Micro-Captive Insurance Tax Litigation
- Attorneys in Freeman’s tax controversy and litigation practice have been named to U.S. News and World Report’s Best Lawyers in America list, recognized by Chambers & Partners as among the leading tax and litigation attorneys in the United States, including for fraud representations, and recognized as the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas.
- Our tax litigation attorneys include former IRS trial attorneys, former clerks to the Chief Judge of the United States Tax Court, tax law professors, dual-credentialed CPAs, and attorneys with advanced LL.M. tax degrees from the most prestigious tax programs in the nation. One third of our attorneys are law professors at tier one law schools, teaching tax law.
- We regularly take on the nation’s biggest litigation firm: The Department of Justice. We bring a systematic approach to tax litigation; and we are rewriting the odds in complex tax disputes, one case at a time.
Captive Insurance Tax Litigation
Freeman’s tax controversy practice regularly represents clients in micro-captive insurance tax disputes. We vindicate, mitigate, and defend our clients against government allegations, bringing big-firm talent, think-tank intellect, and strategic insight to their corners. We are hyper focused; responsive; and battle-tested.
We combine unique litigation skills and experience with substantive tax knowledge. Our attorneys are client-focused problem solvers. They are steeped in substantive tax expertise gained from years of experience in the trenches and provide sophisticated representation and penetrating legal acumen.
Best Lawyers® and U.S. News & World Report have recognized Freeman as a “Tier 1” Tax Law firm and our tax attorneys have garnered national recognition for their tax defense work, such as:
- The “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas
- U.S. News – Best Lawyers® Best Lawyers in America
- The Best Lawyers in America®, Chambers USA
In tax litigation, the right move at the right time can mean the difference between the right outcome and the wrong one. We begin thinking through the end game from day one. We sift through and evaluate the case, cultivating its thematic essence and distilling complex facts into clear and compelling narratives and defenses.
Captive Insurance
The use of captive insurance companies has grown remarkably in recent decades. The concept, first popularized in the 1950s, largely revolutionized the insurance industry.
A captive insurance company is an insurance company that writes insurance policies for its owners and affiliates. A “micro-captive” insurance company is a captive insurance company that makes a section 831(b) election to be taxed only on its investment income and not on its underwriting income, which must be less than $2.2 million per year.
Neither the Internal Revenue Code nor the regulations define “insurance” for federal tax purposes. Under Supreme Court precedent, however, whether an arrangement constitutes “insurance” for federal tax purposes is generally determined by looking to four factors that determine whether an arrangement constitutes “insurance” for federal tax purposes: whether the arrangement involves (1) insurance risk, (2) risk shifting, (3) risk distribution, and (4) commonly accepted notions of insurance.
Insurance Risk
As the Tax Court has held, “[b]asic to any insurance transaction must be risk. . . . If no risk exists, then insurance cannot be present.” Thus, where a transaction is structured in a manner that eliminates insurance risk, the arrangement may not constitute insurance for federal tax purposes. The IRS has also questioned whether certain types of insured risks are, in fact, valid risks faced by the taxpayer.
Risk Shifting
Risk shifting occurs when a taxpayer facing the possibility of an economic loss transfers some or all of the financial consequences of the potential loss to an insurer. Courts have looked to several factors to determine whether a risk of loss has effectively been transferred. Perhaps chief among those factors is whether the insurance company is adequately capitalized. An undercapitalized insurer would lack the ability to satisfy its obligations, leaving the risk with the taxpayer. Likewise, contractual caps on an insurer’s liability or indemnification agreements by related parties may also jeopardize the presence of risk shifting.
Risk Distribution
Risk distribution, a separate and distinct element that is necessary to constitute “insurance,” is focused on whether the captive insurance company has sufficiently spread its risk of loss. That is, has it pooled a sufficiently large collection of unrelated risks to distribute its risk among others. The concept incorporates the statistical phenomenon known as the law of large numbers, a theory that postulates that the average of a sufficiently large number of independent losses will approximate the expected loss. Courts tend to place an emphasis on factors such as the number of parties insured, the types of risk exposures insured, and the portion of premiums received from unrelated parties.
Insurance in the Commonly Accepted Sense
Finally, courts look to whether the arrangement constitutes insurance in the commonly accepted sense. To address this question, courts have traditionally looked to whether the company is organized and operated as an insurance company and regulated as such, as well as whether its premiums were the result of arms-length transactions and actuarially determined. In addition, courts consider other factors, such as whether the insurance policies were valid and binding, whether the premiums were required to be (and were, in fact) paid timely, and whether loss claims were timely satisfied.
Many micro-captive insurance arrangements are entirely legitimate, serving precisely the purpose for which Congress established them. Parties may use captive insurance companies that make elections under § 831(b) for risk management purposes that do not involve tax avoidance.
Nonetheless, the IRS has focused on micro-captives in recent years, often taking the position that their use in certain circumstances is as an abusive tax transaction brought about through the proliferation of micro-captive transactions through promoting companies. The IRS’s Large Business and International (LB&I) Division has engaged in a years-long campaign to target and audit micro-captive insurance transactions. The IRS also initiated a settlement program related to micro-captives and indicated an effort to evaluate criminal referrals for certain micro-captive transactions.
IRS Notice 2016-66 generally purports to require that micro-captive participants who satisfy guidelines set out therein, file a Form 8886 with the Office of Tax Shelter Analysis. In recent years, the IRS began sending taxpayers Letter 6336—so-called “soft letters”—requesting that taxpayers review their micro-captive insurance filing positions and notify the IRS in writing by the response due date stated in the letter, if they have discontinued taking deductions or other tax benefits from a micro-captive insurance transaction. The letter also encourages taxpayers to consult with an independent tax advisor in regard to prior year filing positions.
Micro-Captive Insurance Defense
Our firm and attorneys maintain a reputation for integrity and vigorous representations defending taxpayers and tax professionals. We have experience defending against a range of government agencies, with a particular focus on the IRS. And we provide an in-depth knowledge of the captive insurance rules and issues, as well as the developing case law.
Well-versed in high-stakes tax litigation, our attorneys are trial-ready and battle tested; we’re ready when you are.
Representative Matters
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Criminal Tax
Represented attorney in federal indictment for tax evasion.
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Criminal Tax
Represent client in alleged $12 million tax evasion.
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Criminal Tax Investigation; Non-Prosecution
Represented client in criminal tax investigation by IRS Criminal Investigation Division involving allegations of income tax evasion; “killed investigation,” obtaining agreement from IRS CID not to seek prosecution against client.
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Criminal Tax Investigation; Non-Prosecution
Represented client in criminal tax referral involving allegations of income tax evasion; “killed case,” obtaining declination to prosecute client from United States Attorneys Office.
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Criminal Tax Investigation; Non-Prosecution
Represented client in criminal tax investigation by IRS Criminal Investigation Division involving allegations of income tax evasion; “killed investigation,” obtaining agreement from IRS CID not to seek prosecution against client.
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Criminal Investigation; Seizure; Non-Prosecution.
Represented client under federal investigation for laundering and facilitating cryptocurrency exchanges following government seizure of cash. “Killed case,” and obtained government declination to pursue criminal charges, as well as obtained return of all seized funds.
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Criminal Tax Defense
Represented client as criminal counsel in federal criminal case involving allegations of criminal tax evasion and conspiracy.
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IRS “SEP” Audit/Investigations
Represented client in Special Enforcement Program (“SEP”) audit/investigation involving millions of dollars of alleged unreported income and several million dollars of unpaid tax and assessments; obtained deal to avoid criminal referral and avoidance of fraud penalties.
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Criminal Tax Defense
Represented client against criminal tax evasion charges involving allegations of the evasion of tax in excess of $1.5 million. Obtained result of no prison time.
