The IRS has announced acceptance rates for a time-limited settlement offer made to certain taxpayers under audit who participated in abusive micro-captive insurance transactions. Nearly 80% of taxpayers who received offer letters elected to accept the settlement terms.
The settlement offer followed three U.S. Tax Court decisions confirming that certain micro-captive arrangements are not eligible for federal tax benefits. The terms of the settlement required substantial concession of the income tax benefits claimed by the taxpayer together with appropriate penalties.
The IRS will continue to vigorously pursue those involved in these and other similar abusive transactions going forward. Enforcement activity in this area is being significantly increased. To that end, the IRS is deploying additional resources, including 12 new examination teams composed of employees from the IRS Large Business and International division and Small Business/Self-Employed division, that will focus on these arrangements.
In the midst of this crackdown, it’s important to remember that there are many legitimate uses for captive insurance companies. A captive insurance program, which must meet four criteria to qualify as an insurance company for federal tax purposes, can help businesses manage risks while also taking advantage of tax benefits. Captive structures are primarily formed to supplement existing insurance coverages, to fund blocks of risk exposures, or to provide coverage for atypical risks.
Taxpayers who participate in micro-captive insurance transactions are required to disclose them to the IRS Office of Tax Shelter Analysis under Notice 2016-66. Failure to properly disclose can result in significant civil penalties. Taxpayers involved in these transactions should work closely with their CRI tax advisors to make sure their captive insurance programs operate within the requirements of the law.