From the Desk of Jan Dulman, CPA, Partner
On November 1, 2016 the Department of the Treasury and the Internal Revenue Service (the “Agencies”) cast a wide net in the form of Notice 2016-66 in an attempt to capture and close what is believed to be transactions with the potential for tax avoidance or evasion by captive insurance companies known as micro-captives (captive insurance companies set up under Section 831(b)). The Agencies lack sufficient information to specifically identify the offenders from other Section 831(b) related-party transactions. As a result and in an attempt to gather more information about why and how small or micro-captives are being formed and operated, the Agencies issued Notice 2016-66 defining certain Section 831(b) transactions as transactions of interest, making them subject to additional reporting of the transactions, and imposing penalties for non-compliance.
The reporting requirements can apply to the insurance captives, as well as insurance policy owners, shareholders, and intermediaries on IRS Form 8886 and material advisors of the captives on IRS Form 8918. All filings must be done by January 30, 2017 to the Office of Tax Shelter Analysis and must also be attached to each one of the filer’s annual income tax returns. This notice also states that retroactive reporting is required for captives that have conducted transactions of interest within the last five years.
In Section 2.01 of Notice 2016-66, the Agencies identify transactions of interest to consist of the following (although substantially similar transactions apply):
- “A,” a person, directly or indirectly owns an interest in an entity (or entities) (the “Insured”) conducting a trade or business;
- An entity (or entities) directly or indirectly owned by A, Insured, or persons related to A or Insured (“Captive”) enters into a contract (or contracts) (the “Contracts”) with Insured that Captive and Insured treat as insurance, or reinsures risks that Insured has initially insured with an intermediary, Company C;
- Captive makes an election under Section 831(b) to be taxed only on taxable investment income;
- A, Insured or one or more persons related (within the meaning of Section 267(b) or Section 707(b)) to A or Insured directly or indirectly own at least 20 percent of the voting power or value of the outstanding stock of Captive.
Additionally one or both of the following have to apply:
- The amount of the liabilities incurred by Captive for insured losses and claim administration expenses during the Computation Period (defined in section 2.02 of this notice) is less than 70 percent of the following:
- premiums earned by Captive during Computation Period, less
- policyholder dividends paid by Captive during Computation Period; or
- Captive has at any time during the Computation Period directly or indirectly made available as financing or otherwise conveyed or agreed to make available or convey to A, Insured, or a person related (within the meaning of Section 267(b) or Section 707(b)) to A or Insured (collectively, the “Recipient”) in a transaction that did not result in taxable income or gain to Recipient, any portion of the payments under the Contract, such as through a guarantee, a loan, or other transfer of Captive’s capital.
The Computation Period is the lesser of the most recent five taxable years of Captive or the entire period of the Captive’s existence.
While not all inclusive, some non-compliance to file penalties includes:
- For individuals – a minimum of $5,000 and a maximum of $100,000.
- For businesses – a minimum of $10,000 and a maximum of $200,000.
Based on the limited time to comply (January 30, 2017) and the penalties associated with non-compliance, taxpayers who are uncertain that their reportable transaction applies should consider filing the applicable forms just to protect themselves.
If you feel you may be affected by this, or have any questions, please don’t hesitate to contact us at Rosenfield & Co for guidance.