The IRS announced a one-time settlement offer for certain micro-captive insurance participants currently under IRS exam. Per the announcement, the IRS has already sent settlement eligibility notices to up to 200 taxpayers.
The announcement explains certain terms to be expected in settlements while it omits other important details. Settlement terms include disallowance of 90% of captive premium deductions in all open years (regardless of whether those years are currently under audit). Accuracy penalties are imposed at a reduced rate of 10% (rather than the standard rate of 20% for negligence or 40% for lack of economic substance). The 10% is reduced by 5% if the Taxpayer has not engaged in any other reportable transactions and another 5% if it provides a signed declaration from an independent tax advisor.
Premiums paid to the captive are not treated as taxable income to the captive, contrary to the holding in Syzygy v. Commissioner. However, the captive must liquidate or agree to deemed liquidation under the terms of the letter. Under the deemed liquidation provisions, the captive shareholders will receive a deemed qualified dividend in an amount equal to premium deductions allowed in open and closed years. Shareholders will also be treated as making deemed capital contributions.
The offer provides that the captive’s 831(b) and 953(d) elections will be terminated. It also provides provisions for the liquidation or reorganization of foreign captives.
Taxpayers only have 30 days to respond to the letter with an option for a one-time 30 day extension. Taxpayers should swiftly seek a professional’s guidance to navigate settlements before moving forward with the time-sensitive initiative. Additionally, the settlement initiative is currently only offered to certain taxpayers in exam and, while the announcement leaves open the possibility for expansion of the initiative to additional taxpayers in exam and IRS appeals, it does not divulge if or when such expansion may actually occur.
If not already represented by independent tax counsel, taxpayers should seek it before moving forward with a decision. If you have questions about these letters, please reach out to aliantNational’s National Director of Tax, Steven Miller.