IRS Issues Warning Regarding Abusive Micro-Captive Insurance Arrangements

Hot Topics, Offshore Account Update

Posted on April 30, 2021 |

Earlier this year, we reported that the Internal Revenue Service (IRS) was sending warning letters to micro-captive insurance companies and their clients. On April 9, the IRS issued a News Release that underscores its intent to target taxpayers who participate in abusive micro-captive insurance arrangements in 2021. New Jersey tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, explains:

IRS Prevails in U.S. Tax Court Case Challenging Deductions Related to Micro-Captive Insurance

In its News Release, the IRS touts its recent victory in a U.S. Tax Court case which resulted in a denial of tax benefits related to a micro-captive insurance arrangement. As the IRS explains, the Tax Court held that “yet another micro-captive arrangement failed to qualify as insurance for federal tax purposes . . . [and t]his decision follows several earlier Tax Court decisions that also confirmed the IRS' determinations that certain micro-captive arrangements were not eligible for the claimed federal tax benefits.”

Micro-captive insurance arrangements have now been an enforcement priority for the IRS for several years. The IRS has identified these arrangements as having a high potential for fraud—particularly with regard to participants claiming deductions for which they are ineligible under the Internal Revenue Code. In early 2020, the IRS established 12 new audit teams devoted exclusively to uncovering abusive micro-captive insurance arrangements, and these teams are continuing to operate in 2021.

“Transactions of Interests” At High Risk for IRS Scrutiny

In particular, these new audit teams are focusing on what the IRS has termed, “Transactions of Interest.” These are micro-captive insurance transactions that are “the same as or substantially similar to” those described in IRS Notice 2016-66. Although relatively few taxpayers are likely to be familiar with IRS Notice 2016-66, once the IRS issues this type of notice, it expects full compliance, and it assumes that affected taxpayers will do what is necessary to follow its guidance.

In addition to identifying the six elements of a “Transaction of Interest,” IRS Notice 2016-66 addresses several other topics pertaining to micro-captive insurance arrangements as well. This includes specific types of coverage and payments that are hallmarks of abusive micro-captive schemes, claims procedures that are “red flags” for auditors, and possible exceptions to the general prohibitions that apply.

Avoiding (or Responding to) an IRS Micro-Captive Insurance Audit or Investigation

In order to avoid the risk of facing an audit or investigation, the IRS advises U.S. taxpayers not to claim deductions pertaining to micro-captive insurance arrangements. For taxpayers who have already claimed these deductions – and who are now facing an audit or investigation as a result – it is important to engage experienced tax counsel promptly. As an IRS enforcement priority, matters involving micro-captive insurance arrangements can lead to substantial penalties, and taxpayers need to be prepared to defend themselves by all means available.

Consult with New Jersey Tax Attorney Kevin E. Thorn, Managing Partner of Thorn Law Group

Are you facing IRS scrutiny in relation to a micro-captive insurance arrangement? If so, call 201-355-8202, email or contact us online to schedule an appointment with New Jersey tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group.

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