Liberty Mut. Ins. Co. v. U.S., Civil Action No. 05-11048-RCL.
| Decision Date | 23 January 2008 |
| Docket Number | Civil Action No. 05-11048-RCL. |
| Citation | 532 F.Supp.2d 248 |
| Parties | LIBERTY MUTUAL INSURANCE COMPANY and Subsidiaries, Plaintiffs v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — District of Massachusetts |
Paul F. Lynch, Latronico, John A. La: mire, Black & Whitestone, Boston, MA, Samuel A. Mitchell, Gregory K. Oyler, Joseph A. Sergi, Peter H. Winslow, Scribner, Hall & Thompson LLP, Washington, DC, for Plaintiffs.
Stephen J. Turanchik, Karen Wozniak, U.S. Department of Justice, Washington, DC, for Defendant.
ADOPTED by Lindsay, D.J. on January 23, 2008.
CONSOLIDATED REPORT AND RECOMMENDATION ON PLAINTIFFS' MOTION FOR SUMMARY JUDGMENT (Docket # 21) and UNITED STATES' MOTION FOR SUMMARY JUDGMENT (Docket # 31) and ORDER ON PLAINTIFFS' MOTION TO COMPEL (Docket # 27)
At its base, this is a federal tax refund case. As the parties agreed during oral argument, however, this also happens to be a federal tax refund case of, essentially, first impression for the courts.1 Both Liberty Mutual and the United States move for summary judgment pursuant to Fed. R.Civ.P. 56. For the reasons detailed below the Court FINDS that (1) Liberty Mutual's pre-1990 Hybrid method of accounting was permissible; (2) Liberty Mutual is entitled to the Fresh Start on its Net Lines of business; (3) Liberty Mutual is not entitled to the Special Deduction; and (4) Liberty Mutual is entitled to the gross-up and, accordingly, RECOMMENDS that both Liberty Mutual's and the United States' Motions for Summary Judgment be DENIED IN PART AND ALLOWED IN PART in accordance with this Report and Recommendation. In light of this Court's decision, (5) Liberty Mutual's Motion to Compel is DENIED without prejudice, pending the District Judge's ruling on the instant Report and Recommendation.
Plaintiffs, Liberty Mutual Insurance Company and Subsidiaries and Liberty Mutual Fire. Insurance (collectively "Liberty Mutual") filed suit separately against the United States, of America ("United States") for the recovery of federal income taxes assessed and collected for the taxable year ending December 31, 1990. District Judge Lindsay ordered the cases consolidated due to the commonality of facts and issues.2 Liberty Mutual is a property and casualty company ("P & C") incorporated in Massachusetts.3 After both Liberty Mutual and the United States filed their respective motions for summary judgment, this Court held a hearing on said motions April 20, 2007. The crux of the issues presented can broken down into the following questions:
1. Whether Congress intended the gross salvage transition rule to apply to a taxpayer that used a "Hybrid" method of accounting for computed losses on particular lines of business;
2. Whether section 11305 of the Revenue Reconciliation Act of 1990 entitles Liberty Mutual and other companies, similarly situated, to a "Fresh Start," a "Special Deduction," or a combination of both the "Fresh Start" and "Special Deduction" on salvage recoverable; and
3. Whether Treasury Regulation 1.832-4(d) and Revenue Procedure 92-77 entitle Liberty Mutual to "gross-up" the amount of salvage on its Net Lines so as to realize a greater tax deduction.
Liberty Mutual is an insurance company required to report salvage4 on its Annual Statement filed with the state insurance department in its state of domicile. An insurance company is entitled to count claims paid out as a loss for tax purposes, but must reduce this loss by the amount which it actually recovers through salvage (hereinafter, "salvage recoverable").5
Prior to 1990, P & Cs were permitted, to record salvage for tax purposes in the same manner in which they reported salvage on their Annual Statements. Liberty Mutual maintains that P & Cs had the freedom to choose between three methods of reporting for uncollected salvage: (1) the Cash/Gross method — companies that used this method (hereinafter referred to as "Grosser(s)") took salvage into account only when it was actually recovered and reduced to cash by the P & C [i.e. after having paid the insured's claim and taking possession of a wrecked vehicle, the vehicle is sold and the P & C receives the proceeds]; (2) the Estimated/Net method — companies that used this method (hereinafter referred to as "Netter(s)") took estimated salvage recoverable into account in determining the amount of incurred unpaid losses [i.e. estimating the dollar amount the salvaged vehicle will be sold for, and accounting for it to reduce the amount of unpaid losses for tax purposes]; and (3) the "Cash/Net" or "Hybrid" method — some companies, including Liberty Mutual, reported losses using either the Gross or. Net method, depending upon the line of business involved [i.e. a P & C could use the Gross method for its automobile line and the Net method for its subrogation line].6 In the instant case, Liberty Mutual reported the amount of estimated salvage (Net method) on its 1989 and 1990 Annual Statements for some lines of business, but not others — a Hybrid method — a method the Government contends was impermissible.
In part to address the different accounting methods employed by P & Cs, Congress passed the Revenue Reconciliation Act of 1990, Pub.L. No. 101-508, 104 Stat. 1338 (hereinafter, the "1990 Act"), requiring that P & Cs follow a uniform method of accounting for salvage. Section 11305(c)(2)(A) of the 1990 Act specifies that the amendment is to be treated as a change in method of accounting for tax purposes. 1990 Act § 11305(c)(2)(A). In so doing, the 1990 Act effectively created a potential for double-counting, hi certain aspects of a P & C's accounting methods, namely for use of the Gross method. The Internal Revenue Code's procedure for dealing with double-counting issues arising as a result of change in accounting methods is generally found at 26 U.S.C. § 481. As such, section 481 requires P & Cs effected by the 1990 Act to adjust their Gross Lines to avoid said double-counting.
To minimize the impact of its imposition of a new accounting method, Congress authorized taxpayers using the Gross method to reduce the required adjustment under 26 U.S.C. § 481 to thirteen percent of what it otherwise would have been and to spread the thirteen percent ratably over a four year tax period beginning in 1990 (hereinafter, "Fresh Start"). 1990 Act, § 11305(c)(2)(B) ().
Taxpayers that previously reduced their losses by estimated salvage through the Net method were not required by section 481 to make adjustments to their accounting. As such, these Netters did not receive the same benefit as Grossers by being able to reduce their tax liability. To equitably compensate those taxpayers not required to made adjustments in accordance with section 481, Congress also granted a deduction equal to eighty-seven percent of the discounted amount of estimated salvage to be spread ratably over a four year tax period beginning in 1990 (hereinafter, the "Special Deduction"). 1990 Act § 11305(c)(3) (). Congress created the Fresh Start and Special Deduction as part of the 1990 Act to provide an equal benefit to all P & Cs, compensating them for the 1990 Act's change in accounting method. P & Cs were to begin to take either the Fresh Start or Special Deduction starting with the 1990 tax return filed for the 1989 tax year.
The statutory language is clear that pure Grossers (those who exclusively use the Gross method) are entitled to the Fresh Start and that pure Netters (those who exclusively use the Net method) are entitled to the Special Deduction. The Fresh Start allows pure Grosser P & Cs to report only thirteen percent of the otherwise required adjustment while the Special Deduction allows pure Netter P & Cs to deduct eighty-seven percent of the estimated salvage that would otherwise be recorded. The United States contends that, despite the obviously equitable nature of the two deductions, Congress did not intend for P & Cs that employed a Hybrid method to receive the benefit of either the Fresh Start or Special Deduction.
Liberty Mutual admits that prior to 1990 it used a Hybrid accounting method. More specifically, its Annual Statements for both 1989 and 1990 reflected a split in accounting practices whereby Liberty Mutual used a Gross method on some lines of business and a Net method on others. In light of its Hybrid accounting practices, on its 1990 federal income tax returns for the taxable year 1989, Liberty Mutual claimed the Special Deduction with respect to its Net Lines and the Fresh Start with respect to its Gross Lines. Similarly, in its 1991 federal income tax return for the taxable year 1990, Liberty Mutual used the same accounting practice, claiming the Special Deduction with respect to Net Lines and the Fresh Start with respect to Gross Lines.
Subsequently, in 1992 Congress amended Treas. Reg. § 1.832-4(f)(iii). The purpose of this regulation was to clarify the applicability of the 1990 Act. Section 1.832-4 clearly states that P & Cs claiming the Special Deduction could not also claim the Fresh Start. Treas. Reg. § 1.832-4(f)(iii) (1992). The regulation further provided for its retroactive application to the 1990 tax year and the 1990 Act. The retroactive applicability required Liberty Mutual to reevaluate its federal income tax returns to the extent they were impacted by the 1990 Act. After section 1.823-4 was amended, Liberty Mutual requested affirmative adjustments regarding its tax returns for the previous two years on which it had claimed both the Fresh Start and Special Deduction. To comply...
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