Deferred Compensation Elections & Refund of Taxes Paid on Sale of Demutualized Insurance Company Stock


Deferred Compensation Elections – Last Chance for a “Do-Over”

Almost four years ago, Congress adopted a comprehensive set of rules governing deferred compensation arrangements, including plans that permit employees to elect the time and form of payment of the benefits. Over the past three years, the IRS has issued and amended regulations implementing these rules, including several special transition rules. One of the most significant transition rules permits employees who previously have made elections to receive deferred compensation in a specified form in future years to change their elections prior to January 1, 2009, so long as the plans permit revised elections. With the current uncertainty regarding future income tax rates, participants in these plans should consider taking advantage of this transition rule to accelerate payment of those deferred amounts into 2009. Thus, if you previously made an election to receive a substantial amount of deferred compensation in 2010, but you are worried that tax rates may rise after the November election, and if your company permits a new election, you could accelerate payment to January 2009, with the hope that any increase in tax rates would only be effective after the legislation passes and is signed by the President. Unfortunately, the rules do not permit a revised election that would result in payment of deferred amounts in 2008, nor can amounts that are payable in 2008 be deferred into a later year.

Refund of Taxes Paid on Sale of Demutualized Insurance Company Stock

A federal court recently ruled that a taxpayer who receives stock in an insurance company when the company demutualizes has a tax basis, overturning the IRS position that such stock has a zero tax basis (which would result in significant capital gains upon sale of the stock). In recent years, many insurance companies operating as “mutually owned” (meaning the policyholders are treated as the company owners) converted to stockholding companies, which resulted in the distribution of stock in the new company to policyholders at the time of the demutualization. The IRS initially took the position that the stock received by policyholders would have a zero basis, but many tax advisors believed that the stock should have a basis equal to all or a portion of the premiums paid on the policy. Although the U.S. Federal Court of Claims judge ruled in favor of the policyholders, there are still some open issues relating to the actual cost basis for tax purposes. In any event, anyone who received stock in a demutualization and then sold the stock should consider filing a claim for a tax refund if he or she followed the IRS ruling and paid capital gains tax based on a zero tax basis. Because claims for a refund must generally be filed within three years after filing a tax return, taxpayers may not be entitled to a refund of taxes paid on sales of demutualized stock prior to 2005.

In order to comply with certain U.S. Treasury regulations, we are informing you that any U.S. federal tax advice that may be contained in this document is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding any tax penalties that may be imposed by the Internal Revenue Service or any other U.S. federal taxing authority or agency or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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