Micro-captive Insurance Tax Shelter Participants Receive IRS Settlement Offer
On September 16, 2019 the IRS announced that a time-limited settlement offer is being mailed to certain taxpayers under audit who participated in micro-captive insurance schemes. Taxpayers must receive a letter to be eligible for the settlement.
Since 2014, abusive micro-captives have been on the IRS “Dirty Dozen” list of tax scams because the IRS believes that some “captives” fall short of insuring against risk and are being created mainly for tax avoidance. The IRS notes shortcomings in the arrangement including transactions where “coverages may insure implausible risks, fail to match genuine business needs, or duplicate the taxpayer’s commercial coverage.”
Generally, businesses can create “captive” insurance companies to control risk. Businesses that create “captive” insurance companies claim deductions for premiums or reinsurance premiums paid for insurance policies. These premiums are deposited with the “captive” insurance company owned by the insured or related parties and losses incurred by the business are covered through the “captive”. The micro-captive may elect to be treated as an exempt organization and thereby exclude limited amounts of annual net premiums from income. The captive insurer pays tax on their investment income.
The IRS is skeptical of these types of arrangements as there is a huge potential for abuse. In 2016, the IRS established reporting requirements and created disclosure and list maintenance obligations outlined under Notice 2016-66. The Treasury and the IRS acknowledge that related parties may use captive insurance that make elections under Sec. 831(b) “for risk management purposes that do not involve tax avoidance.” Those failing to report the arrangement may be subject to significant penalties.
IRS offers settlement
There are over 500 micro-captive cases sitting in Tax Court, and the IRS is continuing to examine numerous participants and promoters of these arrangements. On the heels of three straight U.S. Tax Court victories, the IRS has decided to offer settlements to some taxpayers currently under audit who participated in a micro-captive insurance arrangement. Notices have been sent to 200 taxpayers. This pool of taxpayers may be used to assess whether a settlement will be offered to others.
Under the current IRS settlement, taxpayers will concede substantial tax benefits claimed and appropriate penalties will be assessed. Those who opt not to take the settlement will continue to be audited by the IRS and are potentially subject to disallowance of captive insurance deductions, inclusion of income and penalty assessment. In addition, those not accepting the settlement will not be eligible for any potential future settlement initiatives. The IRS commissioner Chuck Rettig said, “we encourage taxpayers under exam and their advisors to take a realistic look at their matter and carefully review the settlement offer, which we believe is the best option for them given recent court cases.”
For more information, please contact a member of the Herbein tax team, or email us at firstname.lastname@example.org
Article written by Mary Hein