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In 1983, petitioner notified the State of California of its
intention to terminate its self-insurance program for workers'
compensation, and the State acknowledged petitioner's intention.
Petitioner complied with State regulations and received State
approval to terminate its self-insurance activity. Petitioner's
future obligations for 1984 under California's workers'
compensation were covered by the Liberty Mutual policy. Liberty
Mutual entered into a reinsurance agreement with OPL wherein OPL
reinsured Liberty Mutual's exposure for claims not exceeding
$250,000 for any one accident. There is no question that the
Liberty Mutual policy was a valid policy that satisfied
petitioner's workers' compensation responsibilities.
In calculating taxable income, section 162(a) permits the
deduction from gross income of all ordinary and necessary
expenses incurred in carrying on a business. Premiums for
insurance, including those for workers' compensation coverage,
are deductible business expenses. See sec. 1.162-1(a), Income
Tax Regs. The insuring taxpayer deducts the amounts paid as
premiums but, of course, cannot deduct covered claims because the
source of the payments is the insurance carrier. See Clougherty
Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9th Cir. 1987),
affg. 84 T.C. 948 (1985).
In lieu of purchasing insurance, one may elect to self-
insure, paying off claims as they arise or setting aside fixed
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