June 7, 2022

The Internal Revenue Service today said that a recent court decision upholds its long-standing position regarding abusive microcaptive insurance transactions. Taxpayers should be alert to these schemes, normally peddled by promoters, as they will ultimately cost them.

On May 12, 2022, in Reserve Mechanical Corp. v. CommissionerPDF, the United States Court of Appeals for the Tenth Circuit appropriately upheld the Internal Revenue Service’s position on abusive microcaptive insurance transactions. The Tenth Circuit affirmed the Tax Court’s decision holding that the taxpayer was not engaged in the insurance business and that the purported insurance premiums it received were therefore taxable. After the Tax Court decided in favor of the IRS in numerous cases involving microcaptives, Reserve Mechanical is the first appellate decision recognizing the IRS’ position that these abusive transactions are shams.

The IRS encourages anyone considering entering a promoted microcaptive insurance transaction to first speak with a qualified, independent advisor. These transactions will result in serious economic loss to taxpayers, including the loss of deductions, required income inclusion and penalties. Taxpayers should understand that the IRS has asserted in many of these cases that the microcaptive insurance transactions lack economic substance and that when transactions are held to lack economic substance, then a 20% penalty (40% if undisclosed) will automatically apply, and it cannot be waived or reduced by the IRS or the courts.

Likewise, taxpayers who have already engaged in such a transaction should speak with a qualified independent tax advisor about their options. The IRS previously offered settlement opportunities for abusive microcaptive transactions, and for taxpayers who come forward seeking to resolve their case, the IRS will consider providing a resolution opportunity as appropriate.

The IRS and Department of Justice will use all available legal options to challenge improper attempts to avoid or evade U.S. income tax, regardless of how long it takes for these cases to wind their way through the courts. The IRS will also aggressively pursue penalties for all participants in these abusive transactions.