Blow for 831(b)s as tax court confirms IRS will seek 40% penalties

Owners of so-called 831(b) microcaptives have been dealt a worrying blow after a ruling by the US Tax Court indicated that the IRS will be seeking 40 percent penalties against owners deemed to have broken tax rules.

Some had believed the IRS would be seeking lower penalties based on the specifics of the case the ruling related to but this notion has now been proved incorrect.

The opinion related to the case of Oropeza v. Comm'r, T.C. Memo. 2020-111 (July 21, 2020), which considered the penalties given out by the IRS to a captive insurance company that made 831(b) election and participated in a risk pool.

The IRS audited the arrangement in 2012 and proposed a $1.07 million increase in the taxpayer's distributive share of his company's income. The agent also awarded a 40 percent penalty based on any of a gross valuation misstatement, a non-disclosed transaction lacking economic substance.

But in the paperwork relating to the case, the supervisor on the case signed a Civil Penalty Approval Form which instead authorized a 20 percent penalty.

The IRS tried to enforce the 40 percent penalty. The US Tax Court has now ruled that invalid because the supervisor signed off a different amount.

However, while the fine was only 20 percent in this case, it has also illustrated that this lower fine is an anomaly. The IRS is indeed seeking 40 percent fines, it just failed to complete the paperwork correctly in this instance.