Ill. Lumber & Material Dealers Ass'n Health Ins. Trust v. United States, Civil No. 13-CV-715 (SRN/JJK)

• Decision Date: 30 April 2014
• Docket Number: Civil No. 13-CV-715 (SRN/JJK)
• Parties: Illinois Lumber and Material Dealers Association Health Insurance Trust, Plaintiff, v. United States of America, Defendant.
• Court: U.S. District Court — District of Minnesota

Illinois Lumber and Material Dealers
Association Health Insurance Trust, Plaintiff,
v.
United States of America, Defendant.

Civil No. 13-CV-715 (SRN/JJK)

UNITED STATES DISTRICT COURT DISTRICT OF MINNESOTA

Dated: April 30, 2014

MEMORANDUM OPINION AND ORDER

Thomas E. Brever and Andrew T. Brever, Foster & Brever, PLLC, 2812 Anthony Lane South, Suite 200, St. Anthony, MN 55418, for Plaintiff

Michael R. Pahl, United States Department of Justice, Tax Division, PO Box 7238 Ben Franklin Station, Washington, DC 20044, for Defendant

SUSAN RICHARD NELSON, United States District Court Judge

This matter is before the Court on Defendant's Motion to Dismiss for Lack of Jurisdiction [Doc. No. 11] and Plaintiff's Motion for Summary Judgment [Doc. No. 16]. For the reasons set forth herein, Defendant's motion is denied and Plaintiff's motion is granted.

I. BACKGROUND

Plaintiff-Taxpayer Illinois Lumber and Material Dealers Association Health Insurance Trust ("Illinois Lumber") filed this action for the refund of taxes paid pursuant

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to an erroneously filed 990 T Unrelated Business Income Tax Return for the fiscal year ending ("FYE") February 29, 2004. (Compl. ¶ 1 [Doc. No. 1].) Illinois Lumber contends that the amount at issue is $200,686, in addition to allowable interest and costs. (Id.) Illinois Lumber is a tax-exempt voluntary employees' beneficiary association ("VEBA") insurance trust. (See Ex. 1 to Ulrich Aff. [Doc. No. 19].)¹ Defendant is the United States of America and its agency, the Internal Revenue Service (the "IRS").

In light of Illinois Lumber's status as a VEBA trust, the IRS informed Illinois Lumber in a May 1989 letter that it was "not required to file federal income tax returns unless [Illinois Lumber is] subject to the tax on unrelated business income under section 511 of the Code." (Id.)

At some point prior to 2003, Plaintiff had obtained a membership interest in the Great American Mutual Holding Company ("Great American"). (See Ex. 2 to Ulrich Aff.]) In approximately September 2003, Great American was involved in a "demutualization" process. (Id.) In this context, demutualization refers to the conversion of a mutually-owned insurance company to a stock-ownership based insurance company. See Mell v. Anthem, Inc., 688 F.3d 280, 282 (6th Cir. 2012) (citing 3 Lee R. Russ & Thomas F. Segalla, Couch on Insurance § 39:43 (3d ed. 2005)). When demutualization occurs, the insurance company's policy holders are typically offered stock or cash in exchange for their ownership rights. See id. at 284 (see also Exs. P8 &

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P9 to Ulrich Aff. at 1).

In September 2003, Albert A. Riederer, Special Deputy Liquidator of Great American, sent a letter to Illinois Lumber, transmitting a cash payment of $1,474,442.30. (Exs. 2 & 3 to Ulrich Aff.) The payment represented Illinois Lumber's initial distribution for its membership interest in Great American. (Id.) In addition to noting that the payment would not affect the benefits of any Great American policies held by Plaintiff, Great American also provided guidance on the tax consequences of the distribution. (Id.) Great American advised that "[t]he liquidator has obtained a private letter ruling from the Internal Revenue Service confirming that your Membership Interest qualifies as a capital asset and the entire amount of the initial distribution to Eligible Members will constitute long-term capital gain." (Ex. 2 to Ulrich Aff.) As reflected in Revenue Ruling 71-233, the IRS considered the demutualization payments to be taxable income to the policyholders, for which the policyholders were to report a long-term capital gain with zero basis. (Rev. Ruling 71-233; see also Ex. P5 to Ulrich Aff. at 11; Exs. P8 & P9 to Ulrich Aff. at 3.) In Great American's September 2003 letter to Illinois Lumber, Great American also attached an IRS Form 1099 on which Plaintiff could report the taxable amount of its distribution. (Ex. 2 to Ulrich Aff.) In addition, Great American indicated that it would distribute the remainder of the demutualization assets in the future, but did not estimate the amount or the approximate time frame of any future distributions. Id.

Plaintiff paid FYE 2004 taxes on February 17, 2004. (Def.'s Ex. in Supp. Mot. to

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Dismiss at 2 [Doc. No. 14].) On or before October 15, 2004, Plaintiff filed the 2004 return, including the tax calculated on the demutualization payment, which it denoted on a 990 T Unrelated Business Income Return.² (Compl. ¶ 9 [Doc. No. 1].) Plaintiff alleges that its taxable income for 2004 consisted solely of two items: the $1,474,134 demutualization distribution and $13,303 of interest and dividends generated from exempt activity income. (Id. ¶ 10.)

Plaintiff also received at least two subsequent demutualization proceeds which it reported as taxable long-term capital gains on its 2006 taxes, filed on July 15, 2006, and its 2008 taxes, filed on July 24, 2008. (Exs. P8 & P9 to Ulrich Aff.) It is unclear from the parties' submissions whether the 2006 and 2008 proceeds were in the form of cash or stock. (Id.)

On August 6, 2008, the Federal Claims Court issued a decision in Fisher v. United States, 82 Fed. Cl. 780 (Fed. Cl. 2008), in which the court ruled against the IRS's position of assigning zero income tax basis to stock received in the demutualization of an insurance company. Under the circumstances of Fisher, the court concluded that the sale proceeds of the demutualized stock were to be treated as a return of capital up to the

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amount of the cost basis in the insurance policy. Id. at 797-99. Any taxable gain would be limited to amounts received in excess of the cost basis. Id. The IRS appealed.

A few months after issuance of the Fisher opinion, Illinois Lumber filed an amended return for its 2006 and 2008 taxes on October 31, 2008. (Exs. P8 & P9 to Ulrich Aff.) Within a few weeks, on November 23, 2008, Illinois Lumber also filed a claim for refund of its 2004 taxes.³ (Compl. ¶ 12 [Doc. No. 1].) On December 1, 2008, Illinois Lumber filed an amended return for its 2004 taxes, claiming no tax due and indicating that it had previously paid $235,000 in estimated taxes. (Ex. P4 to Ulrich Aff.)

In late 2009, the Court of Appeals for the Federal Circuit affirmed the Federal Claims Court's decision in Fisher, issuing an affirmance without a published opinion. Fisher, 333 Fed. App'x 572 (Fed. Cir. 2009) (per curiam).

On December 16, 2009, the IRS disallowed Plaintiff's refund claim with respect to its 2004 taxes. (Def.'s Ex. in Supp. Mot. to Dismiss at 2 [Doc. No. 14].) Plaintiff sought an administrative appeal.

On July 5, 2010, the IRS approved Illinois Lumber's claims for refunds for 2006 and 2008. (Exs. P10 & P11 to Ulrich Aff.) In the IRS's "Explanation of Items" with respect to both the 2006 and 2008 refunds, the IRS noted that the final resolution of the appeal in Fisher "dictated how to move forward on these issues." (Exs. P8 & P9 to Ulrich Aff. at 3.) Finding that Plaintiff's claim for refund for 2006 and 2008 involved the same

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issue, Plaintiff's "claim for refund for taxes for proceeds from insurance demutualization should be allowed in full pursuant to the outcome of [the appellate] decision in [Fisher]." (Id.)

On April 18, 2011, the IRS Appeals Office communicated with Plaintiff by letter regarding Plaintiff's claim for the 2004 refund. (Ex. P14 to Ulrich Aff.) In the letter, IRS Appeals Officer Julie North stated:

[Illinois Lumber] filed a claim for refund asserting that they erroneously reported demutualization gains as taxable income on Form 990T for tax period ended February 29, 2004. Had [Illinois Lumber's] claim been timely filed, we would granted [sic] their claim, resulting in an overpayment of tax and a corresponding refund; demutualization payments are not taxable and are not reportable as unrelated business taxable income (see Fisher v. United States, 82 Fed. Cl. 780 (2008), aff'd per curium, 333 Fed. App'x 572 (Fed. Cir. 2009)). However, [Illinois Lumber's] claim was not filed timely. . . . Since their claim was filed late, it must be denied.

(Id.)

At some point during this process, Illinois Lumber retained the services of certified public accountant Charles Ulrich, in whom Illinois Lumber granted power of attorney. Through Mr. Ulrich, Illinois Lumber responded to the Appeals Office's April 18, 2011 letter, contesting the IRS's denial of Plaintiff's refund claim for 2004. In Mr. Ulrich's letter of May 30, 2011, he emphasized Illinois Lumber's status as a tax-exempt entity, noting that Illinois Lumber was not required to file any Form 990 T unrelated business income. (Ex. P15 to Ulrich Aff. at 2.) Mr. Ulrich argued that the three-year statute of limitations, 26 U.S.C. § 6511, was inapplicable to Illinois Lumber because the statute applies only to persons or entities required to pay tax. (Id. at 3-4.) In addition, Mr.

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Ulrich noted that the IRS's "zero basis" Revenue Ruling 71-233 did not address the specific circumstance of demutualization of an insurance company. (Id. at 4.) Moreover, even if the statute of limitations was applicable to Plaintiff, Mr. Ulrich argued that Plaintiff met the requirements for mitigation under 26 U.S.C. §§ 1311-14, and could avoid the effect of the statute of limitations. (Id. at 5-9.)

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