The case is SCC Holding Company of Pinellas, Inc. v. Commissioner, Docket No. 16285-22, filed in July 2022. At the time of filing, the taxpayer and the IRS were already long-time “friends.” Starting in 2016, the IRS had issued a series of Notice of Deficiency covering tax years 2010 through 2016. Therein, the IRS disallowed deductions for captive insurance premiums and asserted a 40% penalty based on the IRS’ determination that the microcaptive planning lacked economic substance and was not properly disclosed.
Apparently the IRS had more “love” to show this taxpayer. In 2022, the IRS issued another Notice of Deficiency covering the same tax years (2010-2016) but with new theories for additional liability. As brief background, the captive insurance companies at issue were non-U.S. companies that had each made an election under IRC Sec. 953(d) to be treated as a U.S. person for federal income tax purposes. Such election is only available to insurance companies and it allowed the companies to make an IRC Sec. 831(b) election, which entitled the captives to exclude from gross income a fixed amount of earned premium each year. In line with its prior determination that the insurance planning lacked economic substance, the IRS determined that the captives were not “real” insurance companies; therefore, they were not eligible to make a IRC Sec. 953(d). Accordingly, the IRS argued that the captives were foreign entities, and the premiums paid by the taxpayer to the foreign entities were subject to withholding tax. For good measure, the IRS imposed failure to file and pay penalties based on taxpayer’s untimely reporting and payment of this newly-imposed withholding tax.
So, the IRS disallowed the deductions for the captive premiums AND imposed withholding taxes on payment of those same premiums?! Yes sir. For six years?! Yup. Is that legal?! Well, it is clever. Admittedly, though, there is tension between the IRS’ treatment of the premiums paid as non-deductible expenses to the payor, and yet income to the recipient, which the court could view as an improper whipsaw. Regardless, the IRS’ latest move creates another layer of complexity and potential exposure for microcaptive disputes.
If you have any questions about this Blog post or any IRS or tax-related matter, feel free to contact me directly at (214) 749-2464 or firstname.lastname@example.org.