IRS hostility to captives is exacerbating impact of COVID-19 on business: CIC Services


IRS hostility to captives is exacerbating impact of COVID-19 on business: CIC Services

Nate Reznicek, CIC Services

The IRS’ targeting of captive insurance companies has left companies more vulnerable to the economic ravages of COVID-19, according to CIC Services. 

The IRS’ persistent attention on captives has discouraged many businesses from using these risk management tools for fear of provoking an IRS audit, CIC Services said. And this in turn has left them more exposed to the financial turmoil that has arisen in response to the virus, as businesses have shut down and economic activity has ground to a halt. 

Captives allow businesses to cost-effectively insure risks that may be otherwise uninsurable, noted CIC Services. However, many businesses have either not availed themselves of this opportunity, or have shut down existing captives, it said. 

Captives have attracted increased attention since the crisis took hold, as risk managers have noted that the pandemic exclusions that affect many commercial business interruption policies often don’t apply with similar policies written by captives. 

Nate Reznicek, director of operations at CIC Services, said that owners of micro captives are even more reliant on their captives than larger companies, which have better access to capital and may have other tools at their disposal. “The majority of the US economy is SMEs, and SMEs are the ones the IRS targets with its fines,” he said.

One line of attack the IRS has pursued against micro captives in court is that they provide insurance but do not pay out claims. “The IRS has repeatedly alleged that coverages being written are business risk, not insurance risk, which would have significant tax implications for the captive and it’s insureds,” said Reznicek. “The IRS argues the lack of claims points to these risks being business risk, but the COVID-19 pandemic exposes the flaws in this logic. Captives could have been providing pandemic insurance that did not pay out for years, until recently, but it is clearly insurance risk.”

Reznicek added: “The IRS’ argument really holds no water. If I have fire insurance for my house and my house doesn't burn down, that doesn't mean it wasn’t real insurance. This pandemic may make this argument clearer, the next time a captive faces the IRS in court.” 

CIC Services criticised the IRS’ “refusal to provide honest taxpayers with any substantive guidance about operating [captives] in good faith,” noting it has been “hostile to captive insurance arrangements for decades.”

If that hostility has discouraged businesses from using captives, many of those businesses have lost out because of it. Randy Sadler, leader of CIC Services’ marketing and client empowerment, cited physicians groups that earn most of their income from elective surgeries as an example. 

“They lost their income stream when the states banned all elective procedures,” Sadler said. “Unfortunately, the IRS’s scare tactics dissuaded many of them from setting up a captive insurance company that would have helped them endure this interruption to business.”

However, Reznicek predicted there could be a resurgence of interest in micro captives in coming months. Micro captives are particularly flexible structures, and therefore well suited to manage complex risks like pandemics, he said. 

Businesses would certainly feel more emboldened to consider captives, and micro captives in particular, if the next legal battle between a micro captive and the IRS went in favour of the captive.  

In the meantime, Sadler stressed captive insurance is not a tax strategy. “While there may or may not be tax benefits in a given instance, there are essential and sometimes business-saving risk management and insurance benefits in every instance,” he added. “Taxpayers can always enjoy the latter regardless of whether or not they choose to pursue the former.”

CIC Services, Nate Reznicek, Randy Sadler, Internal Revenue Service, IRS

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