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Just like Reserve Mechanical and Avrahami before it, the US Tax Court has ruled in favour of the IRS in the case of Syzygy Insurance v Commissioner, ultimately determining the captive did not constitute insurance in the commonly accepted sense and its 831(b) election was invalid.
Syzygy is a microcaptive set up as a subsidiary of Highland Tank & Manufacturing, a family-owned business in Pennsylvania that provides custom-built steel storage tank solutions.
Syzygy was formed incorporated in Delaware in December 2008 with California-based captive management provider Alta Holdings. Syzygy distributed risk by participating in the US Risk And Newport Re captive insurance pools and reinsuring unrelated risks. US Risk was the fronting carrier for Syzygy from 2008 to 2010, and Newport Re from 2010 until 2011.
Judge Robert Ruwe's opinion, filed on April 10, generally affirmed the IRS’s determinations that Syzygy did not engage in insurance transactions and did not qualify as an insurance company, therefore making its 831(b) election invalid and the premiums it received taxable income.
Captives that make the 831(b) election - or microcaptives - are not subject to tax on their earned premiums. The amounts paid for insurance deductible under section 162(a) of the Internal Revenue Code as ordinary and necessary expenses paid or incurred in connection with a trade or business.
Ruwe made references to Avrahami and Reserve Mechanical throughout the opinion, and highlighted that there are four criteria in deciding whether an arrangement constitutes insurance: (1) the arrangement involves insurable risks, (2) the arrangement shifts the risk of loss to the insurer, (3) the insurer distributes the risk among its policy holders, and (4) the arrangement is insurance in the commonly accepted sense.
The court held that premiums were not actuarially determined, suggesting there had been no evidence to support the calculation of premiums. It found that US Risk and Newport Re were not bona fide insurance companies, meaning they did not issue insurance policies.
Making reference to Avrahami, Ruwe said Syzygy's reinsurance of its policies did not distribute risk, and it did not accomplish sufficient risk distribution through the fronting carriers.
"Syzygy’s absence of risk distribution by itself is enough to conclude that the transactions among Syzygy, HT&A, and the fronting carriers were not insurance transactions,” said Ruwe.
Ruwe also stated: "Although Syzygy was organized and regulated as an insurance company, met Delaware’s minimum capitalization requirements, and paid a claim, these insurance-like traits do not overcome the arrangement’s other failings. Syzygy was not operated like an insurance company. The fronting carriers charged unreasonable premiums and late-issued policies with conflicting and ambiguous terms."
Syzygy, US Tax Court, 831(b) captives, North America