Next week, we will finish our series on the Top 10 Captive Myths. However, late in 2014, the I.R.S. has fortuitously provided a gift to the captive industry and businesses considering owning their own insurance company. That gift is another defeat in U.S. Tax Court in the Securitas case, providing even more reason to be confident that a well-structured captive arrangement will stand up to a potential I.R.S. challenge. Not only was the service defeated soundly in Tax Court, but its challenges against several “aggressive” practices in the Securitas captive arrangement were rebuffed as well.
Last week we noted that after a stinging defeat in early 2014 against Rent-A-Center, the Service challenged Securitas in U.S. Tax Court in late 2014. On October 29, 2014 the Court handed down its ruling in favor of Securitas and its captive insurance arrangement.
In its efforts to attack captive insurance arrangements, the I.R.S. continues to “open the barn door a little wider.” This certainly was the case in Rent-A-Center in early 2014 where several “aggressive” practices by the Rent-A-Center captive arrangement were upheld in the U.S. Tax Court, and all tax deductions taken by Rent-A-Center were sustained.
In its Notices of Deficiency brought against Securitas, the I.R.S. alleged that the employment of a parental guaranty nullified the captive insurance arrangement as being “real” insurance. Parental guarantees have been largely seen as a dangerous practice by most captive managers. Yet, the Tax Court was unmoved by I.R.S. arguments that the parental guaranty nullified true risk shifting. Instead, the Court deferred to the captive domicile’s regulators to determine what level of parental guaranty is acceptable, swinging the barn door open for possible proliferation of parental guarantees. Clearly, the Service lost ground on this front.
Also, the I.R.S. alleged that the Securitas captive arrangement was undercapitalized. This “undercapitalization” was offered up as proof that real risk shifting did not occur. The Court noted that risks insured by the captive were reinsured, which justified lower capitalization. The Court also deferred to the judgment of the captive domicile’s regulators. This was the second point in the case where the Court valued the opinion of the captive domicile regulators over the opinion of the Service. It’s worth noting that many small and mid-size captive insurance companies utilize reinsurance pooling arrangements to achieve risk distribution. The Tax Court’s ruling suggests such reinsurance arrangements could also mitigate the potential of being undercapitalized or being allegedly undercapitalized. The barn door cracks open a little wider.
Finally, it is noteworthy that the ruling repeatedly stated that the captives had no employees and were completely managed and overseen by third parties specialists. This is consistent with prior Tax Court rulings that rejected the Internal Revenue Service’s assertion that captive insurance companies should be run like “real” commercial insurance companies. This case and the Rent-A-Center case should put all “not run like a real insurance company” arguments to rest. And, the barn door swings open a little wider.
Captives managed by CIC Services, LLC are operated more conservatively than the captive arrangements in the Rent-A-Center and Securitas cases. Don’t let fear of the I.R.S. paralyze you. If owning your own insurance company is the right move for your business, the barn door is open and the path is well trodden.