Western & Southern Life Ins. Co. v. Comm'r of Internal Revenue

• Decision Date: 23 March 1971
• Docket Number: Docket No. 4223-69.
• Citation: 55 T.C. 1036
• Parties: WESTERN AND SOUTHERN LIFE INSURANCE COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

55 T.C. 1036

WESTERN AND SOUTHERN LIFE INSURANCE COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 4223-69.

United States Tax Court

Filed March 23, 1971.

Lawrence H. Kyte, Alan R. Vogeler, and Arthur K. Mason, for the petitioner.

Rodney G. Haworth, for the respondent.

Petitioner, a life insurance company, is entitled to exclude the loading portion of ‘deferred and uncollected premiums' and ‘due and unpaid premiums' in computing ‘assets' under sec. 805(b)(4), I.R.C. 1954, and ‘gross amount of premiums' for the purposes of sec. 809(c)(1), I.R.C. 1954.

TANNENWALD, Judge:

Respondent determined the following deficiencies in petitioner's income taxes:

+---------------------------------+
                ¦Taxable year ended  ¦Deficiency  ¦
                +--------------------+------------¦
                ¦                    ¦            ¦
                +--------------------+------------¦
                ¦Dec. 31, 1958       ¦$78,486.51  ¦
                +--------------------+------------¦
                ¦Dec. 31, 1959       ¦143,266.71  ¦
                +--------------------+------------¦
                ¦Dec. 31, 1960       ¦219,300.21  ¦
                +--------------------+------------¦
                ¦Dec. 31, 1961       ¦476,421.04  ¦
                +--------------------+------------¦
                ¦Dec. 31, 1962       ¦659,724.36  ¦
                +--------------------+------------¦
                ¦Total               ¦1,577,198.83¦
                +---------------------------------+
                

The issues involved in this case are:

(1) Whether the loading portion of ‘premiums, deferred and uncollected’ and ‘premiums, due and unpaid’ is excludable from assets within the meaning of section 805(b)(4), I.R.C. 1954;¹ and

(2) Whether the increase in loading on ‘premiums, deferred and uncollected’ and ‘premiums, due and unpaid’ is excludable from premium income under section 809(c)(1), or deductible from such income under section 809(d).

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulations, together with the exhibits attached thereto, are incorporated herein by this reference.

Petitioner is an Ohio corporation having its principal office in Cincinnati, Ohio, at the time it filed its petition herein. Its Federal income tax returns for the years 1958 to 1962, inclusive, were filed with the district director of internal revenue, Cincinnati, Ohio.

Petitioner is a mutual life insurance company organized and existing under the laws of the State of Ohio. Its operations and accounts are subject to the supervision and approval of the superintendent of insurance for the State of Ohio and, because it does business in numerous States, it is subject to periodic audit of its accounts by the National Association of Insurance Commissioners (NAIC), which acts on behalf of the insurance departments of the various States.

The tax returns filed in the years here involved were prepared on the same basis as was used on the annual statement required of life insurance companies by the NAIC, with some adjustments.

In life insurance, premiums are the agreed price for assuming and carrying the risk. Gross premium is the amount actually charged the insured and is composed of the net valuation premium and ‘loading.’ The net valuation premium on a particular policy is that amount of money which, using the mortality table and interest rate assumed for the policy, will be exactly sufficient to provide the benefits of the policy and is required by State law to be added to the policy reserve each year. ‘Loading’ refers to an amount added to the net valuation premium for estimated administration, management, and operating expenses, contingencies, profits in the case of capital stock companies, and dividends in the case of mutual companies. The amount of ‘loading’ results from an independent judgment of each particular company and may vary from company to company. Policyholders may pay premiums in semiannual, quarterly, monthly, or weekly installments. An additional amount is added when an installment method of paying the premium is elected.

‘Deferred and uncollected premiums' are the premiums on policies with premiums payable more often then annually which become due after December 31 of the calendar year and before the next policy anniversary date.

‘Due and unpaid premiums' are premiums which are due to be paid before the end of the year, but which have not been paid by December 31. As required by law, all policies provide for a 31-day grace period for the payment of premiums after their due date, during which period the policy is carried in full force and effect.

‘Deferred and uncollected premiums' and ‘due and unpaid premiums' are hereinafter sometimes referred to as due and deferred premiums.²

There is no obligation, legal or otherwise, on an insured to pay to the insurer due and deferred premiums. If the policyholder does not pay the premium in conformity with the provisions of the policy, the policy is lapsed after the grace period and appropriate adjustments are made.

Petitioner was required by the State of Ohio and by the NAIC to compute its reserves on the great majority of its life insurance policies on the assumption that premiums were paid up 1 year in advance on each anniversary date commencing with the issuance date of the policy, even though premiums were not usually paid in this manner. The reserves so computed were reflected as a liability of petitioner and, as required by the Internal Revenue Code of 1954, as amended by the Life Insurance Company Income Tax Act of 1959,³ were taken into account in the computations required under sections 805 and 809 on the Federal income tax returns filed by petitioner for the taxable years 1958 to 1962, inclusive.

The NAIC annual statement treats deferred and uncollected premiums on a net basis. Item 17, on the assets page of the balance sheet, calls for the statement of ‘Life insurance premiums and annuity considerations deferred and uncollected’ on a net premium basis. Exhibit 13 of the annual statement, which gives the detail of the assets, sets forth deferred and uncollected premiums on a net basis. It provides for a memorandum account to show the amount of loading excluded from the deferred and uncollected premiums. Item 16 of the liabilities page of the balance sheet calls for a statement of the “Cost of collection' on premiums and annuity considerations deferred and uncollected in excess of total loading thereon.' As required by the NAIC annual statement, petitioner's annual statements showed net premiums deferred and uncollected as an asset. Also in conformity with the form, petitioner's annual statement did not show loading as an asset.

In the summary of operations contained in the NAIC annual statements, line 1.1, ‘Premiums and annuity considerations,‘ includes deferred and uncollected premiums on a gross basis. It (line 1.1) provides for the inclusion of such premiums at gross to be added to gross premiums collected during the year less deferred and uncollected premiums at gross as of the end of the previous year. Line 17, which is the ‘Increase in aggregate reserve for policies and contracts with life contingencies,‘ removes from income the net portion of the deferred and uncollected premiums. Line 25 provides for the deduction of the increase in loading on deferred and uncollected premiums and also for the deduction of cost of collection of premiums in excess of loading on deferred and uncollected premiums. In determining net gain from operations, lines 8 through 26A of the Summary of Operations list various allowable deductions, including the deduction in line 25 for increase in loading on deferred and uncollected premiums. This deduction was claimed by petitioner on its Federal income tax returns in determining its net gain from operations. Exclusive of increases in loading, the petitioner deducted all expenses actually paid or incurred each year on its NAIC annual statements and Federal income tax returns.

In its income tax returns for the years involved, petitioner did not include any due and deferred premiums as an asset, but it now concedes that they should be so included in an amount equal to the net valuation premiums. In these returns, petitioner did include, as an income item, an amount of due and deferred premiums equal to the deductions for increase in loading and increase in reserves.

OPINION

This case presents two issues relating to the interpretation and application of the Life Insurance Company Income Tax Act of 1959. 26 U.S.C.sec. 801 et seq. The Act was a comprehensive revision of the prior schemes for taxing the incomes of life insurance companies. See H. Rept. No.34, 86th Cong., 1st Sess., pp. 1-8 (1959); S. Rept. No. 291, 86th Cong., 1st Sess., pp. 1-12 (1959).

Section 802(b) sets out a three-phase approach which is to be followed in computing a life insurance company's taxable income.⁴ In arriving at taxable investment income and gain from operations, the 1959 Act recognizes that life insurance companies are legally obligated to keep policyholder reserves in order to meet future claims, that they normally add a significant portion of their investment income to these reserves, and that these annual reserve increments should not be subjected to tax. United States v. Atlas Ins. Co., 381 U.S. 233, 235-236 (1965). The Act thus attempts to tax only those portions of investment income and premium income which represent profit to the company, legally available for distribution to policyholders or stockholders as dividends, as distinguished from those gains which, under State law, must be set aside to meet the company's future contractual obligations. Jefferson Standard Life Insurance Co. v. United States, 408 F.2d 842, 844 (C.A. 4, 1969).

We note at the outset that we do not approach this case with a tabula rasa. Three Courts of Appeals, as well as this Court on two occasions, have decided similar cases involving one or both of the issues involved herein. Franklin Life Insurance Co. v. United States, 399 F.2d 757 (C.A. 7, 1968); Jefferson Standard Life Insurance Co. v. United States, supra; Western National Life Insurance Co. of Texas v....