IRS Mandates Disclosure of Small Captives Before January 30, 2017
The IRS has officially declared war on small captive insurance arrangements that rely on I.R.C. Section 831(b) and the ability of the captive to exclude from income a certain amount of premiums earned each year. In Notice 2016-66, the IRS identified these microcaptives, as they are commonly known by, as “transactions of interest” for federal income tax purposes. This identification triggers an obligation by taxpayers and material advisors to formally disclose the details of their insurance transactions to the IRS or otherwise face potential penalties up to $50,000. For prior tax years, the disclosure must be made by January 30, 2017. To review the IRS notice, which is summarized below, click here: https://www.irs.gov/pub/irs-drop/n-16-66.pdf.
Notice 2016-66 casts a wide net. Generally the notice applies to transactions where: (i) the taxpayer owns directly or indirectly an interest in an active trade or business, (ii) the business enters into insurance contracts whereby an insurance company that has made an election under Code Section 831(b) (the microcaptive) insures or reinsures risks covered by the insurance contracts, (iii) the taxpayer, the insuring business, or persons related to either of them own 20% or more (by vote or value) of the microcaptive, and (iv) one of the following tests are met – (a) the microcaptive’s combined losses and expenses over a prior five-year period are less than 70% of the net premiums earned, or (b) during the past five years, the captive used its assets to loan, guarantee, or otherwise help in any financing for the taxpayer, the insuring business, or any person related thereto. Notably, no tax avoidance motive or intent is required for a transaction to be subject to the notice and the reporting obligations that flow therefrom.
Notice 2016-66 drops that wide net into deep waters – applying to transactions that are the same or similar to the described transactions entered into on or after November 2, 2006 (yes, ten years ago). Persons who participated in, as well as material advisors with respect to, such transactions must disclose them to the IRS no later than January 30, 2017 for prior tax years. Otherwise they will face potential penalties up to $50,000 under I.R.C. Section 6707A. Participants make disclosure to the IRS by filing Form 8886 and describing the transactions in sufficient detail for the IRS to be able to understand the tax structure. This includes the who/what/where/when/why/how of the microcaptive and its activities, as well as the identity of all involved parties. Material advisors make disclosure to the IRS by filing a Form 8918 and providing comparable information. A material advisor is a person who provides material assistance or advice with respect to the organizing, managing, promoting, selling, implementing, insuring of, or carrying out of the transactions and who makes a statement that relates to a tax aspect of the transaction in exchange for fees in excess of $10,000. Material advisors are also subject to the list maintenance requirements of I.R.C. Section 6112.
The time is now to visit with your clients and colleagues to make sure any required disclosures are timely made by January 30, 2017. If you have any questions about your client’s disclosure obligations, or the obligations that you or your colleagues may have, please do not hesitate to contact me at (214) 749-2464.