IRS Wins 5th Micro-Captive Insurance Tax Court Case

On January 4, 2024, the US Tax Court issued an opinion in Keating et al. v. Commissioner, T.C. Memo 2024-2, holding against the taxpayers and determining that the arrangement in question did not constitute insurance in its latest section 831(b) micro-captive decision. The taxpayers were shareholders in Risk Management Strategies, Inc. (RMS), which was the sole employer for caregivers, guardians, case managers, household staff, and others who provided services for special needs trusts, grantor trusts, family offices, and other entities. The taxpayers formed Risk Retention, Ltd. (RR), an Anguilla captive insurance company, in 2008. RR participated in a risk pool along with other insurers associated with the same captive manager. RR made an election under section 953(d) to be treated as a US insurance company for federal income tax purposes and an election to be taxed as a small insurance company under section 831(b).

In determining whether to characterize the arrangements between RMS and RR as insurance for federal income tax purposes, the court focused solely on whether such arrangements were "insurance in the commonly accepted sense." The court noted that although RR was properly licensed as an Anguilla insurance company and complied with Anguillan insurance regulations (including minimum capitalization requirements), it was not operated as a valid insurance company. The court took issue with several facets of the underwriting process for the coverages involved: underwriting occurred well into the coverage period and was not based on accepted actuarial standards or sufficient documentation or information about the subject risks, the underwriters lacked the requisite expertise to underwrite the coverages involved, and premiums were artificially inflated to reach a final amount close to the applicable limits set forth in section 831(b). The court also described irregularities with respect to the policies and the handling of claims: policies were issued well after the inception date with no binders in place, and RR used board resolutions to pay claims that were plainly not covered under the policies. Additionally, the court reviewed loans made from RR to RMS and determined that the circumstances surrounding these loans cut against insurance in the commonly accepted sense. In light of these issues, the court determined that the arrangement did not constitute insurance and upheld the disallowance of the deductions taken for premium payments made to RR as well as accuracy-related penalties imposed on the taxpayers.

The court raised a number of additional novel issues in its opinion, which the authors will analyze in further depth in a forthcoming article.