Denial of Rehearing in MassMutual Tees Up Government Decision on Seeking Supreme Court Review of All-Events Test Issue
June 29, 2015
Let me just begin with a brief apology to the regular readers of this blog for the infrequency of postings over the past several months. A variety of factors and the press of other matters have interfered with blogging, but we are resolved to get back up to speed in the upcoming months by providing some analysis of intervening developments and posts on some new pending cases.
As we previously reported here, the Second Circuit and the Court of Federal Claims reached different results in considering the application of the all-events test to annual policyholder dividends paid by mutual insurance companies. The Federal Circuit’s recent affirmance of the Court of Federal Claims in the MassMutual case, allowing the taxpayer to accrue those dividend payments in the year before the dividends were actually paid, thus raises the possibility that the Supreme Court will be asked to wade into this controversy. The Federal Circuit’s decision does not necessarily establish a square conflict in the circuits, because the respective courts of appeals viewed the dividend programs of New York Life and MassMutual, though similar, as having differences that warranted the disparate results. But there is sufficient tension between the two circuit court decisions to provide a basis for a credible petition for certiorari to resolve this issue should the government decide to seek Supreme Court review.
The Federal Circuit (Judges O’Malley, Lourie, and Moore) sided with the taxpayer on all issues. With respect to the threshold issue of the existence of an obligation, the court rejected the government’s argument that the facts were indistinguishable from those in the Second Circuit’s New York Life case. The Federal Circuit stated that, “[u]nlike New York Life, however, the policies at issue here stated that MassMutual . . . would pay dividends to eligible policyholders,” thus giving those policyholders “a contractual obligation . . . that they would receive a policyholder dividend.”
The court then distinguished the Second Circuit case again in addressing the key issue of whether the taxpayer’s liability was fixed by the close of the taxable year. The court held that MassMutual had “promised an entire class of policyholders that they would be entitled to the guarantee payments on a pro rata basis,” whereas “New York Life made such guarantees on an individual basis.” The court viewed this difference as a “significant” one that called for a different result. The court explained that an individual’s decision to terminate a MassMutual policy would affect only the amount of that company’s obligation to pay a dividend to the remaining members of the class, but the liability to the class would remain. Thus, the court concluded that “the only uncertainty at the end of the year in which the guarantees were determined was who would ultimately make up the group of policyholders—there was no question that MassMutual had passed an absolute resolution to pay the guaranteed dividend and that at least some policyholders were already qualified recipients of that guarantee.”
Finally, the court held that the dividend payments were “rebates” within the meaning of Treas. Reg. § 1.461-4(g)(3), thereby satisfying the recurring item exception of Code section 461(h).
The government’s response to the opinion was consistent with the approach it has previously taken of minimizing the factual differences between the two cases and presenting them as directly in conflict. The government sought rehearing by the panel, not rehearing en banc, limited to the question whether the liability was fixed at the close of the taxable year. It argued that the Federal Circuit had failed to appreciate that MassMutual would have no liability to pay dividends if the policyholder surrendered his or her policy before the dividend payment date. Accordingly, the government argued, the court erred in finding that “the insurance policies at issue here differed from those at issue in New York Life.” In neither case, the government maintained, did the payment of premiums necessarily entitle the policyholder to a dividend, and therefore the liability was not fixed until the following year when it became apparent that the policyholder was not surrendering the policy before the dividend payment date. The Federal Circuit, however, denied the rehearing petition without comment and without modifying its opinion, thus leaving in place the court’s distinction of its facts from those before the Second Circuit in New York Life.
The question remains whether the government will seek Supreme Court review. The government has preserved its ability to argue that the Federal Circuit and Second Circuit decisions are irreconcilable, which would be a key element in persuading the Supreme Court to hear the case. Specifically, in the petition for certiorari filed by New York Life, the taxpayer had pointed to a conflict between the Second Circuit’s decision and that of the Court of Federal Claims. Ordinarily, when opposing a petition for certiorari that raises a claim of conflicting circuit decisions, the Solicitor General will try to defuse the conflict contention by pointing to distinctions between the two cases if at all possible. In its New York Life brief, however, the SG did not embrace the Second Circuit’s suggested distinction of the two cases, but simply argued that it was premature for the Supreme Court to worry about the alleged conflict because the Court of Federal Claims decision might be reversed on appeal. Now that the Court of Federal Claims has been affirmed on appeal, the government is in a position to file its own petition for certiorari alleging a conflict. The Supreme Court, of course, may not be persuaded by that claim when both the Second Circuit (somewhat diffidently) and the Federal Circuit (more definitively) have stated that they do not see a conflict.
The government’s decision ultimately comes down to its assessment of the importance of this issue, weighed against the importance of other cases that it might choose to bring to the Court. (The Court decided fewer than 70 cases this past year, and not all of those are cases involving the federal government.) That MassMutual was decided by the Federal Circuit heightens the importance of Supreme Court review to some extent because any taxpayer can arrange to file a refund suit and have its case go to the Federal Circuit. Thus, in the future, mutual insurance companies could tweak their policyholder dividend programs to be indistinguishable from MassMutual’s and be guaranteed victory on this issue by bringing a refund suit in the Court of Federal Claims. And by the same token, the government will not be able to get much benefit from its victory in New York Life because savvy taxpayers will not risk litigating this issue in the Second Circuit (or any other circuit, for that matter). Despite these concerns, there is a good chance that the government will simply decide that the policyholder-dividend issue is not of sufficient moment to bring to the Court, and the government will learn to live with its defeat in MassMutual.
A petition for certiorari would be due on September 15.
June 12, 2014
The government has now filed its reply brief in MassMutual. The brief begins by asserting that the taxpayer has abandoned on appeal an argument that had persuaded the trial court — namely, “reliance on its annual-dividend obligation to individual policyholders to establish the fact of its liability under the dividend guarantees.” In the government’s view, that “about-face is fatal to its case.” The reply brief then addresses the taxpayer’s reliance on the Washington Post case. See our previous report here. It argues that, “unlike the group obligations in Washington Post, the alleged group obligations in this case were not otherwise fixed as to liability in the years in which the dividend guarantees were adopted” for reasons unconnected to the indeterminate membership of the group. The rest of the brief hews more closely to the topics discussed in the government’s opening brief, including the Supreme Court’s decision in Hughes Properties and the Second Circuit’s decision in New York Life. See our previous report here. The reply brief also argues again that its economic performance regulation is entitled to Auer deference.
The Federal Circuit has not yet announced a date for oral argument.
May 6, 2014
The taxpayer has filed its response brief in the Federal Circuit in the MassMutual case. See our previous coverage here. With respect to the primary issue of whether its policyholder dividend guarantee was a “fixed liability” within the meaning of the “all events test,” the taxpayer relies heavily on Washington Post Co. v. United States, 405 F.2d 1279 (Ct. Cl. 1969). (The Court of Claims was the predecessor court to the Federal Circuit and its pre-1982 decisions are binding precedent in the Federal Circuit.) According to the taxpayer, Washington Post establishes that “a company can fix a liability to an existing class of beneficiaries, even though the class composition may change before the liability is ultimately satisfied.” In contrast to the government’s brief, the taxpayer does not dwell at length on the Supreme Court’s decisions in Hughes Properties and General Dynamics, but argues that both of those cases are fully consistent with the more-directly-on-point decision in Washington Post.
The brief also addresses the Second Circuit’s decision in New York Life, arguing that the cases are distinguishable. (The Second Circuit had suggested a distinction, but without great conviction, suggesting that it believed the Court of Federal Claims was wrong in MassMutual.) The critical difference, according to the taxpayer, is that “New York Life addressed thousands of separate liabilities to individual policyholders, any one of which could cease to be a policyholder at any time,” whereas MassMutual involves a guarantee to “a class of policyholders” that “does not depend on identifying individual policyholder liability.” Finally, the taxpayer rejects the government’s argument that the dividend guarantees were “illusory,” stating that the trial court correctly ruled that “Board resolutions can fix liability.”
With respect to the second issue of whether the liability fell within the “recurring item exception,” the taxpayer argues that its position comports with “the only sound interpretation of the regulation.” It further argues that the government’s administrative deference argument is waived for failure to raise it below and, in any event, fails because the government is seeking deference to what is no more “than a convenient litigating position” that has not been shown to have been approved at any level by IRS or Treasury.
The taxpayer’s brief is linked below. Also linked below is the government’s brief in opposition to the petition for certiorari filed by the taxpayer in New York Life. That petition was denied by the Supreme Court on April 28.
February 27, 2014
The government has filed its opening brief in MassMutual contesting the Court of Federal Claims’ conclusion that the taxpayer could accrue the amount of certain policyholder dividends in the year before they were paid. See our prior post on this case and the New York Life case here. The government’s brief raises three distinct objections to the decision.
The primary argument is that the liability to pay the dividends was not “fixed” under the all-events test. The government contends that no individual obligation was fixed at the close of the year, even if all the premiums had been paid, because the dividend would not be paid unless the policy remained in force on the anniversary date. This is the same argument that was accepted by the Second Circuit in New York Life, and the government’s brief here argues that the cases are indistinguishable (asserting that the Second Circuit’s effort to distinguish them was based on a misperception of the facts in MassMutual).
The brief argues that the case “clearly fits the General Dynamics fact pattern,” which it describes as one where the “potential obligee has taken some action that renders him preliminarily eligible to receive the payment, subject only to some other condition that is within his exclusive control” – here, “forgoing the right to surrender the policy for its cash value prior to the next anniversary date.” It rejects the proposition argued by the taxpayer that this alleged final condition is not a genuine “event,” but rather just a continuation of the status quo. The government points to a comment in the Restatement (Second) of Contracts stating that “a duty may be conditioned upon the failure of something to happen . . ., and in that case its failure to happen is the event” that constitutes a condition precedent. And it rejects the contrary suggestion in Burnham Corp. v. Commissioner, 878 F.2d 86 (2d Cir. 1989), as misguided. Finally, the brief argues that the taxpayer’s all-events-test interpretation proves too much because its logical implication is that the amount of the dividend could be accrued even if the company had not passed a board resolution in the taxable year guaranteeing an aggregate dividend – a position that the taxpayer has not argued.
Second, the government argues that the dividend guarantees did not even give rise to an obligation, fixed or otherwise, because they were not communicated to the persons who were to benefit from them. Thus, the government argues, the taxpayer could have walked away from the guarantees at any time. In addition, the government argues, the guarantees were not a meaningful “substantive undertaking” because, based on the historical data, the guaranteed payments were “already virtually certain to occur in the ordinary course of the companies’ business operations, independent of any ‘guarantee’ to that effect.” There is some degree of irony in this argument; on its face, certainty that the amounts will be paid would appear to be an argument in favor of accrual, not against it. But the certainty of which the government speaks refers to the aggregate amount of payment; it is not a concession with respect to an individual obligation being fixed.
Third, the government contests the Court of Federal Claims’ holding that the dividends fell within the “recurring item” exception. The government’s primary point here is that this determination turns on the meaning of “rebate, refund, or similar payment” in Treas. Reg. § 1.461-4(g)(3), and therefore the court should have deferred to the IRS’s interpretation of that regulation – even if that interpretation did not conclusively emerge until this litigation and is at odds with some earlier internal guidance on the regulation’s meaning. The general principle of so-called Auer or Seminole Rock deference to an agency’s interpretation of its own regulations has come under fire recently, with Justice Scalia stating that it should be abandoned and Chief Justice Roberts and Justice Alito indicating that they are at least open to reconsidering it. See Decker v. Northwest Environmental Defense Center, No. 11-338 (Mar. 20, 2013). So it will be interesting to see how the Federal Circuit responds to this argument, which presents a relatively weak case for deference because the claimed agency interpretation is just based on its litigation position.
The taxpayer’s brief is due April 4.
February 12, 2014
The Federal Circuit is preparing to consider a government appeal in Massachusetts Mutual Life Ins. Co. v. United States, on an issue involving accrual of annual dividends paid by a mutual insurance company to its policyholders. This issue was also recently addressed by the Second Circuit, and it turns on an application of the “all events test.”
First, a quick refresher course. The “all events test” is described as the “touchstone” for determining when a liability has been incurred and a deduction can be accrued. Dating back to United States v. Anderson, 269 U.S. 422, 441 (1926), and now codified at I.R.C. § 461(h)(4), it originally provided for accrual when “all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy.” In the mid-1980s, litigation over the application of this two-pronged test yielded two Supreme Court decisions in rapid succession, with the taxpayer prevailing in the first one and the government prevailing in the second.
In United States v. Hughes Properties, Inc., 476 U.S. 593 (1986), the Court held that a casino could treat as a fixed liability the amounts shown on the jackpot meters of its progressive slot machines at the close of the taxable year. In United States v. General Dynamics Corp., 481 U.S. 239 (1987), the Court held that a self-insuring employer could not accrue amounts that it had reserved for payment of employee medical claims not yet filed for services already performed, even assuming that the amount of the liability had been determined with reasonable accuracy. The Court held that the fact of liability was not established until the employee filed a claim for reimbursement, which it termed a “condition precedent” to the establishment of liability that was not “a mere technicality” or a mere “ministerial” act. Id. at 242-45 & nn.4-5. Three dissenters argued that the case was essentially indistinguishable from Hughes Properties, where the Court had rejected the government’s argument that the fact of liability did not arise until the winning patron pulled the handle because until then it was possible that the jackpot would never be paid – for example, if the casino went out of business or declared bankruptcy. Id. at 248-49. The majority, by contrast, held that failing to file a claim was not “the type of ‘extremely remote and speculative possibility’” that was found in Hughes Properties not to “render an otherwise fixed liability contingent.” Id. at 244-45.
In 1984, Congress codified the traditional all events test in Code section 461(h)(4) and added a third prong for future years by enacting section 461(h)(1), which provides that generally “the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.” The Code, however, contains an exception from the economic performance requirement for “certain recurring items” if economic performance occurs within a reasonable period after the close of the taxable year and certain other conditions are met. I.R.C. § 461(h)(3). In the case of policyholder dividends issued by mutual insurance companies, the taxpayers have contended that the section 461(h)(3) exception is satisfied and therefore that their right to accrue those dividend payments turns on whether the original two-pronged all events test has been satisfied.
The insurer in MassMutual adopted Board Resolutions before the close of the taxable year guaranteeing an aggregate amount of policyholder dividends that would be paid in the upcoming year on each individual policyholder’s anniversary date. The government argued that the all events test was not satisfied until the year in which the dividends were paid because the Board Resolution could be revoked (though government counsel apparently characterized this as a “weak argument” at oral argument) and also because no precise dividend amounts could be allocated at the time of the resolution to an identifiable policyholder, since any individual policy might not still be in force on the anniversary date.
After a trial, the Court of Federal Claims rejected these arguments and allowed the taxpayer to accrue the amount of the dividends in the year before they were paid. Citing to Hughes Properties, the court said that it was not necessary that the identity of the individual recipients be known at the time of accrual. The court also stated that, “[a]lthough a condition precedent can prevent a liability from being fixed, if the only event(s) still to occur are the passage of time and/or the payment, the liability is considered fixed.” The court added that “the group of policyholders with paid-up policies were not at risk for their policies lapsing,” so the company “had an unconditional obligation” to those policyholders “to pay the guaranteed amounts of policyholder dividends.” The court then ruled that the dividends were “rebates” or “refunds” falling within the “recurring item” exception of section 461(h)(3), and therefore “economic performance” was not required before the expenses could be accrued.
After the Court of Federal Claims decision issued, but before it was ripe for appeal, the Second Circuit came to the opposite conclusion in a case involving policyholder dividends accrued by New York Life. That mutual insurance company also paid annual dividends on the anniversary date, but only if the policy was still in force and fully paid up (payment was required a month in advance). The taxpayer sought to accrue dividend payments due in January of the following year, since those policies had been fully paid up in December. The Second Circuit, however, ruled that the all events test was not satisfied for the January anniversary date policies, because of the possibility that the policyholder might choose to cash in the policy in January before the anniversary date and thus the policy would no longer be in force when the dividend came due.
The Second Circuit reasoned that the case was analogous to General Dynamics, stating that “‘the last link in the chain of events creating liability’—the policyholder’s decision to keep his or her policy in force through the policy’s anniversary date—did not occur until January of the following year.” The taxpayer argued that an “event” that would defeat accrual must be something that marks a change in the status quo, rather than a non-event like the policyholder’s failure to cash in a policy. The court, however, rejected this position, stating that the fact of liability “depend[ed] upon an actual choice by the third-party policyholder: her decision not to redeem her policy for cash, for example, and invest her money elsewhere.”
The court suggested that the MassMutual decision was distinguishable on its facts because there “the policy was considered ‘in force’ simply ‘if the premiums for the policy [had been] paid through its anniversary date,’” whereas in New York Life the company defined eligibility as “requiring both that the policyholder have paid all premiums and that she not have surrendered her policy for cash prior to the policy’s anniversary date.” Recognizing that this distinction might be viewed as less than compelling, the Second Circuit added that, “to the extent the reasoning of the MassMutual court is at odds with ours . . ., we respectfully disagree with that court’s approach.”
New York Life has filed a petition for certiorari seeking review of the Second Circuit’s decision. The petition focuses on the court of appeals’ reliance on the possibility that the policyholder might not receive a dividend because she chose to cash in her policy before the January anniversary date. The question presented in the petition is whether the court erred in holding that “the continuation of the status quo is a required event, and thus a ‘condition precedent,’ needed to establish the fact of liability under the all-events test.”
The petition’s main contention is that the Second Circuit’s decision cannot be squared with Hughes Properties. Because MassMutual is just a trial court decision, the cert petition rests its claim of a circuit conflict primarily on older cases that predate General Dynamics, arguing that the Second Circuit’s decision “recreates a multi-circuit conflict resolved by this Court in Hughes Properties.” The timing of the respective decisions is such that MassMutual is not likely to provide much help in this regard; the Supreme Court can be expected to act on the cert petition by the end of May at the latest, well before a Federal Circuit decision is likely in MassMutual.
The government’s opening brief in MassMutual is due February 20. Its opposition to the petition for certiorari in New York Life is due, after one extension, on March 20.