IRS Torpedoes Results of Over a Decade of Promoter Shenanigans in 831 (b) Captive Insurance
By Beckett G. Cantley, JD, LLM and Geoffrey C. Dietrich, JD
M
ore than a decade ago, tax promoters and life insurance agents seized upon a little-known provision of the Internal Revenue Code (IRC). Section 831(b) had been around for decades and, despite increased exposure after the terrorist attacks of September 11, few taxpayers had ever heard of a Captive Insurance Company (CIC). Over the course of the last 10 years plus, promoters ran roughshod over the judicial doctrines of economic substance (now codified) and business purpose. They convinced taxpayers that a lack of Internal Revenue Service (“IRS”) audits equaled compliant planning. The IRS complained of the abuses. Statutory and regulatory changes, among other IRS actions, followed. The IRS loaded the torpedo tubes. This article focuses on the history of Captive Insurance compliance matters and views current IRS attacks through the lens of articles previously published across the country (See summary of Articles on Abusive Captive Insurance Companies at: https://tinyurl.com/Cantley-SummaryArticle). These articles have provided conscientious advisors reliable case law, code and statutory analysis, and compliance considerations for clients. The information in the articles herein comes in response to the mass marketing by promoters of Section 831(b) CICs. 20
the journal entry | July 2018
IRS Targets the Soft Underbelly
The IRS targeted five specific areas of non-compliant planning: (1) Life Insurance on the owners of the Captive as a core “investment” thereof; (2) Offshore Jurisdictions which pose as unassailable managers; (3) Premiums in Excess of Risk and Inappropriate Coverages; (4) Estate Planning Ownership; and (5) loan back structures. The IRS has aimed a torpedo at each of these areas. Advisors have struggled to sift through promoter-led noise to determine reality for their clients. We will address each non-compliance area and discuss the Avrahami decision’s impact on current Captive planning (Avrahami v. Comm’r., 149 T.C. 7, Aug. 21, 2017). In the IRS 2016-66 Notice, the IRS laid out its disapproval for Captives to own or be involved in investing its “capital in illiquid or speculative assets usually not held by insurance companies" (https://www.irs.gov/pub/irs-drop/n-16-66. pdf). Early startup companies — even if well-funded — will often choose to forego high death benefit insurance policies with large premium on its principals. Large life insurance premiums paid with the received premiums create an illiquid investment otherwise incomprehensible to a compliance officer. Barring some unusual situation,