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Offshore Captives Are Examined Again By IRS – Audit Guide

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IRS Takes Another Look at Offshore Captives

A few years ago, I warned that the IRS was beginning to examine captive more closely – mainly offshore captives.  At approximately, the same time, the IRS decided that offshore captive arrangements were just fine.  There was no need to make any new rules at that time.

Picture Of Internal Revenue Service Offshore Captives Place
Wikimedia Commons – Joshua Doubek

I was astounded that offshore captives were left virtually untouched in reference to taxes.  I had always thought there was a very large pool of funds for the US Government to just leave alone and not devise a method of taxation.

According to a recent Business Insurance article, the IRS is beginning to examine the very small captives under the 831(b) tax election.   One of the hallmarks of any captives is they must have some insurance purpose with elements of risk management.   

Hand Emphasizing Offshore Captives Risk Management
StockUnlimited

The IRS has now said that without the elements of insurance and risk management, the captives are basically tax shelters.  According to Business Insurance article, terrorism insurance is being viewed by the IRS as often abusive tax shelters.   

I decided to see what the IRS says about captives.  The first entry when searching on the IRS website for captives is The Foreign Insurance Excise Tax Auditors Manual.  I found this to be interestingly the first search result.    Chapter 6 is the part of the audit manual that covers captives. 

Tax Form Offshore Captives Paper
Wikimedia Commons – US Federal Government

Below is a great summary for the IRS captive auditor when auditing captives.  The scenarios give a very stark view of how the IRS views many types of captives.  This does speak to the 831(b) tax election for captives.  

 One can easily derive what types of captives would cause an unnecessary tax burden from the IRS. As the Federal Government searches for funds, we will all surely see more cases and rules in the headlines.   

Chart of Cases and Rulings for Offshore Captives Issues

The chart below summarizes the revenue rulings and court cases discussed in this chapter.

Scenario

Result

Reference

1. All premiums paid directly from the parent to a captive.

Income Tax-No insurance expense
Excise Tax-Potential adj. if captive reinsures with a taxable foreign reinsurer.

Rev. Rul. 2001-31
(Facts & circumstances of case to be considered as guided by case law)

2. All premiums paid from parent to unrelated agent then ceded to captive.

Income Tax-No insurance expense
Excise Tax-Potential adj. if captive reinsures with a taxable foreign reinsurer.

Rev. Rul. 2001-31
(Facts & circumstances of case to be considered as guided by case law)
Carnation Co.

3. Premiums paid from parent to captive along with brother/sister premiums.

Income Tax- No insurance for parent but may be insurance for relateds.
Excise- Potential adj. if captive reinsures.

Humana
Harper Group

4. Premiums paid from parent to captive along with unrelated third party premiums.

Income Tax- Possible insurance if percentage of third party premium is significant.
Excise Tax-Tax due on foreign premiums if determined to be insurance.

Sears Roebuck
AMERCO
Ocean Drilling
Harper Group

5. Captive is owned by multiple owners.

Income Tax- Insurance
Excise Tax- Tax due on foreign premiums.

Rev. Rul. 78-338
(No economic family theory position)

6. Captive owned by multiple owners with separate accounts for each owner.

Income Tax- No Insurance
Excise Tax- Potential adj. if captive reinsures.

Black Hills Corp.

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James Moore

Raleigh, NC, United States

About The Author...

James founded a Workers’ Compensation consulting firm, J&L Risk Mgmt Consultants, Inc. in 1996. J&L’s mission is to reduce our clients’ Workers Compensation premiums by using time-tested techniques. J&L’s claims, premium, reserve and Experience Mod reviews have saved employers over $9.8 million in earned premiums over the last three years. J&L has saved numerous companies from bankruptcy proceedings as a result of insurance overpayments.

James has over 27 years of experience in insurance claims, audit, and underwriting, specializing in Workers’ Compensation. He has supervised, and managed the administration of Workers’ Compensation claims, and underwriting in over 45 states. His professional experience includes being the Director of Risk Management for the North Carolina School Boards Association. He created a very successful Workers’ Compensation Injury Rehabilitation Unit for school personnel.

James’s educational background, which centered on computer technology, culminated in earning a Masters of Business Administration (MBA); an Associate in Claims designation (AIC); and an Associate in Risk Management designation (ARM). He is a Chartered Financial Consultant (ChFC) and a licensed financial advisor. The NC Department of Insurance has certified him as an insurance instructor. He also possesses a Bachelors’ Degree in Actuarial Science.

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