Mr. John Glover of the IRS General Counsel's office spoke about captive insurance arrangements Friday in San Francisco at a meeting of the American Bar Association's Tax Section, which was hosted by that Section's Insurance Companies Committee and co-sponsored by the Business Law Section's Committee on Captive Insurance (of which I am the current Chair).
By agreement, the program was not recorded, Mr. Glover's remarks were not "on the record", and what follows comes from my notes and should not be taken as anything like a transcript of his remarks.
Mr. Glover has long been instrumental in IRS rule-making with regard to captive insurance companies, and so many tax practitioners in the field hang on to his every syllable and nuance as if he were the Fed Chairman.
The IRS has concerns about risk pooling arrangements and is beginning to focus on such arrangements, stated Mr. Glover, especially in cases where there is nominal laying and assuming of risks, but in the end reconciliation there really isn't any risk-shift because the captive or business owner will reimburse the pool for significant losses. But there is also concern where the risk pool is simply an account where money comes in, and money goes out, and it is called "insurance" when it is really anything but.
Another concern that the IRS is starting to focus on, stated Mr. Glover, are dubious risks. The example he gave was of a widget shop in Nebraska that purchases tsunami insurance. The IRS has an increased interest in the pricing of captive insurance policies for such things as terrorism, cyber-liability, etc., which may be the subject of abuse.
Notably, Mr. Glover addressed the lack of IRS enforcement in the area of captives, noting that it has taken some time to get cases into the pipeline, but making a special point that the IRS now has more cases pending in tax court against captives than ever before -- and the growth of the sector means that the IRS will be tasking more resources towards abusive practices. (This is not to be read that the IRS is challenging captives generally; to the contrary, the IRS now recognizes the legitimacy of proper captive insurance arrangements, and Mr. Glover has himself drafted much of the guidance for that purpose).
Captive insurance cases currently pending before the U.S. Tax Court include:
- Rent-A-Center, Inc. & Affiliated Subs. (Dkt. Nos. 8320-09, 6909-10 & 21627-10)
- YRC Worldwide & Subs. (Dkt No. 6714-10)
- Securitas Holdings, Inc. & Subs. (Dkt. No. 21206-10)
- Dielco Crane Service (Dkt. No. 21726-10)
- Pilgrim’s Pride (Dkt. No. 16972-10)
- Vincent Enterprises, Inc. & Subs. (Dkt. No. 2759-10
Other cases in other courts include:
- Proliance Surgeons (Dkt. No. 1:09-cv680) (Court of Federal Claims)
- Salty Brine (Dkt. No. 5:10-CV-00108-C); K&T Farm Ltd. (Dkt. No. 5:10-CV-00109-C); Wasson Solid Waste Disposal System (Dkt. No. 5:10-CV-00110-C); Five Star Consolidated Companies (Dkt. No. 5:10-CV-00111-C); Thomas & Kidd Oil Production (Dkt. No. 5:10-CV-00141-C) (U.S. District Court for the Northern District of Texas) (consolidated cases).
Mr. Glover also stated that IRS agent Steve Henson is maintaining a resource well that is available to answer questions for field agents and assist them with particular issues as they increasingly run across captive insurance arrangements.
But Mr. Glover also noted that in attempting to provide guidance for captive insurance practitioners, the IRS is hamstrung by the lack of case law as to many issues, and at this point can only set out various buoys (his term) to help practitioners stay in the safe waters and away from the shoals.
Aside from Mr. Glover's remarks, other discussion focused on the importance of following NAIC reserving standards, which the tax court has found to be among the most persuasive evidence in whether the reserves were fair and reasonable. It is also very important for the Board of Directors of a captive to carefully review and approve an actuary's recommendations.
There was a good deal of discussion at the meeting about so-called "Micro Captive" qualifying for special treatment under Tax Code section 831(b) and about the proliferation of promoters who sell captives as essentially a tax shelter with little or no consideration of the true insurance function of such companies.
Finally, there was a discussion of state taxes as they related to captives after the passage of Dodd-Frank, with some practitioners, notably captive tax attorney Bruce Wright, observing that there has been an significant uptick in the actions by various states to collect these taxes, particularly for businesses in California, New York and Texas. Captive tax attorney Chaz Lavelle pointed out that with rare exceptions the states often win these challenges in the state courts, and, despite there sometimes being good arguments why the taxes should not apply under the Todd Shipyards and Dow Chemical opinions, they are often more costly for captive insurance companies to fight than to just pay the taxes to begin with.
The bottom line is that the captive insurance tax world continues to evolve, and that certain dubious practices that did not merit much attention in the past are now almost certain to receive much stricter attention in the future. That somebody has gotten away with these practices in years before is essentially meaningless, or as the SEC requires in prospectuses:
"Past performance is no guarantee of future returns."
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