IRS rules a state workers'-comp insurer's shift from tax-exempt to taxable status is not a sale or exchange

Plain-English summary

A state-sponsored workers' compensation insurer had been tax-exempt under IRC § 501(c)(27). State legislation began privatizing it by gradually shifting control of its board to its policyholders. Once policyholders appoint a majority of the board (the "Status Change"), the organization will lose its exemption and become a taxable property-casualty insurer. The insurer asked the IRS how that transition is taxed. The IRS ruled that simply losing exempt status and becoming taxable is not a "sale or exchange," so no gain or loss is recognized under § 1001, and no reinsurance transaction is deemed to occur. The ruling also confirms how the newly taxable insurer computes its earned premiums and incurred losses under § 832 for the short year in which the change happens, using the standard 80% unearned-premium adjustment and discounted unpaid losses. The IRS expressly did not opine on exactly when the § 501(c)(27) exemption ends.

Ruling snapshot

• Question: Does an insurer's move from § 501(c)(27) tax-exempt status to taxable status trigger gain under § 1001, and how are its premiums and losses computed under § 832?
• Outcome: Approved (no sale or exchange; no gain/loss; § 832 computation confirmed)
• Key authorities: IRC §§ 1001, 832(b)(4), 832(b)(5), 846, 501(c)(27)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202227004                                              Third Party Communication: None
Release Date: 7/8/2022                                         Date of Communication: Not Applicable
Index Number: 832.00-00, 1001.00-00
                                                               Person To Contact:
----------------------------------------------------------     ----------------------------,
------------------------------------------------------------   ID No. -----------------
--------------------------------------                         Telephone Number:
---------------------------------------                        --------------------
                                                               Refer Reply To:
                                                               CC:CORP:2
                                                               PLR-121522-21
                                                               Date:
                                                               April 15, 2022



                                                   Legend

Taxpayer            = -----------------------------------------------------------------------------------------
                      -----------------------------------------------------------------------------------------
                      -----------------------

Policyholders = -----------------------------------------------------------------------------------------
                ---------------------------------------------------------------------

Legislation         = -----------------------------------------------------------------------------------------
                      -----------------------------------------------------------------------------------------
                      -----------------------------------------------------------------------------------------
                      -----------------------

State A             = ------------

Year 1              = -------

Year 2              = -------

Year 3              = -------

Year 4              = -------

a                   = ---

b                   = --

c                   = --

d                   = --


 e                 = --


Dear --------------:

This letter responds to your authorized representatives’ letter dated October 14, 2021,
as supplemented by subsequent information and documentation. In that letter, you
requested rulings under sections 832 and 1001 of the Internal Revenue Code (the
“Code”). The material information submitted in that letter and subsequent
correspondence is summarized below.

The rulings contained in this letter are based upon facts and representations submitted
by the taxpayer and accompanied by a penalties of perjury statement executed by an
appropriate party. This Office has not verified any of the material submitted in support of
the request for rulings. Verification of the information, representations, and other data
may be required as part of the audit process.

                                          Facts

Taxpayer is a nonprofit, nonstock corporation that is currently exempt from federal
income taxation under section 501(c)(27). Taxpayer is a State A-sponsored workers’
compensation organization. Taxpayer’s articles of incorporation prohibit it from issuing
capital stock or converting to a mutual or stock company. State A law authorizes
Taxpayer to pay dividends to its Policyholders, subject to the approval of State A’s
insurance commissioner. State A law prohibits Taxpayer from liquidating. Each
Policyholder’s policy with Taxpayer is for a term of a months or less.

In Year 1, State A passed Legislation to privatize Taxpayer to a taxable workers’
compensation organization. Prior to Legislation, the State A governor appointed all b
members of the board of directors. Pursuant to Legislation, Policyholders were granted
the right to eventually appoint c of Taxpayer’s b directors. The voting rights would be
phased in gradually, from Year 2 through Year 4, and the governor of State A would
retain the right to appoint d of the board members. Accordingly, Policyholders appointed
d board members in Year 2, appointed another d board members in Year 3, and will
appoint another e board members in Year 4.

Taxpayer has represented that it will cease to be exempt from federal income taxation
under section 501(c)(27) when the Policyholders appoint the majority (i.e., c of b board
members) of Taxpayer’s board of directors (the “Status Change”).



                                     Representation

(a) After the Status Change, Taxpayer will be an insurance company other than a life
    insurance company and will compute its taxable income under section 832.

                                          Rulings

(1) The Status Change will not be treated as a sale or exchange. Accordingly, no gain
    or loss will be realized under section 1001 as a result of the Status Change.

(2) No reinsurance transaction will be deemed to occur solely as a result of the Status
    Change.

(3) Taxpayer’s premiums earned under section 832(b)(4) for the short period ending the
    final day of Year 4 will be determined in relevant part by adding 80 percent of the
    unearned premiums on outstanding business immediately before the Status
    Change, and deducting 80 percent of the unearned premiums on outstanding
    business at the end of Year 4, in each case relating to gross premiums written for
    any year.

(4) Taxpayer’s losses incurred under section 832(b)(5) for the short period ending the
    final day of Year 4 will be determined in relevant part by adding all discounted
    unpaid losses (as defined in section 846 of the Code) outstanding at the end of Year
    4 and deducting all discounted unpaid losses outstanding immediately before the
    Status Change, in each case relating to all accident years.

(5) Taxpayer will determine losses paid under section 832(b)(5)(A)(i) taking into account
    losses paid relating to all accident years.

                                          Caveats

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax treatment of the proposed transaction under any provision of the Code and
regulations or the tax treatment of any condition existing at the time of, or effects
resulting from, the proposed transaction that is not specifically covered by the above
rulings. Specifically, no opinion is expressed as to Taxpayer’s continued qualification as
a tax-exempt organization described in section 501(c)(27), nor is any opinion expressed
regarding the termination date of Taxpayer’s section 501(c)(27) status.

                                 Procedural Statements

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.


                                           Sincerely,


                                           __________________________
                                           Douglas C. Bates
                                           Branch Chief, Branch 4
                                           Office of Associate Chief Counsel (Corporate)

cc: