The application of section 826 may be illustrated by the
following examples:
Example 1.For the taxable year 1963, R, a reciprocal underwriter
subject to the taxes imposed by section 821(a), has the following
items (determined before applying any election under section 826):
Gross
income under sec. 832
$578
Gross
investment income
50
Deductions under
sec. 832 (as modified by sec. 823(b)):
Deduction for
amounts paid by R to attorney-in-fact A
$100
All other
deductions
500
Total
deductions under sec. 832
600
Deductions under sec. 822(c)
40
Incurred losses
400
Protection against loss deduction
4
Underwriting gain
0
Mutual
insurance company taxable income
0
Unused
loss
22
Credit
or refund for taxes paid
0
Assume that the deductions of attorney-in-fact A allocable to the
income received by A from R are 60 and the tax paid by A allocable
to the income received from R is 16. If R elects to be subject to
the limitation provided in section 826(b), the results for 1963
would be as follows:
Gross
income under sec. 832
$578
Gross
investment income
50
Deductions under
sec. 832 (as modified by sec. 823(b)):
Deduction for
amounts paid by R to attorney-in-fact A
$60
All other
deductions
500
Total deduction
under sec. 832
560
Deductions under sec. 822(c)
40
Incurred losses
400
Underwriting gain
8
Protection against loss deduction
6
Mutual
insurance company taxable income
12
Unused
loss
0
Credit
or refund for taxes paid
16
Under the provisions of section 826(b), R's deduction for amounts
paid or incurred to the attorney-in-fact in the taxable year 1963
would be limited to the deductions of A allocable to the income
received by A from R. Thus, R's deductions under section 832 (as
modified by section 823(b)) for 1963 would be 60 (the deductions of
A which are allocable to the income received by A from R). As a
result of making the election under section 826(a) for the taxable
year 1963, R's underwriting gain would be 8, and its statutory
underwriting income would be 2 (the underwriting gain of 8 minus
the protection against loss deduction of 6 - of which 4 represents
the amount determined under section 824(a)(1)(A) - and 2 represents
the amount determined under section 824(a)(1)(B) - or 8 minus 6).
R's mutual insurance company taxable income for 1963 would be 12,
consisting of taxable investment income of 10 (gross investment
income minus deductions under section 822(c), or 50 minus 40) plus
statutory underwriting income of 2. Since all of R's mutual
insurance company taxable income of 12 is attributable to the
limitation under section 826(b), the entire amount is subject to
the surtax under section 821(a)(2) without regard to the $25,000
surtax exemption. The credit of 16, representing that part of the
tax paid by A which is allocable to the income received by A from
R, may be applied by R against its taxes with respect to its mutual
insurance company taxable income of 12 for 1963, and R would be
entitled to a refund of any excess of the amount of such credit
over its tax liability for 1963.
Under the provisions of section 826(d), no portion of the amount
added to the protection against loss account in 1963 by reason of
the election under section 826(a), 2 (25 percent of the amount by
which the consolidated underwriting gain exceeds 25 percent of the
underwriting gain determined without regard to the election under
section 826(a), or the amount by which 25 percent of 8 exceeds 25
percent of 0), may remain in such account beyond the taxable year
1968.
Example 2.For the taxable year 1963, F is a corporate
attorney-in-fact subject to the taxes imposed by section 11(b) and
(c) of the Code. F files its return on the calendar year basis and
reports income received from its reciprocal and the deductions
allocable thereto under the same method of accounting used by its
reciprocal in reporting its deductions for amounts paid to R. F
properly consents to provide the information required by paragraph
(b) of § 1.826-3. In addition to its attorney-in-fact business, F
owns real estate for investment purposes, and operates a real
estate management service. For the taxable year 1963, F has gross
income from these various sources as follows: Attorney-in-fact fees
$85,000 Real estate management fees 18,000 Rental income 25,000 F
allocates its expenses for the taxable year on the basis of their
direct relation to each source of income. During 1963, F acquired
property for use in its attorney-in-fact operations which entitled
F to an investment credit of $800 under section 38. For 1963, F
determines that the tax paid by it which is attributable to its
reciprocal is $21,863, computed as follows:
Attorney-in-fact fees
Real estate management
Rental income
Total
Gross income
$85,000
$18,000
$25,000
$128,000
Allocable
expenses
25,000
3,000
35,000
63,000
Taxable income
(loss)
60,000
15,000
(10,000)
65,000
Normal tax (30
percent)
18,000
4,500
0
19,500
Surtax
exemption
20,000
5,000
0
25,000
Income subject to
surtax
40,000
10,000
0
40,000
Surtax (22
percent)
8,800
2,200
0
8,800
Total tax
26,800
6,700
0
28,300
Investment
credit
800
0
0
800
1963 tax
liability
26,000
6,700
0
27,500
1963 tax paid
27,500
Allocation of tax
paid
21,863
5,637
0
27,500
Under paragraph (b)(1) of § 1.826-5, F computes its taxable income
from its attorney-in-fact fees to be $60,000 ($85,000 minus
$25,000), and its taxable income from its real estate management to
be $15,000 ($18,000 minus $3,000). Since F's rental operations
resulted in a $10,000 loss for the taxable year ($25,000 minus
$35,000), F's taxable income from its rental operations is zero.
Using the 30 percent rate provided by section 11(b), F computes its
normal tax to be $18,000 on its attorney-in-fact fees and $4,500 on
its real estate management operations. F's normal tax on total
income is $19,500. The $3,000 difference between the normal tax on
F's total income and the normal taxes on F's profitable operations
results from the loss on F's rental operations. Under paragraph
(b)(3) of § 1.826-5, F allocates its surtax exemption as follows:
$20,000 $60,000/$75,000 × $25,000) to its attorney-in-fact fees;
and $5,000 $15,000/$75,000 × $25,000) to its real estate management
operations. F computes its surtax on its profitable operations at
the 22 percent rate provided by section 11(c) as follows: $8,800
(22 percent of $40,000) on attorney-in-fact fees; and $2,200 (22
percent of $10,000) on real estate management income. F adds its
normal tax and surtax on its profitable operations and determines
its total tax to be $26,800 on its attorney-in-fact operations;
$6,700 on its real estate management operations; and $28,300 on its
total income. F must allocate its investment credit on the same
basis as it used to allocate its expenses. Thus, F's entire
investment credit must be allocated to its attorney-in-fact
operations. Accordingly, F's 1963 tax liability is $26,000 on its
attorney-in-fact fees; $6,700 on its real estate management
operations; $0 on its rental operations; and $27,500 on its total
income. Under paragraph (b)(7) of § 1.826-5, F allocates $21,863
($26,000/$32,700 × $27,500) of its 1963 tax paid to its
attorney-in-fact fees; and $5,637 ($6,700/$32,700 × $27,500) of its
1963 tax paid to its real estate management business. F's
reciprocal will be allowed a credit or refund of $21,863 for taxes
paid by F which are attributable to F's income received from its
reciprocal. Example 3.Assume the same facts as in example 2, and
assume further that in 1966 F sustains a net operating loss on its
overall operations of $5,000. In carrying the loss back to 1963 as
a net operating loss deduction under section 172, F must allocate
the deduction under the same method it used in allocating its 1963
deductions. Thus, if the loss was entirely attributable to F's
rental operations for the taxable year 1966, F would reduce its
taxable income attributable to those operations by the entire
amount of the loss and would recompute the tax attributable to
those operations under paragraph (b) of § 1.826-5. As recomputed in
the table below, F's 1963 tax liability from attorney-in-fact fees
would be $19,800 and F's total tax liability would be $24,900.
Attorney-in-fact fees
Real estate management
Rental income
Total
Gross income
$85,000
$18,000
$25,000
$128,000
Allocable
expenses
25,000
3,000
35,000
63,000
Net operating loss
deduction
0
0
5,000
5,000
Taxable income
(loss)
60,000
15,000
(15,000)
60,000
Normal tax (30
percent)
18,000
4,500
0
18,000
Surtax
exemption
20,000
5,000
0
25,000
Income subject to
surtax
40,000
10,000
0
35,000
Surtax (22
percent)
8,800
2,200
0
7,700
Total tax
26,800
6,700
0
25,700
Investment
credit
800
0
0
800
1963 tax
liability
26,000
6,700
0
24,900
1963 tax paid
24,900
Allocation of tax
paid
19,800
5,100
0
24,900
As a result of its 1966 net operating loss, F would be entitled to
a refund of $2,600 (1963 taxes paid of $27,500 minus recomputed
1963 taxes of $24,900). Under paragraph (a) of § 1.826-6, F would
be required to notify its reciprocal of its claim for refund and of
the amount of the refund or credit attributable to taxes paid on
income received from the reciprocal. Since the 1963 tax paid by F
attributable to its reciprocal (as recomputed) is less than the
amount claimed in 1963 by F's reciprocal as a credit, F's
reciprocal would be required, under section 826(g), to add the
difference - $2,063 ($21,863 minus $19,800), to its tax liability
for 1966. Thus, F's reciprocal would first compute its tax
liability for 1966 without regard to section 826(g) and then would
increase such liability by $2,063. [T.D. 6681, 28 FR 11126, Oct.
17, 1963]