From its organization in 1938 through December 31, 1986, for Federal income tax purposes, petitioner operated as a taxexempt organization under section 501(c)(4) and its predecessor statutes.

Effective January 1, 1987, as a result of enactment of sections 501(m) and 833 and because petitioner constituted an existing Blue Cross Blue Shield organization, petitioner became subject to Federal income tax. Tax Reform Act of 1986 (TRA 1986), Pub. L. 99-514, sec. 1012(a) and (b), 100 Stat. 2085, 2390-2394. The basis step-up provision of section 1012(c)(3)(A)(ii) of TRA 1986 (hereinafter generally cited simply as TRA 1986 section 1012(c)(3)(A)(ii)) was applicable specifically to petitioner and to other Blue Cross Blue Shield organizations. This basis step-up provision, in situations about which the parties dispute, provided generally that Blue Cross Blue Shield organizations such as petitioner were entitled, for purposes of determining gain or loss for Federal income tax purposes, to step up their tax basis in assets owned on January 1, 1987, to the assets' January 1, 1987, fair market value.

The conversion of Blue Cross Blue Shield organizations to taxable status was enacted because Congress believed that the prior tax-exempt status of these organizations provided the organizations unfair competitive advantages over taxable commercial health insurance companies. H. Rept. 99-426, at 664 (1985), 1986-3 C.B. (Vol. 2) 1, 664.

Petitioner's 376 health insurance group contracts in issue herein for 1994 constituted for petitioner self-created assets.3 Understandably, because it was exempt from Federal income tax, from its organization in 1938 through 1986 petitioner did not reflect in its tax books and records any cost basis relating to its self-created health insurance group contracts. Accordingly, the basis step-up provision of TRA 1986 provides petitioner with the only ground for establishing a tax basis in the 376 group contracts.

3 Apparently, petitioner's 376 group contracts (which were terminated in 1994 and to which the loss deductions in dispute herein relate) do not include any of the Lehigh Valley group contracts that arguably were "purchased" by petitioner in 1985 when petitioner merged with Blue Cross of Lehigh Valley.

4 Also, for the indicated pre-1987 years the evidence does not indicate that petitioner's financial books and records reflected any cost basis in its self-created health insurance group contracts.

Because of petitioner's new taxable status and under petitioner's interpretation herein of the basis step-up provision of TRA 1986, beginning January 1, 1987, petitioner would have been entitled to make adjustments in its tax books and records to reflect a step-up in its tax basis, for purposes of determining gain or loss, relating to each of its 23,526 group contracts that were in effect on January 1, 1987 (including the 376 group contracts at issue herein), from zero to an amount equal to each contract's January 1, 1987, fair market value. During 1987 through 1994, however, in petitioner's tax books and records no such tax basis adjustments were made.

Accordingly, on its originally filed corporate Federal income tax returns for 1987, 1988, 1989, 1990, 1991, 1992, and 1993, petitioner claimed no loss deductions under section 165 relating to its health insurance group contracts that were outstanding on January 1, 1987, and that were terminated during each respective year.

On its 1994 corporate Federal income tax return, petitioner first claimed loss deductions under section 165 relating to terminated health insurance group contracts.

As filed on approximately September 15, 1995, there was reflected on petitioner's 1994 corporate Federal income tax return loss deductions under section 165 in the cumulative total amount of $2,648,249 relating to the claimed fair market value of the 376 group contracts (that were among petitioner's 23,526 group contracts in effect on January 1, 1987, and that were terminated in 1994).5

The total $2,648,249 in loss deductions claimed on petitioner's 1994 corporate Federal income tax return was based on a September 10, 1995, valuation report (initial valuation report) prepared for petitioner by a major accounting firm. The initial valuation report calculated a value for all of petitioner's 23,526 group contracts that were in effect on January 1, 1987, by separating the contracts into two blocks-small groups (with fewer than 100 individual mem

5 Petitioner has not claimed loss deductions relating to the termination of any health insurance contracts that it entered into directly with individuals. Also, where a group entered into more than one contract with petitioner, petitioner claimed a loss deduction with regard to its multiple contracts with that group only in the year in which the group's last contract with petitioner was terminated. Because of this last point, the 376 group contracts for which petitioner now claims loss deductions for 1994 actually represent 698 insurance contracts relating to 376 groups.

bers) and large groups (with 100 or more individual members). The initial valuation report set forth, as of January 1, 1987, a cumulative total value for all of petitioner's small group contracts of $57.8 million, and a cumulative total value for all of petitioner's large group contracts of $105.7 million, for a combined cumulative total value for both blocks (representing all 23,526 of petitioner's group contracts in effect on January 1, 1987) of $163.5 million.

The total $2,648,249 in loss deductions claimed on petitioner's 1994 corporate Federal income tax return apparently constituted simply a pro rata share of the valuation reflected in the initial valuation report of petitioner's small group contracts and a pro rata share of petitioner's large group contracts.6

Also, in the fall of 1995, at approximately the same time that petitioner filed its 1994 corporate Federal income tax return, petitioner filed amended corporate Federal income tax returns for 1991, 1992, and 1993 (the years then open under the applicable refund periods of limitation) in which petitioner claimed loss deductions under section 165 and tax refunds relating to the claimed cumulative total fair market value (as calculated in the initial valuation report) of petitioner's health insurance group contracts that were in effect on January 1, 1987, and that were terminated during each respective year.

On audit, in a notice of deficiency dated August 16, 2001, respondent disallowed completely the $2,648,249 in total cumulative loss deductions for 1994 relating to the 376 group contracts terminated in 1994. Also, petitioner's claimed refunds for 1991, 1992, and 1993, relating to group contracts terminated in those years, were not allowed by respondent.

In its petition filed herein on November 13, 2001, petitioner claimed loss deductions under section 165 in the total amount of $3,342,944 relating to the claimed cumulative total value of the 376 group contracts terminated in 1994. No explanation is provided as to the increase in this amount from the $2,648,249 in total loss deductions claimed on petitioner's 1994 corporate Federal income tax return relating to the 376 group contracts.

6 Because petitioner did not introduce into evidence herein the initial valuation report, the particular math associated with the $2,648,249 total valuation reflected therein is not in evidence.

Subsequently, and in preparation for trial which was held in March and April of 2003, petitioner's trial expert witness prepared a valuation report dated January 30, 2003, in which he calculated, as of January 1, 1987, a cumulative total fair market value of $4 million for the 376 group contracts that were terminated in 1994 (based on a cumulative total fair market value of $131,697,202 for all 23,526 of petitioner's group contracts in effect on January 1, 1987).7

Accordingly, based on its trial expert's valuation of the 376 group contracts, petitioner now claims total loss deductions for 1994 under section 165 in the amount of $3,973,023 (an increase of $1,324,774 over the $2,648,249 in total loss deductions claimed therefor on petitioner's 1994 corporate Federal income tax return).

Further, on March 31, 2002, petitioner filed second amended corporate Federal income tax returns for 1992 and 1993, increasing for those years the total loss deductions claimed under section 165 relating to terminated group contracts for those years.

For years after 1994, petitioner continued to claim loss deductions under section 165 relating to the value of petitioner's group contracts in effect on January 1, 1987, that were terminated in each respective year.

For 1991 through 2000, the loss deductions claimed by petitioner under section 165 relating to petitioner's valuation of group contracts terminated in each year (that were in effect on January 1, 1987) total approximately $37 million as set forth below:

7 The record is unclear as to how, for the 376 group contracts terminated in 1994, petitioner's trial expert calculated a higher cumulative total value ($4 million) than was calculated in petitioner's initial valuation report ($2.6 million), even though for all 23,526 of petitioner's group contracts in effect on Jan. 1, 1987, petitioner's trial expert calculated a lower cumulative total value ($132 million) than the initial valuation report ($163.5 million).

The primary issues for decision involve a legal issue and a factual issue, as follows: (1) Whether the basis step-up provision of TRA 1986 is applicable to calculations of gain or loss relating only to "sale or exchange" transactions and not to calculations of loss relating to the "termination" of assets; and (2) whether the specific and discrete fair market value, as of January 1, 1987, of the 376 group contracts terminated in 1994 has been adequately established by petitioner for purposes of the claimed loss deductions under section 165. Construction of TRA 1986

As explained, supra, in conjunction with their conversion from nontaxable to taxable status, Congress provided for Blue Cross Blue Shield organizations a fair market value basis step-up provision. The purpose of the basis step-up provision was to prevent Blue Cross Blue Shield organizations from being taxed on appreciation in the value of assets that had occurred in pre-1987 years when the organizations had not been subject to Federal income tax. H. Conf. Rept. 99-841 (Vol. II), at II-350 (1986), 1986–3 C.B. (Vol. 4) 1, 350. The relevant statutory language of the basis step-up provision as set forth in TRA 1986 section 1012(c)(3)(A)(ii), 100 Stat. 2394, provides as follows:

for purposes of determining gain or loss, the adjusted basis of any asset held on the 1st day of *** [the 1st taxable year beginning after Dec. 31, 1986], shall be treated as equal to its fair market value as of such day.

Respondent argues that because the above statutory language fails to state expressly the kinds of losses to which the basis step-up provision is intended to apply, the statutory language should be regarded as ambiguous and the legislative history of TRA 1986 section 1012(c)(3)(A)(ii) should be