As budgetary and personnel constraints have had an impact on the IRS approach to compliance, taxpayers and practitioners remain curious over what compliance enforcement will look like in the short term. We do have certainty in at least some areas. The IRS has recently outlined two areas of focus for the IRS in 2020: the Section 831(b) “microcaptive” insurance company area, and the Section 965 “transition tax” created as part of the Trump tax reform bill, better known as the “TCJA”.
With respect to captive insurance, the Service continues to aggressively pursue compliance enforcement for Section 831(b) captives. Emboldened by three Tax Court wins, the IRS announced in Notice IR 2020-26 that it is creating 12 new audit teams to focus on captive insurance examinations. The announcement states that the IRS expects these teams to open examinations of an additional “several thousand taxpayers” in the coming months. This press release comes less than five months after the IRS announced its global settlement program for a number of captives under audit, which sought to decrease the number of captive insurance examinations by offering a settlement option to 200 taxpayers under audit.
While we know that a number of captives are currently under audit, this announcement signals the IRS’s intention to maintain and perhaps increase scrutiny on 831(b) captives. The IRS has not yet stated how large these new exam teams will be or whether they will take over or consult with agents on existing examinations. We also don’t know the IRS’s exact timeline and exactly how many additional captives and captive managers will be impacted. What we do know is that even after the September 2019 global settlement release, the IRS is not backing down from its resource commitment on 831(b) captives.
The September 2019 global settlement offer marked a pivotal moment in IRS enforcement activity regarding captives, in which the IRS announced that it was ready to start settling with taxpayers at the Exam level before reaching Appeals. The announcement touts the success of the settlement initiative, stating that nearly 80 percent of taxpayers who received the offer elected to accept its terms. While the IRS has not yet publicly stated that additional taxpayers would receive the global settlement offer, a number of additional captives in Exam and also in Appeals that we work with have since received the same offer. With the IRS stating that it will audit additional taxpayers, it would make sense for the IRS to expand the universe of captives receiving the settlement offer.
Regardless of whether or not a captive under audit receives a global settlement offer, it makes sense for captives to consider how to best position their cases to stand apart from the facts the Tax Court did not like in Avrahami, Reserve Mechanical, and Syzygy. This could require a dive into the structure of the risk pool and fact rich analysis on how to ensure the arrangement is insurance for tax purposes and has economic substance. Penalties can also potentially be avoided by building out arguments around the formation and operation of the captive.
On November 4, 2019, the IRS announced a compliance campaign focused on the Section 965 transition tax. Prior to the TCJA, foreign earnings of U.S. companies were not taxed until those funds were moved into the United States or fell afoul of complex rules on how the funds could be utilized overseas. Such amounts raised overseas subsequent to TCJA are subject to new rules.
In transitioning to the new regime, Congress enacted Section 965, requiring U.S. shareholders to pay a transition tax on the untaxed foreign earnings as if those earnings had been repatriated to the United States. The Service has stated that it expects to open exams in the coming months to ramp up its review of Section 965 and other international filings, including Global Intangible Low Tax Income (“GILTI”) and Base Erosion and Anti-Abuse Tax (“BEAT”).
The Service believes that many entities miscalculated the deceivingly simple transition tax and expects to look at several issues, including whether taxpayers appropriately segregated cash from other assets and whether taxpayers correctly utilized foreign tax credits.
Taxpayers should seek advice from independent tax counsel when dealing with complex issues that may arise during any IRS examination, whether related to captive insurance or the international transition tax.
If you have questions regarding your or a client’s tax matter, please contact Shane Frank with alliantNational at [email protected].