IRS to Crack Down Further on Microcaptive Insurance Arrangements
Last month, the IRS announced plans to initiate thousands of additional examinations of businesses engaging in microcaptive insurance arrangements. This announcement came after three successful Tax Court cases against companies deemed to have engaged in abusive tax shelters. Businesses paying premiums to microcaptive insurance companies should carefully consider their risks in this quickly evolving area.
What is Microcaptive Insurance?
A captive insurance company is formed by a business owner to insure the risks of related or affiliated businesses. They are often wholly-owned subsidiaries of a holding company and are established to insure business risks for which commercial insurance is not available or may be cost prohibitive including areas like cybersecurity, fraud, and reputation risk.
Captive insurance companies also enjoy certain advantages within the tax code. The premiums paid by the bank or other subsidiaries to the captive insurance company are fully tax deductible while the captive insurance company pays no income tax on the premiums it receives as long as the total premiums are less than $2.3 million annually.
The IRS’s Concerns
The IRS has increased scrutiny of microcaptives in the last two years asserting that some arrangements lack the characteristics of genuine insurance policies and are being used merely to save taxes. In some cases, the plans have been found to cover implausible risks, risks that didn’t match genuine business needs, or insurance that duplicates the taxpayer’s commercial coverage.
This certainly doesn’t mean that all microcaptive insurance arrangements are bad. We believe that there are well-designed arrangements available in the market, but each situation is unique and the burden of proof remains on the taxpayer upon examination.
Further IRS Action
In late 2019, the IRS announced settlement offers to hundreds of taxpayers already under examination for this issue. It is reported that 80% of those taxpayers elected to accept the settlement terms, which included the disallowance of 90% of premium deductions and the payment of substantial penalties. In follow up to that campaign, the IRS is now deploying additional resources including twelve new examination teams and plans to initiate thousands of new exams.
We believe that the initial round of exams and settlements likely targeted some of the worst offenders when it comes to captive arrangements, but this new round of exams that has been announced is likely to target a broader base of entities. Though we certainly don’t know just yet, we feel there is an increased likelihood of community banks and other financial institutions being included in future IRS examination cycles.
Next Steps
The rules surrounding microcaptive arrangements are complex and there is a lot of subjectivity involved in underwriting insurance policies. Management will want to carefully consider the risks associated with their captive insurance arrangement and the costs of going through an IRS exam if one was to occur.
CLA is here to help. Please contact us.
Amanda Garnett is a principal in the financial institutions practice of CliftonLarsonAllen (CLA) from Peoria, Illinois. She currently leads the firm’s Midwest financial institution tax team and serves institutions ranging in size from $15 million to $3.5 billion in total assets. In addition to tax compliance, Amanda assists clients in the areas of tax consulting, mergers and acquisitions, and regulatory reporting. She also routinely teaches courses for banking associations across the country.
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