On November 1, 2016, the IRS issued Notice 2016-66 (the “Notice”), which identifies certain “micro-captive transactions” and substantially similar transactions as “transactions of interest.” Taxpayers entering into those transactions (or who have entered into them since 2006) are required to disclose the transactions according to Treas. Reg. Section 1.6011-4, which are the tax shelter disclosure rules. Also, “material advisers” who are involved in such transactions will have to disclose and satisfy list maintenance requirements under Sections 6111 and 6112.
As stated in the Notice, “The Treasury Department and the IRS recognize that related parties may use captive insurance companies that make elections under Section 831(b) for risk management purposes that do not involve tax avoidance, but believe that there are cases in which the use of such arrangements to claim tax benefits of treating the contract as an insurance contract is improper. Therefore, the Treasury Department and the IRS are identifying transactions described in 2.01 of the notice as transactions of interest.” The information required to be disclosed will help the IRS to determine the characteristics that distinguish tax avoidance transactions from other legitimate 831(b) related-party transactions.
Transactions Identified as Transactions of Interest (as Described in Section 2.01)
A person directly or indirectly owns an interest in an entity conducting a trade or business (the “Insured”), and a separate entity (the “Captive), in which at least 20 percent of the voting power is directly or indirectly owned by the Insured, enters into a contract with the Insured, which the Captive and the Insured treat as insurance;
The Captive makes an 831(b) election to be taxed only on taxable investment income; and
The ratio of the company’s losses and expenses to its premiums minus policyholder dividends is less than 70 percent, or the Captive has provided financing to the Insured or a related party.
Time of Disclosure and Compliance
In general, the disclosure statement for a reportable transaction must be attached to the taxpayer’s tax return for each taxable year in which a taxpayer participates in a reportable transaction. However, if the taxpayer currently owns a captive insurance company and meets the criteria stated above for a transaction of interest, the taxpayer is required to file a disclosure statement prior to January 30, 2017. The penalties for failure to make a timely required disclosure of this nature are significant and can be six figures.
The Treasury Department and the IRS are gathering information to identify which 831(b) transactions have potential for tax avoidance. In the Notice, they state that once they have “enough” information, they may (a) remove the transaction from the transactions of interest category, (b) designate the transaction as a listed transaction, or (c) provide a new category of reportable transaction. In the interim, it is critical that you comply with any and all reporting requirements if you are the owner of a captive insurance company and that you understand these requirements if you are considering the establishment of a captive insurance company. Please contact Mark Martinelli or your Wipfli relationship executive to determine how the Notice impacts your tax reporting requirements and to discuss whether a review of your captive strategy is prudent.