Receipt Of Stock In A Demutualization

Demutualization is the process in which a member-owned business becomes owned by  shareholders. Traditionally, Insurance companies have used the word “mutual” in their name (i.e., Liberty Mutual) indicating mutually-held ownership by their policy holders as a group, rather than ownership by shareholders. These policyholders possess ownership rights such as voting and distribution. Recently, a strong trend has emerged for such companies to demutualize, converting to a shareholder-held ownership base.

Typically, policy holders are offered shares or money in exchange for ownership rights. Demutualization increases the profit potential of shareholders who can sell or trade their stock, in contrast to mere ownership rights, which cannot be sold or traded. The term “demutualization” no longer applies to just insurance companies but  also to the process by which any member-owned organization becomes shareholder-owned.

A demutualization is usually a tax-free reorganization under Internal Revenue Code § 368. If the demutualization qualifies as a tax-free reorganization and an owner elects to receive stock, for tax purposes it will be treated as an exchange of voting and liquidation rights for stock of the demutualized company, and no gain or loss will be recognized by the IRS.

If you elected to receive cash instead of stock in the tax-free reorganization, you are deemed to have received the shares of stock and then to have sold them back to the corporation (i.e., redeemed your shares), which may result in capital gain. If the policy was owned for more than one year as of the date of the demutualization, the gain is treated as long-term capital gain. If owned for a year or less, the gain is short-term capital gain.

If you are an owner of a company that is in the process of demutualizing, call THE TAX EXPERTS at the Thorgood Law Firm For a FREE consultation call 212-490-0704.

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