At the end of July, the IRS began to send what appears to be a second round of “soft compliance” letters to those who previously reported participation in a micro-captive insurance arrangement. IRS Letter 6336 asks taxpayers to report when they ceased participating in a captive transaction, or otherwise kindly consider amending their own returns to remove any tax benefits garnered from a captive program. Individuals that neither respond nor amend are threatened with referral to the Service’s examination division. The first round of 6336 letters went out just as the IRS (and the rest of the world) dealt with pandemic induced closures.
Letter 6336 is a harbinger of continued enforcement focus by the IRS for many captives. The IRS has taken an increasingly aggressive stance on micro-captives and captive insurance service providers, with IRS Commissioner Rettig touting the formation of at least 12 new exam groups dedicated solely to captive insurance exams. The Service has also signaled an increase in 6700 penalties and promoter investigations. In its letter the Service reminds the public of “several” Tax Court victories (in reality, three with at least one case being appealed, and to date NO penalties have been assessed by the Tax Courts for micro-captive participation). Practitioners and captive service providers have decried that this aggressive approach throws the proverbial baby out with the bathwater. Many captives and captive managers have done their best to create compliant programs, despite exceedingly little guidance from the IRS.
Taxpayers are not legally obligated to reply to Letter 6336, though it will often be in one’s best interest to do so, depending on each captive’s facts. Obviously, those that are no longer participating in a captive will benefit from letting the service know that fact. However, many taxpayers have responded to the letter with an illustration of how their programs are different (better) than those addressed by the Tax Court. Even with additional IRS resources dedicated to captives, the IRS simply cannot audit all of the programs in existence. This effort by the taxpayer might be the nudge the Service needs to place that taxpayer at the back of the audit line, so that agents may go after lower hanging fruit. This, of course, is not a one-size-fits-all approach, and should be discussed with competent tax counsel.
Those that received Letter 6336 (and even those with captives that happened not to receive the letter) should strongly consider having their captive program reviewed by tax counsel with examination experience. Now is the time to buttress strengths, and be cognizant of any potential pressure points.
If you have questions about Letter 6336, captive insurance, or any other tax matter, please contact Steve Miller at [email protected]