One of the long-awaited captive decisions by the US Tax Court was issued this month. The microcaptive 831(b) arrangements industry may need to look in the mirror very soon. This makes four major US Tax Cases that could not have been worse for captives, specifically microcaptives.
Ever since I attended a 2009 CICA Conference in Tucson, AZ, I had thought these arrangements were a way for smaller companies to use captives to insure their risks. Many of the microcaptives centers were offshore entities such as the Cayman Islands, Bermuda, and St. Kitts amongst many others.
From 2011 until 2017, I had written a business plan for establishing an offshore captive for Workers’ Compensation claims handling. The IRS placed 831(b)s on its Dirty Dozen List.
I thought I would wait to see if the IRS removed microcaptives from its Dirty Dozen list. The Service removed it in 2019, but not for the reasons that I was expecting.
The Caylor Case – Captives Go Zero For Four
The case was Caylor Land & Development Inc. v. Commissioner of Internal Revenue. Many proponents of the captive industry had been waiting on this decision for quite some time. You can find the full decision here.
The top of the decision’s third page shows two things:
- The US Tax Court will rely heavily on the cases already decided (Avrahami, Reserve Mechanical, and Syzygy).
- The last sentence below on not breaking new ground did not bode well for Caylor.
[*3] In Avrahami v. Commissioner, 149 T.C. 144 (2017), we found that a microcaptive didn’t actually provide insurance because it failed to distribute risk and didn’t act as an insurer commonly would.
In Reserve Mech. Corp. v. Commissioner, T.C. Memo. 2018-86, 115 T.C.M. (CCH) 1475 (2018), appeal filed, No. 18-9011 (10th Cir. Dec. 20, 2018), we found that a microcaptive didn’t actually provide insurance because it failed to distribute risk and didn’t act as an insurer commonly would.
Then in Syzygy Ins. Co. v. Commissioner, T.C. Memo. 2019-34, 117 T.C.M. (CCH) 1165 (2019), we found that a microcaptive didn’t actually provide insurance because it failed to distribute risk and didn’t act as an insurer commonly would.
We will break no new ground today.
Microcaptive 831(b) Arrangements – Great Article to Read
In Forbes Magazine, one of the most intelligent writers on captives (Jay Adkisson) brought up a very salient point. You might want to read his whole article. The analysis is spot-on.
One of the chilling parts of the decision according to Mr. Adkisson was the decision on Caylor could expand outside of the microcaptive 831(b) arrangements:
…the opinion in Caylor Land may potentially extend in its application to far more types of captives than where the IRS has so-far limited its own focus, which is to risk-pooled 831(b) captives. Many captives thought to be very safe from a tax perspective may require introspection and reevaluation..
Yes, you may want to follow the link to Jay’s article. It is one of the best articles on microcaptive 831(b) arrangements after the Caylor decision. Take the time to read it if you have any interest in captives.
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I think the last four tax court decisions are actually good news, for REAL captives. All four of these losers were simply efforts to manage wealth and minimize taxes. None of the four losers were being actually used to manage or finance risk.
I unwittingly formed my first “microcaptive” in 1994 for a group of six un-related residential care operations. The annual premium was just under $1.2 Million. I learned about 831(b) when I met with the accountant to review the audit. I questioned the federal tax number because we had a sizable profit. He explained that any insurance company with premium under $1.2 Million was only taxed on investment income. Good to know.
About 10 years later I started noticing all of the 831(b) promoters who were clearing selling tax shelters, not risk management strategies. Over the yeas I wondered when the IRS was going to crack down. I am glad they finally have. My clients’ captives are all risk financing vehicles. Coverages are standard, not exotic. WC, GL, PL, EPLI, Property, etc… The most exotic coverage is Cyber. Premiums are actuarially determined. Claims are filed and claims are paid.
I say good residence to those who, by thier greed and sloppiness, have tarnished the captive industry.
Dale, your comment is much appreciated. I see that your email extension is from the Cayman Islands. I had consulted for a number of years with a transportation captive in the Caymans. The captive was functioning well. The owner decided to withdraw the captive as he was in his 70’s.
I did notice, as you pointed out, that each of the microcaptive 831b arrangements had one or more defects that the tax court explained very well. The 831b industry was on the IRS dirty dozen list for almost a decade. Many 831bs paid the tax and folded after receiving the IRS audit letters. I almost started a microcaptive in St. Kitt’s but decided against it after the Sygyzy decision.
The next year will be interesting for captives. The one thing that Adkisson covered in his Fortune article was the decision reached outside of microcaptives. I assisted quite a number of captives in disbanding in the last three years. Good luck in your captive ventures and please feel free to visit our website and comment anytime.