September 23, 2010

Stock Acquired in Demutualization

We have been receiving questions regarding recent letters sent to owners of Prudential stock held by Computershare. Why did I get this? What should I do? and How does this affect my taxes? are the primary concerns. This is primarily a tax issue; thus I won’t be commenting on the investment merits of owning Prudential Stock.

First, it is important to understand how the stock was issued to you, or how the person from whom you inherited the stock came to own it. For most of you reading this, it came about as a result of a demutualization. So here is the background:

A mutual insurance company has no shareholders, but instead is owned by its participating policyholders, who possess not only contractual insurance rights, but also ownership rights. Mutual owners’ voting rights differ from those possessed by traditional shareholders in that each policyholder has a single vote, regardless of how many policies are owned or the amounts thereof. Once the mutual company pays its claims and operating expenses, the profits belong to the policyholders. Typically, some of those profits are returned to the policyholders as dividends, while the remainder is retained as surplus. Payment of policy dividends is at the discretion of the policyholder elected board. A stock insurance company is owned by the owners of the stock; the policyowners only have contractual insurance rights.

Beginning in 1986, many mutual insurance companies began the process of demutualization (became stock insurance companies) by issuing stock to the policyholders in exchange for the ownership rights associated with their insurance contracts. The IRS’s position at that time was that the issuance of the stock in exchange for those rights would not be a taxable event. However, the IRS’s opinion was that the cost basis for the shares would be zero (IRS PLR 200020048), so if you sell it, the IRS’s position is that it is 100% taxable as capital gains.

Fast forward to: Eugene A. Fisher, Trustee of the Seymour P. Nagan Irrevocable Trust v. United States, US Court of Claims, 2008-2 USTC ¶50,481, Aug. 6, 2008, affirmed US Court of Appeals for Federal Circuit 2009-5001

The IRS loses; policyholders have basis in shares received in demutualization (absent otherwise determinable value, 100% of premium costs includible as basis). The IRS has yet to give us direction related to how they will treat this issue going forward for the rest of us taxpayers. We will keep you posted.  

Why should you consider selling the stock now? Tax reasons!

Long-term capital gains tax rates are on sale. (The Blue Light Special is on.)

For 2010, if you sell shares of stock that you’ve held for more than a year, any gain is a long-term capital gain, generally taxed at a maximum rate of 15%. If you’re in the 10% or 15% marginal income tax bracket, however, you’ll pay no federal tax on the long-term gain (a 0% tax rate applies). That means if you’re a married couple filing a joint federal income tax return, and your taxable income is $68,000 ($34,000 for single) or less, you pay no federal tax on the gain; state income taxes could still apply. Additionally, the sale could increase the amount of income tax you pay on Social Security benefits.

As of now, these rates expire at the end of 2010. (Watch for pending legislation.) Beginning in 2011, a 20% rate will generally apply to long-term capital gains.

As always, consult your tax advisor!
I would like to thank Ron Roberson, CPA (Twain Harte, CA), and Vern Hoven, CPA (Gig Harbor, WA) (www.hoven.com) for assistance in this post.


Martin James, CPA/PFS

No comments:

Post a Comment

Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.
Securities & Advisory Services offered through World Equity Group Inc, Member FINRA/SIPC.

Securities Licensed to conduct business in the following states: AZ, CO, FL, IL, IN, KY, MI, MO, NM, NC, TN

Martin James Investment & Tax Management, LLC and any of its employees acting as an agent, may only transact business in a particular state if first registered, excluded, or exempted from registration requirements whether individually or as a firm. In addition, follow up conversations or meetings with individuals in a particular state by Martin James Investment & Tax Management, LLC or its employees acting as agent, to effect transactions in securities, investment planning, or other personal investment advice will not be made without first becoming registered, excluded, or exempted from registration requirements either individually or as a firm.

This site has been published in the United States for residents of the United States. The foregoing has been prepared solely for information purposes, and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular trading strategy.

Martin James, CPA, PC and Martin James Investment & Tax Management LLC are not affiliated with World Equity Group, Inc. WEG does not provide tax advice. Martin James is a registered representative of World Equity Group Inc.