namely, $2,217.36 for the year 1925 and $2,376.22 for the year 1926.
FINDINGS OF FACT.
Petitioner is a nonmutual life insurance company, incorporated under the laws of Colorado and having its principal place of business at Denver. It conducts its insurance business upon the level-premium plan.
Various special funds are maintained by petitioner for those policyholders who elect to participate therein and an excess premium is charged for the privilege. The guaranteed dividend fund is provided to care for petitioner's contract liability under riders attached to its policies of certain classes. The fund is created and maintained by setting aside annually $2 from each renewal premium paid on $1,000 of insurance issued and kept in force upon that plan. Petitioner improves the fund at the average net rate of interest earned upon its loans, and agrees to distribute the fund, pro rata, to surviving, persistent members of the class at the end of twenty years from the date of issue of the rider. At the time of distribution any member entitled to participate may use his or her proportion of the fund in purchasing additional paid-up insurance, subject to satisfactory medical examination.
All policies containing the above provisions and issued during the same calendar year constitute a class. The amount of this fund at the close of 1924 was $120,797.12; at the close of 1925 the amount was $127,441.60; and at the close of 1926 it was $135,612.99. The mean of the fund for 1925 amounted to $124,119.36 and for 1926 the mean was $131,527.30. Petitioner claimed a reserve deduction amounting to 4 per cent of the mean of said fund, for each year, but respondent disallowed the deductions on the ground that the fund did not constitute an allowable reserve.
Petitioner's survivorship fund differs from the guaranteed dividend fund only in the amount set aside annually from renewal premiums. The amount of this fund at the close of 1924 was $53,390.50; at the close of 1925 the amount was $57,477.84; and at the close of 1926 it was $61,333.13. The mean for the year 1925 was $55,433.99 and for 1926 the mean was $59,405.49. Four per cent of the mean, for each year, was allowed as a reserve deduction. Respondent now alleges that the fund did not constitute an allowable reserve and asks that the amounts deducted be included in petitioner's taxable income for the respective years.
A coupon fund is maintained to provide for the liability accruing upon coupons attached to certain classes of petitioner's policies. These coupons may be used to reduce premium payments or to purchase paid-up additional insurance, or may be left with the company to accumulate at interest at the option of the policyholder. The amount reserved by petitioner for coupons left at interest at the close of 1924 amounted to $27,179.02; at the close of 1925 the amount was $27,854.83, and at the close of 1926 it was $29,845.94. The mean of this fund for 1925 was $27,516.92 and for 1926 the mean was $28,850.38. Petitioner claims 4 per cent of the mean of said fund for each year as a reserve deduction.
Petitioner owned property, called the "fig" lands, in Galveston County, Texas. On November 9, 1925, petitioner leased those lands for oil and gas production purposes and received a cash consideration of $3,000 for the lease. That amount was carried as gross rent on petitioner's books.
Petitioner also owned what was called the Gray Ranch, located in Texas. In August, 1926, petitioner received $1,000 as consideration for granting a 10-day option to purchase the ranch. The option was not exercised and in September, 1926, petitioner leased the ranch for oil and gas production purposes and received a cash consideration of $30,000 for the lease. The amounts were carried on petitioner's books as gross rents.
The invested assets of petitioner at the close of 1924 amounted to $3,461,694.72 and at the close of 1925 they amounted to $3,587,809.71. The mean for the year 1925 was $3,521,752.22. In its income tax return for 1925 petitioner deducted $7,554.24 as investment expense, which was allowed by the respondent. That amount did not include postage, telephone and telegraph charges, stationery and printing, exchange discount on collection of commercial paper, nor home office traveling expenses, a total of $9,386.38. Petitioner now claims that its deductible allowance for investment expense should be increased to $8,811.88, which is one-fourth of one per cent of the mean of its invested assets.
Petitioner purchased furniture, fixtures and equipment for use in its business as follows: In 1921, $1,290.60; in 1922, $192.20; in 1923, $163.70; in 1924, $403.45; in 1925, $630.48; and in 1926, $302.46. In 1926 petitioner purchased a used automobile for $475 for use in its business. The automobile had a useful life at that time of about three years.
Five main questions are presented for decision by this proceeding. The first is whether petitioner's guaranteed dividend fund, its survivorship fund, and its coupon fund constitute "reserve funds required by law " within the meaning of the Revenue Acts of 1924 and 1926. The provisions of those acts which are here pertinent are identical in wording and read as follows:
SEC. 245. (a) In the case of a life insurance company the term " net income" means the gross income less —
* * * * * * *
(2) An amount equal to the excess, if any, over the deduction specified in paragraph (1) of this subdivision, of 4 per centum of the mean of the reserve funds required by law and held at the beginning and end of the taxable year.
Petitioner concedes in argument that the term " reserve funds required by law " means a true insurance reserve based upon a life contingency and not assets held for the ordinary running expenses of the business. It is contended, however, that the guaranteed dividend fund meets the requirement of a true insurance reserve because the excess premium charged enabled the policyholder to participate in the fund if he survived for twenty years. Hence, petitioner says, there is a mortality element in the fund which distinguishes it from funds set aside for ordinary running expenses.
We can not agree with that contention. In Massachusetts Mutual Life Ins. Co. v. United States, 56 Fed. (2d) 897, the true insurance reserve is described thus:
* * * Under the level-premium plan the insured pays during his early years a sum in excess of the cost of his insurance. The excess is devoted to the creation of a reserve fund which enables the insurance to be maintained in later years when the stipulated level premium would be insufficient to meet the current costs of insurance on the mutual-premium plan.
The table rate of premiums provided for in life insurance on the mutual level-premium plan is calculated, first, by adopting an accepted table of mortality showing the death rate for every age of life, and second, by adopting an assumed rate of interest, such as the company may safely expect to realize upon the investment of the amounts of such premiums for the duration of all of its policies. With these two factors, a calculation is made of the sum each insured must pay in advance so as to put the company in funds with which to pay all outstanding policies as they become claims, providing deaths occur exactly in accordance with the table of mortality, and also providing the rate of interest earned on the company's invested funds is exactly the same as the rate assumed in calculating its premiums. The sum ascertained in this way is called the net or mathematical premium.
The calculation of the reserve is thus an actuarial function, and, being the amount theoretically necessary for reinsuring the risks, is sometimes called the reinsurance fund or reinsurance reserve. As applied to a policy, the term means value or valuation, but that part of the assets of the company, which, according to a specified table of mortality, with interest at the assumed rate, must be set apart to meet or mature the company's obligation to the insured on his death or upon the...
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