Another example of why if you’re going to set up a captive, you need to treat it like an insurance company and not a tax dodge.

Captive Insurance Arrangement Not Insurance; Premiums Not Deductible

A microcaptive insurance arrangement did not meet the definition of insurance; therefore, the payments received by a corporation and its fronting carriers through the arrangement were not deductible as insurance premiums. The corporation’s carriers did not qualify as bona fide insurance companies. For instance, the carriers engaged in a circular flow of funds, the contracts were not arm’s-length contracts but were aimed at increasing deductions and the premiums were not actuarially determined. Since the carriers did not qualify as bona fide insurance companies the carriers did not issue insurance policies. Consequently, the corporation’s reinsurance of those policies did not distribute risk. Moreover, the transactions also did not qualify as insurance in the commonly accepted sense. The corporation’s Code Sec. 831(b) election was invalid and it was required to recognize the premiums it received as income.

In addition, individuals connected to the arrangement were not allowed to deduct the purported premium payments or any fees as payments for insurance because the payments were not made for the purposes of insurance. Nevertheless, the individuals argued that the payments qualified as payments for indemnification that were deductible as ordinary and necessary business expenses. The argument was rejected because at a minimum, the intent to seek indemnification for covered losses should have been present; however, this was not the case. Finally, the individuals and the corporation were not liable for accuracy-related penalties. The corporation and the individuals relied in good faith on the advice of a competent professional.

Syzygy Insurance Co., Inc., TC Memo. 2019-34, Dec. 61,443(M)

source: Wolters Kluwer 4-11-19