n-00-34.pdf

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Part III - Administrative, Procedural, and Miscellaneous
Losses Claimed on Certain Intangible Assets
Notice 2000-34
This notice informs Blue Cross Blue Shield insurance organizations (“BCBS
organizations”) that the Internal Revenue Service will challenge deductions for losses
for the termination of individual customer, provider, or employee contracts or
relationships associated with customer lists, provider networks, and workforce in place
with respect to which the taxpayer claims an adjusted basis derived from §
1012(c)(3)(A)(ii) of the Tax Reform Act of 1986 (the Act).
Section 1012 of the Act revoked the tax-exempt status of BCBS organizations
and added § 833 of the Internal Revenue Code (the “Code”), which treats those
organizations as taxable stock insurance companies. Under § 1012(c)(3)(A)(ii) of the
Act, each organization’s adjusted bases in its assets, for purposes of determining gain
or loss, is deemed equal to the assets’ fair market values as of the first day of its first
taxable year beginning after December 31, 1986.
The Conference Committee Report accompanying the Act states that this fair
market value basis adjustment was provided “solely for purposes of determining gain or
loss upon the sale or exchange of the assets, not for purposes of determining amounts
of depreciation or for other purposes.” H.R. Conf. Rept. 841, 99 Cong., 2d Sess. II-
th
350 (1986). The Conference Report further clarifies that the basis adjustment was
provided because the conferees believed that the formerly tax-exempt organizations
should not be taxed on unrealized appreciation or depreciation that accrued during the

period the organization was not generally subject to income taxation. Id.
The Service has learned that some BCBS organizations are claiming annual or
periodic loss deductions under § 165 of the Code with respect to certain intangible
assets, including customer lists, provider networks, and workforce in place using the
fair market value basis provided under § 1012(c)(3)(A)(ii) of the Act for purposes of
determining gain or loss. For example, some BCBS organizations are claiming loss
deductions in the year in which a customer terminates its relationship with the BCBS
plan, on the theory that each customer relationship is a separate asset for federal
income tax purposes.
The Service believes that BCBS organizations are not entitled to these loss
deductions. In addition to carefully scrutinizing the valuations obtained for the assets
at issue, the Service will challenge the loss deductions under various theories, as
appropriate, including the following:
!These individual customer, provider, or employee contracts or
relationships are not separate assets. The Supreme Court’s decision in
Newark Morning Ledger Co. v. United States
, 507 U.S. 546 (1993), did
not disturb earlier authority denying current loss deductions upon the
termination of an individual customer, provider, or employee contract or
relationship or similar component of a single asset. See
, e.g., Golden
State Towel and Linen Service v. United States, 373 F.2d 938 (Ct. Cl.
1967). In Newark Morning Ledger, the Supreme Court cited Golden State
Towel with approval.
!Under the facts set forth above, annual or periodic loss deductions are

the functional equivalent of amortizing the single assets composed of
individual customer, provider, or employee contracts or relationships, and
as such are contrary to Congress’s express prohibition against using the
§ 1012(c)(3)(A)(ii) basis for amortization purposes. That is, some BCBS
organizations are using these annual loss deductions as a mechanism for
regularly converting a portion of a single intangible asset’s §
1012(c)(3)(A)(ii) basis into an offset against current income, producing the
same tax effect as amortizing that asset’s § 1012(c)(3)(A)(ii) basis.
!By enacting § 1012 of the Act, Congress intended to take away the
advantage the BCBS organizations enjoyed as tax-exempt entities in
competing with commercial insurance companies by subjecting the BCBS
organizations to the payment of federal income taxes to the same extent
as commercial insurance providers. H.R. Rep. No. 426, 99 Cong., 1
thst
Sess. 664 (1985). The legislative history to the Act indicates that
Congress expected to remedy this inequity immediately, with the BCBS
organizations beginning to pay tax in their initial years as taxable entities.
The annual use of a portion of the § 1012(c)(3)(A)(ii) basis to offset a
substantial amount of taxable income immediately upon becoming taxable
would permit BCBS organizations to maintain the competitive advantage
they enjoyed prior to the Act by effectively delaying for many years their
obligation to pay federal income taxes to the same extent as other
commercial insurance providers.
!By not having claimed loss deductions upon the termination of individual

customer, provider, or employee contracts or relationships in prior years,
BCBS organizations effectively adopted a method of accounting that
treats customer lists, provider networks, and workforce in place as single
assets composed of individual customer, provider, or employee contracts
or relationships. A method of accounting cannot be changed without
permission from the Secretary. Section 446(e); Rev. Rul. 90-38, 1990-1
C.B. 57. BCBS insurance organizations that file claims for refund to
begin recovering the basis in individual customer, provider, or employee
contracts or relationships that terminated in prior years are attempting to
make an unauthorized change in method of accounting. See
Treas. Reg.
§ 1.446-1(e)(2)(ii)(a).
DRAFTING INFORMATION
The principal author of this notice is Grace Matuszeski of the Office of the
Associate Chief Counsel (Income Tax & Accounting). For further information regarding
this notice contact Kay Hossofsky of the Office of the Associate Chief Counsel
(Financial Institutions & Products) at (202) 622-3970 (not a toll-free call).