New York Life Insurance Company v. Edwards/Opinion of the Court
The Insurance Company brought suit in the District Court at New York to recover of Edwards, collector, the alleged excessive sum demanded of it as income tax for the year 1913 and obtained judgment for a part. 3 F. (2d) 280. The Circuit Court of Appeals affirmed this, except as to one item. 8 F. (2d) 851. Both parties are here by certiorari, and five questions require consideration. All involve the construction or application of the Revenue Act of October 3, 1913, c. 16, 38 Stat. 114, 172. Section 2 G(a) imposed an annual tax of one per centum upon the net income of 'every insurance company organized in the United States,' and (b) directed-

'Such net income shall be ascertained by deducting from the      gross amount of the income of such * * * insurance company,      received within the year from all sources, (first) all the      ordinary and necessary expenses paid within the year in the      maintenance and operation of its business and properties,      including rentals or other payments required to be made as a      condition to the continued use or possession of property;      (second) all losses actually sustained within the year and      not compensated by insurance or otherwise, including a      reasonable allowance for depreciation by use, wear and tear      of property, if any; * * * and in case of insurance companies      the net addition, if any, required by law to be made within the year      to reserve funds and the sums other than dividends paid      within the year on policy and annuity contracts: Provided,      that * * * life insurance companies shall not include as      income in any year such portion of any actual premium      received from any individual policyholder as shall have been      paid back or credited to such individual policyholder, or      treated as an abatement of premium of such individual      policyholder, within such year. * * *'

1. The company, a New York corporation without capital stock, does business on the mutual level premium plan and issues both 'annual dividend' and 'deferred dividend' policies. Under this plan each policy holder pays annually in advance a fixed sum which, when added to like payments by others, probably will create a fund larger than necessary to meet all the maturing policies and estimated expenses. At the end of each year the actual insurance costs and expenses incurred are ascertained. The difference between their sum and the total of advance payments and other income, then becomes the 'overpayment' or surplus fund for immediate pro rata distribution among policy holders as dividends or for such future disposition as the contracts provide. An 'annual dividend' policy holder receives his proportionate part of this fund each year in cash or as a credit upon or abatement of his next premium. 'Deferred dividend,' or, as sometimes called, 'distribution,' policies provide-

'That no dividend or surplus shall be allowed or paid upon      this policy, unless the insured shall survive until      completion of its distribution period, and unless this policy      shall then be in force. That surplus or profits derived from      such policies on the distribution policy plan as shall not be      in force at the date of the completion of their respective      distribution periods, shall be apportioned among such      policies as shall complete the distribution periods.' Accordingly all overpayments by deferred dividend policy holders must await apportionment until the prescribed period ends, and no one of them will receive anything therefrom if his policy lapses or if he dies before that time. The whole of this fund goes to the survivors.

Overpayments by deferred dividend policy holders for 1912 amounted to $8,189,918. The collector refused to deduct this sum from the total receipts, and demanded the prescribed tax of 1 per centum thereon. We think he acted properly. Both courts below so held.

The applicable doctrine was much considered in Penn Mutual Life Insurance Co. v. Lederer, 40 S.C.t. 397, 252 U.S. 523, 64 L. Ed. 698. We there pointed out the probable reason for the permitted noninclusion in the net income of a life insurance company of 'such portion of any actual premium received from any individual policy holder as shall have been paid back or credited to such individual policy holder, or treated as an abatement of premium of such individual policy holder, within such year.' Here it is insisted that within the meaning of the quoted provision each deferred dividend policy holder's overpayment was actually credited to him during the year; but we cannot accept this theory. The aggregate of all such payments was held for distribution among policy holders alive at the end of the period. The receipts for the year were not really diminished.

2. The company owned many bonds, etc., payable at future dates, purchased at prices above their par values, and to amortize these premiums a fund was set up. It claimed that an addition to this fund should be deducted from gross receipts. The District Court thought the claim well founded, but the Circuit Court of Appeals took another view. Unless the addition amounted to a loss 'actually sustained within the year' no deduction could be made therefor. Obviously, no actual ascertainable loss had occurred. All of the securities might have been sold thereafter above cost. The result of the venture could not be known until they were either sold or paid off. 3. In 1910 the company introduced a clause into some policies by which it agreed to waive payments of premiums after proof of total and permanent disability. The estimated value on December 31, 1913, of future premiums so waived amounted to $16,629. It claimed this should be added to the reserve fund and deducted from gross income. Insurance companies may deduct 'the net addition, if any, required by law to be made within the year to reserve funds.'

The pertinent portion of the agreed statement of facts follows:

In 1910 the plaintiff introduced into some of its contracts      of insurance a clause under which it agreed that upon      receipt, before default in the payment of premium, of due      proof that the insured had become totally and permanently      disabled, the plaintiff would waive payment of any premium      thereafter falling due. In taking its account at the end of      the calendar year 1913, the plaintiff had then received due      proof that the insured under a number of these policies were      totally and permanently disabled in accordance with the terms      of said contracts providing for the waiver of the payment of      future premiums. The value at December 31, 1913, of the      futute premiums waived on account of total and permanent      disability was the sum of $16,629. The value at December 31,      1912, of the future premiums so waived was the sum of $5,637.

In the calculation of the general reserve fund at the end of      any calendar year, the company and the insurance department      of the state of New York make the computation by deducting      from the value of the contractual benefits under each policy      the then value of all future premiums under the policy. The      general reserve fund of the plaintiff stated in its annual      statement is thus the reserve computed by deducting the value      of all future premiums from the valuation of all policy obligations. But, under the      policies on the lives of those who had become totally and      permanently disabled and whose contracts provided for the      waiver of the payment of future premiums, no future premiums      will be received by the plaintiff, and therefore the net      reserve reported for these policies in understated to the      extent of the value of these future premiums.

In the official blank for the plaintiff's annual statement to      be used at December 31, 1913, there was an item of      liabilities, No. 9-a, entitled 'Present Value of Future      Premiums Waived on Account of Total and Permanent      Disability,' and in the plaintiff's annual statement the sum      reported under this item was $16,629 at December 31, 1913.      The sum of $16,629 reported under item No. 9-a was not      included in the plaintiff's general reserve. In the official      blank for use at December 31, 1912, ther was no such item as      No. 9-a, and the plaintiff included the value at December 31,      1912, of future premiums waived on account of total and      permanent disability (viz. $5,637) as a part of the general      reserve at that date.

If said sum of $5,637 had not been included as a part of the      general reserve at December 31, 1912, the net addition to the      value of future premiums waived on account of total and      permanent disability would have been the excess of $16,629      over $5,637. Since, however, owing to the change in the form      of the official blank, the said $5,637 was deducted as a part      of the plaintiff's general reserve in obtaining the net      addition to the general reserve, the sum to use in obtaining      the net addition to the value of future premiums waived on      account of total and permanent disability in the sum of      $16,629.

The Circuit Court of Appeals held the deduction should have been allowed, but we think otherwise.

The superintendent of insurance of New York required this item to be reported as a liability and did not treat it as part of the general reserve. Upon the agreed facts we cannot say that it was part of any reserve required by the laws of the New York. There is nothing to show how 'the value of the contractual benefits' under these policies was arrived at and, considering the evidence presented, we must accept the superintendent's conclusion. The company has not shown enough to establish its right to the exemption.

4. A number of policy holders died during the calendar year, but their deaths were not reported before it terminated. The superintendent of insurance required the company to set aside a special fund to meet these unreported losses, and it claimed that this was an addition to the reserve fund required by law. We think this claim was properly rejected by the commissioner, although the courts below held otherwise. McCoach v. Insurance Co. of North America, 37 S.C.t. 709, 244 U.S. 585, 61 L. Ed. 1333, and United States v. Boston Insurance Co., 46 S.C.t. 97, 269 U.S. 197, 70 L. Ed. 232 (November 23, 1925), pointed out that the net addition, if any, required by law to be made within the year to reserve funds,' does not necessarily include whatever a state official may so designate; that 'reserve funds' has a technical meaning. It is unnecessary now to amplify what was there said. The item under consideration represented a liability and not something reserved from premiums to meet policy obligations at maturity.

5. The company also claimed deduction for additions to a fund set aside to provide for payment of annuities to former soliciting agents as provided by their contracts of employment. The Commissioner properly rejected this item, although both courts below held a different view. The agreed statement of facts shows:

The plaintiff has a form of contract of employment with many      of its soliciting agents under which, if such agents for a      period of 20 years continuously devote their entire time,      talents and energies in soliciting applications for insurance, and if they shall for the 20 years      accomplish certain prescribed minimum results, then at the      end of twenty years of such service each such agent becomes      entitled to an income for life payable monthly, the amount of      the payment being based upon the results obtained by each      such agent during the twenty year period. The laws of New      York require the superintendent of insurance, in making a      valuation of the obligations of the plaintiff to value      annuities on the standard of McClintock's 'Table of Mortality      among Annuitants,' with interest not exceeding four per      centum per annum. Said superintendent of insurance after      making an examination of the plaintiff and valuing its      liabilities, required the plaintiff to carry, and it does      carry, a fund to meet its said liabilities on said contracts      with its soliciting agents, and this fund it increased during      the year 1913. The net addition to said fund for said year      was the sum of $160,641, which the plaintiff, in making its      said return deducted from gross income under that clause of      the law which authorizes a life insurance corporation to      deduct the net addition required by law to be made within the      year to reserve funds. But in amending said return the      Commissioner refused to allow said deduction, and thereby      made the plaintiff's net income for the year appear to be      $160,641 more than it would have been if said deduction had      been allowed, and he assessed and collected an additional tax      on account thereof accordingly in the sum of $1,606.41, which      forms a part of the tax in controversy in this suit.

As pointed out above, the term 'reserve funds,' in the taxing act, has a technical meaning. The compensation which an insurance company agrees to pay soliciting agents has no relation to the reserve held to meet maturing policies, and when it sets aside a fund to provide payments to such agents this cannot be regarded as a reserve within intendment of the statute.

The judgment below must be reversed. The cause will be remanded to the District Court for further proceedings in harmony with this opinion. 

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