At the beginning of each tax season, the IRS publishes a list of highly scrutinized tax matters, generally referred to as the “Dirty Dozen.” In 2015, the IRS added to this Dirty Dozen list a category for Abusive Tax Shelters.
Within that category, the 831(b) Captive Insurance arrangements are the basis for very serious IRS comments and scrutiny. Effectively, the IRS has concluded that the captives are (very often) sham transactions and serve no valid/legal economic purpose. Essentially, the IRS has concluded that Captives are not insuring legitimate risks; rather, they are motivated by the allure of big income tax deductions (theoretically reducing tax obligations—which, as it turns out, is a farce), deferral or elimination of tax income tax, or the opportunity to convey wealth through generations without tax implications.
Needless to say, when taxpayers utilize suspect mechanisms to avoid paying taxes, the IRS not only frowns upon this, but can launch an attack against such arrangements which can, and oftentimes does, end with taxpayers (individuals and businesses) paying back taxes along with tremendous penalties and interest.
These things having been said, the IRS is embarking on a campaign against Captives. Where this started was with “promoter” audits. The promoters are the individuals/businesses who orchestrate the Captive arrangement and either directly, or through others, sell the taxpayer on the concept and entice them to participate with, generally, promises of the wonderful theoretical attributes of the Captives. Of course, these promises are false, thus providing the fodder for the promoter audits. In any event, through the promoter audits, the IRS will determine if the promoter’s transactions were abusive (almost a foregone conclusion).
This might not seem to be cause for alarm to the business or individual participating in the Captive, but the IRS can obtain the promoter’s customer list! The IRS can then turn its attention to the taxpayers participating in the Captives, which is really the goal – so the IRS can go after (and collect) taxes that it deems should have been paid on the money used to fund the Captive arrangement. Among other things, though, the taxpayer will find itself in a dramatic disadvantage when fighting with the IRS. It will have no idea (more than likely) what, if any, underwriting was done or the basis for the insurance pool used in the Captive arrangement. The notion that an individual taxpayer can persuasively argue the merits of a Captive that has been the target of a promoter audit is remarkably unlikely. Thus, major financial implications to the taxpayer are almost undeniable.
Without getting into tremendous detail, the IRS generally takes the position that the “insurance” provided for in a Captive arrangement is not valid. For instance, they argue that the policies are not insuring an insurance risk (because the “policies” are really an investment); that the risks insured against are fictitious (thereby creating the investment); and/or that the Captive was never truly created to pay claims or take on risks.
Also, the IRS has vehemently argued that the insurance “premiums” are not reasonable—and among the various criteria on this, oftentimes the premiums are not actuarially determined or properly underwritten; the premiums are excessive compared to policies in the market; and the premiums do not account for the type of business of the insured or risk history. Also, the IRS has determined that there is no risk distribution; i.e., that the “reinsurance pools” oftentimes used in Captives do not meet criteria for risk distribution in various respects.
As all this is boiled down, the bottom line is that if you or anyone you know is involved in a Captive, there may be tremendous risk. Even if you are not now the subject of an audit, it is likely only a matter of time since the IRS has designated significant resources to fight this battle.
We at the Harris Firm, P.C., a litigation boutique which deals with these matters, can help. We have a network of lawyers who can help not only deal with audits when they occur, but, also, there are some steps that can be taken to “self-audit” and identify and address weaknesses—this may help ameliorate issues.
However, if one is under audit, we have tax counsel who specialize in these issues and we can arrange for their assistance. Moreover, though, if you are under audit, it is certain that you will incur expenses and very likely the Captive arrangement will not pass muster with the IRS, thus resulting in taxes, penalties, and interest. We recommend you contact our firm to advise you about any rights you may have to seek damages from those who created this situation for you.
For a free consultation, please contact Dalton Harris at 214.956.7474 or by email at Dalton@harrisfirmpc.com.
Save
