23 October 2020Accounting & tax analysis

IRS to make a second settlement offer to selected microcaptive owners

The Internal Revenue Service (IRS) has made  a second time-limited settlement offer to certain taxpayers under audit who it believes participated in abusive microcaptive insurance transactions.

The IRS will begin sending settlement offers with terms that are stricter than the first offer it made last year, requiring substantial concession of the income tax benefits claimed by the taxpayer, together with penalties.

The penalties can be partly mitigated if the taxpayer can demonstrate good faith and a reasonable reliance on an independent, competent tax advisor. The taxpayer would also have to demonstrate it did not participate in any other reportable transactions.

This settlement offer is limited to taxpayers with at least one open year under exam. Taxpayers who also have unresolved years under the jurisdiction of the IRS Independent Office of Appeals may also be eligible, but those with tax years involving microcaptive transactions docketed in Tax Court under Counsel's jurisdiction are generally not eligible.

Taxpayers who do not receive an offer letter are not eligible for this settlement, but the IRS said some taxpayers who had received and rejected a previous offer may be sent a second letter making a new offer with stricter terms.

Taxpayers who receive offer letters under this settlement initiative, but who opt not to participate, will continue to be audited by the IRS under its normal procedures. This could lead to the full disallowance of captive insurance deductions, inclusion of income by the captive, withholding tax related to any foreign captives and the imposition of all applicable penalties, among other possible outcomes.

Douglas O'Donnell, large business and international commissioner at the IRS, said:  "Our offer terms are only getting stricter; and taxpayers would be well advised to consult with an objective, competent advisor with the aim of getting out now and putting this behind them."

The IRS recently deployed its 12 newly formed microcaptive examination teams to substantially increase the examinations of abusive microcaptive insurance transactions.

In 2016, the Department of Treasury and IRS issued Notice 2016-66, which identified certain micro-captive transactions as having the potential for tax avoidance and evasion.