nia Department of Insurance replied that the provisions did not apply. They did state, however, that although not statutorily required, there was no objection to a company's making a provision for losses based on its past loss experience. Thus, beginning with 1971, petitioner retroactively set up "reserves for unearned premiums" and "reserves for unpaid losses," using the California Insurance Code's reserve provisions as a guide.4 Pursuant to California Insurance Code section 12382.2 (West 1972), petitioner set up reserves for unearned premiums for the following years in the amounts indicated:

Pursuant to California Insurance Code section 12382.5 (West 1972), petitioner then returned to income in 1972 the following amounts:

pursuant to the foregoing formula, provided that said amounts so set aside shall be treated as if Section 12382 and this section had been effective during the calendar years 1962, 1963 and 1964. Sec. 12388. Reserve for unpaid losses and loss adjustment expense; amount; calculation Every title insurer shall, in addition to other reserves establish and maintain a reserve to be known as the "reserve for unpaid losses and loss adjustment expense", which shall be used for the payment of losses incurred as a result of liability arising under policies of title insurance and the payment of adjustment expenses necessary for the settlement of or defense against claims of any such liability. Said reserve shall be in an amount equal to the sum of (1) the estimated amounts necessary to pay unpaid losses, plus (2) the estimated amounts of loss adjustment expense necessary to settle or defend against every claim presented pursuant to notice from or on behalf of every insured that may result in a loss to or cause expense to be incurred by a title insurer for the proper disposition of the claim. Every title insurer shall calculate such reserve by making a careful estimate in each year of the amounts anticipated to be reasonably necessary for both such purposes. The sum of the items so estimated shall be the total amount of the reserve for unpaid losses and loss adjustment expenses of such title insurer. The amounts so estimated may be revised from time to time as circumstances warrant and reduced by the amount of payments made, but shall be redetermined at least once each year. The amounts set aside in such reserve in any year shall be deducted in determining the net profits for such period of any title insurer. [Emphasis added.]

*Although petitioner's brief repeatedly states that it "relied” upon the Cal. Ins. Code (West 1972), such reliance is not warranted since it had specifically been advised that it was not affected by those statutes.

2,079

31

Per books and return ...

Error in computation in 1972 ...

The stipulation contains the total amount of $2,121 and $42 for the error in computation in 1972. The correct figures should read as above.

Pursuant to California Insurance Code section 12388 (West 1972), petitioner set up reserves for unpaid losses as follows:

In subsequently filing its Federal tax returns for 1971 and 1972, petitioner relied on section 831, specifically applicable to "insurance companies," and took deductions from gross income for its reserves for losses. These deductions totaled $40,860 for 1971 and $9,837 for 1972.

Respondent subsequently disallowed these deductions and assessed deficiencies of $4,939 for 1971 and $9,035 for 1972 on the grounds that petitioner was not an insurance company.

OPINION

The sole issue presented for decision is whether petitioner Cuesta Title Guaranty Co. qualifies as an insurance company within the meaning of section 831. In this regard, section 1.831

1(a), Income Tax Regs., refers to section 1.801-1(b)(2), Income Tax Regs., which provides the following guidance:

Though its name, charter powers, and subjection to State insurance laws are significant in determining the business which a corporation is authorized and intends to carry on, the character of the business actually done in the taxable year determines whether it is taxable as an insurance company under the Code. * [Sec. 1.801-1(b)(2), Income Tax Regs.; emphasis added.][5]

Petitioner asserts that "every single phase" of its business is "intimately allied" with the insurance business, emphasizing a number of factors including its charter powers, revenues, contracts, and "auxiliary" business activities such as escrow services and document preparation. Petitioner contends that these factors, along with its liability to Chicago Title for negligence under paragraph 12 of the underwriting agreement, show that the primary and predominant business activity of petitioner is the issuing of insurance contracts.

Respondent, on the other hand, relies upon the explanation of the term insurance company contained in section 1.801-1(b)(2), Income Tax Regs., recently clarified in Allied Fidelity Corp. v. Commissioner, 572 F.2d 1190 (7th Cir. 1978), affg. 66 T.C. 1068 (1976), cert. denied 439 U.S. 835 (1978). Respondent argues that the character of the business actually being done by petitioner is merely that of an underwritten title company. Respondent concedes that although a part of petitioner's business does consist of supplying title insurance contracts after having completed a title examination, nevertheless the character of the business is not "insurance" within the meaning of Allied Fidelity Corp. because Chicago Title, rather than petitioner, is assuming the insured's "risk of economic loss."

We agree with respondent. After closely studying both the underwriting agreement between petitioner and Chicago Title and the operation of petitioner's business, we are convinced that petitioner does not qualify as an insurance company within the meaning of section 831.

This

[regulation] is the cumulative result of a series of cases decided in the late 1920's and early 1930's. Bowers v. Lawyers Mortgage Co., 285 U.S. 182 (1932); United States v. Home Title Insurance Co., 285 U.S. 191 (1932); United States v. Cambridge Loan & Building Co., 278 U.S. 55 (1928). In Bowers, the Supreme Court was faced with the similar question of whether the taxpayer there involved should be permitted to be taxed as an insurance company. The Court established as its test... [essentially the same] language which subsequently became incorporated into Treas. Regs., sec. 1.801-1(b). [Allied Fidelity Corp. v. Commissioner, 572 F.2d 1190, 1192 (7th Cir. 1978), affg. 66 T.C. 1068 (1976), cert. denied 439 U.S. 835(1978). Fn. ref. omitted.]"

In Allied Fidelity Corp., this Court (66 T.C. at 1073) made it clear that the character of the business actually done by the taxpayer corporation is the determinative factor of its tax status:

We are provided with no helpful, freestanding definitions of the terms "insurance" and "insurance company" for Federal tax purposes. It is clear that our decision is not controlled by nontax classifications and that characterization of particular corporations depends not on labels or certificated powers but on the character of the business actually conducted and that, in the absence of other guides, we should presume Congress to have used words in their ordinary and commonly understood sense. Haynes v. United States, 353 U.S. 81 (1957); Helvering v. LeGierse, 312 U.S. 531 (1941); Bowers v. Lawyers Mortgage Co., 285 U.S. 182 (1932); sec. 1.801-1(b), Income Tax Regs. *** [Petitioner] can be considered an insurance company only if the contracts made in the course of *** [its] business are insurance contracts. ** [Allied Fidelity Corp. v.

*

Commissioner, 66 T.C. 1068, 1073-1074 (1976); emphasis added.]

In affirming this Court's decision in Allied Fidelity Corp., the Seventh Circuit referred to the definition of insurance as provided by Couch on Insurance:

the common definition for insurance is an agreement to protect the insured against a direct or indirect economic loss arising from a defined contingency whereby the insurer undertakes no present duty of performance but stands ready to assume the financial burden of any covered loss. 1 Couch on Insurance 2d sec. 1:2 (1959).

*

*

As the tax court below noted, an insurance contract contemplates a specified insurable hazard or risk with one party willing, in exchange for the payment of premiums, to agree to sustain economic loss resulting from the occurrence of the risk specified and, another party with an "insurable interest" in the insurable risk. It is important here to note that one of the essential features of insurance is this assumption of another's risk of economic loss. 1 Couch on Insurance 2d sec. 1:3 (1959). [Allied Fidelity Corp. v. Commissioner, 572 F.2d 1190, 1193 (7th Cir. 1978); emphasis added.]

Petitioner attempts to distinguish Allied Fidelity Corp. on its facts, stating that the Seventh Circuit merely found that the character of the company's business was that of acting as surety on bail bonds. Pointing out that the court held that bail bonds were not insurance, petitioner argues that the policies it issues are indeed insurance contracts. We note, however, that both this Court and the Seventh Circuit in Allied Fidelity Corp. found that the failure of Allied Fidelity to bear another's risk of economic loss was dispositive.

Although petitioner insists it bears the risk of economic loss

under the contracts issued, this assertion conflicts with its underwriting agreement with Chicago Title. Petitioner points to paragraph 12 as proof of the risk of loss it assumes, but its contractual liability under this paragraph is limited solely to its own negligence, and runs only to Chicago Title. Although the record includes testimony that customers come directly to petitioner when they have a claim, this mechanical business practice cannot be deemed significant in light of the legal obligations of Chicago Title as expressed in the underwriting agreement and in the insurance policies. The issue does not turn on the mechanics of claim presentations, but on who bears the risk of economic loss. Under the insurance contracts before us, the risk of economic loss falls on Chicago Title.

Petitioner cites several cases in which title insurance companies have been classified as insurance companies under section 831. It fails, however, to cite any case which found an underwritten title company to come within that section. In the cases involving title insurance companies, there was no disagreement that the taxpayer company was doing some amount of "insurance business," i.e., "assuming another's risk of economic loss." The issue in these cases was whether such activity constituted the taxpayer's "principle" business activity, and by what means that uncertain standard should be determined. The issue at hand, however, which is the first hurdle petitioner must surmount, is qualitative-whether petitioner is doing any “insurance" business at all. The second hurdle is quantitativewhether insurance is the company's "principle" activity. In attempting to meet the second hurdle by skirting the first, petitioner fails both.

Petitioner minimizes the distinction between underwritten title companies and title insurance companies. Its vice president,

"The heading and signature of the customer's title insurance policy plainly bears the name of Chicago Title Insurance Co. The name of petitioner company is nowhere mentioned in the body of the contract, and only appears in the lower left-hand corner of the first page. The next-to-last paragraph of the policy requests that any correspondence be sent to Chicago Title, and provides that address.

"It is well settled that in guaranteeing land titles for a consideration, a company is in the insurance business, and when this business constitutes its principle business, it is taxable as an insurance company. 8 J. Mertens, Law of Federal Income Taxation, sec. 44.05, ch. 44, p. 15 (1970). Petitioner cites United States v. Home Title Insurance Co., 285 U.S. 191 (1932); Dallas Title & Guaranty Co. v. Commissioner, 40 B.T.A. 1022 (1939); Title & Trust Co. v. Commissioner, 15 T.C. 510 (1950); United States v. Fidelity & Deposit Co. of Maryland, 177 F.2d 805 (4th Cir. 1949); and Rev. Rul. 71-404, 1971-2 C.B. 260, and attempts to analogize these to petitioner's "insurance" business. In all of these cases, however, it was understood that there was some amount of insurance business actually being conducted by the title insurer.