Beckett Cantley, senior partner of Cantley Dietrich, was named to the top ten most downloaded papers published on the research site SSRN under the Consumer Protection & Enforcement and the Life Insurance topic headings. The paper, Summary of Articles on Abusive Captive Insurance Companies, was published by the Utah chapter of the American Institute for CPAs (AICPA) on September 15, 2013.
About the Paper
Author Beckett G. Cantley, JD, LLM, analyzed the current IRS enforcement actions in light of the multiple publications Prof. Cantley had previously published in scholarly journals dissecting the tax promoters and life insurance agents who advised unsuspecting business owners to use Internal Revenue Code (IRC) Section 831(b) to form a captive insurance company (CIC) for reasons not in keeping with the intent and substance of the statute. The provision was rarely used until the late 2000s, and promoters advised clients that since the IRS rarely audited these vehicles, a CIC was compliant as a tax planning, estate planning, or wealth transfer entity.
As CICs gained in popularity, the IRS took note and started updating statutes and regulations to go after individuals or companies abusing the purposes of Section 831(b) CICs.
The IRS Targets CICs
The IRS identified five areas of Section 831(b) non-compliance:
- Life insurance on the owners of CICs as a core “investment”
- Offshore jurisdictions posing as unassailable managers
- Premiums in excess of risk and inappropriate coverages
- Estate planning ownership
- Loan-back structures
In 2016, the IRS released Notice 2016-66, announcing its disapproval of the use of CICs involved in investing “capital in illiquid or speculative assets usually not held by insurance companies.” For example, startup companies sometimes purchased large life insurance policies on their principals as a way to generate commission for life insurance promoters, and not as a sound business decision by a startup.
Unscrupulous promoters were still persuading investors to create Captives, even as the IRS warned in their annual “Dirty Dozen” tax scams list (as early as 2015) that they were potentially abusive tax shelters. Starting in 2017, they backed up these warnings with policy underwriting that created requirements for CICs to meet the threshold of a legitimate financial vehicle.
Congress has passed laws and clarified specific provisions or tests to determine whether a CIC is being used for a legitimate business purpose. There were also enhanced reporting requirements after CICs were designated as a “Transaction of Interest” (TOI), including financial tax shelter disclosure, list maintenance and registration regulations.
The IRS’ ability to prosecute abuses related to Section 831(b) was reinforced in the Tax Court decision Avrahami v. Commissioner (2017) and followed by several other key wins, and highlights the arguments they are likely to use in future enforcement, including anti-abuse and judicial anti-avoidance doctrines:
- Circular cash flows
- Lack of bona fide debt
- Step transaction doctrine
- Sham transaction doctrine
- Business purpose doctrine
- Substance over form doctrine
- Economic substance doctrine
Lessons Learned
Historically, once something is designated as a new TOI, the IRS will target and audit it. Promoters may reassure clients, but this often leads to significant proposed adjustments to taxpayer returns and substantial penalties. While CICs can provide a useful risk management and mitigation tool for business owners, it’s important to work with advisors who won’t blur the legal lines of when they are appropriate.
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The Cantley Dietrich article was also published in the Utah AICPA September 2013 Journal. You can access an electronic version at https://ssrn.com/abstract=3226652