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Rachel Partain Comments in Tax Notes on Microcaptive's Risk Distribution

March 11, 2021, Tax Notes

The Tax Court found a microcaptive insurance arrangement invalid because it lacked sufficient risk distribution through brother-sister entities and didn’t operate as an insurance company, handing the IRS its fourth microcaptive victory. 

. . .

The decision emphasizes “the importance of relatively contemporaneous underwriting and policy documentation, particularly with respect to claims-made policies,” Rachel L. Partain of Caplin & Drysdale told Tax Notes.

No Economic Substance Test

Some practitioners thought that Caylor might finally be a case in which the court addressed economic substance arguments raised by the IRS, but like in the other microcaptive cases, Holmes stopped short of ruling on the economic substance of the transaction. 

The IRS has repeatedly tried to challenge small captives on the primary ground of lack of economic substance, as it did in Reserve. Because the Tax Court concluded in both Avrahami and Reserve that the arrangements weren’t insurance transactions, it had said that addressing that argument was unnecessary. 

“Given the flow of the consulting and insurance payments, I would have expected economic substance to be discussed,” Partain said.

The tax community is split on whether courts should apply economic substance and other judicial doctrines to challenge potentially abusive microcaptive transactions.

Penalties Assessed

Partain pointed out that Caylor “is notable as the first application of penalties in the [section] 831(b) captive context.” 

For the full article, please visit Tax Noteswebsite (subscription required).

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