Tax Court Again Considers an IRC Section 831(b) Case and Rules in Favor of the Internal Revenue Service

Genie R. Jones, et al. v. Comm'r, T.C. Memo 2025–25 is another in the line of cases involving captive insurers which sought to be taxed under section 831(b) of the Internal Revenue Code of 1986, as amended (the "Code") that have been held by the Tax Court not to be insurance companies for purposes of the Code.

Although the facts of each case are obviously different, the holdings by the Tax Court follow a familiar course:

(i) The captive did not distribute risk, either directly or by means of participation in a reinsurance pool;

(ii) The pool reinsurer did not charge arm's-length premiums (i.e., they were excessive by actuarial standards);

(iii) Rev. Rul. 2002–89 (which describes a captive which is an insurer for federal income tax purposes and writes unrelated business) does not apply because it is based on a captive otherwise conducting itself as a bona fide insurance company;

(iv) The captive was not operated as a bona fide insurance company;

(v) Some policies the captive issued are likely invalid;

A few of the findings, however, bear a bit of further comment:

(i) In analyzing the reinsurance pool, the court took note of the fact that over a period of time the reinsurance industry had a loss ratio 99 times greater than that of the pool.

(ii) The court also had an interesting comment on the functions of actuaries and underwriters in a commercial setting based on expert testimony, noting that

"actuaries use published rates and large datasets for particular risks to define the rating scheme, that is, determine the premium that should be charged for applicants that fit into a given bucket (think risk profile) while adjusting for policy limits, deductibles, prior loss experience, etc. Underwriters decide which bucket (or risk profile) an insurance applicant fits into; they determine whether an applicant is insurable and on what terms. The underwriter relies on information disclosed by the prospective insured on insurance applications issued by the insurance company. The application form includes questions the insurance company deems necessary to properly underwrite the risk (for example, questions about the applicant's loss history)."

Elaborating, the Court further noted that no application was submitted by the insured to the captive, although the policy issued makes reference to the application, and the expert noted that it would be unusual for an insurer to write the type of policy written without an application.

(iii) Although not mentioned in the Court's holding, there was a discussion in the statement of facts in the opinion observing that after approximately one year the insurance arrangements with the captive were terminated, right around the time the owners of the captive had gotten offers to buy the operating company on the basis of a multiple of EBITDA (expenses before interest, taxes, depreciation and amortization) and one of the offers indicated that the operating company would be worth more without the insurance expense of premium paid to the captive.

This article was edited to conform to the Chicago Manual of Style.