On the heels of Congress’ amendments last year to Section 831(b) of the Internal Revenue Code to curb perceived abusive use of so-called “micro” captive insurance companies, the IRS recently issued Notice 2016-66 officially classifying such uses as “transactions of interest” as of November 1, 2016. Such classification means that any taxpayers engaging in a transaction similar to the one described in the Notice on or after November 1, 2006 must disclose such participation. Material advisors may also have disclosure and list maintenance obligations under Sections 6111 and 6112. Failure to disclose such a transaction exposes the taxpayer to penalties under Section 6707A of the Code. Other penalties may also apply upon audit.
Section 2.01 of the Notice describes specific attributes of the transaction. They include a person who owns a business entity acting as the Insured. A Captive owned by such person, the Insured, or related persons enters into purported insurance or reinsurance contracts with the Insured. The Captive makes an election under Section 831(b), which allows the Captive to exclude from its income net written premium. The person, the Insured, or related persons own at least 20 percent of the Captive’s stock. Finally, one or both of the following is true:
- Total liabilities assumed by the Captive for insured losses and administrative expenses during the “Computation Period” is less than 70 percent of:
- Premiums earned by the Captive during the “Computation Period,” less
- Policyholder dividends paid by the Captive during the Computation Period; or
- The Captive has made a loan or otherwise conveyed assets to the person, the Insured, or a person related to such person or Insured in a manner claimed to be tax free.
The Notice defines the “Computation Period” as the most recent five taxable years of the Captive or, if the Captive has been in existence for less than five taxable years, the entire period of the Captive’s existence. This means that, for most taxpayers, immediate dissolution of a Captive will not avoid the disclosure obligations. Anyone with a captive arguably within the ambit of Notice 2016-66 should contact a tax professional for further advice.