                        T.C. Memo. 2010-128



                      UNITED STATES TAX COURT



        F.W. SERVICES, INC. & SUBSIDIARIES, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 27134-08.              Filed June 14, 2010.



     Bruce Locke, for petitioner.

     William G. Bissell, for respondent.



                        MEMORANDUM OPINION


     KROUPA, Judge:   Respondent determined a $1,965,456

deficiency in petitioner’s Federal income tax for 2004.    The sole

issue for decision is whether petitioner may deduct $2,483,916
                                - 2 -

deposited with an insurance company as an insurance premium under

section 1621 for 2004.2   We hold that it may not.

                              Background

     This case was submitted fully stipulated under Rule 122.         We

incorporate the stipulation of facts and the accompanying

exhibits by this reference.    Petitioner’s principal place of

business at the time it filed the petition was Houston, Texas.

     Petitioner is a consolidated group of corporations that

provide temporary staffing services.       Petitioner purchased two

insurance policies from American Home Assurance Company (American

Home).   One policy was for workers’ compensation insurance, and

one policy was for employers’ liability insurance.3      The policies

required American Home to pay, for all valid employer liability

claims, up to $1 million for each accident or disease suffered by

an employee of petitioner.    The policies also had a “loss

reimbursement endorsement” that required petitioner to reimburse

American Home up to $500,000 for each accident, disease or claim.

American Home required petitioner to provide financial




     1
      All section references are to the Internal Revenue Code
(Code) in effect for 2004, and all Rule references are to the Tax
Court Rules of Practice and Procedure, unless otherwise
indicated.
     2
      The parties have resolved all other issues in a stipulation
of settled issues.
     3
      Petitioner paid a total premium of $1,654,249 for the two
policies in 2004.
                               - 3 -

responsibility assurance for the $500,000 deductible amounts

before entering into the contracts.

     To provide the requisite assurance, petitioner entered into

a contract with National Union Fire Insurance Company of Vermont

(National Union).   National Union and American Home were both

subsidiaries of American International Group (AIG).    The contract

required petitioner to pay into a National Union reserve fund

(reserve fund).   National Union would then use money from the

reserve fund to pay the first $3.9 million of loss reimbursement

under the American Home policies.    The parties to the contract

expected that the amount paid into the reserve fund would exceed

the $3.9 million liability limit.4

     Petitioner had paid a total of $6,204,334 into the reserve

fund by the end of 2004.5   National Union paid $3,720,418 in

claims and handling expenses from the reserve fund to American

Home in 2004.   Accordingly, National Union had $2,483,916

remaining in the reserve fund for payment of claims at the end of

2004.6


     4
      The parties to the contract estimated that petitioner would
pay $3,919,598 into the reserve fund in 2004, which would exceed
National Union’s $3.9 million liability limit.
     5
      There was $1,153,844 in the reserve fund at the beginning
of 2004. Petitioner deposited an additional $5,050,490 during
2004.
     6
      This is calculated by adding the total amount in the
National Union reserve ($5,050,490 + $1,153,844) and then
                                                   (continued...)
                                - 4 -

     Petitioner treated the two American Home policies and the

National Union contract as one insurance contract.     Petitioner

deducted the premiums paid to American Home and all the payments

made to National Union on its Federal income tax return for 2004

as section 162(a) ordinary and necessary business expenses.

     Respondent examined petitioner’s return for 2004 and issued

a deficiency notice.    Respondent determined that the American

Home policies and the National Union contract should not be

treated as one insurance contract.      Respondent allowed petitioner

to deduct the amount of all claims actually paid by National

Union to American Home in 2004 but disallowed petitioner’s

deductions for the amounts remaining in the National Union

reserve fund at the end of 2004.    Respondent determined that such

amounts do not qualify as premiums for insurance deductible under

section 461(a) for 2004.    Petitioner timely filed a petition

arguing that the amounts remaining in reserve as of the end of

the year are deductible for that year as insurance premiums.

                             Discussion

     We must decide whether petitioner is entitled to deduct as

an ordinary and necessary business expense for 2004 the amounts

that remained in National Union’s reserve fund at the end of that

year.    Respondent claims that such amounts do not constitute


     6
      (...continued)
subtracting the amount paid out by National Union to American
Home ($3,720,418).
                                - 5 -

premiums for insurance, but rather are non-deductible deposits

toward the deductibles on petitioner’s American Home insurance

policies.    Petitioner contends that the two American Home

policies and the National Union contract should be viewed as one

policy for purposes of determining the premiums paid for

insurance for 2004.

     We begin with the general rules of deductibility and then

discuss deductibility of insurance premiums.    Tax deductions are

a matter of legislative grace, and taxpayers must show that they

are entitled to any deduction claimed.    Rule 142(a); Deputy v. du

Pont, 308 U.S. 488, 493 (1940).    Taxpayers may generally deduct

all ordinary and necessary expenses paid or incurred during the

taxable year in carrying on a trade or business.    Sec. 162(a).

     Taxpayers may deduct insurance premiums that constitute an

ordinary and necessary business expense, including those for

workers’ compensation coverage.    Sec. 1.162-1(a), Income Tax

Regs.   The Code does not define “insurance.”   The Supreme Court

has held that insurance entails risk shifting and risk

distribution.    See Helvering v. Le Gierse, 312 U.S. 531, 539

(1941).    Insurance shifts the risk of some potential loss or

portion of the potential loss from the insured to the insurance

company.    See Commissioner v. Treganowan, 183 F.2d 288, 291 (2d

Cir. 1950).
                               - 6 -

     We now focus on the parties’ arguments.    Petitioner concedes

that the National Union contract by itself would not be

considered an insurance contract because the terms of the

contract do not shift any risk to National Union.    Petitioner

argues that the American Home policies and the National Union

contract result in a single insurance contract covering all of

petitioner’s employer liability losses up to $1 million.

Petitioner relies on the Supreme Court’s opinion in Helvering v.

Le Gierse, supra (Court considered an annuity contract and an

insurance contract issued by the same company to one taxpayer as

one contract).   Petitioner concludes that it should therefore be

entitled to deduct all payments made to National Union and

American Home.

     Respondent maintains that the National Union contract is a

separate contract and should be treated as such.    Respondent

argues that the Supreme Court’s decision in Le Gierse was based

on distinct facts not present in this case and asserts that we

should disallow petitioner’s deduction for the amounts remaining

in the reserve fund at the end of 2004.

     We must now determine whether to treat all three contracts

as one contract.   When we consider the three contracts together,

the character of the contracts does not change.    The contracts

continue to be two insurance contracts and one deposit contract.

See Legg v. St. John, 296 U.S. 489 (1936).     The payments into the
                               - 7 -

National Union reserve fund merely provided assurance that the

deductible amounts would be paid.   They did not alter the risk

inherent in the true insurance provided under the American Home

policies.   Cf. Helvering v. Le Gierse, supra (annuity contract

neutralized the risk inherent in the insurance policy).

Similarly, the risk shifted and distributed under the two

insurance policies does not change the nature of the reserve for

policy deductibles established under the National Union contract.

A reserve arrangement does not morph into insurance just because

there is an insurance policy next to it.   We find that no rule of

law compels us to read these three separate contracts entered

into with two different insurance companies as one.

     Petitioner emphasizes that the three contracts were

purchased at the same time and they were all purchased from

subsidiaries of AIG.   Contemporaneousness is not dispositive, nor

do we find any reason to ignore the separate entity of each

subsidiary of AIG.   We find that while American Home did require

petitioner to provide financial assurance for the deductible, it

did not make it a prerequisite that petitioner enter into a

contract with National Union for loss reimbursement.   Cf. id.

(insurance policy and annuity contract considered together when

parties conceded the insurance policy would not have been issued

without annuity contract being purchased).   In contrast, American

Home merely wanted to be certain that petitioner could meet its
                               - 8 -

obligation to pay the insurance company policy deductibles.    The

policies did not contain any provision concerning how petitioner

should provide the assurance or from whom petitioner should

purchase the assurance.

     Petitioner had alternatives to contracting with National

Union.   Petitioner could have purchased an insurance policy to

cover the $500,000 deductible or bought an insurance policy

without deductibles from American Home in the first place.    We

find nothing in the American Home contracts to require petitioner

to enter into the contract with National Union.

     We further reject petitioner’s invitation to treat National

Union and American Home as one corporation merely because they

have the same parent.   See Helvering v. Le Gierse, supra

(taxpayer entered into two contracts with same insurance

company).   Two corporations are generally regarded as distinct

legal entities even if they have a common parent.   See 1 Fletcher

Cyclopedia of Corporations, sec. 43 (perm. ed. 2010 rev.).

Petitioner has not given the Court any reason to disregard the

separate legal status of National Union and American Home.

     We decline to read the three contracts as one.   Accordingly,

we disallow petitioner’s $2,483,916 deduction for the amounts

that remained in National Union’s reserve fund at the end of

2004.
                              - 9 -

     We have considered all remaining arguments the parties made

and, to the extent not addressed, we find them to be irrelevant,

moot, or meritless.

     To reflect the foregoing and the parties’ stipulation of

settled issues,


                                         Decision will be entered

                                  under Rule 155.
