22 February 2017Analysis

Micro-captives makes IRS "Dirty Dozen" list for 3rd year running

The IRS has placed 'abusive' micro-captive insurance tax shelters on its list of "Dirty Dozen" scams for the third year in a row.

The annual list describes the various common scams that taxpayers may encounter, may of which peak during filing season as people prepare their returns or hire others to help them, the IRS said.

“Taxpayers should avoid unscrupulous promoters who encourage the use of phony tax shelters designed to avoid paying what is owed,” said IRS Commissioner John Koskinen. “These scams can end up costing taxpayers more in penalties, back taxes and interest than they saved in the first place.”

Current tax law typically generally allows business to create a captive to protect against certain risks, and traditional captive insurance allows a taxpayer to reduce insurance costs.

The insured business can claim deductions for premiums paid for insurance policies.

Section 831(b) of the tax code states that captive insurers that qualify as small insurance companies can elect to exclude limited amounts of annual net premiums from income, so that the captive pays tax only on its investment income.

One of the main concerns of the IRS regarding the abusive micro-captive structures are promoters, accountants or wealth planners persuading owners of closely-held entities to participate in schemes that lack many of the attributes of genuine insurance.

"For example, coverages may insure implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages," the IRS stated.

"Premium amounts may be unsupported by underwriting or actuarial analysis, may be geared to a desired deduction amount or may be significantly higher than premiums for comparable commercial coverage."

The IRS suggested that policies can contain vague, ambiguous or deceptive terms and otherwise fail to meet industry or regulatory standards.

Notice 2016-66, announced back in November 2016, advised that micro-captive insurance transactions have the potential for tax avoidance or evasion.

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