1943 U.S. Tax Ct. LEXIS 239">*239 Decision will be entered for respondent.
1. Its "reserves" failing to qualify as true life insurance reserves, petitioner, held, not a life insurance company within the applicable law.
2. Premiums received by petitioner in ordinary course, although partly dedicated to the payment of claims under its policy contracts, held, income to it.
1 T.C. 555">*555 These proceedings challenge determinations of deficiencies in income tax for the years 1937, 1938, and 1939 in the amounts of $ 1,755.66, $ 2,438.50, and $ 2,733.69, respectively.
The primary question involved is whether petitioner is a life insurance company within the meaning of sections 201-203 of the applicable law, Revenue Acts of 1936 and 1938 and Internal Revenue Code. It is also contended that funds petitioner was required by the Board of Insurance Commissioners of the State of Texas to place in a mortuary fund were not income to it because of their asserted character as trust funds.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of Texas, with its principal place of business in Dallas, 1943 U.S. Tax Ct. LEXIS 239">*240 Texas. The returns for the taxable years here involved were filed with the collector of internal revenue for the second district of Texas.
Petitioner received its initial charter in 1907, under the name of Yeoman of the World. In 1933 the charter was amended and the name changed to General Life Insurance Co. The amended charter stated the purpose of the corporation to be the payment of benefits in case of incapacity and the payment of death benefits to beneficiaries of members. It was further provided that petitioner should have no capital stock and should "be conducted for the benefit of its members and not for profit." The directors were given authority to adopt bylaws regulating the affairs of petitioner.
New bylaws were adopted in February 1934 to conform to the requirements of House Bill 303 enacted by the state legislature in 1933, covering companies of this type.
Under the title "Membership," the bylaws provided:
Section 4. All policies are to be subject to the authority of the Board of Directors to fix the amount of premiums and the time and the manner of payments 1 T.C. 555">*556 thereof, and the risks to be assumed by the Company and the duration thereof, and to change 1943 U.S. Tax Ct. LEXIS 239">*241 same from time to time as the experience of the Company may require; provided that any policy form may be changed only with the approval of the Department of Insurance.
The bylaws also provided that the maximum benefit for which policies should be issued was $ 500. In 1935 this maximum was raised to $ 1,000.
It was further provided:
Section 13. This Company shall not issue any policy or certificate upon a limited payment plan, nor guarantee or promise to pay any type of endowment or annuity benefits, but shall confine its operation to the issuance of certificates or policies looking to continuous payment of premiums or assessments during the lifetime of the policyholder.
Section 14. This Company shall have the right to create separate groups, clubs, or classes, based upon the age of policyholders, occupation of policyholders, or to designate as one class all those members holding the same form of policy, as may be determined by the Board of Directors, and may provide that the benefits of policies in such designated group, club or class, shall be limited to the premiums or assessments collected from such particular group, club or class, respectively.
In that part of the bylaws1943 U.S. Tax Ct. LEXIS 239">*242 entitled "Officers and Elections" it was provided that the management, control, and direction of petitioner should be vested in a board of directors consisting of seven persons to be elected by ballot at each annual meeting of the members.
That part of the bylaws entitled "Premiums" provides as follows:
Section 1. The Board of Directors as authorized by law shall fix such premiums and/or membership fees in such manner and for such amounts as in their judgment may be required properly to conduct the business of the Company. The money with which the policy obligations of the Company are to be paid shall be by premiums or assessments paid by the members. If the sum realized by this Company from such premiums or assessments shall be insufficient to pay its policy claims in full for which it is liable, then the Company may call for additional premiums or assessments, and the payment of the full amount realized by said Company from said premiums less the amount deducted for expense as herein provided shall discharge the Company from all liability as to said claims, except that in no case shall payment be less than fifty per cent of the amount due under said policy contracts.
Section1943 U.S. Tax Ct. LEXIS 239">*243 2. All moneys collected by this Company shall be placed in two funds known as the Reserve or Mortuary Fund, and the Expense Fund. Sixty per cent of all moneys collected by this Company, except membership fees, shall be placed in the Reserve Fund and forty per cent of all moneys collected by this Company and the whole of membership fees shall be placed in the Expense Fund. The Company may charge a membership fee not to exceed Five Dollars ($ 5.00) for each policy of insurance.
All losses or claims to policyholders or their beneficiaries, under policies issued by this Company shall be charged to the Reserve Fund, and all attorneys' fees and necessary expenses arising out of the defense, settlement, or payment of contested claims shall be charged to the Reserve or Mortuary Fund.
All expenses including the salaries of all officers and employees, operating expenses, office rent and all other expenses of whatever nature, shall be charged 1 T.C. 555">*557 to the Expense Fund. No part of the Reserve or Mortuary Fund shall ever be used for the purpose of operating said Company, but shall be used to pay policy obligations, as herein provided.
By a 1935 amendment the first three months' premiums1943 U.S. Tax Ct. LEXIS 239">*244 were defined as membership fees to be placed in the expense fund. The bylaws further provided:
Section 3. Whenever, from any cause, this Company shall have ceased to exist, all property shall be converted into cash, and all funds in hand or on deposit in bank, trust companies or safe deposit companies shall be divided pro rata among the then existing members of said Company, provided, however, that previous to such division of funds, all existing obligations of said Company of every nature shall have been discharged.
The bylaws as amended were in full force and effect during the tax years here involved.
Policies were issued by petitioner upon a written application calling for general information and making inquiries as to the state of health of the applicant. Petitioner issued five types of policies known as "Level Premium Whole Life," "Level Premium Family Group," "Accumulative Old Age," "Accumulating Family Group," and "3 Way Life, Accident & Health." The latter type of policy was not issued until June 1937. Each of the policies provided for stipulated assessments or premiums at periodic payment intervals with the right reserved to the company to make any additional assessments1943 U.S. Tax Ct. LEXIS 239">*245 as it might see fit. The following provision, or one of similar import, was contained in each policy written by petitioner:
This Policy is subject to the laws of the State of Texas, by which the Company has been licensed and the necessary portion of all amounts collected on the premiums of this and all other like Policies issued by this Company shall be deposited as required by law to the reserve fund, and shall be liable for the payment of death benefits hereunder. The benefits provided in this Policy shall be payable out of the reserve fund, created as provided by the By-laws of the Company, however, if the losses incurred under this Policy and all other like Policies require additional funds the Company reserves the right to collect additional premiums. The maximum liability of the Company under this Policy, on account of the death of the Insured hereunder, shall be the reserve portion of one premium collected plus a pro rata of the reserve fund at the time of claim hereunder, in no event to exceed the face value of this Policy, with accumulations.
The statement in policies by petitioner designating them as "Level Premium" policies was erroneous. Petitioner was able to make1943 U.S. Tax Ct. LEXIS 239">*246 an assessment if necessary.
Petitioner could not issue policies for a guaranteed face amount. It could satisfy its policy claims by paying as low as 50 percent of the face of the policy involved. During the years in question petitioner never failed to pay the full face value of every valid claim. No claims were settled on the basis of the amount received from the 1 T.C. 555">*558 members as the result of one assessment as stated in the above quoted portions of the policies. The basic theory of petitioner's operation was that it reserved the right to make such an assessment at any time it might need it. No assessments have ever been made in addition to those stipulated in the policies.
The stipulated assessment plan was used because under it petitioner could build up a reserve fund which would provide for the increasing age of the members, while the assessment-as-needed plan would result in assessments too high for the members to pay as their age and mortality rate increased.
Beginning in March 1938 petitioner issued a double indemnity rider to be attached to policies, for which an additional premium was charged.
On August 1, 1938, petitioner entered into a general agency contract with1943 U.S. Tax Ct. LEXIS 239">*247 a partnership composed of C. A. Sammons, R. S. Sammons, and S. P. Brooks. C. A. Sammons was president of petitioner. The contract provided that the partnership should receive as compensation for its services as general agent whatever was left out of the expense fund of 40 percent of the income, after the payment of expenses.
There was no such general agency contract prior to August 1, 1938.
During the time here material there was no direct statutory requirement of Texas law for companies of petitioner's type to make the 60-40 division of its assessments, exclusive of membership fees. The Insurance Department of the State of Texas, nevertheless, under its right to approve or disapprove bylaws of such companies, established the requirement for the 60-40 division of assessments. The order read in part as follows:
If the by-laws of an association or company provide for a Membership Fee, such one Membership Fee may be placed in the Expense or General Fund of said association or company.
If no Membership Fee is provided for, then the first three (3) Monthly Premiums or Assessments paid by each member, or an amount equivalent thereto but in no event to exceed the amount of the first 1943 U.S. Tax Ct. LEXIS 239">*248 three payments mentioned above, may be placed in the Expense or General Fund of said association or company in the same manner as if said three payments constituted a Membership Fee.
At least sixty percent (60%) of all other gross income of the association or company shall be placed in the Mortuary Fund. The remaining forty percent (40%) may be placed in the General or Expense Fund.
The by-laws of such companies or associations may provide for the payment out of said Mortuary Fund of all attorneys' fees and necessary expenses arising out of the defense, settlement, or payment of contested claims.
The premiums were not based on any mortality computations and were not designed to provide an amount of money which with accretions 1 T.C. 555">*559 from interest would mature or liquidate the respective policies. The mortuary fund was not regarded as an investment fund to yield income which would form accretions to the premiums or assessments and mature the policies. It was a fund created for the purpose of paying claims as they arose. The petitioner had a small amount of interest income from the investment of part of its mortuary funds. This type of company has little if any income from such1943 U.S. Tax Ct. LEXIS 239">*249 a source. The department of insurance limits the investment of mortunary funds to the same as those in which a legal reserve life insurance company could invest its funds.
The mortuary fund is carried in the name of the particular company involved and under its control. It can be used only for the payment of claims, as they arise, and the payment of expenses in connection with contested claims. In this respect the fund is regarded by the state insurance department in theory as belonging to the beneficiaries after claims have arisen, and as a fund belonging to the company for a designated purpose. Policyholders have no right to any portion of the mortuary fund except in the case of a claim, unless the company is being liquidated. The policies have no cash surrender value. The mortuary fund is carried as an asset on the form required by the state of companies such as petitioner, for annual filing. There is a difference of opinion in the insurance department as to whether it is an asset or a liability. At one time it appeared on the official forms as a liability, but was discontinued.
Petitioner filed annual statements with the insurance department of the state and was examined1943 U.S. Tax Ct. LEXIS 239">*250 by officials of that department at least every two years. Certificates or permits to do business were issued annually as the result of the annual statements filed, or the examination, or both.
The Texas statutes and the department of insurance do not treat petitioner as being in the same category as the "old line legal reserve" companies. The annual reports of the two types are not the same and the "reserve" and "relief fund" requirements are different. The insurance department of the state has no interest in the general or expense fund of petitioner and, as the company was operated, neither had the policyholders as "members" of the "association." The insurance department regarded its control over this fund as limited to the extent of seeing that legitimate bills against petitioner were paid. It has no control over the amounts received by the operators or officials of the company out of this fund but is advised through the annual statements of the amounts paid therefrom.
Petitioner's receipts and disbursements, division of its income and expenses, for the years in question were as follows: 1 T.C. 555">*560
| 1937 | ||
| Income | ||
| Mortuary | General | |
| fund | fund | |
| Membership fees | $ 15,173.69 | |
| Premiums and assessments | $ 30,474.54 | 20,358.12 |
| Interest received | 230.00 | |
| Transfer of funds | 1,000.00 | |
| Total income | 31,704.54 | 35,531.81 |
| Disbursements | ||
| Death claims | 19,595.23 | |
| Investigation and settlement | ||
| expense | 2,231.85 | 1,959.00 |
| Commissions and fees to | ||
| agents (first year) | 15,264.03 | |
| Commissions and fees to | ||
| agents (other years) | 1,645.63 | |
| Salaries of officers | 1,000.00 | |
| Salaries of office employees | 6,182.52 | |
| Cancelations | 63.75 | 176.30 |
| Accrued interest | 87.76 | |
| Appeal bond | ||
| Statutory bond | ||
| Loss on sale of municipal bond | ||
| Taxes | ||
| All other operating expenses | 8,310.84 | |
| Transfer of funds | 1,000.00 | |
| Total disbursements | 21,978.59 | 35,538.32 |
| Total receipts over | ||
| disbursements | 9,725.95 | (6.51) |
| Carried over from prior year | 10,516.85 | 306.83 |
| Balance at end of year | 20,242.80 | 300.32 |
| 1938 | ||
| Income | ||
| Mortuary | General | |
| fund | fund | |
| Membership fees | $ 11,056.45 | |
| Premiums and assessments | $ 39,200.19 | 26,133.53 |
| Interest received | 594.95 | |
| Transfer of funds | ||
| Total income | 39,795.14 | 37,189.98 |
| Disbursements | ||
| Death claims | 20,186.53 | |
| Investigation and settlement | ||
| expense | 4,565.20 | |
| Commissions and fees to | ||
| agents (first year) | 19,278.70 | |
| Commissions and fees to | ||
| agents (other years) | 1,663.53 | |
| Salaries of officers | 325.00 | |
| Salaries of office employees | 7,523.70 | |
| Cancelations | 38.38 | 143.15 |
| Accrued interest | 84.15 | |
| Appeal bond | 17.00 | |
| Statutory bond | 200.00 | |
| Loss on sale of municipal bond | ||
| Taxes | ||
| All other operating expenses | 8,076.90 | |
| Transfer of funds | ||
| Total disbursements | 24,891.26 | 37,210.98 |
| Total receipts over | ||
| disbursements | 14,903.88 | (21.00) |
| Carried over from prior year | 20,242.80 | 300.32 |
| Balance at end of year | 35,146.68 | 279.32 |
| 1939 | ||
| Income | ||
| Mortuary | General | |
| fund | fund | |
| Membership fees | $ 7,930.77 | |
| Premiums and assessments | $ 44,448.80 | 29,632.46 |
| Interest received | 1,182.48 | |
| Transfer of funds | ||
| Total income | 45,631.28 | 37,563.23 |
| Disbursements | ||
| Death claims | 25,769.25 | |
| Investigation and settlement | ||
| expense | 3,049.77 | |
| Commissions and fees to | ||
| agents (first year) | 19,918.83 | |
| Commissions and fees to | ||
| agents (other years) | 1,849.80 | |
| Salaries of officers | ||
| Salaries of office employees | 8,397.25 | |
| Cancelations | 32.60 | 97.50 |
| Accrued interest | ||
| Appeal bond | ||
| Statutory bond | ||
| Loss on sale of municipal bond | 37.94 | |
| Taxes | 117.60 | 370.84 |
| All other operating expenses | 88.86 | 6,273.77 |
| Transfer of funds | ||
| Total disbursements | 29,096.02 | 36,907.99 |
| Total receipts over | ||
| disbursements | 16,535.26 | 655.24 |
| Carried over from prior year | 35,146.68 | 279.32 |
| Balance at end of year | 51,681.94 | 934.56 |
1943 U.S. Tax Ct. LEXIS 239">*252 In its income tax returns for the years in question petitioner reported as gross income on Form 1120 the total amounts received from its members, and listed among its expenses, as "reserve fund for members," an amount approximating that shown in the annual statements as allocated to the mortuary fund out of such income.
In the notice of deficiency respondent computed petitioner's tax as provided in section 204 of the Revenue Act of 1936 and the corresponding sections of the Revenue Act of 1938 and the Internal Revenue Code.
OPINION.
Under the rule which we have consistently followed, petitioner is not a life insurance company within the definition of section 201 of the Internal Revenue Code1 unless at least 50 percent of "its total reserve funds" are true life insurance reserves required to be maintained by the law under which it operates. Standard Industrial Life Insurance Co. of Louisiana, Inc., 42 B. T. A. 1011; Independent 1 T.C. 555">*561 ., 47 B. T. A. 894; see also Swift & Co. Employes Benefit Association, 47 B. T. A. 1011. Petitioner, which does business on 1943 U.S. Tax Ct. LEXIS 239">*253 the mutual assessment plan in Texas, was required by the state board of insurance commissioners to carry in its so-called "mortuary fund" 60 percent of its entire gross income after either the payment of a membership fee, or the first three monthly premiums or assessments, paid by each member. This fund was petitioner's only reserve for the payment of life insurance claims, and if it does not qualify under the definition, then petitioner failed to have 50 percent, or indeed any amount, of its total reserves held as reserves for life insurance contracts.
1943 U.S. Tax Ct. LEXIS 239">*254 There is no indication whatever that the mortuary fund was computed by use of mortality tables or an assumed interest rate or on any actuarial principle. "It is clear that, as used in sections 201 (a) and 203 (a) (2), the word 'reserve' has a technical meaning peculiar to the law of insurance and is not anything which a state statute or officer may so designate. * * * A reserve for a life insurance policy is built up so that in future years as the probabilities of death of the insured increase the premium may remain level. The amount of the reserves is actuarially computed according to recognized tables of mortality and with an assumed rate of interest." Independent Life & Accident Insurance Co., supra.As in that case "The reserve here was not computed upon the basis of any mortality table. It was fixed at a flat rate of * * * [60] percent of gross * * * [income]. Although this fulfilled the requirement of the * * * [Texas law], we do not think it is within the technical meaning of 'reserve' as used in the revenue acts."
Nor does there appear to be any provision of the Texas regulation which requires that the reserve for this type of insurance 1943 U.S. Tax Ct. LEXIS 239">*255 be actuarially computed. As a consequence even if petitioner had calculated its mortuary fund contributions on the basis of accepted life insurance principles the excess, not being required by law, would constitute a voluntary reserve fund and be ineffectual to qualify petitioner under the definition. Independent Life & Accident Insurance Co., supra.
Neither Lamana-Panno-Fallo Industrial Insurance Co. v. Commissioner (C. C. A., 5th Cir.), 127 Fed. (2d) 56, nor National Protective Insurance Co., 44 B. T. A. 978; affd. (C. C. A., 8th Cir.), 128 Fed. (2d) 948, is out of harmony with these conclusions. In the former, a state statute requiring the actuarial computation of reserves was waived in part by the state authorities. Basing its opinion upon the "character" rather than upon the "sufficiency" of the reserves, the court held that they adequately complied with the tax definition. In the latter, the determinative question was the meaning of the term "total reserve funds" of an insurance company rather than the "reserve 1 T.C. 555">*562 funds * * * held for the fulfillment1943 U.S. Tax Ct. LEXIS 239">*256 of" life insurance contracts, which is the question here. In that case the contention was rejected that total reserve funds required by law include only true reserves, and that accordingly reserves for non-life insurance risks not so classified were not to be included in the whole upon which the 50 percent is computed. But there was no holding in either case that reserves held for the fulfillment of life insurance contracts, as that term is used in the statutory definition of life insurance companies, is to be differently defined from the cases first cited. On the authority thereof it is necessary to conclude that petitioner was not a life insurance company for purposes of the revenue acts.
The provision of section 202 (b) referring specifically to assessment insurance 2 does not require a different conclusion. Even if it were not true, as the Board thought in Interstate Reserve Life Insurance Co., 37 B. T. A. 54, 60, that this provision "was meant merely to provide equality of treatment of assessment insurance by including within the meaning of 'reserve funds required by law' funds raised by assessment as well as from premium payments," a statement1943 U.S. Tax Ct. LEXIS 239">*257 fortified by the selection for that provision of a section defining gross income, there are two compelling reasons for rejecting its application here. The mortuary fund is not shown to have been "maintained under the charter or articles of incorporation" of the petitioner, nor to have been available "exclusively for the payment of claims arising under certificates of membership * * * and not subject to any other use." Petitioner's bylaws, not its charter apparently created the fund, which could be used for expenses connected with the contest and settlement of claims as well as with their payment. Since there is and could be no claim that the sums in question were "actually deposited * * * with State or Territorial officers," there is no aspect of that provision which can be said to govern this petitioner's situation.
1943 U.S. Tax Ct. LEXIS 239">*258 Nor is it permissible to exclude from petitioner's gross income the net additions to the mortuary fund on the theory that they were trust funds held for specific purposes. Its premiums are received by petitioner in the first instance in ordinary and unrestricted course and are not appropriated for the use or benefit of particular individuals. Cf. Board v. Commissioner (C. C. A., 6th Cir.), 51 Fed. (2d) 73. 1 T.C. 555">*563 They are merely dedicated in part, after their receipt, to the payment, contest, or settlement of claims arising under the policies for which the respective premiums and assessments are paid. In essence they do not differ from the investment funds and reserves of other insurance companies which are maintained in order to liquidate claims. The receipts which constitute the basis of the payment into the mortuary fund are in effect petitioner's gross income and they are so designated in the ruling of the Texas Insurance Commissioners.
Nor can it be doubted that the premiums or assessments which petitioner received constitute the "underwriting income" expressly included in gross income under section 204 of the Internal Revenue Code and1943 U.S. Tax Ct. LEXIS 239">*259 by inference under section 207. See Regulations 103, sec. 19.207-2; cf. Regulations 86, art. 207-1. The parties agree that these are the only alternative provisions for the taxation of petitioner if it is not a life insurance company. Even though it is required that, upon receipt, 60 percent of petitioner's "gross income * * * shall be placed in the Mortuary Fund," we can not say that that subsequent disposition deprives it of the character of income when received or exempts it from taxation under the applicable section of the law. West Side Tennis Club, 39 B. T. A. 149, 159; affd. (C. C. A., 2d. Cir.), 111 Fed. (2d) 6; certiorari denied, 311 U.S. 674">311 U.S. 674; Clay Sewer Pipe Association, Inc., 1 T.C. 529. If it can be said that the payments into the mortuary fund would have any effect, it would rather be as a deduction or offset against income received. Cf. Monarch Life Insurance Co., 38 B. T. A. 801. For this, however, we look in vain to the section under consideration. We are accordingly of the opinion that the claim of petitioner that1943 U.S. Tax Ct. LEXIS 239">*260 60 percent of its gross income did not constitute any part of its gross income can not be sustained.
The only question that remains is whether petitioner's tax should be computed under section 204, which refers to "insurance companies other than life or mutual," or under section 207, dealing with "mutual insurance companies other than life." The more reasonable view of petitioner's organization contradicts its contention that it was a mutual company. By means of its agency agreement the 40 percent of petitioner's gross income not required for application to the mortuary fund was paid to the individuals responsible for the operation of petitioner and even prior to that agreement it does not appear that the members had any rights in the expense fund. No matter how greatly its receipts from fees and assessments should exceed amounts required to pay expenses and losses, the policyholders were, as a practical matter, precluded from any participation in this portion of the proceeds of petitioner's business. "It is of the essence of mutual insurance that the excess in the premium over the actual 1 T.C. 555">*564 cost as later ascertained shall be returned to the policyholder." Penn Mutual Life Insurance Co. v. Lederer, 252 U.S. 523">252 U.S. 523.1943 U.S. Tax Ct. LEXIS 239">*261 Since the 40 percent was computed without regard to actual cost, petitioner's form of organization and operation apparently eliminated this essential requirement of mutual insurance.
But, however that may be, no adequate answer appears to the respondent's contention that under either section petitioner's tax would be the same in view of the definition of "reserve funds," as used in section 207. E.g. Regulations 94, art 207-4. In our view, accordingly, petitioner's tax liability was correctly computed, and it is of no consequence whether this is done under section 207 or under section 204.
Decision will be entered for respondent.
Footnotes
1. The other laws here applicable, Revenue Acts of 1936 and 1938, sections 201-203, are substantially similar to Internal Revenue Code, section 201, which provides in part:
"(a) Definition. -- When used in this chapter the term 'life insurance company' means an insurance company engaged in the business of issuing life insurance and annuity contracts (including contracts of combined life, health, and accident insurance), the reserve funds of which held for the fulfillment of such contracts comprise more than 50 per centum of its total reserve funds."↩
2. SEC. 202. GROSS INCOME OF LIFE INSURANCE COMPANIES.
* * * *
(b) Reserve Funds Required by Law, Defined. -- The term "reserve funds required by law" includes, in the case of assessment insurance, sums actually deposited by any company or association with State or Territorial officers pursuant to law as guaranty or reserve funds, and any funds maintained under the charter or articles of incorporation of the company or association exclusively for the payment of claims arising under certificates of membership or policies issued upon the assessment plan and not subject to any other use.↩