Lest we forget the IRS’ position on microcaptives, yesterday the IRS issued a reminder to taxpayers that they should consult an “independent tax advisor” to size-up their captive insurance planning because “any future settlement terms will only get worse, not better.” This warning applies not only to Section 831(b) microcaptives, but also variations that do not involve a Section 831(b) election that the IRS also identified as abusive.
This is not a surprising announcement by the IRS, given the approaching October 15th filing deadline. The IRS often employs “scared straight” tactics during filing season. Does that mean the IRS’ warning should be dismissed? Definitely not. There are certainly some bad apples in the microcaptive bunch. Whether by circumstance or intention the IRS would rather throw out the entire lot than pluck out those bad apples.
So what does this mean for taxpayers? Well, embedded in this “or else” warning from the IRS (linked HERE), there is some really good practical advice: Get a disinterested opinion. Too often taxpayers rely solely on the principals of the captive management company (or as the IRS calls them, promoters) whose motivations are sometimes mixed. The start-up costs of a captive are not cheap, and at the outset taxpayers are timid about the additional cost of an independent review. Compared to the potential exposure, however, such a review is a savvy investment and one that is never too late to undertake.
With each additional tax return filing, taxpayers are potentially assuming more risk. They are missing opportunities to fill in gaps and shore-up soft spots in the captive insurance planning in anticipation of an IRS audit that will almost certainly come eventually. Or worse, taxpayers are digging a deeper tax hole from which it will be harder and more painful to climb out. The IRS is not shy about proposing a 40% penalty based on a lack of economic substance where it finds a bad apple. And unless the captive planning was adequately disclosed on the return, which may involve more than a Form 8886 disclosure statement, the taxpayer may be strictly liable for that penalty, as the Internal Revenue Code removes the reasonable-cause defense to penalties based on non-disclosed, non-economic transactions. For more information about professional reviews of microcaptive transactions, see my prior Blog post linked HERE.
Yesterday’s announcement also revealed that “pivots” in the microcaptive insurance industry have not gone unnoticed by the IRS. The IRS revealed that it is “aware of variations of the abusive micro-captive insurance transactions” including “certain Puerto Rico and offshore captive insurance arrangements that do not involve section 831(b) elections.” According to the IRS, these variations are “designed and marketed with the express intent of avoiding reporting under Notice 2016-66 and yet perpetuating in some cases the same or similar abusive elements as abusive micro-captive insurance transactions.” Significantly, the IRS declared that these transactions are substantially similar to Notice 2016-66, and if not disclosed by taxpayers, the IRS “will impose penalties for the failure to disclose.”
If you have any questions about this blog post or any other tax-related matter, please do not hesitate to contact me at (214) 749-2464 or firstname.lastname@example.org.