The IRS has announced in IR 2019-157 (9/16/2019) that it is mailing a time-limited settlement offer to certain taxpayers under audit who participated in abusive micro-captive insurance transactions. In recent days, the IRS started sending notices to up to 200 taxpayers.
Transaction of Interest
Broadly speaking, a micro-captive transaction is a transaction intended to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts claims deductions for insurance premiums. The related company that the parties treat as a captive insurance company elects under IRC § 831(b) to be taxed only on investment income and, therefore, excludes the payments directly or indirectly received under the contracts from its taxable income.
In Notice 2016-66, the IRS expressed concern that micro-captive transactions had the potential for tax avoidance or evasion and classified these transactions as “transactions of interest” for the purposes of IRC § 6011, IRC § 6012, and Treas. Reg. § 1.6011-4. Based on this classification, persons who fail to make required disclosures may be subject to penalties under IRC § 6707(a), IRC § 6707A, and IRC § 6708(a).
The IRS noted that it consistently disallowed the tax benefits claimed by taxpayers in abusive micro-captive structures. The announcement also provides that, although some taxpayers have challenged the IRS position in court, none have been successful. To the contrary, the Tax Court has now upheld the IRS’s disallowance of the claimed tax benefits in three different cases.
Settlement Offered to Certain Taxpayers
The settlement requires substantial concession of the income tax benefits claimed by the taxpayer together with appropriate penalties (unless the taxpayer can demonstrate good faith, reasonable reliance). Taxpayers eligible for the settlement will be notified of the terms by letter from the IRS. The initiative is currently limited to taxpayers with at least one open year under exam. Taxpayers who also have unresolved years under the jurisdiction of the IRS Appeals may also be eligible, but those with pending docketed years under Counsel’s jurisdiction are not eligible. The IRS is continuing to assess whether the settlement offer should be expanded to others.
Taxpayers eligible for this offer will be notified by letter with the applicable terms. Taxpayers who do not receive such a letter are not eligible for this resolution.
Taxpayers who receive letters under this settlement offer, but who opt not to participate, will continue to be audited by the IRS under its normal procedures. Potential outcomes may include full disallowance of captive insurance deductions, inclusion of income by the captive, and imposition of all applicable penalties.
Although taxpayers who decline to participate will have full Appeals rights, the IRS Independent Office of Appeals is aware of this resolution initiative. Given the current state of the law, it is the view of the IRS Independent Office of Appeals that these terms generally reflect the hazards of litigation faced by taxpayers, and taxpayers “should not expect to receive better terms in Appeals than those offered under this initiative.”
Taxpayers who are offered this private resolution and decline to participate will not be eligible for any potential future settlement initiatives.
The IRS will continue to disallow the tax benefits claimed in abusive transactions and will continue to defend its position in court. The IRS also plans to continue to open additional exams in this area as part of ongoing work to combat abusive transactions.
To continue your research on micro-captive transactions as transactions of interest, see FTC 2d/FIN ¶ S-4445.6.
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