In a News Release, IRS has provided updated information on its enforcement efforts with respect to micro-captive insurance transactions.
Background. Broadly speaking, a micro-captive insurance transaction is a transaction in which a taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for premiums for insurance coverage. The related company that the parties treat as a captive insurance company elects under Code Sec. 831(b) to be taxed only on investment income and therefore excludes the payments directly or indirectly received under the contracts from its taxable income.
In Notice 2016-66, the IRS concluded that certain micro-captive insurance transactions had the potential for tax avoidance and evasion and notified taxpayers that these transactions were “transactions of interest” that need to be disclosed to the IRS.
In January 2020, the IRS announced that it would significantly increase enforcement activity around micro-captive insurance transactions. The IRS said it would begin deploying 12 new examination teams comprised of employees from both the IRS Large Business and International and Small Business/Self-Employed divisions to open additional audits.
In March 2020, the IRS provided instructions, on its website, to taxpayers who wished to amend previously filed tax returns to remove deductions or other tax benefits related to micro-captive insurance transactions.
In March and July 2020, IRS issued letters to taxpayers who participated in a Notice 2016-66 transaction alerting them that IRS enforcement activity in this area will be expanding significantly and providing them with the opportunity to tell the IRS if they’ve discontinued their participation in this transaction before the IRS initiates examinations.
IRS provides update. In the News Release, the IRS has updated various aspects of its previous announcements.
The IRS encourages any taxpayer who has continued to engage in an abusive micro-captive insurance transaction to not anticipate being able to settle its transaction with the IRS or Chief Counsel on terms more favorable than previously announced settlement offers and that any potential future settlement initiative that the IRS may consider will require additional concessions by the taxpayer.
With this in mind, the IRS encourages taxpayers who participated in a micro-captive insurance transaction to consult an independent tax advisor. These taxpayers should seriously consider exiting the transaction and not claiming deductions associated with it.
For those taxpayers that do not exit the transaction and continue taking such deductions, the IRS will disallow tax benefits from transactions that are determined to be abusive, may also require domestic captives to include premium payments in income, and may assert a withholding liability related to foreign captives. The IRS will also assert penalties, as appropriate, including the strict liability penalty that applies to transactions that lack economic substance. The IRS Office of Chief Counsel will continue to litigate these abusive transactions in Tax Court.
The IRS says that it has the following tools to combat abusive micro-captive insurance transactions: a dedicated promoter office, a new Fraud Enforcement Office, enhanced service-wide coordination with IRS’s Criminal Investigation and the Office of Professional Responsibility, and advanced data analytics and mining capabilities.
The IRS says that early responses to its March and July 2020 letters indicate that a significant number of taxpayers who participated in these transactions have exited the transaction.
The IRS has become aware of variations of the abusive micro-captive insurance transactions. Examples of these variations include certain Puerto Rico and offshore captive insurance arrangements that do not involve Code Sec. 831(b) elections.
The IRS says that these variations appear to be designed and marketed with the express intent of avoiding reporting under Notice 2016-66 and yet perpetuating in some cases the same or similar abusive elements as the abusive micro-captive insurance transactions described in the Notice. The IRS cautions taxpayers that, to the extent they engage in variations of abusive micro-captive transactions that are substantially similar to those described in Notice 2016-66, they must be disclosed. Otherwise, the IRS will impose penalties for the failure to disclose.
Source: Checkpoint Newsstand 10/5/2020