Company's Dividend Deductions Did Not Meet All-Events Test; No Deduction Allowed.
(Parker's Federal Tax Bulletin: August 23, 2013)

The annual and termination dividends credited by an accrual-basis life insurance company to its policyholders in one year but not paid until the following year were not deductible until the year of payment because the deductions did not satisfy the all-events test for the tax years in which they were accrued. New York Life Insurance Company v. U.S., 2013 PTC 226 (2d Cir. 8/1/13).

New York Life Insurance Company, a mutual life insurance company, is a calendar-year, accrual-basis taxpayer. The company issued policies that entitled its holders to receive a policyholder dividend a share of the company's annual divisible surplus. Certain whole life policyholders were paid an annual dividend, comprised of the policyholder's share of the company's surplus, on the policy's anniversary date. The timing of the distribution of the annual dividend depended on the policy's anniversary date and the schedule of the policyholder's premium payment. The company's practice was to credit a policyholder's account with the amount of the annual dividend on a date before the policy's anniversary date but not pay the dividend until after the anniversary date. The company paid the annual dividend if the policyholder paid the policy premium and the policy was in force on the anniversary date. For most policies, the credit date fell within the same calendar year as the policy anniversary date. For policies with January anniversary dates, the credit date and anniversary date fell within different calendar years. New York Life deducted from its gross income the annual dividends amounts based on the credit dates rather than on the anniversary dates when the dividends were paid. Certain policies were also eligible for a termination dividend, which was paid to the policyholder or beneficiary upon the policy's termination.

On its federal income tax returns for 1990 through 1995, New York Life deducted the annual and termination policyholder dividends as accrued expenses, even though they were not paid until the following years. The IRS disallowed the deductions on the basis that the company could not deduct the dividends until the year of payment. In contesting the ruling, New York Life paid the taxes and filed a refund claim for $99.66 million in a district court. The district court dismissed the suit, concluding that New York Life failed to show that the expenses satisfied the all-events test of Reg. Sec. 1.461-1(a)(2) for the tax years in which they were accrued.

Code Sec. 808 allows life insurance companies to deduct from gross income an amount equal to the policyholder dividends paid or accrued during the tax year. Reg. Sec.1.461-1(a)(2) provides that a liability is incurred and generally taken into account for federal income tax purposes in the tax year in which (1) all events have occurred that establish the fact of liability, (2) the amount of the liability can be determined with reasonable accuracy, and (3) economic performance has occurred with respect to the liability.

OBSERVATION: To satisfy the conditions of the all-events test, the liability must be final and definite in amount, must be fixed and absolute, and must be unconditional. Thus, a liability does not accrue as long as it remains contingent.

New York Life argued that, in each year at issue, it made one of three combinations of dividend payments to eligible policyholders: an annual dividend, a termination dividend, or both an annual and termination dividend. Each year, the company calculated the annual and termination dividends it expected to pay the following year and claimed the amounts as a deduction for an accrued dividend under Code Sec. 808.

The IRS claimed that the deductions did not satisfy the all-events test, which governs the deductibility of accrued but unpaid expenses.

The Second Circuit held that, because the company's liability for the two dividends was contingent, all events had not occurred to fix the company's liability for the tax years in which it took the deductions. The court noted that the all-events test set forth in Reg. Sec. 1.461-1(a)(2) governs whether the liability for the policyholder dividends accrued during the tax year. The court looked to U.S. v. Hughes Properties, Inc., 476 U.S. 593 (1986) and U.S. v. General Dynamics Corp., 481 U.S. 239 (1987), which held that it is fundamental to the all-events test that a liability be firmly established to be deductible and a taxpayer may not deduct a contingent liability or an estimate of an anticipated expense, no matter how statistically certain. The court rejected New York Life's argument that the last event for purposes of the all-events test occurred when the January policyholders paid the final premium to keep their policies in force through the January anniversary dates, because the policyholders' decision to keep the policy in force through the anniversary date did not occur until January of the following year. Policyholders could surrender their policies for cash value at any time.

The court found that, for policies with January anniversary dates, the company had no obligation to pay the policyholder an annual dividend if the policy was surrendered before the anniversary date. The company also had no obligation to pay either an annual or termination dividend in the following tax year, as neither dividend was unconditionally due. The court concluded that the requirements of the all-events test were not satisfied, and the judgment of the district court was affirmed.

For a discussion of the all-events test, see Parker Tax ¶241,520.

Parker Tax Publishing Staff Writers

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