IRS Says It's Getting Tougher on Micro Captive Users

The Internal Revenue Service says it's sending a new settlement offer to taxpayers who have used what the IRS believes to be abusive micro captive insurance transactions.

Resources

A copy of the new IRS micro captive enforcement press release is available here.
An article about a wave of IRS micro captive audits is available here.

The IRS announced Thursday that it's making the new offer to taxpayers who are already being audited.

Taxpayers who are already involved with micro captive cases in Tax Court may not get settlement offers, the IRS says.

In some cases, the IRS says, the agency may offer the new settlement deal to taxpayers who rejected an earlier settlement offer that the IRS made to some micro captive insurers last year.

The new offer is tougher on the affected taxpayers than the 2019 offer was, the IRS says.

A taxpayer who agrees to the standard version of the new settlement offer must make "substantial concession of the income tax benefits claimed by the taxpayer together with penalties," the IRS says.

An eligible taxpayer may be able to reduce the financial impact of the settlement if the taxpayer "can demonstrate good faith, reasonable reliance on an independent, competent tax advisor and if the taxpayer can demonstrate it did not participate in any other reportable transactions," the IRS says.

The IRS says eligible taxpayers who reject the new settlement offers could face "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."

Micro Captive Basics

A micro captive is a small insurance company that's controlled by one taxpayer, or by one organization.

The IRS has been warning taxpayers about its concerns about potentially abusive micro captives since 2014. The agency won three micro captive court rulings in its favor, then, in September 2019, began trying to persuade users of potentially abusive micro captive arrangements to agree to settlement offers.

As of February, about 80% of the micro captive owners who received the offers had accepted the offer terms, according to the IRS.

Many captives are property and casualty insurers. Some of the P&C captives use their cash to buy corporate-owned life insurance (COLI).

The IRS did not refer directly to life insurance captives, or to use of captive cash to buy COLI coverage, in the new micro captives settlement offer announcement.

The Big Picture

One question is whether the IRS approach to handling the micro captives users provides any clues about how the IRS handles other concerns on its "Dirty Dozen tax scam" list.

Most of the IRS concerns on the 2020 Dirty Dozen list relate to obvious cases of fraud, such as criminals using deceptive emails or deceptive websites to steal people's information.

One less obvious item on the 2020 list could be of interest to financial professionals who have clients living in nursing homes or other long-term care (LTC) facilities.

The IRS has warned LTC facilities that it sees facility moves to take federal COVID-19 relief program payments away from residents as a form of theft.

The COVID-19 economic impact payments "do not count as a resource for determining eligibility for Medicaid and other federal programs," the IRS says. "They also do not count as income in determining eligibility for these programs."

The two-step settlement offer process for the micro captive users might not be a good fit for situations involving alleged instances of COVID-19 relief payment theft.

— Read IRS Warns Micro Captive Users of Imminent Shock and Awe, on ThinkAdvisor.

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