Two internal Justice Department memos sent to then-attorney general Griffin Bell in August said that the department's lawyers made critical mistakes in arguing a Supreme Court case that will cost the government $270 million in tax refunds to life insurance companies.
The memos, written by Deputy Associate Attorney General David Yeres and obtained by the magazine Tax Notes, urge the department to find a way to get the high court to reconsider the issues decided in 1977 in a case involving the Standard Life and Accident Insurance Co.
Life insurance companies get special tax treatment because part of their income from premiums paid on policies must be set aside to pay future claims. The Standard Life case involved the question of how to treat so-called unpaid premiums -- premiums due but not paid, or installments on annual policies not yet due, when the company closes its books for the year on Dec. 31.
Life insurance companies don't have to pay income taxes on income earned from the investment of the reserves out of which they must pay claims. Similarly because a portion of each year's premium on a policy must go into the reserves, that part of the premium isn't considered income for tax purposes.
According to the memos, life insurance companies are regulated by the states, not the federal government, and each state specifies exactly how large a reserve must be held for each policy.
Yeres wrote to Bell that the Supreme Court accepted the life insurance industry's view on the treatment of unpaid premiums: that they must be counted as part of the company's reserves even though they haven't been received because it mistakenly thought that the states all required defining reserves that way.
Justice itself was to blame for this because it failed to present "all relevant facts" to the Supreme Court, Yeres said.
Because no tax is due on income from investment of reserves, it is to the company's interest to label as many of its assets as reserves as possible. Adding a figure for unpaid premiums to reserves reduces the company's tax liability.
The amount of money at stake is so large because the Standard Life decision affects life insurance company taxes back to 1958. The decision currently involves "upwards of $55 million each year industrywide," one memo says.
The memos cite several pieces of evidence that state accounting procedures allow companies to overstate their reserves compared to what they by law must have on hand. The latter test is supposed to be used for tax purposes.