Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Revisiting the “Open Transaction” Doctrine:
Exploring Gain Potential and the Importance of Categorizing Amounts Realized
In Fisher v. United States, the United States Court of Federal Claims addressed a dispute over the amount of basis that should be apportioned to the newly severed components of a previously unitary asset—a mutual life insurance policy. In Fisher, the taxpayer-policyholder surrendered certain of its “ownership rights” in a recently demutualized life insurance company in exchange for shares of the resulting stock company. The taxpayer immediately sold the shares on the open market for cash. The question before the court was whether the “open transaction” doctrine should apply to the proceeds received from the stock sale thereby allowing the taxpayer to defer gain recognition and current taxation.
After reviewing the history and the Service’s use of the doctrine, the court rejected the government’s argument that the ownership rights had zero-basis and that the proceeds should be taxed in full. In doing so, the court focused on the inseparability of the ownership rights from the policy as a whole, and the virtual impossibility of assigning a value to those rights distinct from the policy itself. Having concluded that the ownership rights did have basis, albeit indiscernible, the court found that the taxpayer had carried its burden of showing that its case was one of the “rare and extraordinary” instances where the open transaction doctrine should apply rather than the traditional basis apportionment rules under Regulation section 1.61-6. Accordingly, the court held that the taxpayer was permitted to defer current gain recognition by offsetting the entire amount of proceeds from the stock sale against the adjusted basis in the policy, and ordered the payment of the requested refund.
On appeal, the government continued to press its zero-basis arguments, but raised for the first time other issues such as the possibility of gain exclusion. At oral argument, the Federal Circuit expressed skepticism—as had the Court of Federal Claims—that the severed ownership rights were truly devoid of basis. Addressing counsel for the taxpayer next, the Federal Circuit asked whether there was currently a “string of [demutualization] cases sitting [in other courts].” Taxpayer’s counsel stated that there were demutualization cases pending elsewhere, and admitted that the taxpayer brought its case as a matter of principle. Two days following oral argument, the Federal Circuit affirmed without opinion.
After clearing a thicket of issues—including corporate structures and reorganizations, property law concepts, and actuarial estimates—one realizes that the crux of the parties’ dispute in Fisher concerns no more than how the taxpayer’s basis in its previously unitary life insurance policy should be apportioned between the ownership rights surrendered and the policy benefits retained...Based on the facts and the arguments presented, the Fisher court concluded that gain deferral was appropriate, and thus offered good news for taxpayer-policyholders in similar circumstances.
Despite this good news, it may be premature for taxpayers to rest on the laurels of Fisher. This is because the case may have reached a different outcome had the litigants presented more sophisticated arguments to the Court of Federal Claims...