Royal Management: Another 831(b) Tax Court Decision

Recently, the Tax Court decided Royal Mgmt. Ins. Co., Ltd. v. Commissioner, T.C. Memo 2024–87. The case is another in a line of several cases involving companies seeking to be characterized as insurance companies taxable under section 831(b) of the Internal Revenue Code of 1986, as amended. In reviewing most of these cases, we have recounted a lengthy description of the facts and then a similar and by this time familiar series of conclusions by the Tax Court. In order to be brief, we only set forth the conclusions of the Tax Court, which, as noted above, will likely sound familiar to those who have been following this line of cases.

1. Note that the arrangement involved insurance premiums paid by an operating company ("SR") to an unrelated insurer ("CCFC") followed by reinsurance to the captive ("RMIC"). The Tax Court found with respect to the 2012 year that CCFC did not exist during the 2012 policy period as it was not formed until 2013. The policy contained material from an actuarial report completed in 2013, and the policy limits and deductibles in the policy did not match those suggested in the actuarial report completed after the policy period.
2. The reinsurance agreement between CCFC (the insurer) and RMIC (the captive reinsurer) made the owner of SR liable for any claims RMIC could not pay. RMIC had no capital or assets apart from the premium paid by CCFC, and, thus, liability (without the owner's guarantee) could not exceed the premium paid by the insured. Thus, there was no risk shifting.
3. SR was the only insured. Thus, there was no risk distribution.
4. There was no insurance in the commonly accepted sense because:
   1. RMIC was organized as a corporation, not as an insurance company, as it was organized in the Sac and Fox Nation, which had no insurance laws.
   2. RMIC had no initial capital or paid-in surplus.
   3. There were no policies during the 2012 tax year as RMIC (the insurer) was not incorporated until 2013.
   4. Actuarially determined premiums did not exist. Apparently, taxpayers provided several actuarial calculations and none tied into the premium paid.
   5. No claims were submitted during 2012 and 2013, but after the Internal Revenue Service exam started in 2014, SR submitted claims that were paid in full. However, the Court found these claims likely should not have been paid (e.g., late submission of claims, no meaningful proof of loss, etc.).
   6. Because the captive invested all funds in the SR or its shareholders, there was a circular flow of funds.

Accordingly, based on the prior cases, this was clearly a tutorial of what not to do in order to secure a tax deduction.