Help — My Captive is a Transaction of Interest! – What does it mean?
By Michael E. Lloyd, Esq.
On November 1, 2016, the IRS published Notice 2016-66. This Notice identifies certain captive
insurance programs as “transactions of interest” and creating a requirement to report to the IRS
before January 30, 2017. The following Q&As are intended to provide information for captive
owners and their advisors about this Notice.
- Does this mean that all captives are bad? No. This Notice is intended, in part, to inform the public that the IRS believes that certain captive insurance programs have “potential for tax avoidance or evasion”.
- Is this a new Position of the IRS? No. The IRS first expressed a concern of abuse in small captive insurance programs in its 2015 Dirty Dozen List. Since that time, the IRS has been actively looking for abusive captive programs.
- So, What is Important About this Notice? This Notice creates a responsibility for taxpayers (and their advisors) who participate in certain defined captive arrangements to provide notice to the IRS of their participation.
- Is my Captive Subject to this New Notice Requirement? We believe most 831(b) captives will be subject to this new notice requirement. The notice requirement applies to any captive transaction whereby –
- An individual owning an interest in a business purchases insurance or reinsurance from an 831(b) captive insurance company.
- 20% or more of the voting power or value of the Captive is owned directly or indirectly by any of the following:
- An individual owning an interest in the business that has purchased insurance from the Captive,
- The business that has purchased insurance from the Captive, or
- An individual or entity that is a related party to an owner or the business.
- Either one of the following apply:
- The sum of the liabilities incurred by the Captive for insured losses and claim administration expenses during the “Computation Period” is less than 70% of the premiums earned by the Captive during the Computation Period minus any policyholder dividends paid by the Captive during the Computation Period. The “Computation Period” is the most recent five taxable years of the Captive, or if less, the entire existence of the Captive.
- The Captive has at any time during the Computation Period directly or indirectly made available a guarantee, loan or other transfer of the Captive’s capital to any of the parties listed above (an owner, the business or related party).
- Do I have to Provide the Notice if my Captive Does not have the Abuses Listed in the Notice? Yes. Although the Notice describes certain perceived abuses, the requirement to file the required form with the IRS is based on the conditions of number 4 above. Also, the requirement to file applies to any transaction that is the same or “substantially similar” to the transaction described above. The IRS directs that the term “substantially similar” should be construed broadly in favor of disclosure. Accordingly, if a transaction is in any way similar to the transaction described above, a filing should be made.
- If I Provide the Notice, Will I be Audited? Not necessarily. There is no way to know if providing notice to the IRS of participation in a transaction of interest will or will not trigger an IRS audit. The reality is that it could trigger an audit. Our experience with previous transactions that the IRS has made reportable transactions is that the filing of the Form did not appear to trigger audits. For one reason, the number of filers of this notice will make it very difficult for the IRS to audit them all. Further, it has been our experience that the IRS method of attacking perceived abusive transactions is to audit the marketers and then obtain their customer lists for opening mass audits. Also, there is a way to provide the notice on a protective basis to make clear that your captive does not contain the abuses that are of concern to the IRS.
- What Happens if I Don’t Provide the Notice to the IRS? If a taxpayer is required to provide notice to the IRS and fails to provide the notice, the Taxpayer is subject to a civil penalty that is based on a percentage of the tax benefit of the captive with a minimum penalty of $5,000 and a maximum penalty of $50,000. If a form is required to be provided by a business and a captive, the maximum penalty for a year could be $100,000. It is important to note that the application of the penalty is completely independent of whether your captive is tax compliant. Therefore, you may have the best, most compliant captive and still be liable for failing to file this form.
- How do I Provide Notice to the IRS? Each taxpayer who has participated in a captive insurance program at any time after November 2, 2006, must complete IRS Form 8886 and file that Form with the IRS Office of Tax Shelter Analysis before January 30, 2017. This includes the business entity that has made deductible premiums to the captive, its owners if the business is a flow-through entity and the captive itself. The Form must also be attached to each tax return that is filed thereafter while participating in the captive program. Material advisors file an IRS Form 8918 and must keep a list of their customers if requested by the IRS.
- How can I get help preparing the Form 8886? Williams Coulson will be hosting free conference calls discussing the filing requirements of Notice 2016-66 on Wednesdays (11/9, 11/30 and 12/7) at 10:00 est. and Fridays 11/11, 11/18 and 12/2) at 3:00, est. The conference call in number is (877) 239-6424 and code 220067. If you would like to arrange for calls specific to an individual captive program or to arrange for custom protective filings for customers and advisors of a specific captive program, call Mike Lloyd at (412) 454-0225 or email at firstname.lastname@example.org.