Appeal from the United States Tax Court
Before CASTLE, Senior Circuit Judge, PELL and TONE, Circuit Judges.
TONE, Circuit Judge. This case involves two provisions of the Internal Revenue Code concerning the taxation of mutual casualty insurance companies: § 832(b)(5), which allows a "losses incurred" deduction from the companies' underwriting income; and § 821(e), which permits certain companies a "special transitional underwriting loss" deduction from its statutory underwriting income. The issues presented are highly technical and can be adequately stated only after a more detailed description of the statute. The Tax Court ruled in favor of the taxpayer on one issue and in favor of the Commissioner on another. We reverse ane remand in part and affirm in part.
Mutual casualty insurance comanies, including the taxpayer here, Home Mutual Insurance Company, became subject to §§ 832(b)(5) and 821(d) with the passage of the Revenue Act of 1962, Pub. L. No. 87-834, 76 Stat. 960. Before 1963 mutual insurance companies were taxed under a formula that did not include any deduction for underwriting losses or for a special transitional underwriting loss.*fn1 Beginning with that year, however, these companies have been taxed under a method established by the Revenue Act of 1962, in which a company's taxable income is comprised of three components -- taxable investment income, statutory underwriting income, and funds returned from the protection-against-loss account.*fn2 The statutory underwriting income component consists essentially of underwriting income as it has been computed for nonmutual casualty insurance companies since the 1920's, less a deduction for funds set aside in a protection-against-loss account.*fn3 Under the decades-old portion of the computation scheme, underwriting income is defined as the amount of premiums earned during the year, less expenses and "losses incurred." I.R.C. § 832(b)(3). The "losses incurred" deduction in turn consists of losses paid during the taxable year netted against cash salvage and reinsurance recoveries, plus any increase (or minus any decrease) during the year in unpaid losses outstanding, minus any increase (or plus any decrease) in salvage and reinsurance recoveragle outstanding. I.R.C. § 832(b)(5); Treas. Reg. § 1.832-4(c).*fn4 The 1962 Revenue Act also provided companies that had experienced underwriting losses during each of the five preceding taxable years with a special transitional underwriting loss deduction to allow them to garner some tax advantage from those recent losses, which had been irrelevant under the prior statute.*fn5
The issues before us arose following the Commissioner's assertion of deficiencies in Home Mutual's tax liability for 1966 and 1971 totaling $48,530.71.*fn6 In a petition for a redetermination of the deficiencies, Home Mutual contended, first, that the Commissioner had erroneously failed to allow it during the years 1963-1966 and in 1971 to lower its figure for unpaid losses outstanding at the start of each year by the amount by which pre-1963 claims settled during the year had been overestimated. Such a reduction would have increased Home Mutual's losses-incurred deduction for those years, thereby decreasing its underwriting income and thus its tax. Alternatively, Home Mutual argued that its exclusion in its original tax returns during 1963-1966 of cash subrogation recoveries from pre-1963 claims was proper because the underwriting losses incurred on those claims had not lessened its taxes.*fn7 Home Mutual also raised another claim unrelated to the first two, viz., that it should have been allowed to deduct the special transitional underwriting loss from total underwriting gain rather than from underwriting gain less the protection-against-loss deduction.
In a so-called "reviewed opinion," the Tax Court, with one judge dissenting, ruled in favor of Home Mutual on the proper treatment of "unpaid losses," which made it unnecessary to decide the cash subrogation recoveries issue. The court unanimously agreed with the Commissioner on the special transitional underwriting loss issue.*fn8 The Commissioner appeals the determination of the unpaid loss issue; Home Mutual cross-appeals the Tax Court's interpretation of the special transitional underwriting loss and asks that, if we reverse on the unpaid losses issue, we rule in its favor on the treatment of subrogation recoveries. We reverse the Tax Court's resolution of the unpaid losses dispute, remand the subrogation recoveries issue, and affirm the court's ruling on the special transitional underwriting loss.
Home Mutual's contentions with respect to the unpaid loss deduction are ultimately grounded in the inequity it perceives in the Code's treatment of its overestimate of unpaid losses outstanding as of December 31, 1962. That overstimate, totaling $402,314.59,*fn9 resulted in smaller "losses incurred" deductions in later years than a totally accurate estimate of unpaid losses would have, because, in every year that some of those claims were settled, the unpaid-losses-outstanding account was decreased not only by the amounts paid on those settlements, which were offset by a corresponding increase in paid losses, but also by the overestimates on the claims.
The similar effect in the years of settlement of post-1962 overestimated losses is more than compensated for by the increase in the unpaid losses part of the losses-incurred deduction that the overestimates cause in the years in which the unpaid losses were incurred. In those years the overestimates increase the "unpaid losses outstanding at the end of the taxable year," I.R.C. § 832(b)(5)(B), and thus the losses-incurred deduction. Accordingly, for years after 1962, overestimating defers taxable income by allowing a company to accelerate its unpaid losses in this manner.
Although Home Mutual cannot obtain a similar acceleration of losses with respect to pre-1963 claims because those losses were then irrelevant to the computation of taxable income, it wishes to avoid the "erroneous" decrease of the deduction in the years it settled overestimated pre-1963 losses.By lowering its "unpaid losses outstanding at the end of the preceding taxable year" by the amounts by which pre-1963 claims settled during the year had been overestimated, Home Mutual argues, it will obtain as a deduction its "true" amount of losses incurred since 1962.
Home Mutual's position can be illuminated by an example. Assume first that the company was notified of a claim in 1963 and estimated that $10,000 would be required to settle the claim. That $10,000 would be added to the unpaid-losses-outstanding account. By raising the balance of unpaid losses outstanding, this addition would increase the losses-incurred deduction from premiums earned to arrive at underwriting income for 1963, thus conferring a tax benefit for that year. The $10,000 would then be carried as an unpaid loss outstanding until paid. Assume the claim is settled in 1965. If the amount of the settlement is $10,000, that amount is removed from unpaid losses outstanding and paid out with no further tax consequences.*fn10 If, however, the claim is settled for $8000, there are tax consequences in 1965: assuming sufficient income from premiums during the year, the $2000 overestimate is taxed as ordinary income.*fn11 Now assume that Home Mutual had learned of the claim in 1962, not 1963, and therefore had added the $10,000 to its unpaid losses outstanding in the earlier year. Under the pre-1963 tax scheme, this addition would have had no tax consequences. See note 1 supra. If the claim is then settled for $8000 in 1965, the company, under the literal terms of the statute, would have to pay tax on the $2000 overestimate in 1965 as above. While in the first instance the taxation of the $2000 occurs only after a company has received a corresponding tax benefit in 1963 by including that amount in the losses-incurred deduction for that year, in the second case taxation of the $2000 would occur despite the absence of such a prior tax benefit. As a remedy, Home Mutual wishes, in computing its taxes for 1965, to lower its unpaid losses outstanding at the beginning of 1965 by $2000 and thereby prevent its inclusion in taxable income in that year.*fn12
Home Mutual's argument is made in the context of comprehensive, technical, and very specific provisions of the Internal Revenue Code. Especially when dealing with provisions of this kind, and when no support for the theory asserted by the taxpayer can be found in the language of the statute, the appurtenant regulations, or the legislative history, the courts should ordinarily "resist the temptation to attempt any creative rewriting of the Internal Revenue Code."*fn13
There is nothing in the statutory provision involved in the case at bar, its regulations, or its legislative history revealing even a glimmer of any intent that Home Mutual would be allowed to make the retroactive adjustment it wishes. The statutory formula for computing the losses-incurred deduction was first enacted in § 246(b)(6) of the Revenue Act of 1921, ch. 136, 42 Stat. 227, 263, for use in taxing stock casualty insurance companies and has been reenacted since then without substantial change. As the Tax Court pointed out, "[the] 1962 Act was designed to tax the mutual companies on much the same basis as the stock companies." 70 T.C. at 945-46. The first regulations concerning the losses-incurred deduction, which were adopted in 1944, expressly recognized that the unpaid-losses-outstanding component of the deduction is an estimate of the total amount of losses incurred but unpaid at year's end.*fn14 Given the longstanding existence of these regulations interpreting a statutory provision that has remained unchanged, they are deemed to have received congressional approval and have the effect of law. See United States v. Correll, 389 U.S. 299, 305-06 (1967); Hanover Insurance Co. v. Commissioner, 598 F.2d 1211, 1219 n.17 (1st Cir.), cert. denied, 100 S. Ct. 229 (1979). In addition, the casualty insurance industry has adapted its own reporting forms for use under the regulations, so that the forms now serve as the basis on which a company's income is determined. See Hanover Insurance Co. v. Commissioner, 65 T.C. 715, 720-21 (1976);*fn15 Continental Insurance Co. v. United States, 474 F.2d 661, 666-67 (Ct. Cl. 1973). Since the unpaid losses component of the losses-incurred deduction is merely an estimate, the only allowable adjustment by either the Commissioner or taxpayer would be to correct a figure that was not a "fair and reasonable" estimate given the facts at the time the estimate was made. See Hanover Insurance Co. v. Commissioner, 598 F.2d 1211 (1st Cir:), cert. denied, 100 S. Ct. 229 (1979); Treas. Reg.§ 1.832-4(b).*fn16 Home Mutual admits that no legislative history of the 1962 Revenue Act supports its attempt to go outside the language of the statute. In light of this absence of statutory support for the adjustment desired by Home Mutual, only the existence of a principled extra-statutory ground for adjustment could persuade us to go beyond the express bounds of the statute.
We consider in turn two theories that have been advanced to support the adjustment Home Mutual seeks. The Tax Court majority's theory, which Home Mutual does not attempt to support in this court, was that the adjustment is analogous to permissible retroactive adjustments of inventories and also to the ...