Association's Insurance Trust Asserts Stock Sale Is Member Income

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Appellant Texas Medical Association Insurance Trust ("TMAIT") is a taxable membership organization under Section 277 of the Internal Revenue Code of 1986 (the "Code"). As such, it receives contributions from its members and uses those contributions to provide group insurance coverage for its members and members' dependents. TMAIT provided this group insurance coverage, in part, by purchasing group insurance policies from Prudential, a mutual insurance company, for which TMAIT automatically received a Prudential membership interest. When Prudential converted from a mutual insurance company to a stock company (hereafter referred to as "demutualization") on December 18, 2001, TMAIT's membership interest ceased to exist; and in exchange for such interest, TMAIT received 839,303 shares of Prudential stock (the "Prudential Stock") having a per share value of $29.95. In June of 2002, TMAIT sold 209,303 shares of this stock at a price of $33.12 per share for total sales proceeds of $6,925,811, and used $6,600,000 of the proceeds to pay premiums to Aetna Insurance Company on behalf of its members.

On its original return filed with the Internal Revenue Service ("IRS") for 2002, TMAIT reported the gain on the sale of the Prudential Stock but did not take a deduction for the premiums paid to the extent of the total gain attributed to $29.95¹ per share of the Prudential Stock. TMAIT then filed an amended tax return as a claim for refund. Subsequent to the expiration of six (6) months from the date of filing the claim for refund, TMAIT filed suit in the Federal District Court, Western District of Texas, Austin Division. There being no factual dispute both parties filed Motions for Summary Judgment. There was no formal discovery exercised in the case, and both parties filed the summary judgment evidence on which they relied for the underlying base facts, which for TMAIT were affidavits of Larry Stein, the Administrator of TMAIT (the principal executive officer) and Philip S. Dial, the chief actuary of TMAIT. On September 30, 2005, the District Court entered a Final Judgment and an opinion, ruling for the United States and denying TMAIT's Motion and its Claim for Refund.

B. Statement of the Facts.

TMAIT is a taxable membership organization under Section 277 of the Code whose primary function is to provide group insurance programs for its members. TMAIT was established in 1970 for the purpose of providing low cost insurance to its members. Stein Affidavit ¶ 3.

TMAIT members obtain coverage in one of two ways: 1) as individual physicians seeking medical insurance, or 2) clinics seeking group coverage for their employees and dependents of their employees. Dial Affidavit ¶ 10. Both individual physicians and clinic employees make subscription payments to TMAIT. Pursuant to its contracts with the insurance companies, TMAIT retains a portion of the subscription payments to cover its cost of administering the group insurance program. TMAIT then uses the remainder of those payments to pay premiums for coverage provided to its members under various group insurance policies issued by the insurance companies (Prudential and Aetna). Stein Affidavit ¶ 5 and ¶ 6.

Since its inception in 1970, TMAIT has purchased insurance exclusively from Prudential Insurance Company of America ("Prudential"), a mutual insurance company, and Aetna Insurance Company ("Aetna"). TMAIT chose Prudential as an insurance provider because it offered the best combination of low net cost insurance and customized service. In choosing Prudential, TMAIT did not consider as a benefit the potential that Prudential might demutualize at some time. Dial Affidavit ¶ 15.

The purpose of a mutual insurance company is to provide insurance at low net cost to its policyholders. In furtherance of this purpose, a mutual insurance company issues membership interests entitling such members to receive their share of any premium payments in excess of insurance costs (often referred to as the "surplus" of the mutual company) in the event of liquidation. As a mutual insurance company, Prudential charged its insureds premiums sufficient in amount to pay insurance costs and maintain a statutorily mandated surplus. Prudential recognized its members' right to a return of this surplus upon liquidation by issuing such members interests in Prudential. Dial Affidavit ¶ 7.

Upon becoming a policyholder, Prudential issued TMAIT a membership interest, which represented TMAIT's right to Prudential's surplus -- i.e. premiums that TMAIT paid in excess of insurance costs -- after payment of all policy claims and other debts. Although TMAIT purchased numerous policies from Prudential, TMAIT's sole membership interest afforded it only one vote in Prudential's governance. Receipt of the interest in Prudential could not be separated from receipt of the insurance policies, nor was this interest in Prudential transferable or redeemable by TMAIT. In the event that the policies TMAIT held with Prudential expired, the underlying membership interest would also expire. Dial Affidavit ¶ 8 and ¶ 9.

On December 18, 2001, Prudential demutualized and thereby converted from a mutual insurance company to a stock company. As a result of this demutualization, Prudential's members received stock in Prudential for their membership interests. Prudential determined the number of shares received for each membership interest by estimating the contributions that the policies underlying each membership interest made to Prudential's current surplus and what those policies would contribute to future surpluses. For TMAIT's contributions to Prudential's surplus, on December 18, 2001, TMAIT received 893,303 shares of stock, valued at $29.95 per share. Stein Affidavit ¶ 7; Dial Affidavit ¶ 12.

TMAIT made a corporate decision to use the value of the Prudential Stock to stabilize the increasing costs of insurance to its members. TMAIT accomplished this stabilization by supplementing premiums paid to Aetna with the proceeds from the sale of stock. In accordance with this plan, during 2002, TMAIT sold 209,303 shares of this stock at $33.12 per share for total sales proceeds of $6,925,811, and recycled $6,600,000 of these proceeds by using them to supplement premium payments TMAIT made to Aetna. Stein Affidavit ¶ 8; Dial Affidavit ¶ 13.

On July 9, 2003, TMAIT filed its tax return (IRS Form 1120), and in doing so, did not take a deduction for the $6,600,000 paid to Aetna. Tax assessed by filing and paid on the return amounted to $2,325,975 for the tax year ending December 31, 2002. On July 29, 2003, TMAIT filed an amended tax return as a claim for refund (IRS Form 1120X) with the IRS Regional Service Center in Austin, Texas. This claim for refund is based solely on the $6,600,000 deduction for supplemental payments made to Aetna for tax year 2002. Stein Affidavit ¶ 10.

The amended return resulted in assessed tax due of $77,280, thereby creating a tax overpayment by and refund due to TMAIT of $2,248,695. Six months from the date the claim for refund was filed, TMAIT's claim for refund had not yet been granted or dismissed. Stein Affidavit ¶ 11.

On April 6, 2004, TMAIT commenced this present action pursuant to Section 6532(a) of the Code. There being no formal dispute, both parties filed Motions for Summary Judgment. No formal discovery occurred in the case, and both parties filed summary judgment evidence.

The District Court issued its opinion and final judgment on September 30, 2005. Texas Medical Ass'n. Ins. Trust v. United Trust, 391 F. Supp. 2d 529 (W.D. Tex. 2005). The District Court denied TMAIT's motion for summary judgment and granted the United States' motion for summary judgment.

The District Court relied significantly on the Tax Court's decision in Concord Consumers Housing v. Commissioner, 89 T.C. 105 (1987) and reasoned that derived from meant received directly from and that interpretation of Section 277 should apply to TMAIT's Prudential Stock, the same as it applied to the investment interest income in Concord Consumers. The Court further held that TMAIT did not prove that its excess premiums were the same dollars returned to TMAIT in the form of Prudential Stock, that the United States proved that the gain was from realized investment gain, and that the revenue received from the sale of the Prudential Stock was received from nonmember sources (a stockbroker). The Court also noted (and seemed persuaded by) the United States' position that it was not disallowing the deduction of the payment of premiums by TMAIT in 2002; it was simply deferring the benefit of the deduction to a year where TMAIT received premiums from members in excess of premiums paid out by TMAIT in that year.

A. Standard of Review

The parties filed cross motions for summary judgment. The single issue is statutory interpretation of an issue of law. Legal issues are reviewed do novo. San Antonio Savings Ass'n v. Commissioner, 887 F.2d 577, 581, reh. denied, 894 F.2d 1335 (5th Cir. 1989).

B. The Definition of Derived From

Before the District Court, the United States argued that the phrase "derived from" can only mean "received directly from". TMAIT believes this is an unreasonably narrow interpretation. Texas Medical, 391 F.Supp. 2d at 534.

The term "derive from" has more than the single meaning the Government would assign to it.² Aside from meaning to receive, the term derive is also used to refer to a source or an origin of some matter.³ In fact, the term derive has historically had many definitions. The Oxford English Dictionary gives the term a total of 13 broad meanings. The Government's position could fit the meanings described in paragraphs 6 and 11. However, TMAIT's position is represented by the meanings for derive found in paragraphs 6, 8, 9, 10 and 11, all of which define the term derive as a tracing to an origin.⁴ To be clear, it is not TMAIT's position that the meaning "received from" is an incorrect definition for the phrase "derived from." However, "received from" is only one of several possible meanings. The District Court itself noted that Congress did not provide any guidance as to what it meant by the phrase "derived from." Indeed, Congress could easily have used the phrase "received from" or "received directly from" if that had been its specific intent.

The Government argues not only that "derived" should be read as "received", but that unless the income came directly from the hands of TMAIT's members, it cannot be an item of "income derived . . . from members or transactions with members" as required by the Code. The term "derived" should be more broadly interpreted -- akin to a "but for" test, that is, but for the payment of premiums to TMAIT by its members, TMAIT would have never received the Prudential Stock.

Such a broader definition would encompass items of income that, as in this case, represent nothing more than a return of sums overpaid for goods or services. Under either interpretation, however, the unique facts in this case should entitle TMAIT to treat the proceeds from the sale of Prudential Stock during its fiscal year as "income derived from members."

C. The Purpose of Section 277

Code Section 277 provides that a taxable membership organization is allowed deductions for the taxable year only to the extent of "income derived during such year from members or transactions with members." Code Section 277 was enacted by Section 121 of the Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 536 (the "TRA"). An explanation of the Section's purpose is given in the report of the Committee on Ways and Means of the House of Representatives. Both the House bill and the committee's amendments provided that "in the case of . . . [a taxable] membership organization . . . the deduction [for expenses incurred] in supplying services, insurance, goods, and other items . . . to members" is to be allowed "only to the extent of income from members or transactions with members." H.R. Rep. No. 91- 413 (1969), 1969-3 C.B. 200, 232. The purpose is to "prevent membership organizations from escaping tax on business or investment income by using this income to serve its members at less than cost and then deducting the book 'loss'."

The District Court correctly described the legislative history of Section 277 and its broad purpose, but neither Code Section 277 nor its legislative history provides specific criteria for determining whether particular items of income are to be treated as "income derived during the year from members or transactions with members." Furthermore, the IRS has never published a ruling, or any other form of administrative notice, nor has the Treasury finalized any regulation that informs taxpayers that derived from means only received from. In 1972, the Treasury Department proposed regulations under Code Section 277 which, consistent with its litigating position here, defined "income derived . . . from members or transactions with members" to include only "income received by a membership organization from its members." Prop. Treas. Reg. § 1.277-1, 37 Fed. Reg. 9,278 (May 6, 1972). However, these proposed regulations were subsequently withdrawn. 52 Fed. Reg. 2,724 (January 26, 1987). The language in the proposed regulations was inconsistent with the language of the statute itself. The Treasury Department chose instead to use language which improperly mirrors the text of Section 512(a)(3), which, although promulgated at the same time as Section 277, concerns entities that are treated very differently under the Code.

Section 121 of the TRA promulgated both Sections 512(a)(3) and 277 of the Code. Section 512(a)(3) was added in an effort to prevent various tax-exempt membership organizations from escaping tax on their investment and other nonmember income. See Concord Consumers Housing Cooperative v. Commissioner, 89 T.C. 105, 119 (1987). Prior to 1969, these organizations were subject to tax on their "unrelated business taxable income" ("UBTI") or income generated by a trade or business, regularly carried on, and not substantially related to their tax-exempt purpose. Id. at 118. This tax generally did not extend to nonmember income generated from sources other than a trade or business. Id. In an effort to prevent these tax-exempt organizations from escaping tax on their investment and other nonmember income, Congress added Section 512(a)(3) which extended the definition of UBTI to include all income that is not "exempt function income" or "income from dues, fees, charges or similar amounts paid by members." Id. at 119; I.R.C. § 512(a)(3)(B) (emphasis added). Congress reasoned that in order for the tax exemption to serve its purpose, exempt income must be limited to receipts directly received from the membership. Concord Consumers, 89 T.C. at 119 (citing H. Rept. 91-413, (Part 1) (1969), 1969-3 C.B. 230; S. Rept. 91-552, (1969), 1969-3 C.B. 469, 469-470).

Nevertheless, in Concord Consumers, the Tax Court basically blended the language of Section 512(a)(3) with the language of Section 277 even though none of the income from such a Section 277 entity is tax-exempt. See Id. at 122. With respect to tax-exempt membership organizations, income is presumed exempt unless it falls into a specially designated category, such as UBTI. But a different scheme applies for Section 277 entities. There, all income is taxable except for a certain type of income (that income derived from members or transactions with members) which may be offset by deductions related to the furnishing of certain services, including insurance.

The court in Concord Consumers, however, did not consider the differences in the statutory language of the two provisions. There, the Tax Court had to determine whether interest earned on the statutorily mandated reserves of a housing cooperative was "income derived. . .from members or transactions with members." Id. at 106. In making its decision, the Tax Court relied on the "nexus" between Sections 512(a)(3) and 277, holding that the interest was not "income derived. . .from members or transactions with members." Id. at 122.

The Tax Court in Concord Consumers explained that Congress enacted Section 277 at the same time as its enactment of Section 512(a)(3) and for a similar reason -- to prevent certain taxable membership organizations from escaping tax on their investment and other nonmember income. See 89 T.C. at 120-121 (citing S. Rep. 91-552 (1969)). The court, however, did not analyze the unique language Congress used in each provision to accomplish this goal and the significance thereof. In Section 512(a)(3), Congress redefined UBTI to mean all income that is not "exempt function income" or "income from dues, fees, charges, or similar amounts paid by members." (emphasis added). Likewise, a similar -- but not identical -- goal was accomplished through Section 277 by limiting deductions in any taxable year for expenses incurred in providing goods and services to members to the extent of the "income derived. . .from members or transactions with members.'" (emphasis added).

The Tax Court in Concord Consumers equated "exempt function income" with the "income derived. . .from members or transactions with members." See 89 T.C. at 121. But the language of Section 277, on its face, is far broader. Section 512(a)(3) exempts income only if "paid by members,'" while Section 277 allows deductions to the extent of income "derived. . .from members or transactions with members.'" (emphasis added). This variation in statutory language, which reflects the fact that one entity is presumed to have tax-exempt income while the other is presumed not to (unless an exception applies), was not addressed by the court in Concord Consumers. See id. at 122. This distinction, however, provides a solid foundation for concluding that Congress did not intend for the language in Section 277 to be given the same meaning as that in Section 512(a)(3). Given that one entity's income is presumed taxable and the other's is not, even if the language in the two Code Sections was interpreted identically, the income of the two entities' would be treated differently for tax purposes since, pursuant to Section 512(a)(3), the "exempt function income" of tax-exempt membership entities would not be taxed while no analogous exemption applies to Section 277 entities.

In reading a statute for interpretive purposes, one should scrutinize the text and context for specific intention and purpose. See Norman J. Singer, Sutherland Statutes and Statutory Construction, 2A Sutherland Statutory Construction § 45:1 (6th ed.); see also John M. Dernochan, Statutory Interpretation: An Outline of Method, 3 Dalhousie L.J. 333, 348-49 (1976). In the case of Section 277, the text itself is evidence of Congress's specific intent to define membership income to include more than just income received directly from members. The language "or transactions with members" is incontrovertible evidence that membership income was intended to be more broadly interpreted than as suggested by the United States. The context, particularly the surrounding provisions and the legislative history, provides further evidence that the language of Section 277 defining membership income for purposes thereof was intended to be more encompassing than that of Section 512(a)(3) defining the same. Sections 277 and 512(a)(3) were enacted at the same time and for similar purposes, yet Congress chose to use different language, consistent with there being different areas of taxable and tax-exempt income for each type of entity.

A proposed 1992 amendment to Section 277 provides further evidence that Congress did not intend for the language of Section 277 to be interpreted as narrowly as that of Section 512(a)(3). See H.R. Rpt. 102-719 (July 23, 1992); see also H.R. Comm. on Ways and Means, 102^nd Cong., Committee Report Accompanying H.R. 5650, Which Concerns Farmer Cooperatives, 92 TNT 171-21 (August 21, 1992). Congress's Explanation accompanying the proposed amendment included a Statement of Present Law and Reasons for Change. Under the Statement of Present Law, Congress recognized the holding in Concord Consumers and then, under Reasons for Change, stated that it "wish[ed] to clarify that interest earned by a qualifying limited equity housing cooperative from its reasonable reserves shall be treated as derived 'from transactions with members' for purposes of applying Section 277(a)." Id. Under the proposed bill, any "interest earned by any cooperative housing corporation . . . on its reasonable reserves [established in connection with such corporation] (including reserves required by a government agency or lender) [would] be treated as income derived from transactions with members." Id.

For the foregoing reasons, the language of Section 277 is neither defined nor limited by the language of Section 512(a)(3). Without reason to conclude otherwise, the language of Section 277 should be interpreted in accordance with its plain meaning. Here, TMAIT members transferred subscription payments to TMAIT which were then used to purchase insurance coverage on their behalf. TMAIT provided such coverage through group insurance policies purchased from Prudential. As a result of the purchase of such policies, TMAIT automatically received a Prudential membership interest. TMAIT's membership interest was subsequently exchanged for Prudential Stock, representing nothing other than previously paid premiums. TMAIT later sold the Prudential Stock and used the proceeds of this stock to supplement premium payments made to Aetna. From this sequence of events, it is quite clear that the income resulting from the sale of the stock was derived from transactions with TMAIT members. The income from the sale of the Prudential Stock is simply the realized value of the Prudential Stock, i.e., the premiums paid by TMAIT members in excess of insurance costs. But for the purchase of the insurance policies on behalf of its members, TMAIT would not have received the Prudential Stock. Since the proceeds of the stock sale are being used to supplement current premiums from members, it would follow that those premiums should be deductible from the income resulting from the sale of Prudential Stock.

Alternatively, even if the language of Section 277 is ignored and that section is interpreted congruent with Section 512(a)(3), the result in Concord Consumers is readily distinguishable from this case. As discussed above, that fact pattern involved a separate investment initiated by the housing cooperative to establish mandated reserves and such investments necessarily generated interest income. True, the law mandated the reserves -- but the activity engaged in by the housing cooperative on behalf of its members did not generate the interest income. That occurred as a result of the separate investment. Here, the members initially provided funds, which TMAIT treated as income derived from members or transactions with members, for the purchase of insurance. TMAIT then purchased insurance from Prudential with those funds and duly set off the income with those expenditures.

Prudential, however, was a mutual insurance company, which meant its policyholders, by virtue of their status as policyholders, owned the company but only in the sense that they were entitled to a proportionate share of Prudential's surpluses if and when it demutualized. In order to account for each policyholder's share of surplus, Prudential issued each such policyholder a membership interest. But only one membership interest was issued to a policyholder regardless of the number of policies the holder held, each interest afforded its holder only one vote in governance matters, such interests were not transferable and such interests were coterminous with the existence of the underlying policy. Thus, it is evident that these Prudential membership interests merely represented an interest in the return of Prudential's surplus. When Prudential demutualized, its members received stock in Prudential for their respective membership interests in an amount equal to each such policyholder's share of its surplus, or prior years premiums paid in excess of costs. Thus, when Prudential issued stock to TMAIT in exchange for TMAIT's membership interest, Prudential was doing nothing more than returning previously paid insurance premiums to TMAIT in the form of stock.

If the District Court holding is correct, then any refund received for prior payment of goods or services on behalf of members could not be income derived from members or transactions with members. Only in a technical sense is the United States correct that TMAIT did not receive the refund directly from the members but from a stockbroker. An investment, such as that in Concord Consumers however, requires a person or entity to consciously put funds at market risk; an act that did not occur here. In contrast, the transaction at hand is a mere return of funds that were derived from members or transactions with members -- as opposed to interest earned on an investment. It is clearly erroneous to view that refund as an investment along the lines of Section 512(a)(3). Indeed, in a collateral area involving demutualization of insurance companies, it is the position of the IRS that the receipt of shares in exchange for a member's interest is not an investment, which would require a cost basis for the shares: "Payment by each policyholder of the premiums called for by the insurance contracts issued by X [the mutual insurance company] represents payment for the cost of insurance and an investment in his contract, but not an investment in the assets of X. His proprietary interest in the assets of X arises solely by virtue of the fact that his is a policyholder of X." Rev. Rul. 71- 233, 1971-1 C.B. 113, 114 (emphasis added).

D. The United States Tax Court decision in Concord Consumers Holding Cooperative v. Commissioner does not control the issue in this case

The District Court stated that TMAIT argued that the Tax Court's decision in Concord Consumers was erroneous, however, this is not entirely accurate. TMAIT does not challenge the holding of the Tax Court as it applies to the facts in Concord Consumers. Rather TMAIT would point out the differences between the facts of Concord Consumers and this case. TMAIT would further argue that the District Court did not address these differences, but merely relied on the Tax Court and stated that Concord Consumers controlled the outcome of the case. There is a significant distinction between Concord Consumers Housing Cooperative's interest income and TMAIT's receipt of the Prudential Stock, a distinction that is meaningful with respect to the underlying Congressional intent of Section 277 and the application of a "derived from" analysis and a "received from" analysis.

The interest income at issue in Concord Consumers was earned on two deposits required to be maintained by Concord -- one for maintenance and equipment replacement (a replacement reserve fund) and the other was an operating reserve. Any interest earned on the replacement reserve fund was credited to the principal of the fund. Therefore such earned-interest principal increase to the replacement fund in turn accrued additional interest income. Interest earned on the operating fund was also credited to the fund and presumably such interest enhancements to the fund would also earn interest.

Therefore, Concord earned interest on three sources of cash receipts paid to it: (i) funds paid to Concord by its members; (ii) funds paid to Concord by HUD as supplements to the member income; and (iii) the actual interest earned that increased the principal amount of the two funds. Accordingly, it is clear that the income argued by Concord to be traceable to its members could not be directly or even indirectly traceable to its members because there were three possible sources of funds on which interest could have been earned. On the other hand, the Prudential Stock received by TMAIT and held to be non-member income by the District Court, can be directly traced to only one source -- amounts paid to TMAIT by its members.

The IRS has made it clear that when a mutual company such as Prudential makes a dividend payment to its insureds, the dividend is bifurcated and that portion which represents the return of excess premiums charged to the mutual company's policyholders is nontaxable.⁷ Therefore, it is recognized by the IRS that mutual insurance companies charge members excess premiums for extraordinary risk. Further, the concept of recycling the original premium assessed to and paid by TMAIT members is grounded in the income tax treatment of the return of the excess premium paid when the return is by way of dividend. With respect to stock companies, the excess premium charged for the extraordinary risk is never returned to policy holders; it contributes to the net profits of the company and ultimately will be paid out as dividends to the shareholders. The return of excess premiums to policy holders is unique to mutual companies.

When Prudential demutualized it paid out its stock to its policy holders, including TMAIT, based on estimated relative contributions to Prudential's current surplus and its future surpluses.⁸ It is without question that the Prudential Stock was essentially a return of those excess premiums that TMAIT (and all other policyholders) paid to Prudential. The District Court held that TMAIT failed to prove that its members' premium payments to TMAIT then to Prudential could be specifically traced to the Prudential Stock. Texas Medical, 391 F.Supp. 2d at 537. TMAIT acknowledges that it did not prove such tracing because it was not making the argument that TMAIT's dollars representing the contributions to surplus or risk charges could be found on the books of Prudential for each of the many years that TMAIT had been buying policies. To prove such tracing would have been an impossible task, inasmuch as TMAIT had been buying Prudential policies continuously since 1970. Even if Prudential had graciously turned over all of its financial records to its policy holders, no such policy holder could tie its individual premium dollars to any specific portion of the excess premiums charged. Rather, TMAIT's purpose is to show that Prudential distributed its stock in the demutualization process in a manner based on excess premiums (that portion of the premium paid for the contribution to surplus or risk charge) that formed Prudential's surplus. Indeed, there could be no other basis for the payment -- a fact not in dispute. The receipt of the Prudential Stock by TMAIT was a direct result from, and only from, the origin of the premiums paid by TMAIT members to TMAIT and then to Prudential. Therefore, the Prudential Stock can be derived only from the TMAIT members. The taxpayer in Concord Consumers could not make the same argument since the interest income in question there could be traced to three sources, only one of which came from the members of Concord.

E. The District Court's Deference to the Tax Court

The United States urged the District Court to defer to the decision of Concord Consumers, although it is not clear that the District Court "deferred" in the classic sense of the word.⁹ In essence the District Court determined that no distinction exists between the facts here and those in Concord Consumers. It did not analyze the difference between the interest income in Concord Consumers and the Prudential Stock. The issue of deference to either the expertise of the IRS or the Tax Court is very much unsettled.¹⁰ Further, it is not clear whether the District Court was deferring to the Tax Court's decision in Concord Consumers or the United States' interpretation of Concord Consumers and its application to the facts of this case. It's reliance on Yarbro v. Commissioner¹¹ does not answer the question because that case speaks in terms of reasonable reliance on an agency not the Tax Court. The Yarbro court was addressing a position taken by the Commissioner of Internal Revenue (the Agency) in an appeal of a Tax Court decision. It was not addressing the interpretation and application of a previously decided Tax Court decision in the appeal of a difficult case. Notwithstanding this Court's decision in Yarbro, the Fifth Circuit has not blindly followed the Tax Court if the Fifth Circuit believes the reviewed decision of the Tax Court is unreasonable. See, e.g., Nolle v. Commissioner¹² where this Court not only reversed the United States Tax Court but also declared a Treasury regulation invalid.

TMAIT is not urging a ruling different from Concord Consumers as it applied to its facts but rather urges this Court to distinguish Concord Consumers and recognize the different types of income and the sources of the income as existed there and in this case. The District Court's holding could mean only that it was deferring to the IRS' interpretation of Concord Consumers and its application to those facts. The issue of Tax Court deference normally exists only when the respective Courts of Appeal are reviewing a Tax Court decision on appeal; not, as here, when the United States is urging deference to the interpretation and application of a prior Tax Court decision as authority. In this case, the issue of deference as raised by the United States is merely a distraction from the central issue of the meaning of "derived from" in Code Section 277, a phrase which has never been interpreted by the IRS in either a ruling or a regulation.

F. Labeling the Prudential Stock as an Investment

The District Court also pointed to TMAIT's carrying the stock on its books and in its financial statement as an "Investment." Texas Medical, 391 F. Supp. 2d at 534. TMAIT does not seek nor has it ever sought to classify the appreciation in the value of the Prudential shares over the value of the stock on the date it was received ($29.95 per share) as income derived from its members. TMAIT made it clear in its tax return that it did not seek to classify the appreciation in the Prudential shares as anything other than investment income which would not qualify for offset. The reporting of the gain as a sale of investment was appropriate and has nothing to do with the application of Section 277. Once TMAIT made a decision to hold the shares they clearly represent an investment and it was proper to so classify them as such on the financial statements. Doing so does not alter the fact the value of the stock received from Prudential upon demutualization was income derived from TMAIT's members for purposes of taking a deduction for premiums paid.

G. Deferred Use of the Disallowed Deduction

The District Court's statement to the effect that TMAIT will be able to use the $6.6 million premiums paid in 2002 to offset membership income in future years may be technically correct as a matter of law but in this situation it will never occur. To generate income which may be offset by a carryforward deduction, TMAIT would have to assess its members for premium charges that are in excess of the amount that TMAIT will in turn pay to the insurers. Therefore, while the carryforward may have been absorbed, TMAIT will have overcharged its members, resulting in excess cash which it must use for premium payments without an assessment of its members, This would again result in excess deductions over member income. Thus, the cycle of carryforward deductions begins again.

1. Exclusive of the portions exempted by 5th Cir. R. 32.2.7(b)(3), this brief contains 6,175 words printed in a proportionally spaced typeface.

2. This brief is printed in a proportionally spaced, serif typeface using Times New Roman 14 point font in text Times New Roman 12 point font in footnotes, and produced by Microsoft WordXP software.

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² The United States argues (and the District Court holds) that TMAIT received the income from a stockbroker through whom TMAIT disposed of the stock; therefore, the income was derived from a non member source. Texas Medical, 391 F.Supp 2d at 534.

³ "Derive. To receive from a specified source or origin. Crews v. Commissioner of Internal Revenue, C.C.A. 10, 89 F.2d 412, 416. To proceed from property, sever from capital, however invested or employed, and to come in, receive or draw by taxpayer for his separate use, benefit, and disposal. Staples v. United States, D.C.Pa., 21 F.Supp. 737, 739." Black's Law Dictionary 444 (6th ed. 1990).

"derive . . . 1. to receive or obtain from a source or origin . . . . 2. to trace from a source or origin . . . . 5. to come from a source or origin; originate . . . . Random House Dictionary of the English Language; Second Edition, Unabridged, 536 (New York: Random House, Inc., 1987).

"derive . . . 1. To obtain or receive from a source. . . . 3. To trace the origin or development of . . . ." William Morris, ed., American Heritage Dictionary of the English Language. 356 (Boston: Houghton Mifflin Company, 1981).

"derive . . . 1 a: to take or receive esp. from a source. . . ." Philip Babcock Gove, ed., Webster's Third New International Dictionary of the English Language, Unabridged, 608 (Springfield, Mass.: Merriam-Webster Inc., 1981).

⁴ "Derive . . . 6. To draw, fetch, get, gain, obtain (a thing from a source) . . . 8. . . . . To arise, spring, come from something as its source; to take its origin from. . . 9. . . . To be drawn or descended; to take its origin or source; to spring, come from . . . 10. . . . . To trace or show the derivation, origin, or pedigree of; to show (a thing) to proceed, issue, or come from; to trace the origination of (anything) from its source; also, more loosely, to declare, assert, or state a thing to be derived from. . . . 11. To flow, spring, issue, emanate, come, arise, originate, have its derivation from. . . . " Compact Edition of the Oxford English Dictionary: Complete Text Reproduced Micrographically, 695 (New York: Oxford University Press, 1971).

⁵ Dial Affidavit at ¶ 7.

⁶ Dial Affidavit at ¶ 7, ¶ 9.

⁷ Rev. Rul. 64-258, 1964-2 C.B. 134.

⁸ Dial Affidavit at ¶ 12.

⁹ See statements of the District Court on page 536 of its opinion where it states that it "finds the discussion in Concord Consumers regarding the tax policy and legislative purpose of Section 277 instructive and helpful."

¹⁰ The Courts of Appeals are widely split on the question of deference to Tax Court decisions. In many instances, the Courts of Appeal go no further in discussing the standard of review to apply in cases coming from the Tax Court than to say Section 7482 of the Code subjects the Tax Court's factual findings to a clearly erroneous standard and the Tax Court's interpretations of law to review de novo. In some cases, the Courts of Appeals state explicitly that "no deference" or "no special deference" is owed the Tax Court's conclusions of law. See, e.g., Madison Recycling Ass'n. v. Commissioner, 295 F.3d 280, 286 (2d Cir. 2002) (espousing a "no deference" standard); Norton v. Commissioner, 33 F.3d 625, 631 n.10 (6^th Cir. 1994) ("we owe no particular deference to the Tax Court on the question of law. . .") (citations omitted); Hackl v. Commissioner, 335 F.3d 664, 666 (7^th Cir. 2003) ("we owe no special deference to the Tax Court on a legal question); Exacto Spring Corp. v. Commissioner, 196 F.3d 833, 838 (7^th Cir. 1999) ("we owe no deference to the Tax Court's statutory interpretations, its relation to us being that of a district court to a court of appeals, not that of an administrative agency to a court of appeals") (citations omitted); Best Life Assurance Co. v. Commissioner, 281 F.3d 838, 830-31 (9th Cir. 2002) ("we give no special deference to the Tax Court's decision") (citations omitted),: Estate of Caporella v. Commissioner, 817 F.2d 706, 708 (11^th Cir. 1987) (comparing reviewing of Tax Court legal conclusion to no "substantial deference" to district court interpretations).

¹¹ 737 F.2d 479 (5^th Cir. 1984)

¹² 997 F.2d 1134 (5^th Cir. 1993)