Those who helped organize and sell tax-dodging insurance schemes could face penalties adding up to hundreds of thousands or potentially millions of dollars, after the IRS excluded them from a settlement program.
The agency told Bloomberg Tax that it plans to continue enforcement action and open additional promoter examinations in the micro-captive insurance area. The statement comes after the IRS announced it was extending settlement offers to up to 200 taxpayers that participated in micro-captive structures it views as abusive.
The fact that the promoters—which are most often the captive managers, but can also include wealth planners, accountants, and actuaries—were barred from the deal means they may face the severest punishment for their role in facilitating the transactions.
“The IRS is going to continue to go after the promoters and take them down, wipe them out, and keep them from doing another scheme,” said Jay Adkisson, a former chair of the American Bar Association’s captive insurance committee.
Promoters face a slew of potential penalties, including two under under tax code Section 6700. The first under that code section is equal to the lesser of $1,000 or 100% of the gross income the person derived from tax shelter activities involving gross valuation overstatements.
In cases where a promoter is found to have knowingly furnished tax statements that are materially false or fraudulent, the agency imposes a penalty equal to 50% of the gross income the person derived from the activity. This is typically a more serious outcome.
These penalties apply to each instance in which the person organized or sold an abusive plan or arrangement. So, for someone who promoted hundreds or thousands of abusive micro-captive arrangements, the hit can be enormous.
Reserving the Right
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.
In abusive cases “promoters, accountants or wealth planners persuade owners of closely held entities to participate in schemes that lack many of the attributes of genuine insurance,” the IRS said in the Sept. 16 news release announcing the settlement initiative.
By barring promoters from the settlement program, the IRS “is reserving the right to take a more aggressive approach if they view the promoter’s conduct to be egregious,” said Matthew J. Mueller, a shareholder at Wiand Guerra King PA and a former prosecutor with the Department of Justice’s tax division.
“The IRS likely views them, in some cases, as more culpable than the average taxpayer who entered into a micro-captive arrangement,” he said.
But others—like Steven T. Miller, a partner at Zerbe, Miller, Fingeret, Frank and Jadav LLP—urged people not to read too much into what the announcement means for captive managers or others that could fall into the promoter category.
“I don’t take anything one way or another with respect to captive managers because this deals with captives themselves,” said Miller, a former acting IRS commissioner.
The intention of the IRS’s settlement initiative is likely to clear out a large chunk of the agency’s micro-captive inventory because the cases are draining a disproportionate amount of audit resources, said Philip Karter, a shareholder at Chamberlain, Hrdlicka, White, Williams & Aughtry who worked as a trial attorney with the DOJ tax division in the late ‘80s and early ‘90s.
It makes sense then why the agency would focus on the micro-captives and those they have insured because there are a lot more of them than there are promoters, he said.
The smaller number of promoter cases means there isn’t the same inducement to ease up on promoters or offer them some sort of settlement deal—at least in the short term. Still, it’s not out of the question that promoters could get a settlement offer at some point in the future if the dynamics shift, Karter said.
People are looking to the government’s actions against perceived abuses of tax-advantaged land deals for clues as to how the IRS and the Justice Department’s tax division may proceed in the micro-captive area.
DOJ’s tax division in December 2018 filed a lawsuit to shut down promoters of a conservation easement syndication tax scheme operating out of Georgia. Syndicated conservation easements are deals that involve multiple people claiming a charitable deduction for donations of property that will be protected from future development under tax code Section 170(h).
The IRS has contended that some individuals are facilitating transactions that give investors the opportunity to obtain charitable contribution deductions and corresponding tax savings that significantly exceed the amounts they invested.
In the DOJ conservation easement case, United States v. Zak et al, the government is asking a judge to order the promoters to both cease operation of their scheme and relinquish all “ill-gotten gains” from the alleged tax shelter activity dating back to when their promotion began. Promoters of micro-captive arrangements could face similar treatment if DOJ decides to act, Mueller said.
DOJ declined to comment.
Both abusive micro-captive and syndicated conservation easement arrangements are on the IRS’s “Dirty Dozen” list of tax scams and top officials, including IRS Commissioner Charles Rettig, have said cracking down on these transactions is a priority.
Some practitioners, however, want to stress that despite the recent backlash against the micro-captive industry, not all promoters and participants are abusing the system.
It’s worth remembering that before the first micro-captive U.S. Tax Court decision, courts routinely sided in favor of taxpayers over challenges to captive insurance arrangements falling outside the scope of Section 831(b), Karter said.
“With micro-captives, the pendulum has just swung too far in the other direction and, speaking frankly, it is because a few bad apples have spoiled the whole barrel,” he said.