Exchange of Policyholder Interest for Stock

A mutual insurance company is owned by its policyholders and has no stock. When a mutual insurance company demutualizes and becomes a stock company, a policyholder's ownership interest in the mutual insurance company may be exchanged for shares in a stock insurance company and/or cash. The exchange does not cause the policies to change, except for the name of the issuing company. The basis of your equity interest in the mutual company is considered to be zero.

The treatment of the demutualization depends on whether it is a tax-free reorganization under Internal Revenue Code section 368(a)(1). Information on whether the reorganization qualifies under section 368(a)(1) may be obtained from the (former) mutual insurance company.

If the demutualization qualifies as a tax-free reorganization and you elected to receive stock, you will not recognize any gain or loss on the receipt of the stock. Because the basis of your equity interest in the mutual company is considered to be zero, your basis in the stock received is also zero. Your holding period for the new stock includes the period you held an equity interest in the mutual company.

If you elected to receive cash instead of stock in the tax-free reorganization, you are deemed to have received shares and then to have sold them back to the corporation (i.e., redeemed your shares). Generally this results in capital gain or loss reportable on Form 1040 (Schedule D), Capital Gains and Losses. If you owned the policy for more than one year as of the date of the demutualization, the gain or loss is treated as long-term capital gain or loss. If you owned the policy for a year or less, the gain or loss is short-term capital gain or loss. Refer to Internal Revenue Code section 1223(1).

If the demutualization does not qualify as a tax-free reorganization, you must recognize a capital gain in an amount equal to the cash and fair market value of the stock received. Your holding period for the new stock begins on the day after you received the stock.

Refer to Revenue Ruling 71-233, 74-277, and 2003-19 regarding the Federal income tax consequence of a demutualization qualifying as a reorganization under section 368(a)(1). For more information, refer to Publication 550, Investment Income and Expenses.

Copies of Revenue Rulings are available in one of the local Federal Libraries in your community. To find the library nearest to you, visit the Governmental Printing Office Locate Federal Depository Libraries website at: http://catalog.gpo.gov/fdlpdir/FDLPdir.jsp.