Stock received in demutualization has no basis.

• Author: Beavers, James A.

The Ninth Circuit, creating a circuit split, held that the taxpayers, heirs to the Campbell Soup fortune, had a zero basis in the stock of five insurance companies that they received when the companies demutualized.

Background

Bennett Dorrance, grandson of the founder of the Campbell Soup Co., and his wife, Jacquelyn Dorrance, purchased life insurance policies from five mutual insurance companies in 1996 to cover estate tax for their heirs on their approximately $1.5 billion fortune. Over time, the Dorrances paid premiums totaling $15,265,608 on the insurance policies, and the face value of the policies totaled just under $88 million. The Dorrances' contractual rights under the policies entitled them to (1) a death benefit; (2) the right to surrender the policy for "cash value"; and (3) annual policyholder dividends representing their portion of the company's "divisible surplus."

As policyholders, they also had certain membership rights. Specifically, they were entitled to a portion of any surplus in the event of a solvent liquidation and to certain voting rights. The Dorrances' membership rights in the mutual insurance companies were not transferable or separable from the insurance policy, and, if the policies terminated, so too would the membership rights, without any rebate or additional compensation. Voting and other membership rights were governed by state law and company charter.

In 2000 and 2001, each of the insurance companies from which the Dorrances bought policies demutualized. After demutualization, the Dorrances no longer held any mutual membership rights in the companies but retained their contractual interests under the insurance policies and continued to pay the same premiums. In return for their portion of the surplus of each company at the time of demutualization, the Dorrances received stock in the respective company.

When determining how many shares of stock to distribute to each policyholder, the insurance companies calculated (1) a fixed component for the loss of voting rights, as every policyholder was entitled to a single vote regardless of policy size, and (2) a variable component for the loss of other membership rights, which was calculated based on the policyholder's past and projected future contributions to the company's surplus. Each of the companies the Dorrances held policies with used a different formula to determine the amount of stock that they and other policyholders received.

Upon demutualization, the...