Second Circuit Disagrees With Claims Court And Denies Deduction For Contingent Dividend Liability

On August 1, 2013, the U.S. Court of Appeals for the Second Circuit held in New York Life Ins. Co. v. U.S., that the taxpayer's liability for policyholder dividends was contingent, and therefore, was not deductible until the taxpayer paid them. In so holding, the Second Circuit disagreed with the reasoning of the U.S. Court of Federal Claims in Massachusetts Mutual Life Insurance Co. v. U.S., 103 Fed. Cl. 111 (2012), a case with almost identical facts. The Second Circuit did not discuss a number of issues, and its attempts to distinguish precedential authority were unpersuasive.

In New York Life Ins. Co. v. U.S., 780 F. Supp. 2d 324 (S.D.N.Y. 2011), the U.S. District Court for the Southern District of New York granted the government's motion to dismiss the taxpayer's complaint, concluding that New York Life failed to (and could not) allege that for the tax years in which they were deducted, certain liabilities to pay policyholder dividends satisfied the "all-events" test. On August 1, 2013, the U.S. Court of Appeals for the Second Circuit affirmed, and held that the taxpayer's liability was contingent, and therefore the dividends were not deductible until the taxpayer paid them. In so holding, the Second Circuit disagreed with the reasoning of the U.S. Court of Federal Claims in Massachusetts Mutual Life Insurance Co. v. U.S., 103 Fed. Cl. 111 (2012), a case with almost identical facts. The Second Circuit did not discuss a number of issues, and its attempts to distinguish precedential authority were unpersuasive.

New York Life involved two types of dividends: (1) dividends that were payable annually, shortly after the end of the taxable year, if the policy remained in effect, the so-called "Annual Dividends for January Policies," and (2) dividends that were payable upon the termination of the policy, the so-called "Minimum Dividends."

Annual Dividends for January Policies

The Second Circuit found that the taxpayer could not deduct in year one the Annual Dividends for January Policies because the liability was contingent on the policy being in effect at the time of payment, which was in January of year two. While to be deductible a liability must be "fixed" by the end of the year, a contingent liability can be "fixed" if the contingency is "remote and speculative." The Second Circuit, however, did not address this issue, although it noted that its analysis would not change even if the policyholders were "statistically certain" to keep their...