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Captive Insurance Risk Alert, Micro-Captive and the IRS

Micro-captive Insurance Companies Beware

Currently, there is a tax provision that allows ‘micro-captive’ insurance companies – created to provide insurance to small companies that create them – to earn premiums tax free.  Ultimately, this was intended to provide more affordable insurance coverage to policyholders.  When the insurance company is well diversified, these have not been an issue. 

Unfortunately, some taxpayers have abused the system to benefit themselves without providing real or realistic insurance policies, or have provided minimal insurance for exorbitant prices.  These cases of concern around micro-captive insurance companies that are set up with fully deductible premiums and no tax payments, and with little to no ability for the IRS to review them, has provided reasons for policy change.  Therefore, under President Biden’s green book, there are several proposed provisions to make those arrangements much more costly for the captive insurance companies.  Here is a summary of the proposed guidelines and impacts:

• Proposal to establish an untaxed income account (UIA) regime. This applies to any captive insurance companies that receive 20% of more of their premiums from any one policyholder or a related group of policy holders. 

• Impact to captive insurance companies: It allows the company not to pay tax on these premiums, and dividends or loans made to the insured parties would be treated as a deemed distribution from the UIA and taxed at a high rate.

• Impact to agribusinesses: Many captives will ensure that no related group of companies will pay more than 20% of total premium income (the threshold that would create a tax payment by the insurance company).  Should the company exceed this and pay taxes however, it will essentially reduce the benefit to farm operations that have created these captives – ultimately, reducing the ability for captives to survive, and leaving a high tax bill on the table for the previous net premiums earned. 

“At this early stage, coupled with recent IRS activity, we’re watching to see what will take shape to stand before Congress. But we fully expect new tax requirements in some form to eliminate the ability of those captives abusing the tax-free provision for small insurance companies,” says Lance Wallach, an expert witness in captive insurance lawsuits whose side has never lost a case.

If you own or participate in a “micro-captive” insurance company, speak to your captive manager about their reinsurance and ceding percentages, and to your captive manager and captive tax return preparer to discuss potential implications of these proposals.

CIC Services LLC v. IRS

micro-captive transactions, CIC Services LLC v. IRS, micro-captive transactions

A lawsuit arguing that taxpayers are permitted to challenge a Treasury Department reporting requirement without first violating it defies a measure Congress took to protect tax collection, the U.S. Solicitor General’s Office told the U.S. Supreme Court.

The office made that argument in a Wednesday court filing urging the justices against taking up a case testing the reach of the Anti-Injunction Act. The act blocks lawsuits aimed at restraining officials from assessing or collecting taxes, which some interpret as shielding the department from early legal challenges to regulatory actions.

In the new filing, the government insisted that the reporting requirement is directly tied to tax collection.

“Requiring taxpayers and tax professionals to report information (and tax professionals to keep records) about such transactions enables the IRS to ensure that taxes applicable to them are not evaded but are properly assessed and collected”, the Solicitor General’s Office said.

CIC Services LLC, a Tennessee-based company, has argued that the law doesn’t block its challenge to a reporting requirement backed by a penalty in IRS Notice 2016-66 because it’s challenging the burdens of reporting rather than the penalty itself and, in any event, the penalty isn’t a tax.

The case strongly divided judges at the U.S. Court of Appeals for the Sixth Circuit, with a three-judge panel ruling 2-1 in favor of the government and multiple judges weighing in separately when the full circuit declined to rehear that decision.

The IRS notice required CIC Services to report the micro-captive transactions it advised on, which involve small insurance companies that are allowed to pay tax on just their investment income if their premium income doesn’t surpass $2.3 million. The IRS has argued that the arrangements may be tax-avoidance vehicles rather than genuine insurance.

CIC Services has said the notice containing the reporting requirement isn’t legally valid because the IRS didn’t notify the public of its plans for the requirement and respond to comments in advance, which the company says was required by the Administrative Procedure Act.

An attorney for CIC Services LLC didn’t immediately return a request for comment.

The case is CIC Services, LLC v. Internal Revenue Service, U.S., No. 19-930, response brief filed 3/25/20

IRS audit

Understanding The IRS Settlement Initiative Offer For Targeted Captive Insurance Companies

Understanding The IRS Settlement Initiative Offer For Targeted Captive Insurance CompaniesThe so-called tax shelter captive insurance companies are under scrutiny by the IRS. This happens when the promoter dummies up the insurance policies and the risks, in order for the owners of captive insurances are able to artificially generate large tax deductions.

It’s important to understand that the IRS has extended this offer to only 200 taxpayers. Currently at least 2,000 captive arrangements are under audit. There are probably well over 10,000 captive arrangements that may ultimately come under scrutiny by the IRS as well.

The offer will not be extended to captive arrangements and their owners with pending docketed years under IRS Counsel’s jurisdiction.