This is a very rushed job, so please read with a patient, non-editorial eye.
On Tuesday, November 1, the Treasury Department issued Notice 2016-66, Transaction of Interest, Section 831(b) Microcaptive Transactions. Although it’s easy to ascribe an extremely negative interpretation to this document, in reality very little has actually changed regarding the IRS’ position on captive insurance.
First, let’s define a “Transaction of Interest.” According to the IRS
The new reportable transaction category Transaction of Interest (TOI) is defined as a transaction that the IRS and the Treasury Department believe is a transaction that has the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction. The TOI category of reportable transactions will apply to transactions entered into on or after November 2, 2006
This transaction “has the potential for tax avoidance or evasion.” They’re not saying the transaction is abusive per se, but that it could be. This is not the first time the IRS made this characterization about captive insurance; the latest Dirty Dozen list contained the following paragraph:
In the abusive structure, unscrupulous promoters persuade closely held entities to participate in this scheme by assisting entities to create captive insurance companies onshore or offshore, drafting organizational documents and preparing initial filings to state insurance authorities and the IRS. The promoters assist with creating and “selling” to the entities often times poorly drafted “insurance” binders and policies to cover ordinary business risks or esoteric, implausible risks for exorbitant “premiums,” while maintaining their economical commercial coverage with traditional insurers.
The paragraph starts, “In the abusive structure …” clearly implying a non-abusive form exists. This leads back to the second key point of the transaction of interest definition; the IRS, “lack(s) sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction.” In other words, the Service needs additional data. This is not the first time the IRS has requested additional captive information; over the last few years they’re sent out hundreds of questionnaires to captives asking detailed questions about the captive program. This is really more of the same.
The Service is requiring literally all 831(b) captives to file this document. I’ll touch on the exact reasons why in a later writing. But, let’s look at what information the Service is looking for:
Here are some quick and initial conclusions.
Is there reason to worry? No more than we already are. The IRS has been attacking the 831(b) captive world for the better part of the last 3-5 years. They amended the 831(b) legislation last year, increasing the annual limit to $2.2 million (inflation-adjusted) but essentially taking away the estate planning-captive insurance nexus. If the service had the intention of destroying the industry, this is when they should have struck. And here, they could have made captives a fully listed transaction rather than a transaction of interest. The former would have been far more severe in its implications.
Moreover, they’ve lost the last 3 captive cases they filed (Rent-a-center, Seciritas and RVI). While future victories are possible, any win at trial will surely be appealed, increasing the possibility of an IRS loss and overall industry uncertainty.
The information the Service is requesting is already disclosed not only to state regulators as part of the annual reporting process, but also to the IRS as part of the annual tax return. Taxpayers must now add it to a new form. It does appear the IRS is specifically interested in three key pieces of data: claims, premium amounts and loans between the captive and the parent. But their interest in these items is not new.
I’ll have more on this over the next few days/weeks.