The IRS is Targeting the Illegal use of Micro-Captive Insurance Companies in 2020
One of the things IRS agents and auditors greatly frown upon is the practice of creating tax shelters and shell companies to deliberately flout tax laws or claim deductions for which you are not legally eligible. One of the new tax-avoidance schemes that has begun to appear with more and more regularity in the last decade is the creation of micro-captive insurance companies in order to claim tax deductions involving exorbitant premiums. The IRS has cracked down hard on this type of tax shelter scheme, sending letters out in late 2019 to hundreds of taxpayers they believed were fraudulently using micro-captive insurance to avoid taxes and offering them a possible way back into compliance without the risk of criminal tax prosecution. At the Tax Law Offices of David W. Klasing, our experienced Tax Lawyers and CPAs can help you ensure than any captive insurance programs utilized by your businesses are being properly run, and can work to mitigate the damage if the IRS is already looking at you for a potentially fraudulent tax scheme. Continue reading to learn if the IRS is still targeting micro-captive insurance companies in 2020.
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Captive insurance refers to a situation where a company creates a wholly-owned subsidiary that insures them. Most captive insurance programs are entirely legal and not of interest to the IRS. They can be owned by large conglomerates as well as local small businesses or farmers. Micro-captive insurance refers to a small captive company that may be taxed under section 831(b) of the Internal Revenue Code. This section applies to all small insurance companies, not just those that are captive.
For section 831(b) to apply, the insurance entity must meet several standards. First, they must qualify as an insurance company for tax purposes. In a nutshell, this means that it must have adequate risk-shifting and sharing and that it must be operated and regulated like a real insurance company. Second, the company must be a U.S. taxpayer, either through being domiciled in the U.S. or having elected and qualified to be taxed as a U.S. insurer. Third, the gross premium income for the tax year in question must be $2.2 million or less, with the premium cap subject to inflation adjustments.
If a micro-captive qualifies to be taxed under section 831(b) of the code, it will have to pay income taxes only on its investment income and not on its underwriting income. As such, promoters have been selling the use of these micro-captive insurance agencies to small business owners, who attempt to use them in order to achieve lower taxes and such benefits as avoiding the taxation of wealth transfer, among others. This has, in turn, resulted in a rise in the use of these abusive micro-captives that are designed to artificially generate large tax deductions and other benefits rather than act as a legitimate insurance company.
The IRS has long taken note of the rise of micro-captive insurance schemes, placing the scheme on the “Dirty Dozen” of tax schemes to avoid every year since 2014. Their investigations have heated up in recent years. According to the IRS, warning signs that might lead to an investigation include the following: “(1) the coverage involves an implausible risk, (2) the coverage does not match a business need or risk of the insured, (3) the description of the scope of the insurance coverage is vague, ambiguous, or illusory, or (4) the coverage duplicates coverage provided to an insured by an unrelated, commercial insurance company, and the policy with the commercial insurer has a far smaller premium.” Furthermore, agents will often look to see if the claim process was either severely lacking or nonexistent in order to tell if actual insurance underwriting is occurring.
The quick and easy answer to this question is yes. The IRS is still targeting micro-captive insurance schemes and has recently begun to offer a life raft to those who know they may be in violation of micro-captive related fraud. In the fall of 2019, the IRS sent out hundreds of letters to taxpayers placed under audit for suspected fraudulent activity related to micro-captive insurance schemes. The letters offered a settlement to these taxpayers. At the same time, not every individual under audit received such a settlement offer. The terms of these settlements have typically been ‘take it or leave it,’ with no counteroffers being accepted.
Some of the terms of the deal have included filling out a series of forms and making full disclosure, cooperating fully with the IRS, including into a potential investigation of the promoter who sold you on the captive idea in the first place, and that only a 10% deduction for insurance premiums under the plan will be permitted, with the other 90% deduction being disallowed. Other fines and penalties are also likely to be assessed. Only a skilled, experienced tax attorney like those at the Tax Law Offices of David W. Klasing can help you determine whether such a deal is right for you without becoming a potential witness against you under the attorney client privilege.
In early 2020, the IRS sent out a press release touting the early success of these settlement offers and indicating their intent to press on, including adding 12 new examination teams that will be working to address these abusive transactions and open additional investigations. If you receive notice of an audit or believe you may be audited related to a micro-captive insurance scheme, contact an experienced tax lawyer like those at the Tax Law Offices of David W. Klasing right away. We can work to get you a similar or even better settlement and try to mitigate the most dangerous potential consequences, including criminal penalties. Call us today at 800-681-1295 to set up a consultation or schedule online here.
Regardless of your business or individual tax needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.
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