Mirco-Captive Insurance Companies and the IRS




The IRS recently announced that they are expecting to audit more taxpayers in the coming months for participating in micro-captive insurance transactions that the IRS believes to be abusive.

If you are being investigated, audited, or been assessed additional tax and penalties then please contact us.  Freeman Tax Law has a staff of attorneys and accountants with years of experience and will be able to diligently weigh your options and carefully tailor a plan for how to proceed with your case.

Micro-Captive Insurance Under Intense IRS Scrutiny

  • Micro-Captive Insurance Company Overview

    The IRS recently announced that they are expecting to audit more taxpayers in the coming months for participating in micro-captive insurance transactions that the IRS believes to be abusive.

    If you are being investigated, audited, or been assessed additional tax and penalties then please contact us.  Freeman Tax Law has a staff of attorneys and accountants with years of experience and will be able to diligently weigh your options and carefully tailor a plan for how to proceed with your case.

    Captive Insurance Companies have been around for many years. Captive insurance is a form of self-insurance that provides an opportunity for a company to reap the benefits of holding onto premiums that they pay and recover underwriting profits by setting up a separate captive insurance company to handle its particular insurance needs. One reason to set up a captive insurance company is that it allows a company to design an insurance plan to fit their needs including obtaining insurance that is not offered on the commercial market. Setting up a separate captive insurance company can have huge tax advantages to any company who qualifies and takes advantage of the micro-captive insurance company provisions.

    Captive insurance companies that qualify for IRC 831(b) treatment can choose to be taxed on investment income only if they write less than $2.2 million or less in annual premiums per year. This means that underwriting profits accumulate on a tax deferred basis. They must also meet certain diversification requirements.

    Once the election is made it can only be revoked with approval of the Secretary. Further, companies who are paying premiums into their captive insurance company get the added benefit of deducting these premium payments as ordinary and necessary business expenses under IRC 162. Any company whose costs are largely made up of insurance premiums would benefit from setting up their own captive insurance company.

  • History of IRS & Captive Insurance Companies

    The IRS has continually listed certain micro-captive insurance arrangements on its Dirty-Dozen list from 2014-2019. The IRS highly disfavors micro-captive treatment. The IRS’s position is that micro-captive insurance arrangements are really just an estate planning device with a large tax deduction attached to it. This is because the IRS has found that many of these captive insurance companies do not observe the formalities of a common insurance arrangement which include: risk shifting, risk-distribution, insurance risk, and meet commonly accepted notions of insurance.

    If the captive insurance company does not meet these requirements then deductions under IRC 162 are not allowed and the captive insurance company is unable to qualify for IRC 831(b) treatment. The IRS has outlined several captive insurance traits that it deems to be unacceptable under Notice 2016-66 and requires captive insurance companies to disclose the transaction on form 8886 as a transaction of interest. These forms must be filed with their tax return and the Office of Tax Shelter Analysis. The IRS is on the lookout for insurance that involves an implausible risk, coverage that does not meet the needs of the business, scope of coverage in the insurance contract that is vague, ambiguous, or illusory, coverage that duplicates coverage provided by another commercial insurer.

    Notice 2016-66 also points out that captive insurance companies who don’t follow commonly accepted actuarial methods in the industry to determine their premiums generally will not be considered an insurance company. Notice 2016-66 also addresses the IRS’s concern that the captive may not be following all of the requirements to be considered a regulated insurance industry in the jurisdiction that they are incorporated in, which will result in disallowance of micro-captive treatment.

    Notice 2016-66 also points to the fact that some of the captive insurance companies may not be holding enough non-liquid assets to cover the risk that it assumed, which will result in disallowance of micro-captive treatment. The lessons learned from Notice 2016-66 is that captive insurance companies taking advantage of IRC 831(b) treatment need to observe all of the formalities of a traditional insurance company and make sure that their insurance contracts are structured appropriately, that actuarial rates are used to determine the appropriate premiums, that all aspects of the arrangement are documented (including the claims) process, and that the four requirements for insurance are followed as outlined above: risk shifting, risk-distribution, insurance risk, and meet commonly accepted notions of insurance.

  • Recent IRS Tax Cases

    The IRS has recently won three Tax Court cases challenging micro-captive transactions on this basis. (Avrami v. Commissioner, 149 TC 144 (2017), Syzgy Insurance Commissioner, TC Memo. 2019-246, Reserve Mechanical Corp. v. Commisioner, TC Memo. 2018-211). This has given the IRS’s position the teeth that it needs and on January 31, 2020 the IRS announced that 12 new examination teams are expected to audit more taxpayers participating in micro-captive insurance arrangements. The IRS warned that they intend on opening many examinations and several thousand will be opened in the coming months. They further stated that the teams will use all available enforcement tools, including summonses, to obtain necessary information. They also announced that they sent out settlement letters to certain micro-captive insurance companies that were under audit and that 80% of them accepted the offers.

  • IRS Letters to Micro-Captive Insurance Companies

    In March 2020, The IRS began sending letters to certain micro-captive insurance companies stating that the agency had information that they have claimed tax benefits of the micro-captive insurance structure and allowing them to disclose whether or not they were actually entitled to the benefits of their micro-captive insurance election by filing amended tax returns.

    The letter requests that the business filers using paper returns write “Microcaptive” at the top of the amended return and mail to the address listed in the instructions of the amended return. If filed electronically then the filers should list “Microcaptive” as the reason for filing the amended return. The letter stated that “We’ll take your actions in response to this letter into account when considering future compliance activity related to your micro-captive insurance arrangement.” A response to the letter was due within 45 days of sending the letter and the IRS warned that if they do not hear from the taxpayers by the respond date that the company could be subject to examination.

  • Freeman Tax Law Can Help

    Although a micro-captive insurance company may be legitimately set up and have observed all of the formalities of an insurance company the IRS is not backing down and intends on auditing these companies with a fine tooth comb. If the IRS finds that a micro-captive insurance company has not been properly set up they will disallow the IRC 162 deduction, disallow IRC 831(b) treatment, and impose penalties.

    Why do people choose Freeman Tax Law?

    • Straight-Forward, Easy to Understand Style
    • Years of Experience Handling Cases of All Sizes and Types
    • Will Handle All Communication with the IRS on Your Behalf
    • Free, No-Obligation Initial Consultation

“The client is the most important person at our firm….it is our job to understand their facts, clearly explain all options to resolving a problem, treat them with integrity and provide the highest level of representation.” 
— Jeffrey S. Freeman, J.D., LL.M., Attorney and Counselor

The IRS has aggressively stepped up their audits on captive insurance companies. If you are affected, now is the time to come forward and get in compliance.

Jeffrey S. Freeman Attorney and Counselor


ABOUT
JEFFREY FREEMAN

Jeffrey S. Freeman, Esq. has personally represented and counseled hundreds of clients with regard to their tax matters. During his early career, Mr. Freeman worked for a large international tax firm specializing in international tax issues. He has extensive experience representing Fortune 100 clients and high net worth families. By combining large firm training and attention to detail, with a boutique firm approach and a personal focus on resolving complex tax matters efficiently, creatively and strategically, Mr. Freeman’s priority is always to provide his clients with the highest level of representation.

Mr. Freeman holds a Masters of Law in Taxation (LL.M.) from Georgetown University Law Center in Washington, D.C. and Juris Doctor, Cum Laude, from the Detroit College of Law at Michigan State University and a Bachelor of Arts in Accounting, with honor, from Michigan State University.

GET IN COMPLIANCE WITH THE IRS

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