Other 201342013: IRS revokes an insurance association's tax exemption after it fails the premium-income test

Plain-English summary

The IRS revoked an insurance association's exemption under IRC § 501(c)(15), effective January 1, 2007. The organization provided burial certificates and had gross receipts below the statutory dollar limits, but none of its gross receipts consisted of premiums for purposes of the applicable percentage tests. The document also says the organization had not elected the alternative tax under IRC § 831(b), so it could not use that regime for the examined years and any election would apply only prospectively. The organization was required to file Form 1120-PC for the affected years and future years when it did not qualify for exemption.

Ruling snapshot

• Question: Did the mutual insurance association qualify for exemption under IRC § 501(c)(15), and what tax filings followed if it did not?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(15), 831, 831(b), and 834; Treas. Reg. § 301.9100-8

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

INTERNAL REVENUE SERVICE
Attn: Mandatory Review, MC 4920 DAL
1100 Commerce St.
TAX EXEMPT AND Dallas, TX 75242
GOVERNMENT ENTITIES
DIVISION Date: July 27, 2009

Number: 201342013

Release Date: 10/18/2013

LEGEND: Employer Identification Number:
ORG = Name of Organization

Address= Name of Address

YEAR = xx Person to Contact/ID Number:

Contact Numbers:
ORG Voice
Address Fax

UIL: 501.15-00

CERTIFIED MAIL — RETURN RECEIPT REQUESTED

Dear ;

In a determination letter dated June 1986, you were held to be exempt from Federal income tax under section 501(c)(15) of the Internal Revenue Code (the Code).

Based on recent information received, we have determined you have not operated in accordance with the provisions of section 501(c)(15) of the Code. Accordingly, your exemption from Federal income tax is revoked effective January 1, 2007. This is a final adverse determination letter with regard to your status under section 501(c)(15) of the Code.

We previously provided you a report of examination explaining why we believe revocation of your exempt status is necessary. At that time, we informed you of your right to contact the Taxpayer Advocate, as well as your appeal rights. On June 25,20 , you signed Form 6018-A, Consent to Proposed Action, agreeing to the revocation of your exempt status under section 501(c)(15) of the Code.

You have filed a taxable return on Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return, for the year ended December 31, 20 with

us. For future periods, you are required to file Form 1120-PC with the appropriate service center indicated in the instructions for the return.

You have the right to contact the Office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a substitute for established IRS procedures, such as the formal Appeals process. The Taxpayer Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling. You may call toll-free, 1-877-777-4778, and ask for Taxpayer Advocate Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

Taxpayer Advocate Service
If you have any questions, please contact the person whose name and telephone number are shown at the beginning of this letter.

Sincerely,

Sunita Lough
Director, EO Examinations

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street
Dallas, TX 75242

ES”

TAX EXEMPT AND

GOVERNMENT ENTITIES

DIVISION May 15, 2009

Taxpayer Identification Number:

LEGEND:
ORG= Name of Organization Form:
Address = Address of ORG Tax Year(s) Ended:
Year = xx
Person to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:
Dear

We have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization’s exempt status is necessary.

We have also enclosed Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues, and Publication 3498, The Examination Process. These publications include information on your rights as a taxpayer, including administrative appeal procedures within the Internal Revenue Service.

If you request a conference with Appeals, we will forward your written statement of protest to the Appeals Office, and they will contact you. For your convenience, an envelope is enclosed. If you and Appeals do not agree on some or all of the issues after your Appeals conference, the Appeals Office will advise you of its final decision

If you elect not to request Appeals consideration but instead accept our findings, please sign and return the enclosed Form 6018-A, Consent to Proposed Adverse Action. We will then send you a final letter modifying or revoking your exempt status under I.R.C. § 501(c)(15). If we do not hear from you within 30 days from the date of this letter, we will process your case on the basis of the recommendations shown in the report of examination and send a final letter advising of our determination.

In either situation outlined in the paragraph above (execution of Form 6018-A or failure to respond within 30 days), you are required to file federal income tax returns for the tax period(s) shown above, for all years still open under the statute of limitations, and for all later years. File the federal tax return for the tax period(s) shown above with this agent

within 60 days from the date of this letter, unless a request for an extension of time is granted. File returns for later tax years with the appropriate service center indicated in the instructions for those returns.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a substitute for established IRS procedures, such as the formal appeals process. The Taxpayer Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling. You may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance.

If you have any questions, please call the contact person at the telephone number shown in the heading of this letter. If you write, please provide a telephone number and the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Sunita Lough
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018-A

Report of Examination
Envelope

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit Name of Taxpayer Year/Period Ended ORG 12/31/20xx LEGEND: ORG = Name of Organization State = Name of State Year = xx ISSUES

1. Does ORG qualify for tax exempt status under Internal Revenue Code (IRC)
   Section 501(c)(15), for the years beginning January 1, 20xx?
2. If ORG does not qualify for tax exempt status for years beginning January 1,
   20xx, what are the tax consequences?
3. If the tax exempt status is revoked, how will it affect future years?
   FACTS

ORG was formed in the State on January 13, 19xx and follows the state laws of a mutual insurance company. ORG petitioned for the formation of the Association with the Court. The Petition stated that Mrs. Founder and Mr Founder petitioned the Order of the Court authorizing the establishment of this organization. The Petition was signed on January 14, 19xx by a Circuit Judge.

The Articles of Association was filed on January 13, 19xx. It stated that the purpose of the organization was the writing and insurance of burial protection certificates for the payment of funeral and burial expenses of its members as set out in the Bylaws. The principal office of the organization was to be in State. It also stated that to organization would not have any capital stock.

The By-Laws, also dated January 13, 19xx, stated the following:

e The objects and purposes for which this Association is formed and the purposes for which it has been organized shall be to provide a plan for each member of this Association for the payment of all or part of the funeral expenses of such member, or a plan for the furnishing or undertaking to furnish merchandise, supplies and services or any other character of burial benefits to such member, or a plan for the issuance of a certificate which provides for the payment of

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service Page: -1-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31 /20xx

funeral benefits to such member in merchandise, services or supplies, including the services of funeral directors and embalmers.

e Any person who is in good health and not under the treatment of any physician, nor confined in any institution for the treatment of a chronic disease, may become a member of this Association.

Application Form 1024, Application for Recognition of Exemption Under IRC 501(a) was filed on November 27, 19xx. The Application stated that the date incorporated for the organization was January 18, 19xx. The purpose as stated in the Application was, “ORG association, collection of dues to provide fixed burial benefits”. The Application also stated that 0% of dues collected are paid to ORG for management services and that it is authorized by the State Burial Board.

On August 1, 19xx, The Service issued a determination letter to ORG, granting tax exempt status under IRC 501(c)(15).

The only type of insurance provided has been the burial certificates with a value of

$ . There have been no other types of insurance and there has been no reinsurance activity conducted by ORG. Payment of benefits are towards funeral expenses at time of death.

At the end of 20xx, ORG had 3 certificates outstanding.

Form 990 was filed for the 20xx tax year. The following is a breakdown of the Gross Receipts received by ORG for the year ending December 31, 20xx, based on the Form 990 and annual statement provided to the State Burial Board and the percentage of Gross Premiums to Gross Receipts for the same year per Notice 2006-42.

Form 886-A rev.4-68) Department of the Treasury - Internal Revenue Service Page: -2-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit Name of Taxpayer Year/Period Ended ORG 12/31 /20xx ORG BURIAL 20xx

Membership Fees $

Total Membership Fees $

Interest/Dividend Income $

Total Gross Receipts $

Percentage- Gross
Premium/Reinsurance
Income to Gross Receipts

%

An election under IRC 831(b) has never been filed. As of the writing of this report, there has never been a filing of the election, either with the filing of the Forms 990 or

separately.

ORG was not involved in any court ordered liquidation or receivership during or 20xx.

Form 886-Arev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -3-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit Name of Taxpayer Year/Period Ended ORG 12/31 /20xx LAW AND ANALYSIS

1. Does ORG qualify for tax exempt status under Internal
   Revenue Code (IRC) Section 501(c)(15) for the years beginning January 1, 20xx?

Internal Revenue Code section 501(c)(15)(A) exempts from Federal income tax insurance companies (as defined in section 816(a)) other than life (including interinsurers and reciprocal underwriters) if-

(i.) (I) the gross receipts for the taxable year do not exceed $600,000, and (Il) more than 50 percent of such gross receipts consist of premiums, or

(ii.) in the case of a mutual insurance company-
(I) the gross receipts of which for the taxable year do not exceed $150,000 and, (I!) more than 35 percent of such gross receipts consist of premiums.

Clause (ii) shall not apply to a company if any employee of the company, or a member of the employee’s family (as defined in section 2032(A)(e)(2), is an employee of another company exempt from taxation by reason of this paragraph (or would be so exempt but for this sentence).

Sec. 206, Clarification of Exemption from Tax for Small Property and Casualty Insurance Companies, of the Pension Funding Equity Act of 2004, P.L. 108-218, amended section 501(c)(15)(A) to change the definition of small property and casualty insurance companies (insurance companies other than life insurance companies) exempt from income taxes to: (1) a company whose gross receipts for the taxable year do not exceed $600,000, and over half such gross receipts consist of premiums (currently, whose net written premiums (or, if greater, direct written premiums) for the taxable year do not exceed $350,000); or (2) a mutual insurance company (a) whose gross receipts for the taxable year do not exceed $150,000 and more than 35 percent of which consist of premiums and (b) none of whose employees (or member of the employee’s family) is an employee of another company exempt from tax under section 501(c)(15). These changes were applicable after December 31, 2003.

Notice 2006-42, IRB, 2006-19 provides guidance as to the meaning of “gross receipts” for purposes of section 501(c)(15)(A) of the Internal Revenue Code. This notice advises taxpayers that the Service will include amounts received from the following sources during the taxable year in “gross receipts” for purposes of § 501(c)(15)(A):

Form 886-A ev.4-68) Department of the Treasury - Internal Revenue Service

Page: -4-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31/20xx

A. Premiums (including deposits and assessments), without reduction for return premiums or premiums paid for reinsurance;

B. Items described in § 834(b) (gross investment income of a non-life insurance company); and

C. Other items that are properly included in the taxpayer’s gross income under subchapter B of chapter 1, subtitle A, of the Code.

Thus, gross receipts include both tax-free interest and the gain (but not the entire amount realized) from the sale or exchange of capital assets, because those items are described in § 834(b). Gross receipts do not, however, include amounts other than premium income or gross investment income unless those amounts are otherwise included in gross income. Accordingly, the term gross receipts does not include contributions to capital excluded from gross income under § 118, or salvage or reinsurance recovered accounted for as offsets to losses incurred under

§ 832(b)(5)(A)(i).

Section 834(b)(1)(D) of the Internal Revenue Code includes under gross receipts the gains from the sale or exchanges of capital assets to the extent provided in subchapter P (section 1201 and following, relating to capital gains and losses).

Section 834(c)(6) of the Internal Revenue Code allows a deduction for Capital Losses to the extent provided in subchapter P (section 1201 and following) plus losses from capital assets sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to policyholders.

Based on the changes in the limitations under Internal Revenue Code (IRC) Section 501(c)(15)(A), and the operation of ORG during 20xx, it was determined from the chart above that ORG did not qualify for tax exempt status for the years beginning January 1, 20xx. ORG did have gross receipts of under $600,000 and $150,000 but was unable to meet either the 50% or 35% requirement (0%).

Section 206(e) of the Pension Funding Act of 2004, P.L. 118-218 provides the effective date of the new requirements for exemption under IRC 501(c)(15). It states:

EFFECTIVE DATE-
(1) IN GENERAL- Except as provided in paragraph (2), the amendments made by this section shall apply to taxable years beginning after

December 31, 2003.

(2) TRANSITION RULE FOR COMPANIES IN RECEIVERSHIP OR
LIQUIDATION- In the case of a company or association which--

Form 886-A crev.4-68) Department of the Treasury - Internal Revenue Service Page: -5-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31/20xx

(A) for the taxable year which includes April 1, 2004, meets the requirements of section 501(c)(15)(A) of the Internal Revenue Code of 1986, as in effect for the last taxable year beginning before January 1, 2004, and (B) on April 1, 2004, is in a receivership, liquidation, or similar proceeding under the supervision of a State court, the amendments made by this section shall apply to taxable years beginning after the earlier of the date such proceeding ends or December 31, 2007.

ORG was not involved in a court ordered liquidation or receivership during 20xx. Therefore, Section 206(e)(2) does not apply to this organization.

Therefore, for the years beginning January 1, 20xx, ORG did not qualify for tax exempt status under IRC 501(c)(15).

2. If ORG does not qualify for tax exempt status for years
   beginning January 1, 20xx, what are the tax consequences?

Since ORG did not qualify for tax exempt status under IRC Section 501(c)(15) for the years beginning January 1, 20xx, ORG’s tax exempt status should be revoked for years beginning January 1, 20xx. ORG’s filing of the Form 990 for 20xx was incorrect. ORG should have filed Form 1120-PC for years beginning January 1, 20xx.

IRC 831 discusses tax on insurance companies other than life insurance companies.

IRC 831(a) states as a general rule, “Taxes computed as provided in section 11 shall be imposed for each taxable year on the taxable income of every insurance company other than a life insurance company.”

IRC 831(b) provides an alternative tax for certain small companies. It states in IRC 831(b)(1) that, in general, “In lieu of the tax otherwise applicable under subsection (a), there is hereby imposed for each taxable year on the income of every insurance company to which this subsection applies a tax computed by multiplying the taxable investment income of such company for such taxable year by the rates provided in section 11(b).”

IRC 831(b)(2) discusses the companies to which this subsection applies.

• Form 886-Arev.4-68) Department of the Treasury - Internal Revenue Service
  Page: -6-

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31 /20xx

(A) In general. This subsection shall apply to every insurance company other than life (including interinsurers and reciprocal underwriters) if- (i) the net written premiums (or, if greater, direct written premiums) for the taxable year do not exceed $1,200,000, and (ii) such company elects the application of this subsection for such taxable year. The election under clause (ii) shall apply to the taxable year for which made and for all subsequent taxable years for which the requirements of clause (1) are met. Such election, once made, may be revoked only with the consent of the Secretary.

Regulations (Regs.) 301.9100-8(a)(2) discusses the time for making elections. Under (i) it states in general that except as otherwise provided in this section, the elections described in paragraph (a)(1) of this section, must be made by the later of-

(A) The due date (taking into account any extensions of time to file obtained by the taxpayer) of the tax return for the first taxable year for which the election is effective, or

(B) January 22, 1990 (in which case the election generally must be made by amended return)

Regs. 301.9100-8(a)(1) mentioned above includes IRC 831(b)(2)(A).

Regs. 301.9100-8(a)(3) describes the manner of making elections. It states, “ Except otherwise provided in this section, the elections described in paragraph (a)(1) of this section must be made by attaching a statement to the tax return for the first taxable year for which the election is to be effective.”

Based on the Code and Regulation sections above, ORG is not entitled to the relief under 831(b), for years under examination and for any future year, until they decide to file the election. The election has never been filed, either with the Form 990 or separately. Any election filed now or in the future would only be effective for the year the election was filed and all subsequent years. The election can not be made retroactive.

3. If the tax exempt status is revoked, how will it affect future years?

The tax exempt status should be revoked for the years beginning January 1, 20xx. Form 1120-PC is required for each year and all future years where ORG does not qualify for exemption. If ORG meets the requirements under IRC 501(c)(15) in future years, it may be allowed to file the Form 990 for each year they qualify, as a self- declared entity. Otherwise, Form 1120-PC would be required. Any year in the future

Form 886-Acrev.4-68) Department of the Treasury - Internal Revenue Service Page: -7-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31/20xx

that the Form 1120-PC is required, ORG is allowed to make an election under IRC 831(b). Once the election is made, it is effective for the year the election was made and for all future years that the Form 1120-PC is required. The election can not be made retroactive.

TAXPAYER’S POSITION

Unknown at the time of this writing

SUMMARY

It is the Governments position, based on the above facts, law and analysis, that the tax exemption status of ORG for the years beginning January 1, 20xx, should be revoked based on not meeting the qualifications for exemption under IRC 501(c)(15). Form 1120-PC would be required to be filed for any year where ORG does not qualify for exemption under IRC 501(c)(15).

Form 886-A ceev.4-68) Department of the Treasury - Internal Revenue Service Page: -8-