T.C. Memo. 2010-128
UNITED STATES TAX COURT
F.W. SERVICES, INC. & SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 27134-08. Filed June 14, 2010.
Bruce Locke, for petitioner.
William G. Bissell, for respondent.
MEMORANDUM OPINION
KROUPA, Judge: Respondent determined a $1,965,456
deficiency in petitioner’s Federal income tax for 2004. The sole
issue for decision is whether petitioner may deduct $2,483,916
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deposited with an insurance company as an insurance premium under
section 1621 for 2004.2 We hold that it may not.
Background
This case was submitted fully stipulated under Rule 122. We
incorporate the stipulation of facts and the accompanying
exhibits by this reference. Petitioner’s principal place of
business at the time it filed the petition was Houston, Texas.
Petitioner is a consolidated group of corporations that
provide temporary staffing services. Petitioner purchased two
insurance policies from American Home Assurance Company (American
Home). One policy was for workers’ compensation insurance, and
one policy was for employers’ liability insurance.3 The policies
required American Home to pay, for all valid employer liability
claims, up to $1 million for each accident or disease suffered by
an employee of petitioner. The policies also had a “loss
reimbursement endorsement” that required petitioner to reimburse
American Home up to $500,000 for each accident, disease or claim.
American Home required petitioner to provide financial
1
All section references are to the Internal Revenue Code
(Code) in effect for 2004, 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
Petitioner paid a total premium of $1,654,249 for the two
policies in 2004.
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responsibility assurance for the $500,000 deductible amounts
before entering into the contracts.
To provide the requisite assurance, petitioner entered into
a contract with National Union Fire Insurance Company of Vermont
(National Union). National Union and American Home were both
subsidiaries of American International Group (AIG). The contract
required petitioner to pay into a National Union reserve fund
(reserve fund). National Union would then use money from the
reserve fund to pay the first $3.9 million of loss reimbursement
under the American Home policies. The parties to the contract
expected that the amount paid into the reserve fund would exceed
the $3.9 million liability limit.4
Petitioner had paid a total of $6,204,334 into the reserve
fund by the end of 2004.5 National Union paid $3,720,418 in
claims and handling expenses from the reserve fund to American
Home in 2004. Accordingly, National Union had $2,483,916
remaining in the reserve fund for payment of claims at the end of
2004.6
4
The parties to the contract estimated that petitioner would
pay $3,919,598 into the reserve fund in 2004, which would exceed
National Union’s $3.9 million liability limit.
5
There was $1,153,844 in the reserve fund at the beginning
of 2004. Petitioner deposited an additional $5,050,490 during
2004.
6
This is calculated by adding the total amount in the
National Union reserve ($5,050,490 + $1,153,844) and then
(continued...)
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Petitioner treated the two American Home policies and the
National Union contract as one insurance contract. Petitioner
deducted the premiums paid to American Home and all the payments
made to National Union on its Federal income tax return for 2004
as section 162(a) ordinary and necessary business expenses.
Respondent examined petitioner’s return for 2004 and issued
a deficiency notice. Respondent determined that the American
Home policies and the National Union contract should not be
treated as one insurance contract. Respondent allowed petitioner
to deduct the amount of all claims actually paid by National
Union to American Home in 2004 but disallowed petitioner’s
deductions for the amounts remaining in the National Union
reserve fund at the end of 2004. Respondent determined that such
amounts do not qualify as premiums for insurance deductible under
section 461(a) for 2004. Petitioner timely filed a petition
arguing that the amounts remaining in reserve as of the end of
the year are deductible for that year as insurance premiums.
Discussion
We must decide whether petitioner is entitled to deduct as
an ordinary and necessary business expense for 2004 the amounts
that remained in National Union’s reserve fund at the end of that
year. Respondent claims that such amounts do not constitute
6
(...continued)
subtracting the amount paid out by National Union to American
Home ($3,720,418).
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premiums for insurance, but rather are non-deductible deposits
toward the deductibles on petitioner’s American Home insurance
policies. Petitioner contends that the two American Home
policies and the National Union contract should be viewed as one
policy for purposes of determining the premiums paid for
insurance for 2004.
We begin with the general rules of deductibility and then
discuss deductibility of insurance premiums. Tax deductions are
a matter of legislative grace, and taxpayers must show that they
are entitled to any deduction claimed. Rule 142(a); Deputy v. du
Pont, 308 U.S. 488, 493 (1940). Taxpayers may generally deduct
all ordinary and necessary expenses paid or incurred during the
taxable year in carrying on a trade or business. Sec. 162(a).
Taxpayers may deduct insurance premiums that constitute an
ordinary and necessary business expense, including those for
workers’ compensation coverage. Sec. 1.162-1(a), Income Tax
Regs. The Code does not define “insurance.” The Supreme Court
has held that insurance entails risk shifting and risk
distribution. See Helvering v. Le Gierse, 312 U.S. 531, 539
(1941). Insurance shifts the risk of some potential loss or
portion of the potential loss from the insured to the insurance
company. See Commissioner v. Treganowan, 183 F.2d 288, 291 (2d
Cir. 1950).
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We now focus on the parties’ arguments. Petitioner concedes
that the National Union contract by itself would not be
considered an insurance contract because the terms of the
contract do not shift any risk to National Union. Petitioner
argues that the American Home policies and the National Union
contract result in a single insurance contract covering all of
petitioner’s employer liability losses up to $1 million.
Petitioner relies on the Supreme Court’s opinion in Helvering v.
Le Gierse, supra (Court considered an annuity contract and an
insurance contract issued by the same company to one taxpayer as
one contract). Petitioner concludes that it should therefore be
entitled to deduct all payments made to National Union and
American Home.
Respondent maintains that the National Union contract is a
separate contract and should be treated as such. Respondent
argues that the Supreme Court’s decision in Le Gierse was based
on distinct facts not present in this case and asserts that we
should disallow petitioner’s deduction for the amounts remaining
in the reserve fund at the end of 2004.
We must now determine whether to treat all three contracts
as one contract. When we consider the three contracts together,
the character of the contracts does not change. The contracts
continue to be two insurance contracts and one deposit contract.
See Legg v. St. John, 296 U.S. 489 (1936). The payments into the
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National Union reserve fund merely provided assurance that the
deductible amounts would be paid. They did not alter the risk
inherent in the true insurance provided under the American Home
policies. Cf. Helvering v. Le Gierse, supra (annuity contract
neutralized the risk inherent in the insurance policy).
Similarly, the risk shifted and distributed under the two
insurance policies does not change the nature of the reserve for
policy deductibles established under the National Union contract.
A reserve arrangement does not morph into insurance just because
there is an insurance policy next to it. We find that no rule of
law compels us to read these three separate contracts entered
into with two different insurance companies as one.
Petitioner emphasizes that the three contracts were
purchased at the same time and they were all purchased from
subsidiaries of AIG. Contemporaneousness is not dispositive, nor
do we find any reason to ignore the separate entity of each
subsidiary of AIG. We find that while American Home did require
petitioner to provide financial assurance for the deductible, it
did not make it a prerequisite that petitioner enter into a
contract with National Union for loss reimbursement. Cf. id.
(insurance policy and annuity contract considered together when
parties conceded the insurance policy would not have been issued
without annuity contract being purchased). In contrast, American
Home merely wanted to be certain that petitioner could meet its
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obligation to pay the insurance company policy deductibles. The
policies did not contain any provision concerning how petitioner
should provide the assurance or from whom petitioner should
purchase the assurance.
Petitioner had alternatives to contracting with National
Union. Petitioner could have purchased an insurance policy to
cover the $500,000 deductible or bought an insurance policy
without deductibles from American Home in the first place. We
find nothing in the American Home contracts to require petitioner
to enter into the contract with National Union.
We further reject petitioner’s invitation to treat National
Union and American Home as one corporation merely because they
have the same parent. See Helvering v. Le Gierse, supra
(taxpayer entered into two contracts with same insurance
company). Two corporations are generally regarded as distinct
legal entities even if they have a common parent. See 1 Fletcher
Cyclopedia of Corporations, sec. 43 (perm. ed. 2010 rev.).
Petitioner has not given the Court any reason to disregard the
separate legal status of National Union and American Home.
We decline to read the three contracts as one. Accordingly,
we disallow petitioner’s $2,483,916 deduction for the amounts
that remained in National Union’s reserve fund at the end of
2004.
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We have considered all remaining arguments the parties made
and, to the extent not addressed, we find them to be irrelevant,
moot, or meritless.
To reflect the foregoing and the parties’ stipulation of
settled issues,
Decision will be entered
under Rule 155.