Opinion
No. 18.
January 3, 1946.
Petition to Review a Decision of the Tax Court of the United States.
Petition by the City Title Insurance Company to review a decision of the Tax Court of the United States redetermining a deficiency determined by the Commissioner of Internal Revenue.
Affirmed.
Taxpayer, a New York corporation, is engaged in New York in the business of insuring titles to real estate. It keeps its books and files its tax returns on the accrual basis. For the taxable years 1938 to 1941 inclusive, taxpayer reported gross underwriting income in the following amounts:
1938 ...................... $ 66,246.94 1939 ...................... 73,908.00 1940 ...................... 91,232.36 1941 ...................... 143,573.32
Before the year 1938 taxpayer had set up on its books an account which it termed a title policy loss reserve. At the beginning of the year 1938 this reserve was in the amount of $800. At the end of the year 1938 this reserve had been increased to $1,277.17, and at the end of the years 1939, 1940 and 1941 it had been increased to the respective amounts of $3,456.27, $6,208.58, and $10,355.18.
The reserve thus described was set up and maintained by the taxpayer under the provisions of Section 434 of the New York State Insurance Law, Consol.Laws N.Y. c. 28, and in accordance with the requirements of the Superintendent of Insurance of the State of New York. Taxpayer deducted from its underwriting income for each of the taxable years involved herein the amount which it added in that year to its title policy loss reserve, as follows:
1938 ......................... $ 477.17 1939 ......................... 2,179.10 1940 ......................... 2,752.31 1941 ......................... 4,146.60
The Commissioner disallowed each of the deductions claimed by the taxpayer in the amount set out in the last preceding paragraph and restored the respective amounts to the taxpayer's underwriting income for the respective years.
The Tax Court held that no part of the reserve set up and maintained by the taxpayer under Section 434 of the New York State Insurance Law might be deducted under Section 204(b)(5) of the Internal Revenue Code as unearned premiums.
Section 204 of the Internal Revenue Code, 26 U.S.C.A. Int.Rev.Code § 204, provides:
"Sec. 204. Insurance companies other than life or mutual * * *
"(b) Definition of income, etc. In the case of an insurance company subject to the tax imposed by this section —
"(1) Gross income. `Gross income' means the sum of (A) the combined gross amount earned during the taxable year, from investment income and from underwriting income as provided in this subsection, computed on the basis of the underwriting and investment exhibit of the annual statement approved by the National Convention of Insurance Commissioners, and (B) gain during the taxable year from the sale or other disposition of property, and (C) all other items constituting gross income under section 22 * * *;
"(2) Net income. `Net income' means the gross income as defined in paragraph (1) of this subsection less the deductions allowed by subsection (c) of this section. * * *
"(4) Underwriting income. `Underwriting income' means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred;
"(5) Premiums earned. `Premiums earned on insurance contracts during the taxable year' means an amount computed as follows: From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance. To the result so obtained add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year * * *;
"(6) Losses incurred. `Losses incurred' means losses incurred during the taxable year on insurance contracts, computed as follows: To losses paid during the taxable year, add salvage and reinsurance recoverable outstanding at the end of the preceding taxable year, and deduct salvage and reinsurance recoverable outstanding at the end of the taxable year. To the result so obtained add all unpaid losses outstanding at the end of the taxable year and deduct unpaid losses outstanding at the end of the preceding taxable year * * *."
Section 434 of the Insurance Law of New York provides:
"Sec. 434. Reserves. 1. Every title insurance corporation heretofore or hereafter organized and doing a title insurance business under this article shall set up, accumulate and maintain a premium reserve as follows: (a) During the first ten years of its doing business after June first, nineteen hundred thirty-eight, it shall set up, accumulate and maintain a reserve at the end of each calendar month at least equal to three per cent of the total gross fees and premiums received by it during the next preceding calendar month for title insurance, examinations or searches of title, and for abstracts of title written, issued or performed, as the case may be, after June first, nineteen hundred thirty-eight; and at the end of every such calendar month the amount so required to be accumulated shall be charged as a reserve liability of such corporation in determining its financial condition. (b) After the expiration of the said first ten years and in lieu of the reserve required by the preceding paragraph (a), every such corporation shall thereafter set up and maintain a similar reserve of three per cent of the total of said gross fees and premiums received during the one hundred twenty immediately preceding calendar months; and at the end of every such calendar month thereafter the amount so required to be accumulated shall be charged as a reserve liability of such corporation in determining its financial condition.
"2. In addition to the reserve required by the foregoing subsection one, every existing title insurance corporation heretofore organized and doing a title insurance business under this article shall maintain an accrued loss reserve for all outstanding title insurance policies issued or written prior to June first, nineteen hundred thirty-eight, which reserve shall be in an amount equal to three times the average annual net losses paid on title insurance policies issued by it during the twenty calendar years ending with December thirty-first, nineteen hundred thirty-eight. In the event that any such corporation has been engaged in business for a period less than twenty years prior to June first, nineteen hundred thirty-eight, then such accrued loss reserve shall be in an amount equal to three times the average annual net amount of such losses for the number of years that the corporation has been doing business prior to such date. Every such corporation which shall have set up and maintained such reserve may from time to time withdraw therefrom the amount or amounts necessary to pay its outstanding losses and claims under title insurance policies, and may at the expiration of ten years from January first, nineteen hundred thirty-nine withdraw the balance thereof, if any, then remaining, if such corporation is then maintaining the reserve required by subsection one.
"3. Every title insurance corporation whether heretofore or hereafter organized or authorized to do business in this state shall on or before March first each year, file a report of all unpaid losses and claims upon title insurance policies of which the corporation has received notice or which are imminent. Every title insurance corporation hereafter organized and doing business under this article shall set up and maintain a loss reserve at least equal to the aggregate estimated amounts due or to become due on account of all such unpaid losses and claims."
Henry Halpern, of Brooklyn, N.Y., for petitioner-appellant.
Samuel O. Clark, Jr., of Washington, D.C. (Sewall Key, Robert N. Anderson, and Morton K. Rothschild, all of Washington, D.C., of counsel), for appellee.
Albert S. Willey, of Rochester, N.Y., amicus curiae.
Before SWAN, CHASE, and FRANK, Circuit Judges.
The revenue statute expressly provides, in sections 202 and 203, 26 U.S.C.A. Int. Rev.Code, that, as to certain insurance companies, percentages of certain reserve funds, including some required by a state statute, may be deducted from gross income. No similar deduction is referred to in § 204, which governs here. Consequently, the existence of a reserve or the mere fact that it was required by a state statute, cannot justify the deduction taxpayer claimed. The sole issue here, then, is whether the sums set apart in the reserve are "unearned premiums."
The Commissioner urges that we should hold that premiums of title companies are earned when received, so that no reserve, whether or not required by state statute, can consist of deductible "unearned premiums." Cf. American Title Co. v. Commissioner, 3 Cir., 76 F.2d 332. We need not decide that question. For we shall assume, arguendo, that Early v. Lawyers Title Ins. Co., 4 Cir., 132 F.2d 42 is correct and, if apposite here, would, as taxpayer asserts, lead to reversal. In the Early case, the court had before it a Virginia statute which required that portions of premiums be set aside "initially" in a reserve and should "at all times and for all purposes be considered and constitute unearned portions of the original premiums"; but the statute also provided that the reserve, as to insurance contracts, "for a fixed time" should be reduced at stated periods and, "If not for a fixed time, then a risk shall be deemed to have been written * * * for twenty years from the date of the contract * * *." The Fourth Circuit, in the Early case, held that sums while in this reserve were "unearned premiums" and deductible as such under § 204.
The Virginia statute, Code 1942, § 4325a(e), reads:
"On any contract of title insurance, hereafter issued by a domestic title insurance company, there shall be reserved initially a sum equal to ten per centum of the original premium, whether or not the risk shall be for a fixed time. If for a fixed time, then at the end of each year for the first five years, there shall be a reduction in the sum reserved of one per centum of the original premium, and thereafter at the end of each year of the remainder of said time a reduction of a pro rata portion of the remaining five per centum thereof, except that if the risk is of a mortgage, trustee in a deed of trust to secure debt, or creditor secured thereby, no reduction shall be made that will decrease the sum reserved below five per centum of the original premium, until the expiration of the time of the risk. If not for a fixed time, then a risk shall be deemed to have been written, if of an owner of property, or any interest therein, for twenty years from the date of the contract and if of a mortgagee, trustees in a deed of trust to secure debt, or creditor secured thereby, for a time expiring three years after the final maturity of the debt as stated in the mortgage or deed of trust, or for twenty years from the date of the contract, whichever time shall be longer. On any contract of title insurance heretofore issued, a reserve shall be set up and hereafter maintained, in such sum as would have been required if the above requirements had existed at and after the date of the contract. Said sums, herein required to be reserved for unearned premiums on contracts of title insurance shall at all times and for all purposes be considered and constitute unearned portions of the original premiums. In calculating reserves, contracts of title insurance shall be assumed to be dated in the middle of the year in which they were issued."
Funds in that reserve were plainly to be held but for a limited period, after which they were released and then became "free assets," i.e., "earned premiums" subject to the federal tax. But no one can tell whether the funds in the reserve prescribed by subsection 1(a) of § 434 of the New York statute will ever be released and become "free assets." The New York statute thus in this respect differs so substantially from the Virginia statute that the Early case is not apposite. Moreover, the New York statute does not explicitly state that the sums in the reserve should "constitute unearned portions of the original premiums." While such a statement in a state statute would not alone suffice to convert a reserve into one of unearned premiums, its absence here is another fact telling against the pertinence of the Early case. It must not be forgotten that taxpayer, seeking a deduction from gross income, must bring itself plainly within some provision of the federal tax statute. New Colonial Co. v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 78 L.Ed. 1348; McDonald v. Commissioner, 323 U.S. 57, 60, 65 S.Ct. 96, 155 A.L.R. 119; Equitable Life Assurance Society v. Commissioner, 321 U.S. 560, 64 S.Ct. 722, 88 L.Ed. 927.
Under subsection 1(a), for the first ten years, a reserve of "at least" 3% of the gross receipts must be set aside and "maintained." Under subsection 1(b), "in lieu of" the reserve required by (a), the company must set up and maintain "a similar reserve" of 3% of the gross receipts "received during the one hundred twenty immediately preceding calendar months," i.e., the immediately preceding ten years.
Roughly speaking, therefore, the result is that no funds can ever be released from the present reserve unless, if ever, 3% of the gross receipts for any ten-year period is less than 3% of the gross receipts for the first ten-year period.
Consequently, no one can say that any of the funds will ever be released and become "free assets."
It is also to be noted that the reserve in the first ten years is not 3% of the receipts but "at least" that percentage, so that a company could perhaps use its discretion to set aside a reserve larger than 3%; however, our decision would be the same without regard to that factor.
Taxpayer makes much of an amendment to Section 434 of the New York statute, enacted April 9, 1945, after the Tax Court's decision, and effective June 1, 1945, Laws N.Y. 1945, c. 635. Taxpayer urges that this amendment is but declaratory of the pre-existing law, and a brief of amicus curiae points to the fact that, on November 7, 1945, the Acting Commissioner of Internal Revenue advised a New York title insurance company that "unearned portions of the original premium reserve established and segregated" under the amended statute "as a reinsurance reserve from and after June 1, 1945, may be treated as `unearned premiums'" but that "such unearned portions so established from June 1, 1938 to May 31, 1945" may not be so treated. To understand that letter, the amended statute must be read. It provides, inter alia, that the reserve prescribed in subsection 1 of § 434, called a "reinsurance reserve" in the amendment, shall "at all times and for all purposes be deemed and shall constitute unearned portions of the original premiums" and "shall be cumulative and * * * consist of" the reserve theretofore set up under subsection 1(a) of the statute before amendment and also, beginning June 1, 1945, of certain amounts and percentages of gross receipts. It further provides that, after June 1, 1953, "that portion of the reinsurance reserve established more than one hundred eighty months prior shall be released and shall no longer constitute part of the reinsurance reserve and may be used for any corporate purpose." This amendment obviously is far more than "declaratory." It represents a marked change, is strikingly different from the statutory provision now before us. We do not, however, now decide what, if any, may be its effect on the application of Internal Revenue Code, § 204.
Affirmed.