On October 22, the IRS announced (IR-2020-241) a second time-limited settlement initiative for certain taxpayers under audit who participated in abusive micro-captive insurance transactions. The IRS will begin sending settlement offers to applicable taxpayers with terms that are stricter than the settlement terms from the first time-limited settlement initiative. (See our prior alert.) Taxpayers who received offers from the first settlement initiative may receive offers from the second settlement initiative but will be limited to the stricter terms of the second initiative.
In Notice 2016-66, the IRS designated certain micro-captive insurance arrangements as “transactions of interest.” Although many taxpayers engage in captive insurance arrangements to legitimately self-insure against business risk, the IRS expressed concern that some arrangements may result in tax abuse. The notice requires taxpayers participating in such arrangements to disclose the transaction on Form 8886, Reportable Transaction Disclosure Statement, and file the form with their current tax return and with the Office of Tax Shelter Analysis. The IRS has successfully litigated several cases regarding abusive micro-captive insurance arrangement in the last few years.
The recent announcement advises that the IRS has decided to resolve certain cases by requiring “substantial concession” of tax benefits claimed by the taxpayer in addition to penalties. The penalties could be partly mitigated if the taxpayer can demonstrate that it acted in good faith, reasonably relied on an independent, competent tax advisor and if the taxpayer can demonstrate it did not participate in any other reportable transactions.
Taxpayers must receive an offer letter in order to be eligible for the settlement. The settlement initiative is currently limited to taxpayers with at least one open year under exam. Taxpayers with unresolved years under the jurisdiction of the IRS Independent Office of Appeals may also be eligible. However, tax years involving micro-captive transactions docketed in the Tax Court under the Chief Counsel's jurisdiction are not generally eligible.
Taxpayers who do not choose to participate in a proffered settlement will continue to be audited under normal procedures. The IRS warns that outcomes of such exams may include the full disallowance of captive insurance deductions, inclusion of income by the captive, withholding tax related to any foreign captives and imposition of all applicable penalties.
Taxpayers who receive a settlement offer from the IRS should consult with their tax advisor to determine the consequences of accepting or declining an offer. Taxpayers who engage in micro-captive insurance transactions should examine the structure of their captive insurance arrangement to determine if they are at risk of having their structure examined for abusive tax avoidance.