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.
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.
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.
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 | Rev. Rul. 2001-31 |
2. All premiums paid from parent to unrelated agent then ceded to captive. | Income Tax-No insurance expense | Rev. Rul. 2001-31 |
3. Premiums paid from parent to captive along with brother/sister premiums. | Income Tax- No insurance for parent but may be insurance for relateds. | Humana |
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. | Sears Roebuck |
5. Captive is owned by multiple owners. | Income Tax- Insurance | Rev. Rul. 78-338 |
6. Captive owned by multiple owners with separate accounts for each owner. | Income Tax- No Insurance | Black Hills Corp. |
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