Wellpoint, Inc., f.k.a. Anthem, Inc., Successor In Interest to Anthem Insurance Companies, Inc., & Subsidiaries, Petitioners

T .C . Memo . 2008-23 6 UNITED STATES TAX COURT WELLPOINT, INC ., f .

.a . ANTHEM, INC . ; SUCCESSOR IN INTEREST TO ANTHEM INSURANCE COMP NIES, INC ., AND SUBSIDIARIES, Petitioner v . COMMISSION R OF INTERNAL REVENUE, Responden t Docket No . 13585-05 . Filed October 27, '2008 .

Philip C . Cook, ichelle M . Henkel,-and-Nancy B . Pridgen, for petitioner .

Ruth M . Spadaro , John M . Altman , Robin L . Herrell , and Thomas M . Rath , for r spondent .

MEMORAND~N FINDINGS OF FACT ,AND OPINIO N KROUPA, Judge : espondent .determineda $49,075,74 0 deficiency in petitio6er's Federal income tax for 1999 :and a $2,630,548 deficiencylfor 2000 . Petitioner is WellPoint, Inc .

& SERVED OCT 2 7 2008 Subsidiaries, formerly known as Anthem, Inc . (Anthem), which wa s the successor to Anthem Insurance Companies, Inc ., and Associated Insurance Companies, Inc . (both referred to as AICI) . All of these entities will be referred to as the Blue Crossland Blue Shield Parent Company or petitioner .

We are asked to decide two issues . The first issue is whether petitioner may deduct under section 162(a)' three settlement payments totaling $113,837,500 that it made to resolve lawsuits brought against it by the attorneys general of Kentucky, Ohio, and Connecticut (collectively the lawsuits and individually the Kentucky litigation, the Ohio litigation, and the Connecticut litigation) . The second issue is whether the legal and professional expenses that petitioner incurred to defend agains t these .lawsuits are deductible .2 The parties agree that bot h issues are governed by the "origin of the claim" doctrine . W e hold that both the settlement payments and the legal and professional expenses are capital expenditures and therefore no t deductible .

!1 'All section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated .

2The parties have resolved all other issues in . ..a stipulation of settled issues, .I FINDINGS -OF FAC T Some of the facts have been stipulated and are so found .

The stipulation of facts, the accompanying exhibits, and the stipulation of tettl d,issues are incorporated by this reference .

Petitioner is a mutual insurance company organized under Indiana law .

Petitioner is in the business of providing commercial health insurance through its subsidiaries . Petitioner and its predecessors . provided healthcare insurance coverage to members in exchange for premiums, paid claims, and invested reserves and surplus .

Many,of petitioner's direct or indirect .operating subsidiaries are -lice sees of the Blue Cross and Blue Shield Association .3 Petiti ner merged with the largest'Kentucky, Ohio and Connecticut Blue ross and Blue Shield (BCBS) 'plans (th e Settlement Subsidiari s) between 1993 and-199T .- The attorneys ge eral of Kentucky,-Ohio, and Connecticut .began looking into th -corporate and legal history of the Settlement Subsidiari s, . ultimately deciding to bring lawsuits, primarily cy-pres or haritable trust actions, against AICI an d 3The Blue Cross and Blue Shield Association, a trade, . association formed in 1982 from the merger-of the Blue Cross Association and the Association of Blue Shield Plans, owns the Blue Cross and Blue S ield trade names and marks . Licensees of . the Blue Cross and Bl e Shield Association were required to be nonprofit organizatio s until 1994 .

its subsidiaries .4 Each attorney-general separately~!claimed that the State's BCBS entity had a charitable purpose, had received beneficial treatment under State and Federal law because of tha t purpose, and held assets impressed with a charitable,,trust .5 The attorneys general asserted that the entities' charitable purposes were no longer being met and that the charitable assets that had accumulated should be taken from petitioner's control and .

redirected to the same or similar charitable purposes . ' 'There were multiple lawsuits and multiple claims, but the predominant . claim in each State was the cy-pres claim .

5The Kentucky BOBS subsidiary was formed as a nonprofit organization with a charitable purpose . Its charter ; proscribed private pecuniary profit . The Ohio BOBS subsidiary',s original Blue Cross predecessors were local hospital service associations that had formed during the Great Depression with the, purpose of assisting individuals with payment .of their medical expenses . The Connecticut BOBS subsidiary and/or its predecessors were formed as nonprofit organizations whose purpose was to promote social welfare . Their charters prohibited private inurement . They based charges to individuals for medical services on family income and received discounted physician services and public subsidies .

6Count I of the Kentucky litigation asserted a cy-pres claim, and counts II and III asserted unlawful conversion and . unjust enrichment claims. The Ohio Attorney General asserted a cy-pres claim and alleged that Anthem had breached its fiduciary duty to hold and apply Blue Cross assets to their charitable purposes . The Connecticut Attorney General sought td protect charitable assets and property impressed with a charitable trust and alleged that Anthem breached fiduciary duties and made negligent representations . Petitioner repeatedly characterized the lawsuits as disputes over assets in their financial statements, their annual reports, and their statements to shareholders .

Petitioner made settlement payments totaling $1l3837,500 i n 1999 to resolve pending and potential claims in the Kentucky litigation, the Ohio litigation, and the Connecticut litigation .

Petitioner agreed to pay $45 mi'llion .to settle all claims in the Kentucky litigation, relinquished all possession and ownership of the funds, and transferred those funds to the Commonwealth of Kentucky to create a section 501(c)(3) organization that promoted Kentucky healthcare . Petitioner agreed to settle the Ohio litigation for $36 million, reflecting the value of the Blue Cross assets of the Ohio entity as of October 1, 1987, . and that money was used to establish the Anthem Foundation .' Petitioner settled the Connect .ic t litigation for $40,836,500, which it paid .

to a newly formed ,cha itable corporation to serve the health .

needs of the citizens of Connecticut . ' Petitioner filed returns for the taxable years ending December 31, 1999 . and :, 2000,, deducting the $113,837,500 settlement amount in 1999 and de ucting $819,201 in 1999 and $8,394 in 2000 for legal and professorial fees incurre d 7Petitioner wa s charitable contribut i only $28 million of t iven an $8 million credit for prio r ns and, accordingly, . was required to pay te $36 million settlement .

'Some of this litigation is described in Capital . Blue Cross & Subs . v . Commi ssion r, 122 T .C .. 224 (2004), reed . 431 F .3d 117 .(3d Cir . 2005) . That decision is neither binding on no r dispositive of this -cse .

in connection with the lawsuits .9 Respondent examined an d disallowed the deductions for settlement payments and legal fees .

Petitioner timely filed .a petition .

OPINION

We are asked to decide whether the-settlement-payments and legal fees are deductible as ordinary and necessary expenses a s petitioner argues or whether, as respondent argues, petitioner must capitalize these expenses .10 The parties agree that the origin of the claim doctrine controls the outcome of ; this case .

I . Origin of the Claim Doctrin e Distinguishing between expenses that can be deducted under section 162 and those that must be capitalized under section 263 requires an examination-of all . the pertinent facts and events, and each case "`turns on its special facts' ."

INDOPCO, Inc . v . .

Commissioner , 503 U .S .-79, 86 (1992) (quoting Deputy v . du Pont , 308 U .S . 488, 496 (1940)) ; Boagni v . Commissioner , 59 T .C . 708 (1973) .

Whether expenses are deductible on the .one hand, or subject to being capitalized on the other hand, may be determined by the origin of the claim test .

Woodward v . Commissioner ; 397 U .S . 572 (1970) ; United States v . Gilmore , 372 U .S . 39 (1963) . Under thi s 9The parties already resolved their dispute about other legal and professional fees in the stipulation of settled issues .

"Respondent argues alternatively that the settlement payments and legal fees are neither capitalizable nor deductible . We need not reach that issue because of our holding ;..

test, the substance c f the underlying claim or transaction out`-`of which the expenditure in controversy arose governs whet-her th e item is a deductible expense or a capital-expenditure, regardless of the motives of th payor making the payment or-the .

consequences that ma result from the failure to defeat the claim . See Woodward v . Co mmissioner , supra at 578 ; Newark Morning Led er .Co . v . United States, 539 F .2d 929, 935 (3d Cir .

1976) ; Clark Oil & R f . Corp . v . United States, `473,F .2d 1217 , 1220 (7th Cir . 1973) ; Anchor Coupling Co . v . United States , 427 F .2d'429, 433--(7th Ci r . 1970) . The origin of the claim test does not involve" ,a `„mecha ical search for the first in the-chain o f events," but requires consideration of the issues involved, the, nature and objectives of the litigation, the,defenses asserted, the purpose for whic the amounts, claimed as deductions were expended, and all of er facts relating to the litigation .

Boagn i v . Commissioner , sup ra at 713 .

A . Character of the Claim-Settlement Paments ' The predominant claim in each-of the lawsuits was the cy- pres claim . " Cy-pres is defined-'.as "a rule for the .construction .

of ,instruments in _equ ity, by which-the intention of,the party-is * carried .out as near .als .may be , when it would be-impossible o r illegal to give it li teral effect ." Black's Law Dictionary :-38 7 (6th ed . 1990) . Unde r the cv=pres doctrine, if property has"been dedicated in trust fo r a particular "charitable purpose" and that purpose is not being carried out, a State attorney general is authorized to initiate a cy-pres proceeding to carry out the charitable purpose in a way. that is "as near as" possible to the original purpose . 4A Scott &-Fratcher, The Law of Trusts, secs .

399, 399 .2, at 476-484, 489-517 (4th ed . 1989) .

B . Deductibility of Cy-Pres Claim Litigatio n We now focus on whether the payments made by petitioner for litigation and settlement of the claims under the cy-pre s doctrine are deductible ordinary and necessary expenses under section 162 or expenses that must be capitalized under sectio n 263 . The costs incurred in litigating title to property are capital expenditures . Sec . 1 .263(a)-2(c), Income Tax Regs .

Defending or perfecting title to property encompasses not only disputes over legal title but also disputes over beneficial interests of trusts, including contests over, whether' a trust, exists . See Boagni v . Commissioner , supra ; Reed v . Commissioner ,

Commissioner , T .C . Memo . 1987-579 . Settlement payments and legal fees expended to resolve disputes over ownership of ;;assets may be capital expenses . See Anchor Coupling Co . v . United States , supra ; Wallace v . Commissioner , 56 T .C . 624 (1971) .

Payment s that settle challenges to ownership that are of questionable merit may also be ca ital .

See Am . Stores Co . v . Commi ssioner , 114 T .C . 458 .(2000) ; Duntley v .,Commissioner , supra .

A deduction is enerally allowed for expenses incurred i n defending a busine-ss and its policies from attack .

INDOPCO, Inc .

v . Commissioner , sup a at 83 ; Commissioner v . Tellier , 383 U .S .

687 (1966) ; Commissioner v . Heinin er, 320 U .S . 467 (1943) .

II . Parties' Ar umen s Petitioner argu s that the settlement payments ar e deductible under sec ion 162(a) as ordinary and necessar y expenses paid or inc rred in carrying on its .-profit-seeking insurance business a d are directly connected to its profit- seeking activities .

Petitioner argues that the payments cannot be capitalized .becau e the lawsuits did not challenge title of specific-items of pr CD perty . Respondent argues that petitioner may not deduct the s ttlement payments because they .represent transfers of'assets eld in charitable trust . " III . Analysi s The record show that none of the lawsuits in question was brought to enjoin o r change AICI's business practices, a s "The State atto petitioner that they According to the Sta subsidiaries held th Because the subsidia U operated for charita' F sought to recover th charitable purpose . assets from petition, of title .

F neys general sought to recover assets from claimed were never petitioner ' s assets . e attorneys general, petitioner' s se assets in trust for a 6haritable purpose . ies, like the parent company, were no longer le purposes , the State attorneys genera l se assets and return them to their Respondent claims that the transfer of these r to their charitable purpose is a transfe r 1 0 petitioner argues . In each case, the origin of the claim was a dispute over the equitable ownership of assets allegedly impressed with charitable trust obligations . In each case, th e settlement provided that the assets AICI relinquished wer e it transferred to a section 501(c)(3) organization with,the same charitable purpose that the attorneys general claimed the charitable trust assets benefitted .

The Kentudky litigation involved a title contest to : alleged charitable assets . Relying upon its research into legislative and corporate history, the Kentucky Attorney General's office brought suit alleging that predecessors to,the Anthem subsidiary in Kentucky held their assets in charitable trust for the benefi t of public health in the State . The complaint, the settlement document, and the parties' own descriptions of the nature of th e lawsuit convince us that the purpose of the'Kentucky,iiilitigatio n E was to determine title to the alleged charitable assets .

The $4 5 million settlement directly responded to the Kentucky Attorney General's allegation that the assets held by .petitioner were committed to a charitable purpose . The $45 million went to establishing a section 501(c)(3) organization that addresses healthcare . needs . There is no evidence that the attorney gener .al sought to change AICI's business practices, as petitioner alleges .

The Ohio Attorney General's office filed .a complain t alleging that certain assets were impressed with a charitable trust and seeking the return of .those assets . to their original charitable purpose because BCBS-Ohio's~merger with AICI frustrated that purp,se . The claim alleged beneficial ownership in the public of the Blue Cross entity's assets because-of the entity's relationshi with charitable hospitals ;=the tax exemptions it receiv d, .and its own declarations that it was organized solely for social welfare purposes .

The Connecticut Attorney General also found(cid:127)a basis for a charitable trust clam because the BCBS entity was a non-profit low-cost healthcare provider . devoted to(cid:127)public welfare . The complaint and the settlement focused on the ownership of trust assets . Again, peti ioner's financial statements and annual .

.

reports characterize m this lawsuit as a dispute over title t o assets allegedly imp essed with .a"charitable trust .

-Petitioner deni s the existence of a-charitable trust , obligation and asser s that it settled only to . avoid interruption of business or loss f good will . We find this argument irrelevant to our analysis . A taxpayer's motive-for settling is .not controlling in d termining whether a settlement payment is deductible . . Woodwar v . Commissioner, 397 U .S . at 578 ;' Anchor Cou lin Co . v . Unit d States, . 472 F .2d at 431 .

1 2 Petitioner further argues that the attorneys general may have . been confused about whether the Settlement Subsidiaries were section 501(c)(3) organizations or charities under Federal tax law . We decline to relitigate the underlying merits of each lawsuit, and our analysis of the origin of the claim=does not demand it . As a result, because the attorneys general brought suit to recover equitable title to assets they believed were impressed with charitable trusts, the origins of the claims in all three lawsuits were disputes over title to assets .

Petitioner nevertheless contends that the origin of the lawsuits was a challenge to the manner in which petitioner' s subsidiaries conducted their profit-seeking health insurance business . All the evidence suggests otherwise . No prayer for relief demanded a change .in business behavior, and none of the testimony of the attorneys who worked on these cases .for the Kentucky, Ohio, and Connecticut attorneys general suggested that they sought to change AICI's business practices or shut them down .

Petitioner also relies heavily on the theory that the settlement payments are per se deductible because they were necessary to defend its business . Petitioner relies ; primarily o n two cases to argue that the settlement payments are per se deductible, BHA Enters ., Inc . v . Commissioner , 74 T .C . 593 (1980) and A .E . Staley Manufacturing Co . .& Subs . v . Commissioner , 119 -1 3 F .3d 482 (7th Cir . 1997), revg . and remanding 105 T .C . 166 (1995) . In BHA , the origin of the claim was grounded in th e taxpayer's effort to keep the FCC from revoking its broadcasting licenses, without which the taxpayer could not do business .

There is no evidence in the record, however, that the attorney s general sought to st p petitioner's business . . Moreover , petitioner's busines did not fail despite the attorneys general's success i n removing many of these assets from ' petitioner's control.

The uncorroborated and .'self-servin g testimony of peti(cid:127)tio :

er's witnesses that they could no longer-do business if 'they lo s these suits is unconvincing .

The facts in A .

Staley are equally unavailing t o petitioner . In that case,=the Court of Appeals allowed deductions for certa n investment banking and printing costs .

incurred by the taxp yer in an unsuccessful effort to defend it s business against a t benefit .

A .E . Stale Manufacturing Co . & Subs . v . Commissioner , supra at 48-9 . Our c se'is factually distinguishable because the future . benefits accr ing from the-defense and settlement-of th e cyy-pres litigation a e manifest, enabling petitioner in effect to convert the assets f om charitable to income-producing purposes .

We need not add ess respondent's alternative theorie s because we hold that the settlement payments originated from .

1 4 suits to resolve title to assets and therefore are no t deductible .

IV . Character of Legal and Professional Expense s We turn now to the question of whether the legal and professional expenses petitioner incurred .in defending itself from the lawsuits are deductible . Legal and professional expenses, like settlement payments, are analyzed under the origin of the claim doctrine .

Mosby v . Commissioner , 86 T .C . 190 (1986) . Costs incurred in defending title to property are capital expenditures . Sec . 1 .263(a)-2(c), Income Tax Regs .

Moreover, legal expenses incurred in defending against claims challenging a taxpayer's ownership of assets may be capital expenditures .

Duntley v . Commissioner , T .C . Memo . 1987-579 .

Petitioner's legal and professional fees arose from defendin g II against claims that had their origin in equitable ownership of assets . Accordingly, these fees are capital expenditures .

V . Conclusion Petitioner's settlement payments and litigation-and II professional . fees are capital expenditures and not deductible under section 162(a) .

In reaching our holdings, we have considered all arguments made , and to the extent not mentioned, we consider the m irrelevant, moot, or without merit .

To .reflect the f

55. T .C . 32 (1970) ; Stevens v . Commissioner , T .C . Memo . 1999-259 ; Barr v . Commissioner , T .C . Memo . 1989-420 ; Duntley v .