By including micro captives on the list, the Service has telegraphed that it will continue vigorously challenging micro-captive arrangements.
For three consecutive years, the Service has targeted micro-captive insurance arrangements as an abusive tax shelter. Micro captives are discussed in detail by the Service as an abusive tax shelter and have been listed as a “transaction of interest” since 2016. Being listed as a transaction of interest means that the Service and the Treasury Department have found that it has the potential for tax avoidance or felonious tax evasion, but lack sufficient information to determine whether to list the transaction as a “tax avoidance transaction.”
As a “transaction of interest,” micro-captive arrangements must report to the Service using IRS Form 8886. The report must include: the insurance coverage provided, identification of the actuaries and underwriters, an explanation of how premiums were determined, a description of claims, and a description of the captive’s assets. The initial report for transactions was due May 1, 2017. Failing to report the transaction incurs a penalty equal to 75% of the reduction in the tax, subject to a minimum penalty of $5,000 for individuals and $10,000 for other taxpayers and a maximum of $10,000 for individuals and $50,000 for other taxpayers.
Because micro-captive insurance arrangements are authorized by the tax code under section 831(b), they are not per se abusive. Problems developed with captives failing to operate in good faith, jeopardizing recognition as a bona fide captive insurance company. These problems were exacerbated by unscrupulous promoters promising tantalizing tax benefits. These promoters implemented slipshod insurance structures to reverse-engineer the promised tax benefits.
Widespread uncertainty exists as to the how the Service’s challenges to micro-captives will be resolved. There are currently a host of tax cases percolating through the courts which will ultimately provide guidance. Notably, the Service recently obtained a victory in the case of Avrahami v. Commissioner, a case with particularly bad facts.
If your company currently maintains a micro-captive arrangement, it is a good time to confirm that you have complied with the reporting requirements. Likewise, it is also a good time to obtain professional review of the arrangement to make sure that best practices have been followed.
Metz Lewis Brodman Must O’Keefe LLC is experienced advising companies through the captive lifecycle from implementation to termination. Our firm provides counsel to rehabilitate a captive to mitigate risk of negative outcomes. In the event of a tax audit, examination, and subsequent litigation, clients further benefit from our captive insurance team’s knowledge of the current litigation landscape. If you would like to speak to an attorney about your options, contact Brian Must, Josh Baker, Steve Seel, or LeRoy Metz.