The Economic Family Cases: Conclusion

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We're presenting a webinar on Friday, May 6th, titled, "What Kind of Insurance Policies Does a Captive Issue, Anyway?" During the presentation, we'll provide a basic overview of common policy exclusions covered by captives, along with an explanation of other standard captive policies.  You can sign up at this link.

The captive cases can be broken down into two segments: the economic family cases -- where the IRS gained trial momentum for their theories, and the Humana cases, where taxpayers began scoring victories.  Because we're the Humana case is next, this is an appropriate place to stop and sum up the overall captive legal situation before moving forward.

1.) Business necessity drove the formation of early captives.  Market failure (a lack of insurance or very expensive coverage) led to the formation of the early captives.  For example, the taxpayer in Ocean Drilling was engaged in a new business the was extremely risky; only Lloyd's of London would provide coverage.  The taxpayer in Beech Aircraft wanted to gain control of the insurance policy drafting process.  The taxpayers in Clougherty and Carnation wanted to lower their worker's compensation costs.  Business necessity drove these transaction.  

2.) The IRS was prepared.  The service had several years to develop their legal theory.  They could also choose their cases to find facts that were most beneficial to their position -- a standard IRS tactic.  Finally, they had a stable of credible experts to support their primary argument.  The service presented a solid case backed by the intellectual heft of their experts.

3.) The taxpayers were poorly prepared.  The taxpayers' cases relied on a strict reading of the law.  None used an expert or presented any in-depth analysis of the transaction. All the taxpayers argued that the IRS' theory violated the separate corporate existence as espoused in the Moline Propertiescase.  That is where the taxpayer's argument ended.  The taxpayers were out-maneuvered by the service.   

4.) The IRS was most successful against the single parent structure: the one case the IRS lost  was Crawford Fitting, where the insured's captive insured multiple entities and where the captive had multiple owners.  However, all single parent cases resulted in IRS victories.

5.) The overall analysis lacked a great deal of nuance:  Captives were a new business; courts lacked practical knowledge them, making judges dependent on the IRS' arguments, documentation and experts.  The thinness of the taxpayers' cases exacerbated this trend.  The decisions lacked a serious discussion of actuarial sciences, the insurance process or any counter-veiling theories. With the exception of the Crawford Fitting case, the courts' decision is essentially the IRS' legal theory, nothing more.

Next up, we'll take an in-depth look at the Humana case, where taxpayers began gaining ground.