Mutual insurance companies are owned by their policyholders, who do not hold stock but instead have ownership rights tied to their policies. The terms of ownership are outlined within the insurance policy itself. When such a company undergoes demutualization to become a stock-based entity, eligible policyholders are typically given a choice: receive newly issued stock in the reorganized company or opt for a cash payout. The insurance policy remains in effect with only minor modifications, such as renaming the issuing entity and removing any voting or liquidation privileges.

In most cases, demutualization qualifies as a tax-free reorganization under Section 368 of the Internal Revenue Code.

If the demutualization is tax-free and you choose to receive stock, it is considered an exchange of your voting and liquidation rights for shares in the new company. Your ownership period for tax purposes includes the entire duration of your policy in the previous mutual company, and this exchange does not generate any immediate taxable gain or loss.

If you opt for a cash payment instead of stock in a tax-free reorganization, tax regulations treat this as if you had received stock and subsequently sold it back to the company. This transaction could result in a capital gain that must be reported on Schedule D (Form 1040), Capital Gains and Losses, as well as on Form 8949, Sales and Other Dispositions of Capital Assets. If your policy ownership exceeded one year at the time of demutualization, the gain is categorized as a long-term capital gain. Otherwise, it is considered a short-term capital gain under Section 1223(1) of the Internal Revenue Code.