We have now discovered that in 2013 the IRS finally launched its long-anticipated investigation of the managers of smallish insurance companies. This has finally culminated in the IRS issuing notices this year that it is conducting so-called “promoter audits” of these manager, and serving subpoenas that request a broad swath of information regarding these captives.
The subpoenas issued by the IRS focus on the managers’ risk pools, including how premiums are calculated and claims paid (if any; some of these pools are notorious for never paying any substantial claims), as well as on individual client insurance policies.
But more importantly, the subpoenas seek marketing materials of the managers, and communications with the clients, which obviously means the IRS is focusing on the true purpose behind the captive: Was it an insurance vehicle as it must be, or a tax-avoidance vehicle which it should not be?Not all small captive insurance arrangements are invalid; far from it. The vast majority of small captive insurance companies making the 831(b) election are valid and play by the rules, and are not going to be bothered by any of this.
Unfortunately, the captive industry over the last decade has been inundated with promoters who sell small captive insurance companies as the tax shelter du jour, with only a wink and a nod being paid to what should be the true insurance and risk financing purpose of a captive.
Going after certain managers allows the IRS, limited as it is by scarce resources, to take down many abusive captive arrangements at once. Instead of going after individual captives one-by-one through random audits, by promoter audits the IRS has the opportunity to invalidate several hundred captive arrangements at one time.
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