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Clock Ticking for Micro-Captives Considering IRS Settlement Offer (2)

Sept. 16, 2019, 7:23 PMUpdated: Sept. 16, 2019, 10:32 PM

Taxpayers who have used a certain insurance arrangement to dodge taxes have a small window for accepting a recent settlement offer from the IRS.

The Internal Revenue Service in a Sept. 16 news release said its offer—available to only some taxpayers who participated in abusive micro-captive insurance arrangements—is time-limited.

“That means hurry,” said David J. Slenn, a partner at Shumaker, Loop & Kendrick LLP and a former chair of the American Bar Association’s captive insurance committee. Taxpayers who receive an offer from the IRS should contact their advisers immediately to determine it if it makes sense for them to take the deal, he said.

One of the offer letters obtained by Bloomberg Tax gives the taxpayer 30 days to decide, with the option to request a one-time 30-day extension.

The IRS’s announcement comes after the agency picked up three consecutive wins in U.S. Tax Court cases involving micro-captive insurance arrangements. The agency has increased scrutiny of the arrangements in recent years, asserting that some lack the attributes of genuine insurance and are merely created to sidestep taxes.

Micro-captives are small insurance companies that qualify under tax code Section 831(b) to choose to pay tax only on their investment income. To be eligible a company must have $2.3 million or less in premium income.

The IRS’s deal “is perhaps really good news for a lot of people who just want to put this behind them,” Slenn said.

Take the Deal?

Taxpayers will need to decide whether to take the IRS’s deal on a case-by-case basis, said Kristin Gutting, a managing director at Dixon Hughes Goodman LLP.

Without getting into the specific terms of the settlement offer, which the IRS didn’t disclose in its news release, Gutting said the deal is favorable if considered against the outcomes that have been reached in court.

The letter—obtained by Bloomberg Tax—would allow the taxpayer to deduct 10% of the premiums paid to the micro-captive. The remaining 90% would be treated as a nontaxable capital contribution to the captive or it could presumably be refunded as excess premium, practitioners who read the letter said.

“Letters mailed to date have included similar terms for settlement, the actual application of which could vary depending on facts and circumstances,” the IRS said in a statement emailed to Bloomberg Tax.

The IRS in its news release said the settlement requires “substantial concession of the income tax benefits claimed by the taxpayer together with appropriate penalties” unless the taxpayer can successfully convince the agency that penalties should be waived.

‘Sweetheart Deal’

Jay Adkisson, another former chair of ABA’s captive insurance committee, called the IRS’s offer a “sweetheart deal” compared with what taxpayers who have challenged and lost to the agency in court have faced.

“So I suspect anybody that gets one of these letters is probably going to take it,” he said. “I can’t imagine that they won’t.”

Taxpayers who are eligible for the IRS’s settlement offer will be notified by mail. The agency recently began sending letters to up to 200 taxpayers.

If taxpayers decline the offer the IRS will continue to audit them under its normal procedures, and eventual outcomes will likely be far less favorable, the agency said in its news release.

“We encourage taxpayers under exam and their advisors to take a realistic look at their matter and carefully review the settlement offer, which we believe is the best option for them given recent court cases,” IRS Commissioner Charles Rettig said in the news release. “We will continue to vigorously pursue these and other similar abusive transactions going forward.”

Potentially More to Come

The IRS’s settlement initiative is currently limited to taxpayers with at least one open tax year under audit.

“Taxpayers who also have unresolved years under the jurisdiction of the IRS Appeals may also be eligible, but those with pending docketed years under Counsel’s jurisdiction are not eligible,” the agency said in the news release.

This means that taxpayers involved in the more than 500 docketed micro-captive cases sitting at the Tax Court won’t be able to take advantage of the deal.

Barring taxpayers who have filed cases with the Tax Court from participating in the settlement is a way for the IRS “to turn the faucet off of Tax Court litigation,” Adkisson said. “Somebody who goes to Tax Court now, if they have a chance of getting one of these offers, is making an awfully bad decision.”

The IRS in its news release said it’s assessing whether to expand its settlement initiative to more taxpayers. Adkisson said he expects those who aren’t eligible for the current deal will be clamoring for something similar.

The agency is keeping that door open, meaning this might just be the “first wave” of settlement offers, Slenn said.

(Updates with IRS statement in 11th paragraph. An earlier version added additional practitioner comments.)

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com