The IRS’s latest enforcement push against small insurance companies seen as tax shelters comes as businesses, including insurers, deal with the economic fallout of the coronavirus pandemic.
Owners of small insurance companies, known as micro-captives, recently received letters from the IRS—Letter 6336 (3-2020)—stating the agency had information that they may have claimed tax benefits for which they weren’t eligible. The letters, which warned the owners that they may be subject to a future audit and penalties, include a May due date for taxpayer responses.
The IRS has increased scrutiny of micro-captive arrangements in recent years, asserting that some lack the attributes of genuine insurance and are merely created to sidestep taxes. The agency already has several U.S. Tax Court wins under its belt. The letters, which were sent shortly after President Donald Trump declared the Covid-19 outbreak a national emergency, are the latest development in that saga.
While the correspondence doesn’t come as a surprise to the industry, “the timing is unfortunate,” said Steven Miller, a former acting IRS commissioner who now works as the national tax director at alliantgroup LP. His firm is representing a number of companies that have used captive insurance.
Many businesses are dealing with disruptions because of shelter-in-place orders, including office closures and cash flow problems that are requiring immediate attention.
It’s likely the IRS planned the release of the letter far in advance, not accounting for the current crisis, Miller said.
“The service doesn’t turn on a dime,” he said, adding that the agency may consider extending the response date on the letters but it’s unlikely to revoke them entirely.
The letters serve two purposes for the IRS: they warn micro-captives that the agency is serious about auditing them, and the responses can help the agency make a more intelligent decision about where to focus enforcement resources, Miller said.
The IRS declined to comment.
The Self-Insurance Institute of America Inc. is asking the IRS to suspend the response deadline, pause any further audit activity, and potentially reconsider the letter altogether given that the agency may be able to pull some of the requested information from other forms filed by most micro-captives.
Ryan C. Work, vice president of government relations at SIIA, referred to the enforcement letters as “clearly insensitive” and “thoughtlessly timed” in a letter sent to the IRS and the Treasury Department Monday. Work’s letter included a redacted version of the agency’s enforcement letter.
Micro-captive businesses 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 newest campaign assumes all micro-captive insurance arrangements are abusive, even as some have offered crucial support to businesses harmed by the coronavirus, Work said. Their ability to offer coverage options during this time that aren’t available on the commercial market has “vindicated” micro-captives previously maligned by the government, he said.
The pandemic doesn’t turn a weak company into a strong one, David J. Slenn, a partner at Shumaker, Loop & Kendrick LLP, said, disagreeing with the idea that the virus has vindicated anyone. Slenn is a former chair of the American Bar Association’s captive insurance committee.
The law firm Hochman Salkin Toscher Perez P.C. in a blog post last week said the new letters to micro-captives allow them to revisit the legitimacy of the tax benefits they’ve claimed.
The letters “may present an opportunity to take proactive, corrective measures that may assist in avoiding onerous examinations and steep penalties that could otherwise be asserted against them,” the post said.
The IRS letter recommended that insurers consult an adviser before filing their 2019 tax returns to determine whether past benefits were claimed correctly and to file amended returns if they weren’t. The agency also said it’ll take the taxpayers actions into account when considering future compliance activity.
Matthew J. Mueller, a shareholder at Wiand Guerra King PA and a former prosecutor with the Department of Justice’s tax division, said he hopes this language indicates that those who are proactive will be eligible for penalty mitigation if penalties are deemed appropriate.
The bottom line is micro-captives should take the letters seriously and try to respond to the IRS by the current deadline, Mueller said. It wouldn’t be wise for them to ignore the agency’s request, he said.