IRS wins latest micro-captive victory in insurance case

 

The IRS won another victory in Royalty Management Insurance Co. Ltd. v. Commissioner (T.C. Memo. 2024-87) in its campaign against abusive micro-captive insurance arrangements.

 

The issue centers on Section 831(b), which permits electing insurance company taxpayers that qualify to exclude premiums received from gross income (a “micro-captive”). Thus, a captive insurance arrangement between related parties provides a permanent benefit. The IRS has identified such arrangements as potentially abusive and has an active campaign targeting them.

 

In Royalty Management, there were several unfavorable facts, including:

  • Circular cash flow
  • Setting up the putative captive in a jurisdiction that did not even provide for insurance company status
  • Setting putative premiums without real actuarial input
  • Not paying any claims

The case is primarily notable because of two important observations made by the Tax Court in its ruling:

  • Risk shifting: First, when analyzing whether “risk shifting” had been met (a requirement for a valid insurance arrangement), the court not only looked at whether the risk was transferred to another entity but also to the ability for the putative insurer to make the insured whole. The putative captive insurance company in Royalty Management only collected the so-called premiums but had no other outside capitalization Thus, if a loss were to happen, the insured could only ever get back the premiums paid in, which made the arrangement tantamount to putting money into a rainy-day fund.
  • Risk distribution: Second, when analyzing whether “risk distribution” was met (another requirement for a valid insurance arrangement) the court reaffirmed earlier, taxpayer friendly results in Rent-A-Center and Securitas which provide that the focus should be on whether the law of large numbers was present with diverse, independent risks of sufficient quantity to distribute risk rather than number of legal entities in the insureds pool.
 
 

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