By Doug Connolly, MNE Tax
The US Tax Court held on March 10 that a microcaptive insurer purportedly established to insure a number of related construction companies did not actually provide insurance for federal tax purposes because the insurer neither distributed risk nor acted as an insurer commonly would. (Caylor Land & Development, et al v Commissioner, T.C. Memo 2021-30 (Mar. 10, 2021).)
Microcaptives are small captive insurers with annual premiums below a certain inflation-adjusted threshold ( USD 1.2 million during the years at issue in the current case) that can take advantage of special tax rules. They have garnered IRS scrutiny in recent years due to their potential for tax abuse. This case marks another in a string of victories for the IRS on this issue.
Several factors apply under established case law for determining when “insurance” is deductible insurance for federal tax purposes. In this case, the court determined that the company failed the risk distribution prong of the test because of the limited number of entities insured (about a dozen) and the fact that they all operated almost exclusively in the real estate market in one metropolitan area (Tucson, Arizona).
In addition, the court determined that the captive arrangement didn’t look like insurance because losses were paid without proof of loss, policies weren’t written until after the covered period, and the premiums ( USD 1.2 million / year) far exceeded historic losses (about USD 50,000 / year).
Doug Connolly
Doug Connolly is Editor-in-Chief of MNE Tax. He has more than 10 years of experience covering tax legal developments, previously working with both a Big Four firm and a leading legal publisher. He holds a law degree from American University Washington College of Law.
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The pricing issue is interesting. With the expected losses being $50,000 per year and the price for insurance paid to 3rd parties before 2007 being $60,000 per year, an intercompany insurance fee = $1.2 million per year certainly appears to be excessive.