Beckett G. Cantley [1]
Geoffrey C. Dietrich [2]

On April 7, 2020 the U.S. Tax Court ruled in Estate of Moore v. Commissioner, T.C. Memo. 2020-40, that certain deathbed transfers should be includible in the decedent’s estate for United States Federal Estate Tax (“estate tax”) purposes. The court applied Internal Revenue Code (“I.R.C.”) § 2036 to the transfers due to the decedent’s continued interests in the transferred property. The Tax Court stated that I.R.C. § 2036 creates “a general rule that brings back all property that a decedent transfers before he dies, subject to two exceptions.” [3] The first exception is for bona fide sales for full and adequate consideration. The second exception is for “any property that [the decedent] transferred in which he did not keep a right to possession, enjoyment, or rights to the issue of the transferred property.” [4] The Tax Court stated that the first exception depends on the transferor’s motivations, and that the decedent’s actions made it clear there was no bona fide sale. As a result, the Tax Court determined that I.R.C. § 2036(a)(1) applied to the transfer.

Estate of Moore is the latest in a line of cases in which taxpayers made deathbed transfers close to the date of death and the IRS successfully argued that the transferred property is includible in the decedent’s gross estate. In Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), the Tax Court created a three-part test to determine whether I.R.C. § 2036 pulls property back into a decedent’s estate.

In Estate of Strangi v. Commissioner, T.C. Memo. 2003-145, aff’d 417 F.3d 468 (5th Cir. 2005), the Tax Court provided additional guidance for how the court interprets I.R.C. § 2036(a)(1).

In Estate of Nancy H. Powell v. Commissioner, 148 T.C. No. 18 (2017), the court builds on the rationale established by Strangi, but ultimately invokes I.R.C. § 2036(a)(2) to include the transferred assets in decedent’s gross estate. This article: (1) provides an overview of deathbed transfers case law; (2) describes typical such deathbed transfers; (3) outlines the I.R.C. § 2036 statute; (4) discusses the main seminal cases in the area of deathbed transfers, including Estate of Bongard, Estate of Strangi, Estate of Powell, and Estate of Moore; (5) synthesizes the case law on I.R.C. § 2036 and analyzers policy considerations regarding such law; and (6) concludes with a summary of the article’s findings.

I. Introduction: Death and Taxes

The only thing more inevitable than taxes and death … is taxes on death. When an individual dies, the person is taxed on the right to transfer property at death under the estate tax. [5] The tax is assessed against the individual’s “gross estate,” which consists of the fair market value of all property and certain interests the person owned at the time of death. [6] Once the gross estate is calculated, certain deductions are applied to arrive at the “taxable estate.” [7] Added to the taxable estate is the value of lifetime gifts subject to the United States Federal Gift Tax (“gift tax”). [8] Instead of being a tax on the transfer of property at death, the gift tax is a tax on an individual’s inter vivos transfer of property where the individual receives nothing, or less than full value, in return. [9] After adding the value of lifetime gifts to the taxable estate, the estate tax is computed. Finally, the tax is reduced by the available Unified Credit. [10]

Despite I.R.C. § 2001(a) imposing the estate tax on the taxable estate of every decedent who is a citizen or resident of the United States, [11] very few people end up paying any tax. Out of the 2.8 million people expected to die in 2020, it is estimated that the estates of only 1,900 people will be taxable—less than 0.1% of decedents. [12] The major reason for this is the Unified Credit. After a series of increases, [13] in 2020, a decedent can exclude up to $11,580,000 from his or her taxable estate before he or she must pay any federal estate and gift tax. [14] While most estates fall within the Unified Credit amount, [15] for those that exceed it, the tax consequences are significant. The current estate tax rate is 40%. [16] Thus, for every $1,000,000 included in the taxable estate, the tax bill rises by $400,000.

With such large amounts of money at stake, it is easy to see why high-net-worth individuals engage in estate planning to reduce estate and gift taxes. While many techniques are used to reduce estate and gift taxes, they center on transferring property out of an individual’s estate prior to death. Because the timing of death is uncertain, the earlier individuals plan their estates, the higher the chance their estate plan will accomplish the tax objectives.

Of course, not all individuals plan their estate well in advance of death. Many begin only after a serious decline in health or when death becomes imminent. These last-minute estate plans, or “deathbed transfers,” and how the court interprets I.R.C. § 2036 [which limits them], is the subject of this article. Part II of this article discusses common deathbed transactions. Part III discusses § 2036. Part IV discusses the line of seminal cases which interpret § 2036. Part V discusses: (1) the rules after the holding in Moore; (2) the policy behind the rules; and (3) the potential future of deathbed transactions.

II. Common Deathbed Transactions

Deathbed transactions take many forms. Typical transactions include outright gifts to loved ones, trust funding for the benefit of children, and asset sales to satisfy debts pre and post death. Most of these transfers are done simply to tie up loose ends before an individual’s death. However, as the estate value approaches and exceeds the estate and gift tax exemption amount, the consideration shifts to the reduction of estate and gift taxes. While multiple options exist to lower estate and gift taxes, the following section focuses on two types of transactions which frequently come under increased scrutiny from the IRS: family limited partnerships and discounted transfers.

A. Family Limited Partnerships

A family limited partnership (“FLP”) is a partnership created to administer a family business where members of the immediate family and close relatives serve as partners. [17] Just as in other limited partnership formats, there are general and limited partners. [18] The general partner is responsible for managing and controlling the assets and receiving and distributing profits. [19] The general partner is legally responsible for losses but does not hold title to the underlying assets of the partnership as an individual. [20] The limited partner shares in the profits of the partnership, but has limited liability and does not control day-to-day operations. [21] Limited partners in FLPs differ from other partnerships entities as FLP limited partners commonly receive an ownership interest without first contributing capital to the partnership. [22] In these instances, the limited partner is gifted the ownership interest based solely on the individual being a member of the family. [23]

Family limited partnerships are a popular vehicle for several reasons. [24] They offer centralized management of assets, ability to pool assets across multiple generations, ease of ownership transfers, asset protection, [25] and avoidance of probate. [26] The potential estate and gift tax savings is a particularly persuasive reason why individuals form FLPs. This option reduces estate and gift tax by transferring an underlying asset from an individual’s estate to an FLP in exchange for a partnership interest. [27] When the individual dies, the value of the partnership interest is included in the gross estate, not the fair market value of the underlying asset. [28] The partnership interest has a value less than the underlying asset because of valuation discounts. [29]

Two valuation discounts commonly apply to FLP interests. One is for “lack of marketability” [30] and the other is for “lack of control.” [31] A lack of marketability discount is applied to reflect that a partnership interest in a closely-held business is less attractive and more difficult to market than a publicly traded business interest. [32] The partnership interest can be harder to sell because the interest is only a minority stake or because of the difficulty of removing an underlying asset from a FLP. [33] The lack of a readily available market to sell the FLP interest, in turn, creates potential short-term liquidity problems and increases the risks of ownership. [34] Thus, courts have allowed a discount for lack of marketability to reflect the difficulties inherent in FLP interest ownership. [35] The lack of control discount is a result of the different rights and different levels of control afforded to general and limited partners. [36] Limited partners “lack control” because they are unable to force distributions or control the daily decisions of the partnership. [37]

Valuation discounts are not uniform. The size of the discount depends on several factors, including the type of asset or assets transferred, market conditions at the time of the transaction, the interest the decedent receives, and restrictions on the transfer of property in the partnership agreement. [38] A lack of marketability discount can range as high as 30-60% of the fair market value of the FLP interest. [39] A lack of control discount can be 25-55% of the pre-discount value of the partnership interest. [40] Overall, valuation discounts applied to FLP interests are such an important estate planning tool because they can reduce the value of an asset that was previously part of the decedent’s estate by 30-60%. [41] This “shrinks” the decedent’s estate and results in significant tax savings.

B. Discounted Transfers

Estate and tax planning opportunities do not end once the initial asset transfer into the FLP occurs. Individuals may receive additional estate reduction by transferring the discounted FLP interest. Common discounted transfers include transfers to children, a Grantor Retained Annuity Trust (“GRAT”), and a Charitable Lead Annuity Trust (“CLAT”). Transfers to children within the family accomplish a multitude of objectives. A transfer to a child of a FLP interest can serve the purpose of giving the child a stake in the family business while teaching the child how to run the business while a parent retains control and management of the business as general partner. [42] Depending on the parent’s goals, the transfer can be structured as a gift or a sale. [43] If the transfer is a gift, the value of the FLP interest is removed from the parent’s estate with the gifted interest’s value counting against the gifting parent’s lifetime exclusion amount. [44] Nonetheless, the valuation discounts reduce the gift tax exclusion amount less than if the underlying assets were transferred outright. [45] If the transfer is structured as a sale, the value of the FLP interest is removed from the parent’s estate and the consideration received for the interest remains. [46] Due to valuation discounts, this amount will be less than an outright sale of the underlying asset. [47]

Another popular discounted transfer to reduce estate and gift tax is the transfer of FLP interests to a GRAT. In this arrangement, a FLP interest is transferred to a GRAT, while the grantor retains the right to the FLP interest’s income stream in the form of an annuity for the term of the GRAT. [48] When the term of the GRAT ends, the FLP interest is transferred to the remainder beneficiary (usually another family member). [49] This allows for an even greater valuation discount because the right to the FLP interest’s stream of income is valued less than the value of the actual FLP interest. [50]

A third common discounted transfer is the transfer of an FLP interest to a CLAT. In this arrangement, the FLP interest is transferred to a CLAT where annuity payments are made to a charity for a certain timeframe. [51] Once the specified period ends, whatever remains in the trust is transferred to or for the benefit of the remainder beneficiary. [52] The remainder beneficiary, importantly, does not have to be a charitable organization. [53] Often, they are the descendants of the CLAT’s grantor. [54] Beyond the benefit of transferring the FLP interest out of the donor’s estate, the donor receives a gift tax charitable deduction for the present value of the lead interest. [55] While the present value of the remainder estate is a taxable gift, steps can be taken to reduce the amount of taxable gift to zero. [56] Thus, successful implementation of a CLAT allows the donor to remove the value of the underlying FLP interest from their estate, receive a gift tax charitable deduction, and transfer the FLP interest to their children or other family members. [57]

III. I.R.C. § 2036

When properly structured and executed, FLPs, discounted transfers, and other vehicles can achieve a significant estate and gift tax reduction. However, the transfers must not fall within the scope of I.R.C. § 2036(a). I.R.C. § 2036(a) is an Internal Revenue Code provision that brings the value of certain transferred property back into the decedent’s gross estate. [58] I.R.C. § 2036(a) provides:

(a) General rule. The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—

(1) the possession or enjoyment of, or the right to the income from, the property, or

(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

Essentially, I.R.C. § 2036(a) includes the value of any transferred property in the decedent’s estate where the decedent either retained: (1) the possession or enjoyment of; (2) the right to possess or enjoy; or (3) the right to designate who shall possess or enjoy such transferred property. The purpose of I.R.C. § 2036 is to “prevent the circumvention of federal estate tax by the use of inter vivos transactions which do not remove the lifetime enjoyment of property purportedly transferred by a decedent.” [59] I.R.C. § 2036 is “part of a Congressional scheme to tax the value of property transferred at death,” whether the decedent “accomplishes the transfer by will, by intestacy, or by allowing his substantial control over the property to remain unexercised until death so that the shifting of its economic benefits to the beneficiary only then becomes complete.” [60] The IRS has increasingly turned to I.R.C. § 2036 in order to pull the value of deathbed transfers back into a decedent’s estate. [61] The following cases explore how the court has interpreted I.R.C. § 2036 and responded to the IRS’s increased use of the provision.

IV. I.R.C. § 2036(a) Deathbed Transfers Seminal Cases

Over the past twenty years, courts have issued a line of decisions providing guidance on the application of I.R.C. § 2036(a) to deathbed transfers. Each of these cases resulted from IRS challenges to decedent asset transfers to an FLP. The IRS increasingly disputes these transfers as they “often view these partnerships as efforts to pass valuable assets to one’s heirs at a discount for lack of marketability and lack of control.” [62]

A. Estate of Bongard

In Estate of Bongard v. Comm’r, [63] the United States Tax Court (“USTC”) outlined a general test that has become the standard courts use to determine whether an inter vivos transfer falls within I.R.C. § 2036(a). [64] In Bongard, decedent established Empak, Inc. (“Empak”), an electronics materials packaging company, where decedent served as CEO and sole member of Empak’s board of directors. [65] Decedent and an Irrevocable Stock Accumulation Trust (“ISA Trust”) set up for the benefit of decedent’s children owned all the stock of Empak. [66] On January 30, 1996, WCB Holdings, LLC. (“WCB Holdings”) was established to pool the family members’ ownership interests in Empak in preparation of a corporate liquidity event. [67] On December 28, 1996, decedent and ISA Trust contributed their shares of Empak stock to WCB Holdings in exchange for WCB Holdings Class A and Class B membership units. [68] The following day, decedent and ISA Trust created Bongard Family Limited Partnership (“BFLP”). [69] In exchange for a 99% limited partnership interest in BFLP, decedent transferred all of his WCB Holdings class B membership units to BFLP. [70] ISA Trust received a 1% general partnership interest after transferring a portion of its WCB Holdings class B membership units to BFLP. [71] Subsequent gifts and distributions, including a BFLP 7.72% limited partnership interest gift from decedent to his wife, followed up until decedent’s death. [72] On November 16, 1998, Decedent died unexpectantly. [73]

The IRS argued that decedent’s inter vivos transfers to WCB Holdings and BFLP should be included in the gross estate because I.R.C. §§ 2035(a) and 2036(a) and (b) applied. [74] The estate countered the IRS’s argument on the two transfers, stating that they: (1) were not “transfers” within the meaning of I.R.C § 2036, (2) satisfied the bona fide sale exemption, and (3) did not include decedent’s retention of I.R.C. § 2036 interests. [75] The Tax Court held that: (1) decedent’s transfer of Empak stock to WCB Holdings satisfied the bona fide sale exception of I.R.C. § 2036(a); [76] and (2) the value of decedent’s transfer of WCB Holdings class B membership units to BFLP was includable under I.R.C. § 2036(a)(1). [77] First, the USTC explained I.R.C. § 2036 applies when three conditions are met:

(1) the decedent made an inter vivos transfer of property; (2) the decedent's transfer was not a bona fide sale for adequate and full consideration; and (3) the decedent retained an interest or right enumerated in section 2036(a)(1) or (2) or (b) in the transferred property which he did not relinquish before his death.

Estate of Bongard v. Comm'r, 124 T.C. No. 8, at *112 (2005). Next, the USTC applied their newly created test. The Tax Court found both of decedent’s transactions to be “transfers” within the context of I.R.C. § 2036 because “transfer” is a broadly defined term [78] and decedent voluntarily made the inter vivos transfers of the property. [79]

For the second condition of the test, the UTSC found decedent’s initial transfer of Empak stock to WCB Holdings did qualify for the bona fide sale exception, [80] while decedent’s subsequent transfer of WCB Holdings class B membership units to BFLP did not. [81] As the United States Court of Appeals for the Fifth Circuit did in Kimbell v. United States, [82] the Tax Court broke the bona fide sale exception into two prongs: (1) whether the transaction qualified as a bona fide sale; and (2) whether the decedent received adequate and full consideration. [83] For FLPs, the first prong is satisfied when the objective evidence indicates a “legitimate and significant nontax reason” for the FLP creation and the transferors receive “partnership interests proportionate to the value of the property transferred.” [84]

Decedent’s transfer of Empak stock to WCB Holdings satisfied the first prong of the test because the court found the pooling of decedent’s and ISA Trust’s Empak shares was for the significant nontax reason of attracting potential investors and raising capital for additional growth. [85] Furthermore, the Tax Court determined the second prong was satisfied because both decedent and ISA Trust received interests in WCB Holdings proportionate to the amount of shares each transferred. [86] Thus, the Tax Court determined decedent’s transfer of Empak stock to WCB Holdings satisfied the bona fide sale exception of I.R.C. § 2036(a), and there was no need to determine whether decedent retained an I.R.C. § 2036(a) or (b) interest. [87]

The USTC held decedent's transfer of WCB Holdings class B membership units to BFLP did not satisfy the bona fide sale exception because it failed to exhibit a significant nontax purpose. [88] The USTC rejected the estate’s arguments that BFLP was established to provide additional credit protection and to facilitate decedent’s post-marital agreement with his second wife. [89] The tax court reasoned WCB Holdings already satisfied those objectives. [90] Furthermore, decedent “recycled the value” of the property he transferred to BFLP because BFLP did not perform a management function for the assets received or engage in any businesslike transaction. [91] All decedent did was “change the form” in which he held his interest in the transferred property. [92] Thus, decedent’s transfer of WCB Holdings class B membership units to BFLP did not qualify for the bona fide sale exception. [93]

Finally, the USTC turned to the third consideration of the I.R.C. § 2036 test and held decedent retained an I.R.C. § 2036(a) interest in BFLP. [94] The Tax Court stated a right is retained “if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred.” [95] The USTC concluded there was an implied agreement between the parties that decedent retained the right to control the WCB membership units based on decedent’s ability to decide whether the membership units and underlying Empak stock would be redeemed. [96] After determining decedent retained the enjoyment of the property transferred to BFLP, the USTC concluded the value of the WCB Holdings class B membership units was included in decedent’s gross estate under I.R.C. § 2036(a). [97]

B. Estate of Strangi

While Bongard established a test for courts to use for I.R.C. § 2036(a) inclusion, [98] Estate of Strangi v. Comm’r [99] outlines the application of I.R.C. §§ 2036(a)(1) and (a)(2) to deathbed transfers. In Strangi, decedent transferred 98% of his wealth to Strangi Family Limited Partnership (“SFLP”) two months before his death. [100] On July 19, 1988, decedent executed a power of attorney naming Mr. Gulig, his son-in-law, as his attorney-in-fact. [101] During 1993, decedent underwent surgery to remove a cancerous mass from his back and was diagnosed with a degenerative brain disorder. [102] After attending a seminar discussing the use of family limited partnerships for asset preservation, estate planning, income tax planning, and charitable giving, on August 12, 1994, Mr. Gulig formed SFLP while acting as decedent’s attorney-in-fact. [103] Property of decedent totaling a fair market value of $9,876,929, or 98% of decedent’s wealth, was transferred to SFLP in exchange for a 99% limited partnership interest. [104] Assets contributed to SFLP included the residence occupied by decedent, securities, accrued interest and dividends, insurance policies, an annuity, receivables, and partnership interests. [105] Stranco, a Texas corporation Mr. Gulig created the same day as SFLP, purchased the remaining 1% of SFLP as managing general partner. [106] Stranco was funded by decedent and his four children. [107] Decedent contributed $49,350 in assets for 47% of Stranco’s common stock, while decedent’s children contributed $55,650 for 53% of Stranco’s common stock. [108] Additionally, decedent and decedent’s children were named as the initial five directors of Stranco and Mr. Gulig was hired by Stranco to manage the day-to-day business of the corporation. [109] Decedent died of cancer on October 14, 1994—less than three months after the transfers to SFLP and Stranco. [110]

In the Tax Court, the IRS argued that SFLP should be disregarded because it lacked economic substance and business purpose. [111] After the subsequent approval of a motion to amend its answer, the IRS further argued the full value of the assets decedent transferred to SFLP and Stranco should be included in decedent gross estate because decedent retained a “right” within the meaning of I.R.C. § 2036(a)(2). [112] On its second trip to the Court of Appeals, the Fifth Circuit affirmed the Tax Court’s holding that the value of the assets decedent transferred to SFLP should be included in decedent’s estate under I.R.C. § 2036(a)(1). [113] The Fifth Circuit stated two requirements were needed to trigger I.R.C. § 2036(a)(1). [114] First, the decedent must retain “possession or enjoyment” of the property.” [115] This requirement is met if the decedent retains a “substantial present economic benefit” from the transferred property. [116] For the second requirement, the court used the same “expressed or implied” agreement test used by the court in Bongard. [117] The Fifth Circuit concluded that decedent satisfied both requirements based on numerous facts, [118] including: (1) various payments made from the FLP, both before and after decedent’s death, to meet his needs and expenses; (2) decedent’s continued residence in his house after it was transferred to the FLP; (3) his nonpayment of rent to the FLP for three years; and (4) his failure to retain sufficient assets outside the FLP to meet his living expenses for his remaining life expectancy. [119] Based on these circumstances and the inapplicability of the bona fide sale exception, [120] the Fifth Circuit affirmed the Tax Court’s I.R.C. § 2036(a)(1) holding. [121]

Because the Fifth Circuit held the transferred assets were included in the taxable estate under I.R.C. § 2036(a)(1), the Fifth Circuit did not discuss the IRS’s alternative contention for inclusion under I.R.C. § 2036(a)(2). [122] However, the Tax Court’s assessment of the IRS’s I.R.C. § 2036(a)(2) argument is important to discuss as it serves as the basis for later holdings. [123] The Tax Court held, as an alternative to their I.R.C. § 2036(a)(1) holding, that decedent, through Mr. Gulig, retained the “right to designate the persons who shall possess or enjoy the property or its income” within the meaning of I.R.C. § 2036(a)(2). [124] Specifically, the court found Mr. Gulig’s dual roles as decedent’s attorney-in-fact and manager of Stranco problematic. [125] The SFLP partnership agreement named Stranco managing general partner of SFLP and gave the managing partner sole discretion to determine distributions. [126] When Mr. Gulig was hired as Stranco’s manager, this power was then conferred upon Mr. Gulig, [127] placing decedent in a position “to act, alone or in conjunction with others, through his attorney-in-fact, to cause distributions of property previously transferred to the entities or of income therefrom.” [128]

Citing United States v. Byrum, [129] the estate argued I.R.C. § 2036(a)(2) was not applicable because decedent’s “rights” were limited by Mr. Gulig’s fiduciary duties to SFLP and Stranco. [130] The court rejected this argument because: (1) Mr. Gulig already owed fiduciary duties to decedent personally as his attorney-in-fact before the formation of SFLP and Stranco; and (2) the fiduciary obligations of Stranco and its directors were duties essentially owed to decedent himself. [131] The Tax Court then rejected the fiduciary duties argument by stating, “[i]ntrafamily fiduciary duties within an investment vehicle simply are not equivalent in nature to the obligations created by the United States v. Byrum . . . scenario.” [132]

C. Estate of Powell

Estate of Powell v. Commissioner [133] builds on Strangi and is a major victory for the IRS in its battle against FLP deathbed transfers. In Powell, decedent’s son, acting under a power of attorney, transferred approximately $10 million of assets from decedent’s revocable trust to an FLP while decedent was hospitalized in intensive care. [134] Decedent received a 99% limited partnership interest, while her two sons contributed an unsecured note in return for a 1% general partnership interest. [135] Notably, the FLP agreement gave decedent’s son sole discretion over the timing and amount of partnership distributions. [136] The agreement also permitted dissolution of the FLP upon written consent of all partners. [137] On the same day cash and securities were transferred into the FLP, decedent’s son, again acting under a POA, transferred decedent’s 99% limited partner interest to a charitable lead annuity trust (“CLAT”) with her two sons receiving the remainder upon her death. [138] Decedent died seven days after the funding of the FLP and same-day transfer of her limited partner interest to the CLAT. [139]

The IRS argued that I.R.C. § 2036(a)(1) and (2) applied to decedent’s transfer of cash and securities to the FLP. [140] The IRS contended that I.R.C. § 2036(a)(1) applied to the transfer because it was subject to an implied agreement under which decedent retained possession or enjoyment of the transferred property or the right to income from that property. [141] The IRS argued that I.R.C. § 2036(a)(2) applied because of decedent's ability, acting with her sons, to dissolve the FLP and thereby designate who could possess the transferred property or the income from it. [142] Finally, the IRS asserted the bona fide sale exception to I.R.C. § 2036(a) did not apply because the estate failed to demonstrate a “significant nontax purpose” for the creation of the FLP and because, in the light of the claimed valuation discount, the transfer was not made for “full and adequate consideration.” [143]

The USTC held for inclusion of the cash and securities under I.R.C. § 2036(a)(2), making it unnecessary to consider the IRS’s I.R.C. § 2036(a)(1) argument. [144] Drawing heavily from Estate of Strangi, [145] the Tax Court found decedent’s cooperative ability to dissolve the FLP with her sons constituted a right in conjunction with others to designate the persons who shall possess or enjoy the transferred property within the meaning of I.R.C. § 2036(a)(2). [146] The USTC found the ability to dissolve the partnership problematic because it comes with the ability to direct the disposition of the partnership assets. [147] While the decedent’s ability is in conjunction with her sons, it was enough to trigger I.R.C. § 2036(a)(2) inclusion. [148] Decedent’s ability to determine the amount and timing of distributions through her son’s dual role as managing general partner and her attorney-in-fact constituted a “right” within the meaning of I.R.C. § 2036(a)(2). [149]

In finding this way, the Tax Court echoed Strangi and precluded the “fiduciary duties” argument. [150] The USTC reasoned Mr. Powell owed duties to decedent prior to or upon formation of the FLP. [151] Since decedent held a 99% interest in the FLP, whatever fiduciary duties limited her son’s ability to determine partnership distributions were duties owed “almost exclusively” to decedent herself. [152] Finally, the court found any fiduciary duties Mr. Powell may have owed to decedent as “illusory” because there was no evidence that the FLP was anything but an investment vehicle for decedent and her sons. [153] Since the estate did not argue that the transfer was exempted by the I.R.C. § 2036(a) bona fide sale exception, the USTC concluded the value of the transferred assets was includible in the value of decedent’s gross estate. [154]

D. Estate of Moore

The most recent case in the deathbed transfer inclusion is Estate of Moore v. Commissioner. [155] In Moore, decedent built a successful family farm (“Moore Farms”). [156] In 2004, decedent, in his late eighties, began negotiating a sale of Moore Farms to Mellon Farms. [157] In December 2004, before decedent could complete the deal with Mellon Farms, he was rushed to the emergency room with congestive heart failure. [158] After release from the hospital, a hospice doctor gave him less than six months to live. [159] Decedent then began his estate planning. [160] The result was a complex web of entities including a Living Trust (“Living Trust”), a Charitable Lead Annuity Trust (“Charitable Trust”), a Children’s Trust (“Children’s Trust”), a Family Management Trust (“Management Trust”), an Irrevocable Trust (“Irrevocable Trust”), and a Family Limited Partnership (“FLP”)—all created on the same day. [161] Decedent’s estate planning attorney testified that in decedent’s initial call to him, decedent believed his discharge from the hospital was “an extension of his life” and he wanted to wanted to meet with his attorney in order to try to “save the millions of dollars of taxes.” [162] On February 4, 2005, decedent finalized the sale of Moore Farms to Mellon Farms. [163] Decedent continued to live on the farm and made various transfers among and from the trusts and FLP until his death at the end of March 2005. [164]

The IRS argued the majority of the estate plan failed under I.R.C. § 2036 because: (1) decedent lacked a legitimate nontax reason for forming the FLP, thus, the transfer of four-fifths of the farm to the FLP did not qualify for the I.R.C. § 2036(a) bona fide sale exception; and (2) decedent retained possession and enjoyment of Moore Farms even after its sale. [165] The USTC agreed with the IRS and held the transfer of four-fifths of the farm to the FLP did not meet the requirements of the bona fide sale exception [166] and decedent retained possession or enjoyment of Moore farms within the meaning of I.R.C. § 2036(a)(1). [167] The USTC found decedent’s transfer of Moore Farms to the FLP did not qualify for the bona fide sale exception because the formation of the FLP lacked a significant nontax reason. [168] The Tax Court reached this conclusion because: (1) there was no “business” for the family to run after decedent sold the farm within five days of its transfer to the FLP; (2) the business retained significant amounts of capital for any “alleged” creditors who may make claims; (3) decedent began planning his estate only after he faced significant health problems; (4) decedent told his estate planning attorney he wanted to “save millions of dollars of taxes” through his estate plan; and (5) the decedent’s unilateral actions underlined the general testamentary nature of the plan and transfers. [169] Because the formation of the FLP failed to have a significant nontax purpose, the USTC did not consider the issue of value—i.e. whether decedent’s transfer was for adequate and full consideration—and moved to the “retained possession or enjoyment of” the transferred asset part of the analysis. [170]

The USTC concluded decedent retained possession or enjoyment of Moore Farms after he transferred it to the FLP. [171] Applying the two-prong I.R.C. § 2036(a)(1) test from Strangi, [172] the USTC found decedent retained a “substantial present economic benefit” from the farm after he transferred it. [173] The Tax Court pointed to several facts to support its conclusion. [174] First, decedent continued to live on the property and run the farm as he did before the sale, and did so up until his death. [175] Second, while decedent retained sufficient assets to support himself unlike the decedent in Strangi, [176] he did not draw upon them. [177] Instead, he used FLP assets to pay his personal expenses and make gifts. [178] Finally, despite not holding the controlling general interest, decedent ignored formalities and continued to exercise control over the farm and make unilateral decisions. [179] The USTC reasoned these facts indicated an implicit understanding between Moore and his children that he would continue to use the FLP assets and that his relationship with the transferred assets “changed formally, not practically.” [180] Thus, the Tax Court held the value of the farm should be included in the value of the gross estate under I.R.C. § 2036(a)(1). [181]

V. Analysis

A. The Post-Moore Rules

After Moore, I.R.C. § 2036(a) tends to bring all deathbed property transfers back into the gross estate, [182] unless: (1) the estate can show the sale was a bona fide sale for adequate and full consideration; [183] or (2) the decedent did not retain a right to possession, enjoyment, or rights to the issue of the transferred property. [184] A sale is bona fide, in the family limited partnership context, when the objective evidence establishes the existence of a “legitimate and significant nontax reason” for the creation and transfer of assets to the FLP. [185] A sale is for adequate and full consideration when the decedent receives a “partnership interests proportionate to the value of the property transferred.” [186] Essentially, the bona fide sale prong is a question of motive, while the “for adequate and full consideration” prong is a question of value. [187]

If a transfer does not qualify under the “bona fide sale” exception, the analysis moves to the second exception. A decedent retains the right to possession or enjoyment if the decedent retains “substantial present economic benefit” from the property after transferring it and there is an “express or implied agreement” that the decedent will continue to possess or enjoy the property “at the time of transfer.” [188] While the right to the issue of the transferred property part of the rule is the least developed, the court has held the ability “to act, alone or in conjunction with others,” [189] to cause partnership distributions [190] or dissolve the partnership triggers inclusion under I.R.C. § 2036(a)(2). [191]

B. The Policy Behind these Rules

The policy behind these rules is clear—prevent the circumvention of federal estate tax by including the value of any inter vivos transfer where the decedent retains an interest or right in the transferred property in the decedent’s gross estate. [192] I.R.C. § 2035 works in conjunction with I.R.C. § 2036 to pull the value of any gift transferred or gift taxes paid within three years of the decedent’s death back into the gross estate. [193] The purpose of I.R.C. § 2035 is the same as the purpose for I.R.C. § 2036, except I.R.C. § 2035 focuses on a different method of transfer: a gratuitous transfer versus a transfer for consideration. [194] While the policy for these rules is simple, whether it is correct is a more complicated question.

As a basic tenant of property and trusts and estates law, individuals have the right to transfer property in life or at death. [195] This “right of disposition” is one of the “sticks” in the bundle of rights that accompany property ownership. [196] The issue with I.R.C. § 2036, and by extension I.R.C. § 2035, is that these rules infringe on this right when an individual makes a deathbed transfer. Although the transfer’s substance is respected, I.R.C. § 2036 violates the transaction’s financial effect by pulling the value of the transferred property back into the decedent’s gross estate. If individuals have the right to transfer property, why does sudden illness or other desperate conditions change this right? In the context of deathbed transfers of family limited partnership interests, the IRS could alternatively adjust the valuation discount and then count the value of the transfer against the decedent’s Unified Credit without pulling the full value of the asset back into the decedent’s gross estate. This approach more directly addresses the IRS’s central concern of the size of the valuation discount. Unfortunately, instead of dealing with the issue in a more straightforward manner, the IRS invokes I.R.C. § 2036 and in turn, seems to create a fraudulent transfer statute.

While adjusting the applied valuation discount is a more precise method, the practical reason for applying I.R.C. § 2036 likely boils down to process simplification. When a dispute arises, it is much less complicated for the court to include the full undiscounted value of the transferred FLP interest in the decedent’s gross estate. This also allows the court to avoid having to make difficult judgements regarding the value of an asset. In the court’s opinion, these types of assessments are better left for CPAs and other valuation experts. While an in-depth discussion of the interplay between I.R.C. § 2036 and the consideration offset provisions in I.R.C. § 2043 is beyond the scope of this article, one only has to look at the Tax Court’s discussion in Estate of Moore regarding of the net inclusion amount to get an idea of just how complex valuation and discounting calculations can get. [197]

With the court’s increased use of I.R.C. § 2036 to pull the value of decedent’s deathbed transfers back into the gross estate raises serious concerns, the court’s decisions can be summed up by the saying “bad facts make bad law.” For example, in Estate of Moore, the decedent knew he only had months to live and clearly stated the purpose of his deathbed planning was to “save the millions of dollars of taxes.” [198] Furthermore, the decedent continued to live on the property and run the farm as he did before the sale and continuously used FLP assets to pay personal expenses. [199] Facts such as these made it easy for the Tax Court to hold for inclusion under I.R.C. § 2036. [200] The facts of Estate of Powell tell a similar story. The day before the partnership was funded, two hospital doctors indicated the decedent lacked capacity and “could not act on her own behalf.” [201] Additionally, objective evidence indicated the FLP had no business purpose. [202] It was merely an investment vehicle for the decedent and her two sons. [203]

While the deathbed element does increase the chances that inclusion may occur, simple steps can be taken to avoid triggering I.R.C. § 2036. In order to qualify for the bona fide sale exception to I.R.C. § 2036, individuals should first and foremost establish a nontax motive for creating the FLP. The decedent in Estate of Moore did not fail the bona fide sale exception because he had a tax purpose for the formation for the FLP, he failed the exception because he only had a significant nontax reason for the transfer to the FLP. [204] To provide additional factual support, the nontax reasons for the entity’s formation can be listed in the recitals of the FLP’s partnership agreement. Furthermore, to increase the chances of satisfying the second prong of the bona fide exception, the interest credited to each partner should be proportional to the fair market of the value of the assets each partner contributed to the FLP. Also, the assets contributed by each partner to the FLP should be properly credited to the respective capital accounts. In the case of an IRS challenge, this provides support to the estate’s position that entity formalities were followed.

When it comes to funding and operating the FLP, additional steps should be taken to avoid the perception that a decedent retained an interest or right in the assets transferred to the FLP. As the court in Strangi made clear, [205] the decedent should not transfer all of their assets to the FLP. If the decedent does, the IRS will likely argue there was an implied agreement for the decedent to continue using the assets as they did before the transfer. Additionally, the decedent keeping sufficient assets outside of the FLP avoids the pitfall of the FLP to pay post-death expenses such as funeral costs. In the same vein as keeping sufficient assets outside of the FLP, the decedent should not commingle FLP and personal funds. This was a major factor in the USTC applying I.R.C. § 2036 in both Strangi [206] and Estate of Moore. [207] Another important point is to continue or further the entity’s nontax business purpose. This point was highlighted by the first transfer in Estate of Bongard. [208] Decedent’s transfer of stock to the holding company did not trigger I.R.C. § 2036 because pooling family assets in the holding company was part of a legitimate nontax business decision to facilitate the sale of the business. [209] This plan to continue legitimate business operations contrasts with the circumstances in Estate of Moore where the decedent sold the farming business days after forming the FLP. [210] Finally, decedents should make sure to divest themselves of any rights they may have alone or in conjunction with another to affect the operations or distribution of partnership assets. Estate of Powell made clear different individuals should act as the decedent’s attorney-in-fact and manager of the FLP. [211]

C. Where We Go from Here

This string of recent I.R.C. § 2036 decisions make it obvious that the law is moving in an ever-more-restrictive direction. The courts historically have not often used I.R.C. § 2036 to pull the value of assets back into a decedent’s estate. However, this is no longer the case. Due to the IRS’s insistence, the courts have increasingly used I.R.C § 2036 as the main weapon against family limited partnerships asset transfers. The IRS often view FLPs “as efforts to pass valuable assets to one’s heirs at a discount for lack of marketability and lack of control.” [212] This seems to reflect that judges may be implying a general-purpose common law that all types of tax planning must get more restrictive if tax reduction is the principle purpose. This could be a result of the numerous income tax economic substance cases over the last two decades. The economic substance doctrine and the “legitimate and significant nontax purpose” requirement of I.R.C. § 2036(a) share a similar rationale and seek to invalidate aspects of tax transactions.

Beyond the reasons for increased use of I.R.C. § 2036, two aspects of the recent court decisions indicate even greater use of I.R.C. § 2036 to restrict the tax benefits of deathbed transfers. The first comes from Estate of Powell. While the case law regarding the bona fide exception and the restriction on the retention of “possession or enjoyment” of the transferred asset of I.R.C. § 2036(a)(1) are fairly well developed, significant questions remain as to what “rights” fall under I.R.C. § 2036(a)(2). While the court found for inclusion under I.R.C. § 2036(a)(1), [213] the reasoning in Strangi regarding I.R.C. § 2036(a)(2) indicated inclusion may be triggered by decedent’s attorney-in-fact also serving as manager of the FLP. [214] Estate of Powell took this retention of a “right” even further by holding decedent’s cooperative ability to dissolve the FLP with her sons, although decedent made no effort to exercise such a right, constituted a right in conjunction with others to designate the persons who shall possess or enjoy the transferred property within the meaning of I.R.C. § 2036(a)(2). [215] Taking these decision together, they seem to indicate that only the possibility—and not the actual execution—of affecting the operation or distributions of the FLP will pull the value of the transferred assets back into the gross estate. With this as the precedent, future decisions will likely hold things such as the retention of minority interest voting rights cause inclusion under I.R.C. § 2036(a)(2).

The second, and likely more important, indication of greater use of I.R.C. § 2036 to invalidate the tax benefits of deathbed transfers is the tone of the Tax Court’s ruling in Estate of Moore. Initially, the Tax Court stated that the three-part test developed in Estate of Bongard was the test that determined whether I.R.C § 2036 recaptures transferred property back into the decedent’s estate. [216] While the elements of the Estate of Bongard test are still present in the Estate of Moore decision, the emphasis has shifted. [217] In Estate of Moore, when discussing the Estate of Bongard test, the Tax Court stated, “[a]nother way of looking at this--and another way we frequently discuss it--is to look at 2036(a) as creating a general rule that brings back all the property that a decedent transfers before he dies, subject to two exceptions.” [218] Instead of the court “not respect[ing] a transfer” if it does not meet the three requirements under the Estate of Bongard test, [219] the transfer is now automatically not respected and the estate must reestablish the transfer’s validity. [220]

As stated above, this seems to indicate judges will apply a general-purpose common law that all types of tax planning (in which the primary purpose is tax reduction) “smell bad” and the decedent’s estate must prove otherwise. This has procedural and practical consequences as it increases the cost and time required to settle a decedent’s estate. As indicated supra Part IV. Section B, forward-looking steps can be taken to significantly reduce the chance transfers to an FLP will not be included under I.R.C. § 2036. The problem with deathbed transfers though is that many of these planning decisions are made in a chaotic and stressful environment. This has the compounded effect of making it more difficult for individuals to plan their estate to avoid inclusion and to produce sufficient evidence that concerns beyond tax savings motivated their formation and transfer of assets to a family limited partnership. With this in mind, it is of the utmost importance for individuals conducting deathbed planning to seek appropriate counsel and avoid the increasing “squeeze” of I.R.C. § 2036.

V. Conclusion

This article discussed the formation and purpose of family limited partnerships. Further, it outlined the advantages of using such as an estate planning vehicle. This article also detailed the requirements of I.R.C. § 2036 and the seminal cases interpreting the statute. Moreover, the present state of I.R.C. § 2036 was reviewed and the article provided recommendations to avoid the value of transferred assets included in the decedent’s gross estate. Finally, this article discussed the implications of the court’s increased use of I.R.C. § 2036 and the likely results of this change in judicial review.

If you have clients in the upper income brackets who share these concerns, the attorneys at Cantley Dietrich would enjoy having a conversation with you about how you can protect them from some of the challenges they will likely face in the next few years.

by Beckett Cantley[1] and Geoffrey Dietrich[2]

This article is intended to provide a basic set of frequently asked questions on captive insurance companies. The questions are in no way meant to be exhaustive on the subject, but rather solely cover certain basic uniform questions potential captive insurance company owners need to ask before forming one. Please note that the authors only advise captive owners and advisors on specific issues of captive insurance law and do not form or operate captive insurance companies.

What is an IRC § 831(b) Captive Insurance Company?

An Internal Revenue Code (“IRC”) § 831(b) small captive insurance company (“CIC”) is, in essence, a corporation formed to offer insurance to a parent corporation or other affiliated entities.[3] The CIC may offer administrative and tax benefits over self-insurance and commercially available insurance. The questions addressed below briefly discuss the history, the structural details, and the potential benefits.

How Did Captive Insurance Start?

Captives emerged as a planning tool in the 1950’s.[4] Fred Reiss created American Risk Management in 1958 to assist U.S. corporations in establishing their own insurance companies as an alternative to conventional risk management.[5] Due to the peculiarities of state insurance laws at the time, most CICs were formed outside the U.S., often in “debtor havens” where the companies experienced few, if any, local tax consequences.[6] After the U.S. passed tax legislation temporarily eliminating many benefits of CIC insurance arrangements for U.S. companies, Reiss formed International Risk Management in Bermuda.[7] This move precipitated the dominance of offshore domiciles in the CIC market for the remainder of the twentieth century.[8]

Historically, CICs were most often utilized by large U.S. corporations.[9] One common motivation was, and continues to be, a company’s inability to purchase commercial insurance at acceptable premium and coverage levels.[10] The taxpayers in Consumers Oil[11] and Weber[12] had operations in areas prone to flooding and neither taxpayer was able to obtain commercial insurance coverage due to the elevated risk.[13] Similarly, the taxpayers in Gulf Oil[14] and Ocean Drilling[15] operated in high-risk industries and were only able to obtain commercial insurance at prohibitively high prices. The companies formed CICs to provide the coverage they could not otherwise obtain under acceptable terms.

Another common theme is a company’s desire for more administrative control over the insurance policy.[16] Beech Aircraft[17] was unable to obtain commercial insurance that would allow the company to control its legal defense in the event of a claim. [18] The company had been sued under a previous policy, and the jury returned a sizeable verdict against the company, the majority of which was designated as punitive damages.[19] After an investigation, the company was convinced that the verdict was a result of a failure by the insurer’s legal team to adequately prepare and try the case.[20] The company had monitored the activity of the insurer’s attorneys during the course of the trial, and even unsuccessfully filed a motion to have those attorneys removed.[21] To afford itself more control over the administrative terms of the policy, the company formed a wholly owned subsidiary CIC.[22]

Throughout the 1970’s and 1980’s, judicial and executive interpretation identified circumstances under which a CIC insurance arrangement would be respected in the U.S.[23] In general, courts ruled captive structures were valid insurance companies when they either insured a sufficiently large number of the parent company insureds[24] or obtained at least 30% non-parent risk.[25] Increased certainty through pro-taxpayer decisions led to increased utilization of CICs as a risk management strategy by major U.S. corporations.[26] States began passing legislation enabling formation of CICs, and more growth to the domestic sector resulted.[27] A concomitant increase in courtroom activity led to a rise in certainty as judges circumscribed the permissibility of CICs.[28] A critical mass accumulated in the 1990’s, and the CIC industry “exploded” as smaller and even privately-held businesses began to view CICs as an attractive alternative to more common risk management strategies.[29] Today, a majority of states have passed CIC-enabling legislation.[30]

What Can a Captive Do?

Generally speaking, a CIC may offer coverage of virtually any type to the operating business, and the terms of the policy are remarkably flexible.[31] By far the most common arrangement is for the parent company to maintain existing coverage through commercially available policies while having the captive fill policy gaps[32] and provide coverage for stochastic (low frequency, higher payout) risks.[33] Also, Congress has provided a tax incentive for the formation of IRC § 831(b) small CICs. In effect, the tax code helps offset the costs of establishing and operating a regulated, small insurance company.

What are the Benefits of a Captive?

A CIC may afford its owners numerous benefits. A CIC can provide niche coverage for unique or specific risks that would not be otherwise transferrable, or not transferrable at an acceptable cost, in the commercial insurance market. This is especially advantageous to an entity with an above average risk profile that seeks to reduce its exposure in a cost-effective manner. Thus, so long as the policies are commercially reasonable, a CIC owner can “create whatever type of coverage for the operating business [he] can dream up.”[34] In his authoritative book on the subject, Jay Adkisson lists dozens of policy types ranging from the relatively mundane, e.g, errors and omissions, and malpractice, to the somewhat esoteric, e.g., confiscation and expropriation, and weather risks.[35] Moreover, as highlighted by the Beech Aircraft case, the policy terms may be tailored to meet the individual needs of the insured, again, subject to commercial reasonableness.

Also, a CIC may be used as a means of cost stabilization for an insured who has grown weary of premium increases in a hardening commercial insurance market. These increases may be based on market forces or underwriting software rather than the claims experience of the insured entity. For a company with a better than average loss experience, a CIC can save premium dollars that would otherwise be used to subsidize the loss experience of other market members.

Next, a CIC can reduce or eliminate brokerage commissions and marketing and administrative expenses, which are typically wrapped into commercial insurance premiums. Thus, a CIC arrangement allows a business to potentially lower its overhead while leaving more premium dollars in reserve for claims payment and surplus investment. If the CIC “wins its gamble” with the insured, it can generate profit for the parent corporation that would otherwise accrue to the third-1.party commercial insurer. As surplus funds accumulate, the funds can be invested. Moreover, a parent corporation may generally exercise some control over the investment decisions of the CIC.

In addition to these benefits, Congress has provided a tax incentive for CIC formation under IRC § 831(b). In effect, § 831(b) helps offset the costs of establishing and operating a regulated, small insurance company. A valid IRC § 831(b) CIC may allow a parent corporation to manage risk exposure without incurring the income tax problems associated with self-insurance. Whereas contributions to a reserve account for self-insurance are generally not tax deductible, premiums paid to a CIC by its insured entity may be deductible, similar to the deductibility of premiums paid for commercial insurance. IRC § 162(a) provides that “there shall be allowed deductions on necessary and ordinary business expenses incurred in carrying on a business.” Treasury Regulations § 1.162-1(a) states that business expenses include insurance premiums paid on policies covering fire, storm, theft, accident, or similar losses in the course of business. Thus, provided that the CIC is considered an “insurance company,” issuing “insurance” through arrangements that are considered “insurance contracts,” as discussed above, the parent corporation should be able to deduct premium payments to the CIC.

Furthermore, a CIC may earn premiums, within limits, without incurring federal income tax. IRC § 831(a) provides that tax shall be imposed under IRC § 11 on the taxable income of any insurance company other than life insurance companies. However, IRC § 831(b) provides that a non-life property and casualty insurance company, which receives annual premiums not to exceed $2.3 million, can elect to receive these premiums tax-free. Thus, the CIC would incur no tax on underwriting income earned on premiums paid, so long as the aggregate premiums total less than $2.3 million annually.

Notably, the CIC is still taxed on income earned through investment activity. Assuming that the CIC is profitable in its underwriting and investment operations, profits will be distributed to the CIC shareholders in the form of dividends. Alternatively, a CIC shareholder could realize profits through the sale of his shares in the CIC. In either the case of a qualified dividend or sale of stock, the income would be taxed at the long-term capital gains rate, under current law, rather than at the rate applicable to ordinary income.

How is a Captive Owned?

Typically, a CIC is either owned directly by its parent corporation or by the shareholders of the parent corporation. The organizational structure of a CIC closely resembles that of a mutual insurance company, albeit for a more limited number of participants. “CIC” refers to a brother-sister arrangement in the discussion below unless otherwise noted. Without belaboring the details of the day-to-day operation of an insurance company, this discussion seeks to give a brief overview of selected topics. The CIC and its insured should independently operate in an arms-length relationship to the greatest extent possible.[36] Thus, while the CIC should be tightly woven into the parent company’s overall business plan to maximize efficiency, the CIC should maintain its own business goals and plan for success.

Who Manages a Captive?

The ongoing management of the CIC is critical in ensuring the success of the enterprise. The CIC should recruit appropriately credentialed professionals to fulfill management, underwriting, accounting and audit duties. The insurance manager fills the fundamental role of determining which risks to underwrite and drafting the policies that insure the chosen risks. The insurance manager must seek actuarial assistance in evaluating risks and determining premium and reserve levels. Also, it is ultimately the insurance manager’s responsibility to ensure that the CIC complies with its license terms, regulatory requirements, deadlines, and the like.

Are Captives Audited?

Most jurisdictions require annual audits of insurance companies by an accounting firm approved by the Insurance Commissioner. Choosing a firm that is experienced in CIC insurance may help the CIC avoid the myriad pitfalls that await CICs in the IRC.

The CIC should undergo periodic reevaluation to maximize efficiency. Such reevaluation may allow a CIC to underwrite more risk given its capital structure, and the goals of management. Moreover, risks currently underwritten by the CIC may have become more inexpensive to insure in the commercial market, again, subject to management goals. Typically, a CIC must provide notice to the Insurance Commissioner of its jurisdiction when there will be significant changes to its operations or ownership structure.[37]

How are Captive Insurance Companies Formed?

Aside from what structure the CIC will take, many factors must be considered before undertaking the formation of a CIC. First, an experienced attorney or consultant should be engaged to perform a feasibility study.[38] This will provide the prospective owner with an independent, clinical opinion as to whether a CIC is an appropriate vehicle to achieve the desired benefits, given the owner’s business and overall financial plan. This step should also begin to educate the proposed owner of the regulatory and compliance requirements associated with operating an insurance company according to the statutory regime of the licensing jurisdiction.

Also, a detailed actuarial study should be prepared, and, in fact, generally must be submitted with the insurance license application. The actuarial study should determine the amounts and types of coverage that will be underwritten. The study should also include information as to how the premium amounts will be determined and the capitalization requirements associated with the new CIC. There should be no communication between the potential insured, the party supervising the study, and the actuary that attempts to manipulate the numbers to arrive at tax-friendly numbers. Once the feasibility and actuarial studies are completed, the insurance license application can be submitted in the jurisdiction of choice.

Where are Captive Insurance Companies Formed?

A CIC can be formed and licensed pursuant to the laws of a U.S. state, or those of a foreign country. The company will be “domiciled” in the jurisdiction where it was formed. Many factors impact the decision as to whether to form the CIC domestically or offshore and the choice between domiciles in either arena. Those factors include, but are not limited to: (1) the CIC’s exposure to the U.S. tax system; (2) the capitalization burden required at formation; (3) the flexibility the CIC is allowed in investing its resources; and, (4) the asset protection afforded the U.S. shareholders of the CIC.[39]

The tax and compliance burdens imposed by U.S. law on a CIC and its U.S. shareholders may be a consideration in deciding whether to form a CIC domestically or offshore. Notably, an organization in an offshore jurisdiction will not preclude the IRS from assessing and collecting U.S. income tax. Therefore, the decision as to whether to form a CIC in a domestic or offshore jurisdiction should be made based on the local reporting requirements and taxation to which a CIC would be subject, accepting as fact that the IRS is quite capable of visiting federal income taxation on an offshore CIC.[40]

Both domestic and offshore CICs are subject to U.S. income taxation. A foreign CIC may elect to be taxed as a domestic entity under IRC § 953(d).[41] A company making such an election directly subjects all income earned globally to U.S. federal income tax, rather than indirectly through its U.S. shareholders under IRC subchapter F.[42] The benefits to a U.S.-owned offshore CIC making an IRC § 953(d) election include exemption from the federal excise tax (“FET”), simplified compliance and administration and, at least theoretically, communication to the IRS that the CIC need not be subjected to heightened scrutiny by virtue of its offshore domicile.[43] An IRC § 953(d) election is irrevocable absent IRS consent.[44]

A CIC that chooses not to make an IRC § 953(d) election could find itself categorized as a controlled foreign corporation (“CFC”) if more than 25% of its shares are held by U.S. owners.[45] A CFC classification would render the CIC income currently taxable its U.S. shareholders. Under these circumstances, the U.S. shareholders of the CIC would be required to currently include all CIC profits not directly allocable to insurance contracts issued on risks outside the U.S. in the CIC owner’s taxable income, irrespective of the timing of the distributions.[46]

What are the Disadvantages of Forming a Captive Insurance Company Offshore?

The disadvantages of forming a CIC under the laws of a foreign country potentially include subjecting the policy premiums to the FET and increasing the compliance burden of the CIC by exposing the company to a greater risk of an intrusive audit.[47] Policy premiums paid to an offshore CIC by a U.S. insured may be subject to the FET if the IRS views the arrangement as an “importation” of a foreign service. Foreign services imported to the U.S. are subject to the FET. Specifically, property/casualty premiums paid to an offshore CIC by a U.S. insured are subject to a FET of 4% for original insurance and 1% for reinsurance.[48] Because the offshore CIC provides insurance, actuarial, and management services to its U.S. shareholders, the IRS may view the arrangement as an “importation” of foreign services, thus exposing its U.S. shareholders to the increased U.S. tax burden of the FET. While some domestic jurisdictions charge premium taxes, shareholders of a domestic CIC can generally avoid the additional tax liability in the form of premium taxes by simply choosing to organize the CIC in a state that does not require premium taxes.[49]

An otherwise compliant CIC should have nothing to fear from the mere fact that it is domiciled offshore. However, that offshore domicile alone may be enough to subject the company to an “ever-changing and perilous compliance burden” and a risk that the company will be swept up in the increasing number of IRS audits of offshore entities.[50] Around 2005, the Senate Permanent Subcommittee on Investigations (“PSI”), under the leadership of Senator Carl Levin, began to view U.S. taxpayers’ offshore holdings with increasing suspicion.[51] This sentiment grew out of the government’s reduced ability to monitor its citizens’ offshore holdings. When PSI investigations began to uncover empirical evidence supporting this suspicion, Congress, the Department of Justice, and the IRS became engendered with a belief that U.S. holdings in offshore arrangements were potentially abusive and evasive. Congress has enacted and continues to propose, numerous legislative schemes to assist the IRS in enforcing U.S. tax laws offshore. Without addressing the details of the various enacted or proposed legislation, it is sufficient to say that organizing a CIC offshore to reduce one’s exposure to U.S. tax laws is by no means a foolproof strategy.

How are Captives Capitalized?

The capitalization burden, or the sum of money required under local law to be contributed to a reserve account upon formation, will likely affect whether one decides to organize a CIC domestically or offshore, and the choice of domicile within these categories. Domestic jurisdictions have historically required between $300,000 and $300 million capitalization to form a CIC, depending on such factors as the type of CIC, the proposed coverage offered by the CIC, and the relationship between the CIC and the insured. Laypeople, and indeed some tax and insurance professionals, have long espoused the relaxed offshore regulatory environment as a benefit of organizing a CIC offshore. This perception arises in part from the lower minimum capital contributions typically required in offshore jurisdictions and the less restrictive rules and regulations many offshore jurisdictions impose on insurance and financial institutions. For example, offshore regulators generally rely on independent CPA verifications, whereas domestic regulators typically require examinations by state regulatory bodies and state-approved audit firms.

While the local regulatory environment is important in choosing a jurisdiction in which to found a CIC, a planner must not overlook the requirements superimposed on all insurance companies by the IRS The IRS must consider the CIC an insurance company for premiums to be deductible under IRC § 162, and for a CIC to receive the tax benefits of IRC § 831(b), and the policies issued must reflect an insurance arrangement. To consider a policy an insurance arrangement, the IRS must find that the risk of economic loss was shifted from the parent-insured to the CIC, i.e. “risk shifting”. Without adequate capitalization, the CIC may have insufficient reserves to cover its insureds’ current and anticipated claims. Because an insured would bear the entire risk of loss if his insurer failed to satisfy the insured’s claim, adequate capitalization factors heavily in determining whether risk has shifted between an insured and a CIC. Therefore, any CIC seeking to participate in the benefits bestowed upon insurance companies by the IRC may be subject to substantially higher capitalization requirements than those imposed by the offshore jurisdiction.

Notably, some U.S. states have made their minimum capitalization requirements more palatable in recent years. For example, Delaware reduced its requirement to $250,000 combined capitalization among separate CIC entities formed and administered as part of the same series. Under such an arrangement, a group of individual CIC entities may share the same capitalization. Thus, provided that all other CIC law is strictly observed, the individual entities can maintain the reserves necessary for proper risk-shifting while keeping their individual capitalization requirements reasonably low. Such domestic options at least warrant a second look from a prospective owner seeking to minimize his initial capital contribution without inviting IRS scrutiny.

What Investments Can a Captive Insurance Company Make?

One consideration in choosing whether to organize a CIC domestically or offshore is the investment flexibility a jurisdiction affords a CIC with respect to its surplus. Surplus is the income that a CIC retains in excess of the funds needed to satisfy its current claims. Some foreign jurisdictions permit a CIC to invest its surplus in any investment vehicle, provided the investment does not impair the capital base or run afoul of the foundational requirements of the insurance arrangement, including making investments so unreasonably illiquid as to potentially prevent the payment of its actuarially anticipated claims.[52] Because the primary responsibility of an insurance company is to pay claims as they arise, a CIC that fails to abide by its solvency requirements would not be considered a valid insurance company for any purpose. As such, while a foreign jurisdiction may permit a CIC greater investment flexibility, the CIC is still subject to the IRC requirements applicable to all insurance arrangements. A CIC not primarily engaged in the business of underwriting insurance or reinsurance activities would not be considered an insurance company.[53] Thus, CIC compliance with the regulations of the foreign jurisdiction is significant in assessing whether a CIC is primarily engaged in the business of insurance, but the controlling factor in analyzing whether a CIC qualifies as an insurance company is the nature of the business transacted in the taxable year.

IRS pronouncements warn that certain arrangements where an insurance company’s insurance business is outweighed by its investment activities may not withstand this analysis. While some of this guidance appears in the context of life insurance, which a CIC may not insure, the issues raised with respect to life insurance companies should apply with equal force to companies that insure risks other than life. IRS Notice 2003-34 warned taxpayers that investing in certain U.S. shareholder-owned offshore purported life insurance companies to defer recognition of ordinary income, or to re-characterize ordinary income as capital gains, may present a compliance risk. The IRS recognized that arrangements of this type are used to invest in hedge funds or those investments in which hedge funds ordinarily invest, typically resulting in a relatively small proportion of genuine insurance activities in comparison to the offshore entity’s investment activities.

These arrangements result in the offshore entity earning investment income substantially in excess of the entity’s ordinary insurance business needs. Shareholders often eschew any current distribution, claiming that since the appreciation arises from the conduct of insurance business rather than passive investment income, the appreciation constitutes capital gain instead of ordinary income. The IRS recognized that operating an insurance company will almost certainly involve investment activity. However, genuine insurance companies use the returns from their investments to satisfy claims, underwrite more business, and fund distributions to the company’s shareholders. A foreign jurisdiction’s certification of an entity as an insurance company under the jurisdiction’s local rules does not necessarily equate to IRS recognition of the entity as an insurance company, especially where the entity is not primarily occupied in the issuance or reinsurance of insurance or annuities. For federal income tax purposes, an entity is only considered an insurance company when it primarily employs its capital in the pursuit of income from underwriting additional insurance risks. In making this determination, the IRS will analyze an entity’s aggregate operations and sources of income.

The IRS may determine that an offshore CIC is not an insurance company for federal income tax purposes if the CIC is predominantly used as a conduit for hedge fund investment. Under such circumstances, the IRS could impose current taxation on those U.S. persons earning passive income through the offshore entity under the Passive Foreign Investment Company (“PFIC”) rules.[54] Under IRC § 1279(a), a foreign corporation is a PFIC if (1) 75% or more of the entity’s gross income is passive income, or, (2) at least 50% of the entity’s assets produce, or are held for the production of, passive income. Corporations engaged primarily in the active conduct of insurance business are outside the purview of the PFIC rules, as they are subject to federal income taxation under the IRC subchapter L U.S. life insurance company rules. IRS Notice 2003-34 stated that the IRS will challenge the validity of these types of investment schemes, through the application of the PFIC rules, on a finding that a foreign corporation is not an insurance company for federal tax purposes. Thus, the latitude a foreign jurisdiction gives a CIC with respect to investing its surplus may be significantly circumscribed, at least to the extent that the entity’s investment activities may not exceed its insurance activities, lest the CIC find itself challenged as a PFIC.

Does a Captive Insurance Company Provide Asset Protection?

Adding a layer of asset protection may enter into the calculus when deciding whether to organize a CIC domestically or offshore. Various offshore jurisdictions claim that their regulators hold information about CIC assets in strict confidence, allowing a CIC to be organized and operated in secrecy. Many people also believe that disclosure of the identity of the parent entity to the IRS can be avoided through a valid IRC § 953(d) election, on the rationale that the CIC itself is the U.S. taxpayer and owner of all CIC assets. Avoiding disclosure to both foreign and domestic authorities may seem a beneficial attribute of offshore CIC organizations. Such secrecy may render a creditor unable to follow the money, leaving him less enthusiastic about the prospect of costly, protracted litigation, given the uncertainty as to whether the debtor is “judgment proof.”

Moreover, an IRC § 953(d) election could force a creditor to file suit against the CIC in the courts of the offshore domicile, effectively allowing the CIC to choose both the venue and the controlling law. Such a result is possible because a valid IRC § 953(d) election applies only to the IRC, and not to any other titles of the U.S. Code, including the Federal Rules of Civil Procedure. Thus, a creditor would be unable to argue that the CIC was domiciled in the U.S. and would have to prove that the U.S. court had personal jurisdiction over the CIC. A U.S. court could only exercise personal jurisdiction over the corporation on a showing that the corporation had the requisite minimum contacts with the jurisdiction or had purposefully availed itself of the U.S. court’s jurisdiction. An offshore CIC that collects substantial premiums from a U.S. insured in exchange for insurance may indeed have sufficient contacts to fall within the U.S. court’s jurisdiction. However, assuming a U.S. court could not exercise personal jurisdiction over a foreign CIC, creditors would effectively be forced to bring suit against the CIC in the foreign domicile’s courts, under the foreign domicile’s laws. Creditors may be unwilling to undertake such a daunting task, particularly where the offshore domicile has strict asset protection and account secrecy laws. Furthermore, even if U.S. courts are able to exercise personal jurisdiction over the CIC, and a creditor secures a judgment against the corporation, the foreign jurisdiction may be unwilling to enforce the U.S. judgment. Such a blow could be fatal to a creditor in the case of a debtor who has few assets outside the offshore jurisdiction.

If a creditor secures a judgment against a U.S. citizen, a U.S. court may very well declare a transfer offshore illegal or invalid at its source. The Court may be hesitant to relinquish jurisdiction over a transfer it perceives as a fraudulent attempt to evade the transferor’s creditors, especially if the creditor successfully maneuvers the transferor into a bankruptcy action. U.S. bankruptcy courts have broad powers to invalidate transfers that hinder or delay satisfaction of a creditor’s claim, and often use these powers to frustrate offshore asset protection arrangements. A hypothetical debtor could transfer significant assets offshore and outside the debtor’s control and beneficial enjoyment in the form of premium payment to a foreign CIC in an effort to become insolvent. Once found insolvent, creditors could position the debtor into bankruptcy, and the bankruptcy trustee would take control of the debtor’s estate. The trustee may be able to force a waiver of the attorney-client privilege, and obtain any information provided to the debtor by an asset protection attorney. This would likely allow the bankruptcy trustee to uncover documents and information revealing the location of the debtor’s offshore assets. In the case of a CIC, this information would likely include the non-public records of where the CIC assets are located. Once the bankruptcy trustee uncovered this information, it would be an easy task to unwind an asset protection arrangement designed to render the debtor insolvent. Then, the bankruptcy trustee could reclaim the assets, or repatriate premiums paid to the CIC or assets purchased with those premiums to satisfy creditor claims.

U.S. courts have declared that it is against public policy to enforce the laws of a foreign jurisdiction where those laws violate established principles of U.S. law. Foreign jurisdictions that are known for asset protection often intentionally draft legislation to circumvent the laws of other jurisdictions, including the U.S. As such, a U.S. judge may be loath to apply a foreign law that is unlikely to withstand an attack on public policy grounds. Thus, if a U.S. court finds that foreign laws are being used in contravention of public policy, the Court may unwind an offshore CIC.

A creditor may successfully void a transfer of funds from a U.S. party to an offshore CIC if the creditor can convince the Court that the transfer was made for improper asset protection purposes. Thus, a court may rule that capitalization or premium payments made to an offshore CIC by a U.S. shareholder or insured are void ab initio, especially if the debtor is before the U.S. bankruptcy court, as discussed above. Moreover, if the IRS and DOJ suspect that a CIC was formed for asset protection, they may question whether the CIC is being primarily operated as an insurance company, irrespective of creditor claims.

How Do Captive Insurance Companies Operate?

A CIC is, first and foremost, an insurance company, and must be operated in a manner consistent with being predominantly in the business of insurance. To avail itself of the favorable tax treatment the IRC bestows upon insurance companies, a CIC must, of course, meet the definition of “insurance company.”[55] Failure to meet this requirement could result in the exposure of all of the entity’s income to C corporation double taxation. Treasury Regulations § 1.801-3(a) provide that an insurance company is one whose primary and predominant business activity is the issuance of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. Under IRC § 816(a), an “insurance company” is any company more than half the business of which during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by an insurance company.

Captives must also comply with the “Harper Test,” so named because it is based on three factors outlined in the Harper case.

The three factors are:

(1) Whether the arrangement involves the existence of an “insurance risk”;
(2) whether there was both risk-shifting and risk distribution; and
(3) whether the arrangement was for “insurance” in its commonly accepted sense.[56]

“Insurance risk” requires the insurance company to specifically define the risk, which is contained in the policy. In addition, the insured must be able to demonstrate a premium was paid and the insurance company issued an insurance policy. Risk shifting and distribution are covered below.

Insurance in its commonly accepted sense requires the transaction to comply with generally accepted industry practice.

The Harper court found adequate capital and arms-length premiums determinative, as was the existence of regulatory authority (here, the Hong Kong government). Other IRS documents have discussed the need for the captive to comply with the state law definition of an insurance company and the existence of standard insurance company documentation.[57]

If a CIC charges commercially unreasonable premiums and/or otherwise engages in non-arms-length transactions, the IRS may not respect the CIC as a legitimate insurance company. While arms-length dealing and separate management fees alone are not sufficient to prove that an entity is an insurance company, such conduct telegraphs the existence of a bona fide “insurance company.” As discussed above, any CIC hopeful of recognition as an “insurance company” must otherwise operate as an “insurance company,” employ professionals with the appropriate credential to fill critical roles within the company and comport with local licensing and capitalization requirements.

Also, an “insurance company” must provide “insurance” through “insurance contracts.”[58] Unfortunately, the IRC provides little guidance in defining these terms. In general, an agreement must transfer the risk of economic loss, contemplate the occurrence of a stated contingency, and comprise something more than a mere business or investment risk to receive insurance treatment for federal income tax purposes.[59] Insurance Services Offices often provide policies for captives.[60] A CIC must show that it has adequately shifted the risk of economic loss from the insured to the insurer (“risk shifting”), and that the insurer has adequately spread that risk among various insurance companies or other unrelated entities such that no single entity bears the entire risk of economic loss (“risk distribution”).[61] A CIC may accomplish this goal using IRS safe harbors or otherwise.

What is Risk Shifting?

In Helvering v. LeGierse, the United States Supreme Court (“Supreme Court”) analyzed the risk-shifting issue. In LeGierse, an elderly, uninsurable taxpayer purchased a life insurance policy and a life-only annuity contract one month before her death.[62] By purchasing the annuity contract from the same insurer, without which the insurer refused to issue the life insurance policy, the taxpayer neutralized the insurer’s risk with respect to the life insurance policy. The taxpayer purchased the life insurance policy primarily to take advantage of favorable estate tax treatment available, and the arrangement had a little net effect on her economic position. The Court held that because the life insurance policy and the annuity contract offset one another, there was no risk shifting from insured-to-insurer.

Risk shifting is only present when a party facing the risk of economic loss transfers some or all of the financial consequences of that potential loss to an insurer.[63] Risk shifting generally requires an enforceable written insurance contract, with premiums negotiated and actually paid at arms-length, and the insurance company to be a discrete entity capable of satisfying its obligations and properly formed under the laws of the applicable jurisdiction. The thrust of the risk-shifting analysis is whether the premium-paying party has truly transferred the economic impact of the potential loss to the insurer.[64]

The Humana[65] court held that an arrangement solely between a parent company and a subsidiary CIC could not be considered insurance for federal income tax purposes because it failed to shift risk from the insured to the insurer. Humana paid premiums on its own behalf to a wholly-owned CIC in exchange for coverage. The Court noted that the similarities between such an arrangement and a reserve account for self-insurance, contributions to which are not tax-deductible, were impossible to ignore. The underlying rationale for the Court’s decision was that Humana did not truly transfer any risk of loss to the CIC, since any loss incurred by the CIC would ultimately be absorbed by Humana as the sole owner of the CIC. Nonetheless, the Humana court held that an arrangement between a subsidiary CIC and several dozen other subsidiaries of the parent entity did satisfy the risk-shifting element. The Court reasoned that a loss incurred by the CIC would not directly transfer to the sibling subsidiaries in the same way a loss would transfer between a wholly-owned subsidiary CIC and its parent.

Notably, the Court stated that the doctrine of substance over form, discussed in greater detail in another of our FAQ articles, could be invoked to challenge the existence of separate and distinct entities, which are required to show the existence of risk shifting. However, the Court went on to state that the doctrine would only be applicable where no valid business purpose exists for the transactions or where a clear Congressional intent to curtail such transactions can be shown. The Humana court concluded that Congress had not yet manifested any intent to disregard the separate corporate entity in the context of CICs and respected the separate identities of the entities.

With proper planning and execution, a CIC should have no trouble showing a valid business purpose for maintaining separate corporate entities. Thus, a substance over form argument employed to challenge the existence of risk shifting should be ineffective unless the transaction is found to lack economic substance aside from mere tax benefits (discussed further, below).

Since Humana, the IRS has provided broad “safe harbor” rulings. In the main “safe harbor” provision, found in Revenue Ruling 2002-90, the IRS explained that an arrangement of at least twelve subsidiaries paying premiums to an affiliated CIC constitutes effective risk-shifting where each subsidiary has no more than 15% and no less than 5% of the total risk insured and none of the claimed twelve subsidiaries are disregarded entities.

Since the promulgation of the “safe harbor” provisions, the IRS appears eager to challenge a CIC on the grounds of risk-shifting in only the most egregious and abusive of circumstances. This underscores the importance of adhering to the general guidelines discussed above. Risk shifting may be questioned where guarantees exist to neutralize a CIC risk of loss and where contracts are not entered into at arms-length. Other factors the IRS may consider in a risk-shifting challenge include: whether the insured parties face a genuine hazard of economic loss in an amount which justifies premium payments made at commercially reasonable rates; whether the validity of insurance claims was investigated and established before the claims were paid; and, whether the CIC business operations and assets are maintained separately from the business operations and assets of the parent entity.

What is Risk Distribution?

Risk distribution is also required for an arrangement to be considered insurance. Risk distribution involves the pooling of insurance premiums from separate insured entities so that an individual insured is not paying for a significant portion of its own risk. Rather, the risks, and claims, of an individual insured would be subsidized in large part by the premiums paid by other insured entities in the pool.[66] The law of large numbers dictates that the likelihood of a single claim exceeding premium payments for a given period of time decreases as the length of time and number of insureds in a given pool increase.

A risk distribution analysis is broader in focus than that of a risk-shifting analysis. The risk distribution analysis looks to whether an insurer has distributed the risk of an individual insured over a larger group of entities, rather than strictly between the insurer and the single insured. Unfortunately, authority adequately discussing what constitutes risk distribution where risk shifting is found to exist is scarce. However, the Humana[67] court found that an arrangement where a CIC insured multiple sibling subsidiaries from an affiliated group constitutes valid risk distribution since the premiums paid by each insured could offset the CIC losses as a whole. While decisions have never established the minimum quantity of unrelated business sufficient to constitute risk distribution, courts have ruled that 30% is sufficient and 2% is not.

The IRS has issued several Private Letter Rulings that outline two different risk distribution models. In the first, the insured pays a premium to an insurance company, which then cedes risk back to the insured’s captive. For example, the insured pays a premium of $100,000 to an insurer, which then cedes a percentage of the risk (anywhere between $30,000 and $90,000) back to the captive. Here, the risk distribution occurs within the financial accounts of the insurance company, as the insured's premium is combined with those from other, unique insureds.

In the second, the insured pays the full premium to his captive, which then cedes at least 50% of its risk to a pool where other, unique insureds do the same. Then, after an insured’s pool contribution is mixed with other, unique insureds, the pool cedes most of the original contribution back to the insured.
For example, an insured pays $100,000 to his captive, which then cedes at last $50,000 of its premiums to a pool, which in turn returns a majority of the original funds to the captive.

In summary, to be treated as an insurance company for federal income tax purposes, a Captive Insurance Company must show that its insureds have adequately shifted their risk of loss to the CIC and that the CIC has adequately distributed that risk over various diverse entities. A CIC maintaining its own arms-length operational identity and conducting its business in a manner consistent with standard insurance industry norms will also support such treatment. If a CIC can meet these requirements, many advantages may be available to the CIC and its owner.