As the world continues to struggle with the effects of the COVID-19 pandemic, the Internal Revenue Service has its eye on a return to normalcy with respect to the examination of so-called “abusive” micro-captive transactions. In March, the IRS unveiled its “People First Initiative,” which involved the postponement of return filing (and payment) deadlines as well as putting a hold on a myriad of collection and enforcement activities. For many taxpayers, this hiatus will come to an abrupt conclusion in a matter of weeks. July 15 is the due date for returns that would have otherwise been due in the preceding months if not for the global pandemic and the resulting continuance granted by the Service. While many taxpayers will struggle to reconcile federal tax obligations with an economy suppressed by a work-from-home regime, the Service has signaled that it will not put all people first indefinitely.
The Service continues to name micro-captive insurance transactions as a choice enforcement target. In January, Commissioner Rettig touted, “The overwhelming acceptance rate of the private settlement offer” that was issued in 2019. The settlement offer went to a relatively small group of participants. Those taxpayers signed a nonbinding agreement to move forward with the settlement program, which includes a disallowance of 90% of open-year captive insurance premium deductions as well as an agreement to wind up the captive. It is unclear how many participants will see the settlement through to its conclusion, as practitioners and taxpayers have expressed frustration with the Service’s implementation of the program.
Rettig separately announced the formation of up to twelve exam groups dedicated to the review of captive cases. This is an ambitious expenditure of resources, considering the Service’s historic issues with personnel and funding.
Merely days after the COVID-19 pandemic, some captive participants were surprised to receive IRS Letter 6336, a soft compliance letter, requesting that recipients notify the Service if their captives were no longer operational (under penalties of perjury, no less). It further suggested that taxpayers engaged in a captive transaction consider voluntarily amending their returns to remove the tax benefit. The March 30 letter originally had a response date of May 4th. Due to the shutdown caused by the Pandemic, the due date was extending to June 4th, however the Service’s website was not updated to reflect the extension until the original deadline had passed. The Service further indicated that as many as 10% of the letters were not sent due to the temporary closure of various IRS campuses. So captive participants that did not receive Letter 6336 should keep an eye on their mailbox.
Considering the mail processing backlog caused by the pandemic, it could take the Service a considerable amount of time to read, analyze, and sort taxpayer responses to Letter 6336. Nevertheless, the Letter shows that the Service is at least posturing for an increase in compliance activity. Responses will no doubt be a component the Service’s cost/benefit analysis in selecting captives for examination.
Comments came most recently in panels hosted (remotely) by the NYU Tax Controversy Forum. Several IRS employees alluded to compliance efforts—existing and prospective—in the area of captive insurance as well as conservation easements. Employees indicated that the service would now consider “all penalties” in campaign enforcement areas. A statement that is intriguing considering that the Service is already aggressively chasing the 40% economic substance penalty in captive exams. Notably, the Tax Court has yet to implement the economic substance or negligence penalties in any published micro-captive case. Speakers also suggested that taxpayers should expect an uptick in promoter and advisor enforcement. Specifically, we could see the assessment of penalties for material advisors and promoters of reportable transactions.
This Monday, June 22, the IRS (via DOJ Tax) picked a fight with the State of Delaware, filing a federal suit to enforce a summons issued to the Delaware Department of Insurance. The DOJ is demanding documents related to its review of a Delaware captive manager. This is not the first time a state agency and the Service have not seen eye-to-eye on captive insurance. Several states have taken issue with federal interference in what has traditionally been a state regulated industry.
Now more than ever, it is important that taxpayers and captive participants secure the guidance of competent counsel. The Service is postured to increase compliance activities in the near future, specifically in select areas such as captive insurance. If you have questions about captive insurance or any other tax matter, please contact alliantNational’s Managing Director of Tax Controversy, John Dies, at (713) 877-9600.