Modern Life & Accident Ins. Co. v. Comm'r of Internal Revenue

• Decision Date: 25 March 1968
• Docket Number: Docket No. 3501-65.
• Citation: 49 T.C. 670
• Court: U.S. Tax Court
• Parties: MODERN LIFE & ACCIDENT INSURANCE COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

49 T.C. 670

MODERN LIFE & ACCIDENT INSURANCE COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 3501-65.

Tax Court of the United States.

Filed March 25, 1968.

Carl Schulz and Harry S. Tressel, for the petitioner.

Seymour I. Sherman, for the respondent.

Petitioner is in the business of issuing cancelable and noncancelable accident and health insurance policies on the assessment plan in Illinois. Its members have a common equitable ownership of assets; its policyholders have the right to be members to the exclusion of others and to choose management; its sole business purpose is to supply insurance at cost to its members; and its members have a right to premiums in excess of amounts to cover losses and expenses. Held, that petitioner is taxable as a mutual insurance company under sec. 821, I.R.C. 1954, and not as an insurance company other than life or mutual under secs. 831 and 832.

DAWSON, Judge:

Respondent determined the following income tax deficiencies against petitioner:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦1959  ¦$12,911.77   ¦
                +------+-------------¦
                ¦1960  ¦11,699.33    ¦
                +------+-------------¦
                ¦1961  ¦14,878.33    ¦
                +------+-------------¦
                ¦1962  ¦17,688.48    ¦
                +--------------------+
                

The issue for decision is whether petitioner, for the years 1959 through 1962, is taxable as a mutual insurance company under the provisions of section 821, I.R.C. of 1954,¹ or whether it is taxable as an insurance company other than life or mutual under sections 831 and 832.²

FINDINGS OF FACT

Most of the pertinent facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference and are adopted as part of our findings.

Modern Life & Accident Insurance Co. (herein called petitioner) is an insurance company organized in 1923 under the laws of the State of Illinois. Its principal place of business when it filed its petition and amended petition herein was Chicago, Ill. It filed its Federal income tax returns for the calendar years 1959 through 1962 with the district director of internal revenue at Chicago, Ill., on Forms 1120L as a life insurance company. It annexed to each return a copy of its annual statement filed with the Department of Insurance for the State of Illinois for the corresponding calendar year.

At all times relevant herein the petitioner has carried on the business of issuing cancelable and noncancelable accident and health insurance policies on the assessment plan in Illinois. It has no shareholders and is controlled by its policyholders who have the right to elect its directors. Its articles of incorporation contain the following provisions:

ARTICLE I

Section 3. The Board of Directors of the Company shall fix the fee rates and the amount of premiums, and the time and manner of payments thereon, and may change the same from time to time, as the experience of the Company may require; they have also the power to vote for an additional assessment whenever it may be necessary. An affidavit made by the person having charge of the mailing of notices of assessments, shall be prima facie evidence thereof.

ARTICLE II

Section 1. The members of the Company shall be those who appear on the books of the Company as holders of one or more policies that are not over four weeks in arrear.

Section 4. A quorum at any meeting of members shall consist of a majority of members, in person or by proxy, except failing such a quorum the meeting may be postponed to a date not later than thirty days, and a quorum at such postponed meeting shall consist of 300 members in person or by proxy.

Section 5. At such meetings, all questions shall be determined by a majority vote of the policyholders present in person or by proxy; each policyholder being entitled to one vote for each policy in his names as appears upon the record.

ARTICLE III

Section 1. The affairs of this Company shall be under the management of its Board of Directors, and such officers and agents as said Board may elect or employ.

Section 2. The Board of Directors shall consist of five (5) members. Said Directors shall be elected each year at the annual meeting of the policyholders to hold office for a continuous three year term, until the election of their successors. Vacancies in the Board shall be filled by the Board of Directors. The person elected shall hold office until the next annual meeting of the policyholders, when the vacancy shall be filled as usual.

The board of directors fixes the amount of assessments to be collected from petitioner's policyholders. These assessments are called premiums. No assessments except the regularly scheduled premiums have been levied against the policyholders since prior to 1947.

Petitioner has never paid dividends to its policyholders. However, all of the policies issued by it are participating policies.

Petitioner's unassigned surplus is held solely for its policyholders. It had the following unassigned surplus at the end of each year:

+-------------------+
                ¦Year  ¦Amount      ¦
                +------+------------¦
                ¦1959  ¦$140,296.98 ¦
                +------+------------¦
                ¦1960  ¦192,288.77  ¦
                +------+------------¦
                ¦1961  ¦222,499.74  ¦
                +------+------------¦
                ¦1962  ¦228,219.63  ¦
                +-------------------+
                

In each of the above years, however, the annual statement filed by petitioner showed an outstanding liability in the amount of $115,000 which represented advances by outsiders to enable petitioner to carry on its business. These ‘Guarantee Fund Certificates' were treated as a contingent offset against its unassigned surplus.

OPINION

Petitioner was incorporated in 1923 to operate as an insurer under an assessment plan in accordance with an Illinois statute enacted in 1893. During the years 1959 through 1962 it operated as an Assessment Accident and Health Company under article XXI of the Illinois Insurance Code of 1937.³ Petitioner contends that it cannot be taxed as a mutual company under section 821 of the Internal Revenue Code and related sections because its surplus fund is such that it can never be converted into a domestic mutual company under article III of the Illinois Insurance Code of 1937⁴ due to the nature of its activities and the fact that it has never paid a dividend to its policyholders. Therefore, the petitioner claims that it must be taxed as an insurance company other than life or mutual under the provisions of sections 831 and 832. We reject these arguments because we think the petitioner was a mutual insurance company during these years and, as such, taxable under section 821(a).⁵

Petitioner asserts that, in determining whether it is a mutual company for Federal tax purposes, we must rely on pertinent State law. We disagree. The petitioner's status for Federal income tax purposes must be determined under Federal law. There is no indication, either in the statutory language of the insurance provisions or in the related legislative history, that Congress intended for mutual insurance companies to be taxed other than under a nationwide scheme of taxation.⁶ Cf. Local Finance Corp., 48 T.C. 773, 793 (1967), and the cases cited therein. This view is fortified by those cases in which courts have wrestled with the problem of whether an insurance company is to be taxed as a mutual company for Federal tax purposes. In Ohio Farmers Indemnity Co. v. Commissioner, 108 F.2d 665, 667 (C.A. 6, 1940), the court in ‘seeking to ascertain the intention of the Congress,‘ said it must be assumed that Congress ‘used the word ‘mutual’ as applied to insurance companies in the sense it had long and generally borne in insurance matters. In other words, the term should be given its usual trade signification.' See also Keystone Automobile Club Casualty Co. v. Commissioner, 122 F.2d 886, 889 (C.A. 3, 1941). And in Estate of Clarence L. Moyer, 32 T.C. 515 (1959), this Court found that a gratuity fund established by a Philadelphia-Baltimore Stock Exchange was a mutual insurance company taxable under section 821 despite the fact that it was not an insurance company for State law purposes.

Prior to 1942 mutual insurers were taxed under rather loose, ineffective statutes. The Revenue Act of 1942 introduced the present breakdown of insurers into life, mutual, and other than life or mutual, the latter category also including specific types of mutuals. The House report⁷ accompanying that bill contains the following statements:

2. MUTUAL INSURANCE COMPANIES OTHER THAN LIFE

Section 144 of the bill * * * also completely revises the taxing provisions, basing the levy on underwriting and investment income, in a manner similar to that applied to stock insurance companies other than life. * * *

3. INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL

These deductions are granted under the limitations that obtain for mutual insurance companies other than life, and their effect is to put stock companies on a fair competitive basis with mutual companies in respect of their participating insurance.

These statements by the House reflect an intent to define mutual insurance companies in an extremely broad manner for Federal tax purposes, i.e., in the sense of policyholder-oriented organizations as opposed to stock companies. A similar intent is revealed in the Senate report.⁸ In addition, it is clear that Congress considered assessable insurance policies and intended to treat assessment companies as mutual insurers for Federal tax purposes. This is shown by language that: ‘Section 207(b)(2) (sec. 822(e), I.R.C. 1954) defines ‘net premiums' in a manner that produces substantially the same effect as in section 204(b)(5) of the Code, and includes deposits and assessments, but excludes amounts returned to policyholders which are treated as dividends under section 207(b)(3).'⁹ Likewise, the courts have indicated that an insurance company operating on an assessment basis can be treated as a mutual insurer. See Thompson v. White River Burial Ass'n., 178 F.2d 954 (C.A. 8...