TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

Back in November 2016, I wrote about the IRS’s recent designation of “micro-captive” insurance arrangements as “transactions of interest.” In Notice 2016-66, the IRS required most captive insurers to file a form describing who sold and set up the captive, among other things.  Presumably, the IRS wanted that information to quickly determine which persons to target for possible promoter penalties or even criminal prosecution.

On January 31, 2017, the IRS issued a notice showing that its focus on captive insurers won’t be going away anytime soon.   The IRS’s Large Business and International Division issued a statement identifying 13 “campaigns” that target “compliance issues” that greatly concern LB&I.  The IRS’s notice suggests that the agency is focusing its scarce resources on a handful of issues to get the most bang for the buck, instead of hoping to catch issues with a randomized approach.  The list of 13 campaigns contains some of the usual suspects for LB&I, including Offshore Voluntary Disclosure Program rejects, related-party transactions, and repatriation schemes.  However, the bulk of the campaigns are issues or schemes that the IRS has more-recently identified as possible tax dodges.  And that includes “micro-captive” insurance companies.

After stating what micro-captive insurance companies do – often wholly owned by the insured, they provide insurance to related companies, allowing a premium deduction to the insured and, if the rules are followed, tax-advantaged treatment of premiums by the captive – the IRS described its concerns with captives. In particular, the IRS believes “the manner in which the [insurance] contracts are interpreted, administered, and applied is inconsistent with arm’s length transactions and sound business practices.”  In plain English, the IRS is concerned that: the insurance policies aren’t targeting real risks (think hurricane insurance in Nebraska); the premiums are set to maximize tax savings instead of based on actuarial analysis of the risks; or the captives are administered as personal piggy banks instead of true insurers.

The IRS then gave the answer that many of us were expecting after it issued Notice 2016-66 and required thousands of captive insurers to file a disclosure form: it will be conducting issue-based examinations of captives. The surprising part of the announcement – which may be disconcerting to captives that have pushed the boundaries – is that the IRS also announced that it developed a training strategy for the campaign.  Given how few IRS employees currently understand captive insurers, the agency’s captive-insurance experts were presumably overwhelmed with the disclosure forms.  The IRS stepped up with money and personnel, so this campaign appears to have legs.

Left unsaid is how many of the issue-based examinations will lead not just to audit adjustments but also civil penalties and criminal prosecutions of both clients and, more likely, promoters. The IRS will expect a return on its investment, and that spells bad news for the more-aggressive promoters and clients.  The only silver lining is that – having investigated a captive insurer while I was a federal prosecutor – captives are sufficiently complicated that very few situations would make a compelling criminal case, and neither the IRS nor the Department of Justice likes to lose a tax prosecution.

EVAN DAVIS – For more information please contact Evan Davis – davis@taxlitigator.com or 310.281.3200. Mr. Davis is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former AUSA of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) handling civil and criminal tax cases and, subsequently, of the Major Frauds Section of the Criminal Division of the Office of the U.S. Attorney (C.D. Cal) handling white-collar, tax and other fraud cases through jury trial and appeal. He has served as the Bankruptcy Fraud coordinator, Financial Institution Fraud Coordinator, and Securities Fraud coordinator for the Criminal Division.

Mr. Davis represents individuals and closely held entities in criminal tax investigations and prosecutions, civil tax controversy and litigation, sensitive issue or complex civil tax examinations and administrative tax appeals, federal and state white collar criminal investigations. He is significantly involved in the representation of taxpayers throughout the world in matters involving the ongoing, extensive efforts of the U.S. government to identify undeclared interests in foreign financial accounts and assets and the coordination of effective and efficient voluntary disclosures (OVDP, Streamlined Procedures and otherwise).