IRS Stirring the Pot Again with Micro-Captives: Settlements Announced

On September 16, 2019, the Internal Revenue Service (“IRS“) announced that it would be mailing settlement offers for certain taxpayers under audit who participated in “abusive” micro-captive insurance transactions.1 The micro-captive transactions were listed as a transaction of interest by the IRS back in 2016.2 Section 2 of Notice 2016-66 described the transaction itself as being subject to reporting as a transaction of interest.

The IRS stated in its announcement that it decided to offer settlements to taxpayers currently under exam. At the time of the release, the IRS stated that it started sending notice to up to 200 taxpayers. Per the IRS release, taxpayers who receive letters under this settlement offer, but who opt not to participate, will continue to be audited by the IRS under its normal procedures. Potential outcomes may include full disallowance of captive insurance deductions, inclusion of taxable income by the captive, and imposition of all applicable penalties. Additionally, for those who utilized captives to assist with estate and gift tax planning, the terms of the settlement essentially neutralize those benefits.3 Participants will be required to file gift tax returns, as applicable, and either pay gift tax or use their unified credit.

The settlement may be an opportunity to bring finality to taxpayers with respect to certain micro-captive insurance issues. Per the IRS release, the settlement requires substantial concession of the income tax benefits claimed by the taxpayer together with appropriate penalties (unless the taxpayer can demonstrate good faith and reasonable reliance). Taxpayers eligible for the settlement will be notified of the terms by letter from IRS. The initiative is currently limited to taxpayers with at least one open year under exam. Taxpayers who also have unresolved years under the jurisdiction of the IRS Appeals may also be eligible, but those with pending docketed years under the IRS Chief Counsel’s jurisdiction are not eligible. The IRS is continuing to assess whether the settlement offer should be expanded to others.

Additionally, the release states that the IRS Independent Office of Appeals is aware of the settlement offers and that the settlement offers generally reflect the hazards of litigation faced by taxpayers, and that taxpayers should not expect to receive better terms in Appeals than those offered under the IRS settlement initiative.

Taxpayers who are offered this private resolution and decline to participate will not be eligible for any potential future settlement initiatives. The IRS also plans to continue to open additional exams in this area as part of ongoing work to combat these allegedly abusive transactions

Yes, there may be some bad actors out there. Perhaps not everyone needs volcano insurance. It certainly seems the IRS is as frustrated with micro-captives as it was with the combination of Roths and domestic international sales corporations, which did not work out so well for the IRS.4 Based on its passing of the relevant statutes in question, on would think Congress wanted taxpayers to have a tool to self-insure and mitigate taxes.

Joshua W. Sage, J.D., LL.M.

Josh is a partner at ESD Law. Josh practices in the areas of tax, business, and estate planning. View Full Profile.

Footnotes

  1. See IR-2019-157 and Settlement Agreement
  2. See Notice 2016-66
  3. See Settlement Agreement Section 2(g)
  4. See Summa Holdings, Inc. v. Comm’r, 848 F.3d 779 (6th Cir. 2017).