Rev. Rul. 80-120

ISSUE

Are payments made by a professional corporation to a mutual insurance company as professional liability insurance premiums deductible as ordinary and necessary business expenses under section 162 of the Internal Revenue Code?

FACTS

The taxpayer is a professional corporation that has a contract with a hospital to provide professional medical services. The taxpayer employs 10 doctors and 15 registered nurses.

M, a mutual insurance exchange, was formed and qualified pursuant to state law to provide medical professional liability insurance, which includes malpractice insurance. It is a physician-owned carrier offering non-assessable professional liability insurance policies to all physicians and medical professional corporations, including the taxpayer, licensed to practice in the state who maintain at least 50 percent of their practice in the state. M is managed by a board of directors consisting of member-policyholders. Its sole business purpose is to supply insurance coverage to the policyholders at the lowest possible cost. Over 5,000 doctors and several professional corporations are insured by the exchange. M is subject to tax as a mutual insurance company under section 821(a) of the Code.

During the taxable year, premium payments to the exchange in the amount of 1000x dollars for professional liability insurance were made by the taxpayer. These premium payments are established according to customary rating formulas dependent upon the hazard and expense differences among the insured doctors.

LAW AND ANALYSIS

Section 162(a) of the Code provides a deduction for all ordinary and necessary expenses paid or incurred in carrying on any trade or business.

Section 1.162-1(a) of the Income Tax Regulations provides that among the items included in business expenses are insurance premiums against accident, or other similar losses in the case of a business.

Essential to the concept of insurance is a sharing and distribution of the insurance risk by all the parties insured. See Helvering v. LeGierse, 312 U.S. 531 (1941), 1941-1 C.B. 430. When there is no economic shift or distribution of the risk "insured," the contract is not one of insurance. See Rev. Rul. 77-316, 1977-2 C.B. 53, which sets forth examples in which payments denominated insurance premiums are not deductible under section 162 of the Code because there is no economic shifting or distributing of risks of loss where the alleged insureds are all economically interrelated and the risks are carried or retained by a foreign corporation that is wholly-owned by one of the alleged insureds.

Rev. Rul. 78-338, 1978-2 C.B. 107, deals with a group of 31 unrelated corporations all owning shares of a foreign insurance company. No shareholder in Rev. Rul. 78-338 owned a controlling interest in the insurance company. The insurance company provides insurance only to its shareholders and their subsidiaries and affiliates, and no shareholder's individual risk coverage was permitted to exceed 5 percent of the total risks insured by the company. Premium rates are established according to customary industry rating formulas, dependent upon the hazard and expense differences among the insureds. Rev. Rul. 78-338, in distinguishing Rev. Rul. 77-316, holds that the requisite risk-shifting and risk-distribution necessary to constitute insurance are present, therefore the amounts paid as premiums are deductible under section 162 of the Code.

In the instant situation, as in Rev. Rul. 78-338, the requisite risk-shifting and risk-distribution necessary to constitute insurance are present. There is a sufficient number of policyholders; no one policyholder owns a controlling interest in the exchange, and the policies are non-assessable.

HOLDING

Payments made by the professional corporation to a physician-owned mutual insurance company as professional liability insurance premiums are deductible as ordinary and necessary expenses under section 162 of the Code.