Appeals Court Denies Delaware Bid To Block IRS Micro-Captive Summons

A federal appeals court has ruled against the Delaware Department of Insurance's efforts to block a summons from the Internal Revenue Service (IRS) for information about Delaware-domiciled captive insurance companies.

The summons compels the department to disclose to the IRS regulatory filings and other information provided to the Delaware department by Delaware-domiciled captive insurance companies, which are treated as confidential information under the Delaware Insurance Code.

A lower court had earlier denied the Delaware department's motion to quash the summons, leading to the appeal.

Now the United States Court of Appeals for the Third Circuit has upheld the lower court's ruling in the case of United States of America v. State of Delaware Department of Insurance.

The Delaware department had argued that under the McCarran-Ferguson Act (MFA), Delaware law overrides the IRS's statutory authority to issue and enforce summonses.

"While the MFA does protect state insurance laws from intrusive federal action when certain requirements are met, the District Court concluded that, before any such reverse-preemption occurs, our precedent requires that the conduct at issue—in this case, the refusal to produce summonsed documents—must constitute the 'business of insurance' within the meaning of the MFA," the appeals court noted in its ruling. "The District Court held that this threshold requirement was not met here, and we agree. We will therefore affirm."

The appeals court found that the Delaware department's refusal to comply with the summons for information regarding certain Delaware-domiciled micro-captives did not constitute "the business of insurance."

Further, the appeals court ruled, its affirmation of the lower court ruling will leave the Delaware department "no less entitled to the information it currently receives to license captive insurance companies than it has previously been. The same is true of the Department's entitlement to information to determine whether already-licensed captive insurance companies should be allowed to continue to operate."

The ruling noted that the IRS had identified micro-captive transactions, small captive insurance companies that elect to be taxed under section 831(b) of the Internal Revenue Code, which allows small insurance companies to be taxed only on their investment income, as having "a potential for tax avoidance or evasion," and had subsequently increased its scrutiny of micro-captive transactions.