Quick Thoughts on the New "Transaction of Interest" Requirements

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:

1. Under what authority Captive is chartered: 
2. A description of all the type(s) of coverage provided by Captive during the year or years of participation (if disclosure pertains to multiple years); 
3. A description of how the amounts treated as premiums for coverage provided by Captive during the year or years of participation (if disclosure pertains to multiple years) were determined, including the name and contact information of any actuary or underwriter who assisted in these determinations; in other words, the IRS wants a detailed actuarial report.
4. A description of any claims paid by Captive during the year or years of participation (if disclosure pertains to multiple years), and of the amount of, and reason for, any reserves reported by Captive on the annual statement: 
5. A description of the assets held by Captive during the year or years of participation (if disclosure pertains to multiple years); that is, the use Captive has made of its premium and investment income, including but not limited to, securities (whether or not registered), loans, real estate, or partnerships or other joint ventures, and an identification of the related parties involved in any transactions with respect to those assets.  

     Here are some quick and initial conclusions.

1. The IRS has admitted (again) that the captive transaction could be abusive but that they need to collect additional information to determine what an abusive transaction looks like.  
2. They want the following detailed information, most of which is already disclosed as part of the annual tax return:
   1. Detailed premium information
   2. Detailed claims information, and
   3. Information about any loans between the captive and the parent company

     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. 
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     I’ll have more on this over the next few days/weeks.