Season 2
Season 2
S2:E13 - Captives & The IRS: Where are We Now?
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The IRS has been monitoring the captive insurance industry with heightened scrutiny for several years. Between major court victories, settlement letters, and a stated focus on 831(b) captives, an active approach has been long established. In this episode of It Figures, join CRI Partners Scott Bailey and Robert Miller as they provide an update regarding the IRS’ activity and what to expect from the captive insurance market in the future.


Intro:

From Carr, Riggs & Ingram, this is It Figures: The CRI Podcast, an accounting, advisory and industry-focused podcast for business and organization leaders, entrepreneurs and anyone who is looking to go beyond the status quo.

Scott Bailey:

Hi and welcome to the It Figures Podcast for Carr, Riggs & Ingram. Or as we refer to ourselves as CRI. And we’re here today to talk about the IRS’s focus on captives. Yeah. Really looking forward to it.

My name is Scott Bailey and I’m a partner out of our Raleigh, North Carolina office. I’ve been with the firm about eight years. And I have a primary focus in insurance, specifically in captive insurance and in construction. And I’m here today to speak with Robert Miller. Robert, if you’d like to introduce yourself.

Robert Miller:

Sure. Hey, Scott, this is Robert Miller. I am a partner in the Montgomery office of Carr, Riggs & Ingram. I’ve been in public accounting for a little over 25 years. I have a focus in insurance taxation as well as I work with numerous small medium-sized businesses, mostly on a local practice type of thing. But I am an insurance tax partner with the firm and primarily focused in the captive world.

Scott Bailey:

Thanks, Robert. So just to start things off and give people an idea of what we’re talking about today, because not everybody may be either an insurance professional or have exposure to that area. And even more people may not have a full accounting for what captive insurance is and what captive insurance means.

So what we’re talking about to start with is captive insurance is a form of insurance whereby a small insurance company, which we refer to as the captive is primarily owned by the insureds. So basically, that group is writing for primarily the owners or group of owners, however that shakes out. But essentially, the actions of that small insurance company are controlled by the entities being covered by the insurance, primarily.

In particular, there’s a subset of that that we refer to as 831(b) captives. That 831(b), as it sounds, is the internal revenue code section reference referring to insurance and how insurance is taxed. So I don’t want to get too hung up there on the number and letter for fear of sounding like we’re talking about a serial number for a fax machine, but it does matter in the context of the conversation we have today. Because our topic at hand, where we’re talking about the IRS is focused on captives, is primarily related to these 831(b) captives, which can also be called micro-captives or small captives or things like that.

So this is an area that’s been at times in the IRS’s dirty dozen list. They’ve been looking at this for quite some time, even though captives have been around in our country since the 70s. So given all that context, Robert, one of the things we know is that the IRS is on a winning streak in the tax courts. Could you tell us a little bit about what they’ve got going on there?

Robert Miller:

Yes, Scott. So since 2017, the IRS has won for tax cases related to micro-captive insurance. These cases, at least in my view, had fact patterns that made them primarily fairly easy for the IRS. They were insurance companies that were not operating as such. That’s an important part of being a captive insurance company is to act like an insurance company. And there’s been issues with that. None of these cases have met any of these various safe harbors that have been established over decades of cases related to captive insurance. The other cases have primarily been larger captives, whereas these are in the micro-captive world. And the micro-captives for 2020, I think the premium threshold was $2.3 million. And that’s for companies that are basically insuring related entities.

Scott Bailey:

So the four cases you referenced there, we’ve got the Avrahami case, the Reserve Mechanical case, the Syzygy case, which is about as hard to say as it is to spell. And then most recently, the Caylor Land case. Is there any common thread we can draw between these? Is there anything we can look at and say, “Okay, these are things that the IRS thinks is okay, these are things that the IRS just really doesn’t like?” What are these cases telling us about how they’re viewing captives?

Robert Miller:

So the first case, the Avrahami case, was back in 2017. And in that case as well as all three of the other cases, they established that there was no risk distribution. And risk distribution is basically the law of large numbers. You have enough independent exposure units, in which case, no one claim or no few claims would take down the whole group in itself.

So in the Avrahami case, they said there was no risk distribution. Avrahami was part of a risk pool, which is a group of insurers that basically they pulled their funds in order to take a little bit of risk from each other and in order to create risk distribution. In the IRS, that is one of the common threads. So the first three cases involved risk pools. And the issue becomes is there’s no determination that in some of these risk pools that you’re actually not just taking back your own risk. If you’re putting in $500,000 of premium and taking $500,000 of risk and in some situations, it’s limited to your only your risk, then it’s understandable that that may be an issue from a risk distribution standpoint.

In the Caylor case. They did not participate in a risk pool, and they were trying to use enough independent exposure units within their businesses themselves to pass the risk distribution test. In all the other cases, the courts have said that exposure units are a method of reaching risk distribution. However, in Caylor, there just wasn’t nearly enough in there.

Scott Bailey:

Gotcha. So really, the big thing we learned about where the IRS is looking when it comes to these risk pools is they just want to make sure that captives out there are not putting their risk essentially in the washing machine, sending it for a spin and getting their own stuff back out. So then with Caylor, they just couldn’t find enough that the courts felt like could support that they were actually achieving risk distribution, right?

Robert Miller:

Correct. And the independent exposure units has passed the tax court’s test in the past. There was the Rent-A-Center case several years ago. It was based purely on independent exposure units. But with a company such as Rent-A-Center, you can imagine the tens and thousands of pieces of property and the employees are depending on what are all kinds of risks are involved, but a local business would have a hard time achieving such. Although, I believe they did say in I think it was the Caylor case that they do recognize that in a micro-captive or a smaller captive, that there could be a smaller number of exposure units. Except that in Caylor, they just simply didn’t even begin to touch whatever that number might be.

And there’s been no establishment of any kind of safe harbor to help us with this. It’s all mercy of the court at this point. If they could give us some parameters, it would make things a lot easier. I mean, just tell us what we need to do. And if the situation fits, it fits. And if the situation doesn’t fit, then somebody doesn’t go down this path and end up like one of these cases.

Scott Bailey:

Gotcha. So as a counterpoint to all this as well, we’ve got the CIC Services case that just went before the Supreme Court and the Supreme court ruled in favor of CIC Services. This is in reference to their challenge of IRS notice 2016-66, which created a reporting requirement for captive insurance companies filing the 831(b) election. Basically, requiring them to file a lot of information with the department on who the owners are and things like that. A tremendous amount of information.

The Supreme court ruled in favor of CIC. So what does this mean in the immediate context, Robert? And then what do you think this also means in terms of the future of the case? Since it’s not done, it’s just one piece of it, but the future of where this goes next.

Robert Miller:

So CIC filed … before they got to the Supreme Court, they went through a few filings. They withdrew a filing, refiled, had some filings thrown out. And at that point, that’s what led them to the Supreme Court situation. And they were fighting against the IRS’s … The case has escaped me.

Scott Bailey:

I think the premise of the case was essentially that they didn’t actually have grounds to file the case. I think the IRS was arguing that it wasn’t actually a tax, whereas CIC’s position was that it was a de facto tax.

Robert Miller:

Right. The law says you cannot file an injunction against the ability for the IRS to collect tax. And that’s what the IRS is claiming they were trying to do. But in fact, they were trying to make the IRS go through the proper channels. Not just say, “Okay, all of you people have to start filing these disclosures that are very honorous and include extreme penalties for not properly filing.” And in fact, CIC was wanting to, or at least this is what they went on, the ability to say, “Well, now you need to get some disclosures out and get feedback from the taxpayers and the profession before you can just wave a magic wand and require all these significant filings.”

So with that said, where we are now is really no different than where we were before the ruling came out. They said that they’re going to have to go back to a lower court and continue the process. So there’s no change on whether we should have filings or not related to the notice from 2016.

Scott Bailey:

And as much as I would love to speculate with you about whether we think they will be successful or perhaps not, probably for a different time, different discussion where we sort of speculate on that. I don’t know that we’re really in a position where we can do that. Although, we are very much interested in how that case goes and certainly the outcome. Since really, it looks like the Supreme Court just told them, “Okay. Yeah, you can make a case. Go make your case now.” So very, very interesting there.

Also, Robert, I think there’s some new developments coming out of the IRS as it relates to captives. Because it looks like, as they’ve created their team and they’ve widely publicized this in a variety of letters and communications with taxpayers and press releases, they’re creating something new in addition to that. Could you tell us a little bit about that? What it is? What it looks like?

Robert Miller:

Sure. Yeah. So back in April of this year, the IRS announced that it was establishing a new, what they call, the Office of Promoter Investigations. And it is specifically focused on abusive microcaptive arrangements. And again, when we talk about microcaptives, we’re talking about those that have made that 831(b) election, which means they can only write premium up to, I believe it is now at 2.4 million for this tax ’21. But that’s what their specific focus is. And it is a part of the IRS’s small business and self-employed division.

So just by the name itself, they’re not going after large companies here. And I’m making some presumptions here, but I can pretty much presume that every large corporation that you could think of in this country has a captive insurance company that’s not necessarily a microcaptive. But nonetheless, the microcaptives will be falling under the small business and self-employed division.

With that said, they also have the ability to work with large business and international divisions, tax-exempt divisions, fraud enforcement divisions, and the criminal investigations division. So this Promoter Investigations Office has a fairly broad range of where they can go, but they are looking for those promoters of these microcaptive arrangements.

Scott Bailey:

So that’s pretty significant because they’ve moved beyond just looking at the tax-paying entities, but they’re looking at some of these groups that are out there promoting, trying to convince people to start captives or join captives and things like that. So how do they hope to do that? What do they hope to target there? And how do they intend to approach that? Are they looking at sort of the business practices? Or do we know enough now to say what they’re going to look at and what they aren’t going to look at?

Robert Miller:

I don’t know that we know enough. But with all the disclosures that have occurred since the 2016 filings, they have a ton of information. It would seem to me that that would give them the ability to start linking promoters, I guess for lack of a better word. So I would think that they could look at these to see who might’ve been related to the situations in the cases they’ve already had. And they could very easily go find some other entities that have used some of those advisers and follow that path. And a great deal of it is trying to, I don’t want to say scare people, but just make people aware that the IRS is not …

Scott Bailey:

They didn’t come to play around.

Robert Miller:

Yeah, they’re serious in dealing with all this. They have absolutely created, I guess, a laser focus on going after these small related party captives.

So with that said, what happens after they’re done with the small related party captives? Do they go after the larger captives? Because at the end of the day, all these entities are trying to qualify as insurance companies. And whether we’re talking about risk distribution or exposure units, how many related entities that a company may try to insure? If they apply some rules to it and then they can win in the courts, then why couldn’t those rules apply to a larger entity? So maybe they are going to go after the bigger fish at some point down the road. But right now, they’re definitely focused on the small entities insuring related parties.

I mean, I would say if your company is involved with a microcaptive at this point, it would be wise to seek advice and determine whether you think you could withstand the exam process with the IRS. And that’s a lot of what they’re advising people as well, although in a little more threatening language.

Scott Bailey:

And Robert, I know you and I have advised some folks together on similar matters as well in the past. So if people need it, we can certainly be there to help. But however that works out, it sounds like it’s not hard to foresee some additional litigation activity coming in the future, particularly as it relates to this new program.

Robert, thank you for joining me this afternoon. It’s great to talk with you.

Robert Miller:

Absolutely, Scott. I enjoyed it.

Scott Bailey:

And thanks to all of our listeners. We appreciate your time. We appreciate you tuning in and listening to The It Figures Podcast here by Carr, Riggs & Ingram. You can check us out on our website, cricpa.com. You can find us on Facebook, Instagram, Twitter, LinkedIn. Wherever you need to find us, we can be there. Thank you for your time and have a great day.

Outro:

If you want more CRI insights or are interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures: The CRI Podcast. You can subscribe to It Figures on iTunes, Spotify or wherever you prefer to listen to your podcasts. If you liked what you heard today, please leave us a review.