U.S. Tax Court Upholds Tax Penalties Against Taxpayer’s Insurance Scheme for Lacking Economic Substance

The U.S. Tax Court held that a 40 percent accuracy-related penalty applied to taxpayers’ underpayment attributable to a microcaptive insurance arrangement that lacked economic substance, affirming the IRS’s penalty determination. Taxpayers, a married couple, entered a microcaptive insurance arrangement where their passthrough entity paid purported insurance premiums to a captive insurance company owned by the husband. The court found the arrangement lacked economic substance under IRC §7701(o) because it did not meaningfully change taxpayers’ economic position apart from tax effects, and taxpayers had no substantial non-tax purpose for entering it. The court rejected the taxpayers’ argument that the economic substance ...