Syzygy Captive Not in the Business of Insurance, According to Tax Court

Editor's Note: Since last year, the captive community has been expecting to hear from the Tax Court on three small captive insurance company cases. The cases include Caylor (Judge Holmes), for which there is no opinion yet and that involved a brother-sister arrangement and no risk pool; Wilson (Judge Holmes), whose final brief is not due until November 8, 2019; and Syzygy, a Delaware captive case where the Internal Revenue Service sought to tax both the insured and the captive insurer to deny a deduction to the insured and tax the premiums.

The Syzygy ruling arrived this month with key details summarized below by Eversheds Sutherland. A more detailed write-up from Eversheds will be provided in the next edition of Captive Insurance Company Reports.

In Syzygy Ins. Co. v. Commissioner, T.C. Memo 2019–34, the Tax Court considered yet another case involving a company that had elected to be taxed under section 831(b) of the Internal Revenue Code of 1986, as amended (IRC).

The Tax Court reviewed a complex set of facts, ultimately concluding as follows.

• Premiums paid to Syzygy were not deductible either as premiums or other "ordinary and necessary expenses" under IRC § 162.
• Syzygy was not in the business of insurance and as such its election under IRC § 831(b) was invalid.
• Amounts paid to Syzygy as premiums were taxable.
• Accuracy-related penalties were not imposed.

In considering whether the transactions were insurance for federal tax purposes, the Tax Court took the following factors into account, among other items.

• Premiums were not actuarially determined.
• Although a number of losses would have been covered under a deductible reimbursement policy issued by the captive, claims were not submitted.
• One of the original coverages contemplated by the insureds as being beneficial to their businesses was never provided.
• The only loss paid as a result of the pooled risks (with more than 800 other insureds) was questionable, nevertheless it was never questioned by the captive.
• Documentation was ambiguous and issued late.
• The captive manager promoter was fired because it expressed a concern that premium for the captive coverages should be reduced.
• The rate on line for commercial coverages purchased by the insured was about 1 percent and the captive coverages were about 6 percent, although the captive coverages were all issued on an excess basis.
• During the last year at issue, interest in a split-dollar policy, which was highly illiquid, constituted approximately 50 percent of Syzygy's assets.