T.C. Memo. 2008-236
UNITED STATES TAX COURT
WELLPOINT, INC., f.k.a. ANTHEM, INC., SUCCESSOR IN INTEREST TO
ANTHEM INSURANCE COMPANIES, INC., AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13585-05. Filed October 27, 2008.
Philip C. Cook, Michelle M. Henkel, and Nancy B. Pridgen,
for petitioner.
Ruth M. Spadaro, John M. Altman, Robin L. Herrell, and
Thomas M. Rath, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KROUPA, Judge: Respondent determined a $49,075,740
deficiency in petitioner’s Federal income tax for 1999 and a
$2,630,548 deficiency for 2000. Petitioner is WellPoint, Inc. &
2
Subsidiaries, formerly known as Anthem, Inc. (Anthem), which was
the successor to Anthem Insurance Companies, Inc., and Associated
Insurance Companies, Inc. (both referred to as AICI). All of
these entities will be referred to as the Blue Cross and Blue
Shield Parent Company or petitioner.
We are asked to decide two issues. The first issue is
whether petitioner may deduct under section 162(a)1 three
settlement payments totaling $113,837,500 that it made to resolve
lawsuits brought against it by the attorneys general of Kentucky,
Ohio, and Connecticut (collectively the lawsuits and individually
the Kentucky litigation, the Ohio litigation, and the Connecticut
litigation). The second issue is whether the legal and
professional expenses that petitioner incurred to defend against
these lawsuits are deductible.2 The parties agree that both
issues are governed by the “origin of the claim” doctrine. We
hold that both the settlement payments and the legal and
professional expenses are capital expenditures and therefore not
deductible.
1
All section references are to the Internal Revenue Code in
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
2
The parties have resolved all other issues in a stipulation
of settled issues.
3
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the accompanying exhibits, and the
stipulation of settled issues are incorporated by this reference.
Petitioner is a mutual insurance company organized under Indiana
law.
Petitioner is in the business of providing commercial health
insurance through its subsidiaries. Petitioner and its
predecessors provided healthcare insurance coverage to members in
exchange for premiums, paid claims, and invested reserves and
surplus.
Many of petitioner’s direct or indirect operating
subsidiaries are licensees of the Blue Cross and Blue Shield
Association.3 Petitioner merged with the largest Kentucky, Ohio,
and Connecticut Blue Cross and Blue Shield (BCBS) plans (the
Settlement Subsidiaries) between 1993 and 1997.
The attorneys general of Kentucky, Ohio, and Connecticut
began looking into the corporate and legal history of the
Settlement Subsidiaries, ultimately deciding to bring lawsuits,
primarily cy-pres or charitable trust actions, against AICI and
3
The Blue Cross and Blue Shield Association, a trade
association formed in 1982 from the merger of the Blue Cross
Association and the Association of Blue Shield Plans, owns the
Blue Cross and Blue Shield trade names and marks. Licensees of
the Blue Cross and Blue Shield Association were required to be
nonprofit organizations until 1994.
4
its subsidiaries.4 Each attorney general separately claimed that
the State’s BCBS entity had a charitable purpose, had received
beneficial treatment under State and Federal law because of that
purpose, and held assets impressed with a charitable trust.5 The
attorneys general asserted that the entities’ charitable purposes
were no longer being met and that the charitable assets that had
accumulated should be taken from petitioner’s control and
redirected to the same or similar charitable purposes.6
4
There were multiple lawsuits and multiple claims, but the
predominant claim in each State was the cy-pres claim.
5
The Kentucky BCBS subsidiary was formed as a nonprofit
organization with a charitable purpose. Its charter proscribed
private pecuniary profit. The Ohio BCBS subsidiary’s original
Blue Cross predecessors were local hospital service associations
that had formed during the Great Depression with the purpose of
assisting individuals with payment of their medical expenses.
The Connecticut BCBS subsidiary and/or its predecessors were
formed as nonprofit organizations whose purpose was to promote
social welfare. Their charters prohibited private inurement.
They based charges to individuals for medical services on family
income and received discounted physician services and public
subsidies.
6
Count I of the Kentucky litigation asserted a cy-pres
claim, and counts II and III asserted unlawful conversion and
unjust enrichment claims. The Ohio Attorney General asserted a
cy-pres claim and alleged that Anthem had breached its fiduciary
duty to hold and apply Blue Cross assets to their charitable
purposes. The Connecticut Attorney General sought to protect
charitable assets and property impressed with a charitable trust
and alleged that Anthem breached fiduciary duties and made
negligent representations. Petitioner repeatedly characterized
the lawsuits as disputes over assets in their financial
statements, their annual reports, and their statements to
shareholders.
5
Petitioner made settlement payments totaling $113,837,500 in
1999 to resolve pending and potential claims in the Kentucky
litigation, the Ohio litigation, and the Connecticut litigation.
Petitioner agreed to pay $45 million to settle all claims in the
Kentucky litigation, relinquished all possession and ownership of
the funds, and transferred those funds to the Commonwealth of
Kentucky to create a section 501(c)(3) organization that promoted
Kentucky healthcare. Petitioner agreed to settle the Ohio
litigation for $36 million, reflecting the value of the Blue
Cross assets of the Ohio entity as of October 1, 1987, and that
money was used to establish the Anthem Foundation.7 Petitioner
settled the Connecticut litigation for $40,836,500, which it paid
to a newly formed charitable corporation to serve the health
needs of the citizens of Connecticut.8
Petitioner filed returns for the taxable years ending
December 31, 1999 and 2000, deducting the $113,837,500 settlement
amount in 1999 and deducting $819,201 in 1999 and $8,394 in 2000
for legal and professional fees incurred
7
Petitioner was given an $8 million credit for prior
charitable contributions and, accordingly, was required to pay
only $28 million of the $36 million settlement.
8
Some of this litigation is described in Capital Blue Cross
& Subs. v. Commissioner, 122 T.C. 224 (2004), revd. 431 F.3d 117
(3d Cir. 2005). That decision is neither binding on nor
dispositive of this case.
6
in connection with the lawsuits.9 Respondent examined and
disallowed the deductions for settlement payments and legal fees.
Petitioner timely filed a petition.
OPINION
We are asked to decide whether the settlement payments and
legal fees are deductible as ordinary and necessary expenses as
petitioner argues or whether, as respondent argues, petitioner
must capitalize these expenses.10 The parties agree that the
origin of the claim doctrine controls the outcome of this case.
I. Origin of the Claim Doctrine
Distinguishing between expenses that can be deducted under
section 162 and those that must be capitalized under section 263
requires an examination of all the pertinent facts and events,
and each case “‘turns on its special facts’.” INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 86 (1992) (quoting Deputy v. du Pont,
308 U.S. 488, 496 (1940)); Boagni v. Commissioner, 59 T.C. 708
(1973).
Whether expenses are deductible on the one hand, or subject
to being capitalized on the other hand, may be determined by the
origin of the claim test. Woodward v. Commissioner, 397 U.S. 572
(1970); United States v. Gilmore, 372 U.S. 39 (1963). Under this
9
The parties already resolved their dispute about other
legal and professional fees in the stipulation of settled issues.
10
Respondent argues alternatively that the settlement
payments and legal fees are neither capitalizable nor deductible.
We need not reach that issue because of our holding.
7
test, the substance of the underlying claim or transaction out of
which the expenditure in controversy arose governs whether the
item is a deductible expense or a capital expenditure, regardless
of the motives of the payor making the payment or the
consequences that may result from the failure to defeat the
claim. See Woodward v. Commissioner, supra at 578; Newark
Morning Ledger Co. v. United States, 539 F.2d 929, 935 (3d Cir.
1976); Clark Oil & Ref. Corp. v. United States, 473 F.2d 1217,
1220 (7th Cir. 1973); Anchor Coupling Co. v. United States, 427
F.2d 429, 433 (7th Cir. 1970). The origin of the claim test does
not involve a “mechanical search for the first in the chain of
events,” but requires consideration of the issues involved, the
nature and objectives of the litigation, the defenses asserted,
the purpose for which the amounts claimed as deductions were
expended, and all other facts relating to the litigation. Boagni
v. Commissioner, supra at 713.
A. Character of the Claim–Settlement Payments
The predominant claim in each of the lawsuits was the cy-
pres claim. “Cy-pres” is defined as “a rule for the construction
of instruments in equity, by which the intention of the party is
carried out as near as may be, when it would be impossible or
illegal to give it literal effect.” Black’s Law Dictionary 387
(6th ed. 1990). Under the cy-pres doctrine, if property has been
dedicated in trust for a particular “charitable purpose” and that
8
purpose is not being carried out, a State attorney general is
authorized to initiate a cy-pres proceeding to carry out the
charitable purpose in a way that is “as near as” possible to the
original purpose. 4A Scott & Fratcher, The Law of Trusts, secs.
399, 399.2, at 476-484, 489-517 (4th ed. 1989).
B. Deductibility of Cy-Pres Claim Litigation
We now focus on whether the payments made by petitioner for
litigation and settlement of the claims under the cy-pres
doctrine are deductible ordinary and necessary expenses under
section 162 or expenses that must be capitalized under section
263. The costs incurred in litigating title to property are
capital expenditures. Sec. 1.263(a)-2(c), Income Tax Regs.
Defending or perfecting title to property encompasses not only
disputes over legal title but also disputes over beneficial
interests of trusts, including contests over whether a trust
exists. See Boagni v. Commissioner, supra; Reed v. Commissioner,
55 T.C. 32 (1970); Stevens v. Commissioner, T.C. Memo. 1999-259;
Barr v. Commissioner, T.C. Memo. 1989-420; Duntley v.
Commissioner, T.C. Memo. 1987-579. Settlement payments and legal
fees expended to resolve disputes over ownership of assets may be
capital expenses. See Anchor Coupling Co. v. United States,
supra; Wallace v. Commissioner, 56 T.C. 624 (1971). Payments
that settle challenges to ownership that are of questionable
9
merit may also be capital. See Am. Stores Co. v. Commissioner,
114 T.C. 458 (2000); Duntley v. Commissioner, supra.
A deduction is generally allowed for expenses incurred in
defending a business and its policies from attack. INDOPCO, Inc.
v. Commissioner, supra at 83; Commissioner v. Tellier, 383 U.S.
687 (1966); Commissioner v. Heininger, 320 U.S. 467 (1943).
II. Parties’ Arguments
Petitioner argues that the settlement payments are
deductible under section 162(a) as ordinary and necessary
expenses paid or incurred in carrying on its profit-seeking
insurance business and are directly connected to its profit-
seeking activities. Petitioner argues that the payments cannot
be capitalized because the lawsuits did not challenge title of
specific items of property. Respondent argues that petitioner
may not deduct the settlement payments because they represent
transfers of assets held in charitable trust.11
III. Analysis
The record shows that none of the lawsuits in question was
brought to enjoin or change AICI’s business practices, as
11
The State attorneys general sought to recover assets from
petitioner that they claimed were never petitioner’s assets.
According to the State attorneys general, petitioner’s
subsidiaries held these assets in trust for a charitable purpose.
Because the subsidiaries, like the parent company, were no longer
operated for charitable purposes, the State attorneys general
sought to recover these assets and return them to their
charitable purpose. Respondent claims that the transfer of these
assets from petitioner to their charitable purpose is a transfer
of title.
10
petitioner argues. In each case, the origin of the claim was a
dispute over the equitable ownership of assets allegedly
impressed with charitable trust obligations. In each case, the
settlement provided that the assets AICI relinquished were
transferred to a section 501(c)(3) organization with the same
charitable purpose that the attorneys general claimed the
charitable trust assets benefitted.
The Kentucky litigation involved a title contest to alleged
charitable assets. Relying upon its research into legislative
and corporate history, the Kentucky Attorney General’s office
brought suit alleging that predecessors to the Anthem subsidiary
in Kentucky held their assets in charitable trust for the benefit
of public health in the State. The complaint, the settlement
document, and the parties’ own descriptions of the nature of the
lawsuit convince us that the purpose of the Kentucky litigation
was to determine title to the alleged charitable assets. The $45
million settlement directly responded to the Kentucky Attorney
General’s allegation that the assets held by petitioner were
committed to a charitable purpose. The $45 million went to
establishing a section 501(c)(3) organization that addresses
healthcare needs. There is no evidence that the attorney general
sought to change AICI’s business practices, as petitioner
alleges.
11
The Ohio Attorney General’s office filed a complaint
alleging that certain assets were impressed with a charitable
trust and seeking the return of those assets to their original
charitable purpose because BCBS-Ohio’s merger with AICI
frustrated that purpose. The claim alleged beneficial ownership
in the public of the Blue Cross entity’s assets because of the
entity’s relationship with charitable hospitals, the tax
exemptions it received, and its own declarations that it was
organized solely for social welfare purposes.
The Connecticut Attorney General also found a basis for a
charitable trust claim because the BCBS entity was a non-profit
low-cost healthcare provider devoted to public welfare. The
complaint and the settlement focused on the ownership of trust
assets. Again, petitioner’s financial statements and annual
reports characterized this lawsuit as a dispute over title to
assets allegedly impressed with a charitable trust.
Petitioner denies the existence of a charitable trust
obligation and asserts that it settled only to avoid interruption
of business or loss of good will. We find this argument
irrelevant to our analysis. A taxpayer’s motive for settling is
not controlling in determining whether a settlement payment is
deductible. Woodward v. Commissioner, 397 U.S. at 578; Anchor
Coupling Co. v. United States, 472 F.2d at 431.
12
Petitioner further argues that the attorneys general may
have been confused about whether the Settlement Subsidiaries were
section 501(c)(3) organizations or charities under Federal tax
law. We decline to relitigate the underlying merits of each
lawsuit, and our analysis of the origin of the claim does not
demand it. As a result, because the attorneys general brought
suit to recover equitable title to assets they believed were
impressed with charitable trusts, the origins of the claims in
all three lawsuits were disputes over title to assets.
Petitioner nevertheless contends that the origin of the
lawsuits was a challenge to the manner in which petitioner’s
subsidiaries conducted their profit-seeking health insurance
business. All the evidence suggests otherwise. No prayer for
relief demanded a change in business behavior, and none of the
testimony of the attorneys who worked on these cases for the
Kentucky, Ohio, and Connecticut attorneys general suggested that
they sought to change AICI’s business practices or shut them
down.
Petitioner also relies heavily on the theory that the
settlement payments are per se deductible because they were
necessary to defend its business. Petitioner relies primarily on
two cases to argue that the settlement payments are per se
deductible, BHA Enters., Inc. v. Commissioner, 74 T.C. 593 (1980)
and A.E. Staley Manufacturing Co. & Subs. v. Commissioner, 119
13
F.3d 482 (7th Cir. 1997), revg. and remanding 105 T.C. 166
(1995). In BHA, the origin of the claim was grounded in the
taxpayer’s effort to keep the FCC from revoking its broadcasting
licenses, without which the taxpayer could not do business.
There is no evidence in the record, however, that the attorneys
general sought to stop petitioner’s business. Moreover,
petitioner’s business did not fail despite the attorneys
general’s success in removing many of these assets from
petitioner’s control. The uncorroborated and self-serving
testimony of petitioner’s witnesses that they could no longer do
business if they lost these suits is unconvincing.
The facts in A.E. Staley are equally unavailing to
petitioner. In that case, the Court of Appeals allowed
deductions for certain investment banking and printing costs
incurred by the taxpayer in an unsuccessful effort to defend its
business against a takeover because the costs produced no future
benefit. A.E. Staley Manufacturing Co. & Subs. v. Commissioner,
supra at 489. Our case is factually distinguishable because the
future benefits accruing from the defense and settlement of the
cy-pres litigation are manifest, enabling petitioner in effect to
convert the assets from charitable to income-producing purposes.
We need not address respondent’s alternative theories
because we hold that the settlement payments originated from
14
suits to resolve title to assets and therefore are not
deductible.
IV. Character of Legal and Professional Expenses
We turn now to the question of whether the legal and
professional expenses petitioner incurred in defending itself
from the lawsuits are deductible. Legal and professional
expenses, like settlement payments, are analyzed under the origin
of the claim doctrine. Mosby v. Commissioner, 86 T.C. 190
(1986). Costs incurred in defending title to property are
capital expenditures. Sec. 1.263(a)-2(c), Income Tax Regs.
Moreover, legal expenses incurred in defending against claims
challenging a taxpayer’s ownership of assets may be capital
expenditures. Duntley v. Commissioner, T.C. Memo. 1987-579.
Petitioner’s legal and professional fees arose from defending
against claims that had their origin in equitable ownership of
assets. Accordingly, these fees are capital expenditures.
V. Conclusion
Petitioner’s settlement payments and litigation and
professional fees are capital expenditures and not deductible
under section 162(a).
In reaching our holdings, we have considered all arguments
made, and to the extent not mentioned, we consider them
irrelevant, moot, or without merit.
15
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.