IRS, Treasury Seek Additional Input on Micro-Captive Insurance Transactions
Nov 2, 2016
In Notice 2016-66 issued yesterday, November 1, 2016, the U.S. Treasury Department and the Internal Revenue Service (“IRS”) requested feedback from interested parties on how Micro-Captive Insurance Transactions might be addressed in future published guidance.
Comments should be submitted in writing on or before January 30, 2017.
To view the complete Notice, click here.
Earlier this year, the IRS outlined how these types of transactions have the potential for tax avoidance or evasion. However, in yesterday’s Notice, the agencies explained that they lack sufficient information to identify which § 831(b) arrangements should be identified specifically as a tax avoidance transaction and may lack sufficient information to define the characteristics that distinguish the tax avoidance transactions from other § 831(b) related-party transactions.
In addition to inviting written comment, the Notice identifies the transaction as described and substantially similar transactions as transactions of interest for purposes of § 1.6011-4(b)(6) of the Income Tax Regulations and §§ 6111 and 6112 of the U.S. Tax Code. The Notice also alerts persons involved in such transactions to certain responsibilities and penalties that may arise from their involvement with these transactions.
Micro-Captive Insurance Transactions are described by the IRS as a legitimate tax structure involving certain small or “micro” captive insurance companies. The IRS explained in its February 2016 “Dirty Dozen” list that U.S. tax law allows businesses to create “captive” insurance companies to enable those businesses to protect against certain risks.
The insured claims deductions under the tax code for premiums paid for the insurance policies while the premiums end up with a captive insurance company owned by the owners of the insured or family members. The captive insurance company, in turn, can elect under a separate section of the tax code to exclude up to $1.2 million of its net premium income per year, so that the captive is taxed only on its investment income.
In the abusive structure, unscrupulous promoters, accountants, or wealth planners persuade the owners of closely held entities to participate in these schemes. The promoters assist the owners to create captive insurance companies onshore or offshore and cause the creation and sale of the captive “insurance” policies to the closely held entities. The policies may cover ordinary business risks or esoteric, implausible risks for exorbitant “premiums,” while the insureds continue to maintain their far less costly commercial coverages with traditional insurers. Captive “insurance” policies may attempt to cover the same risks as are covered by the entities’ existing commercial coverage, but the captive policies’ “premiums” may be double or triple the premiums of the policy owners’ commercial policies, the IRS noted.
Annual premium amounts are frequently targeted to the amounts of deductions business entities seek in order to reduce their taxable income, the IRS explained. In these abusive schemes, total premiums can equal up to $1.2 million annually to take full advantage of the premium income exclusion provision. Underwriting and actuarial substantiation for the insurance premiums paid are either absent or illusory. The promoters manage the entities’ captive insurance companies for substantial fees, enabling taxpayers unsophisticated in insurance to continue the charade from year to year.
The Protecting Americans from Tax Hikes Act of 2015 is intended to curb certain micro-captive abuses that the IRS is currently combatting. Those provisions are effective for small insurance companies’ taxable years beginning after December 31, 2016.
To access a copy of the new law, click here and go to page 176, Section 333.
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