By Anthony Diosdi
Once upon a time, there was a type of insurance company known as a micro-captive insurance company. The use of micro-captive insurance companies were a very effective vehicle for transferring wealth out of an operating business so that wealth was not trapped and exposed to higher taxation by the IRS. By paying premiums to a micro-captive insurance company, wealth was effectively transferred out of the operating business and into the captive. The premiums of the policies were paid with pre-tax dollars by the business. Because micro-captive insurance companies had the benefit of being able to accrue reserves tax-free and other tax advantages available only to insurance companies, micro-captive insurance companies offered huge tax benefits. For example, Internal Revenue Code Section 831(b) permitted micro-captive insurance companies to claim up to $1.2 million tax-free per year.
Unfortunately, micro-captive insurance companies were abused by a number of tax advisors who believed they could be used primarily for tax avoidance. The IRS has begun to aggressively audit owners of captive insurance companies. Through audits, the IRS typically has disallowed any business deductions related to policies issued by micro-captive insurance companies. The IRS has also imputed taxable income to captive insurance company owners and has assessed significant penalties against owners of captive insurance companies. In addition to auditing taxpayers that have participated in micro-captive transactions, the IRS is litigating captive insurance company cases in federal court. At last count, the IRS has over 500 docketed Tax Court cases involving captive insurance companies.
The IRS recently announced the mailing of a time-limited settlement offer for certain taxpayers under audit who they believed participated in abusive micro-captive insurance transactions. 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 a settlement offer.
The IRS has stated that taxpayers who receive letters under this settlement offer, but who opt not to participate, will continue to be audited. The “potential outcomes [of these audits] may include full disallowance of captive insurance deductions, inclusion of income by the captive, and imposition of all applicable penalties.”
If you have received a letter from the IRS settlement offer letter from the IRS or if you participated in a micro-captive insurance company structure in the past, you should immediately contact a tax attorney who has experience with micro-captive insurance structures.
The attorneys at Diosdi Ching & Liu, LLP has advised clients throughout the United States regarding the use of micro-captive insurance companies and has represented clients who were owners of micro-captive insurance companies in IRS audits.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi represents clients in federal tax controversy matters and federal white-collar criminal defense throughout the United States. Anthony Diosdi may be reached at 415.318.3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.