In his hit song, “The Gambler,” Kenny Rogers famously penned, “you’ve got to know when to hold ‘em and know when to fold ’em.” Small captive owners under audit appear to be facing a similar choice. After decades of viciously attacking captive insurance companies and losing most every tax court case of consequence (Humana, UPS, Rent-a-Center, Securitas, RVI, etc.), the IRS has managed to win the last three in a row by selectively targeting smaller captives with some rather obvious flaws—obvious at least if the tax court got its facts right, and it might not have since at least one of the cases is on appeal and another may soon be appealed.
Partly as a result of these victories, the IRS has recently refused to make any good faith effort to distinguish abusive captive insurance arrangements from perfectly legitimate ones, instead issuing “cut and paste” Notices of Deficiencies that often contain demonstrably false factual allegations and that ignore the unique and relevant facts and circumstances of each case. And, partly as a consequence of this bull-headedness, there are presently hundreds of captive insurance cases pending in tax court, many of which are perfectly legitimate captives.
WHEN TO HOLD ‘EM?
It’s rather clear to most experienced insurance experts and tax controversy attorneys that the Service will lose some of those pending cases. And when it does, other taxpayers with pending cases will be emboldened by the favorable precedent. This will then make it more difficult for the IRS to coerce favorable settlements from taxpayers. Instead, the IRS will be forced to offer better terms, to drop some cases altogether or to risk additional precedent-setting losses.
WHEN TO FOLD ‘EM?
Recognizing that it’s presently poised at a point of maximum leverage over taxpayers, and also that time is of the essence given the pending tax court cases, the Service yesterday made a nationwide offer to settle every pending audit on reasonably favorable terms. Basically, the IRS has agreed to settle any pending audit if the taxpayer agrees to accept a 90% denial of the captive insurance premium deduction for the tax years presently under audit and agrees to effectively wind down the captive insurance company. Additional terms apply, but those are the main ones. In most all cases, no penalties will be assessed.
And presumably, the IRS will not open audits for subsequent completed tax years that have yet to be audited if the taxpayer accepts the offer and agrees to wind down the captive. It’s important to note that the offer applies only to cases and years presently under audit, that the IRS is agreeing to accept less than the full amount of disputed tax and that in most cases no penalties will apply. The IRS has indicated that it will not settle ANY pending audits/cases except on these proposed terms. In other words, any taxpayers electing to settle will, until further notice, have to accept these terms.
WHEN TO FOLD ‘EM?
For taxpayers in structures that look a lot like those in the Avrahami, Reserve Mechanical or Syzygy cases (the three cases the IRS recently won), this settlement offer comes as welcome news to be sure. The IRS can now wind up those audits and collect a lot of tax revenue without incurring the time and expense of pursuing taxpayers one-by-one. And those taxpayers can get the IRS out of their lives, avoid the cost of litigation and avoid the potentiality of far worse outcomes.
WHEN TO HOLD ‘EM?
But what about those taxpayers with likely-legitimate structures that look nothing like those in Avrahami, Reserve Mechanical or Syzygy? Well, for them, this settlement offer makes deciding how to proceed much more difficult. Just because the IRS is attacking their structure and denying deductions doesn’t mean that the IRS is legally right to do so, as the taxpayers in the UPS, Humana, Rent-a-Center, Securitas and RVI cases thankfully learned. So, if these taxpayers decline the IRS’ settlement offer, some of them may eventually be fully vindicated, albeit only after incurring the cost of litigation. Or, they may get far better settlement offers in the future after the IRS loses some relevant cases.
COUNT YOUR MONEY WHEN YOU’RE SITTING AT THE TABLE
By contrast if these taxpayers accept the settlement offer then they may well end up negotiating away tax benefits to which they are legally entitled. Some of them, especially those who lack the stomach for a fight, may conclude to follow path of least resistance. And that, of course, is the IRS’ objective and why it’s acting NOW, at its point of maximum leverage. By making this offer now, the IRS can obtain settlements not only from “bad captives” but even from many perfectly legitimate captive structures.
This settlement offer doesn’t extend to all small captives, but only those whom the IRS deems worthy. All others fight it out in the U.S. Tax Court as before. Also, taxpayers already in the jurisdiction of the IRS Counsel’s office, i.e., those already in the U.S. Tax Court: “Taxpayers who also have unresolved years under the jurisdiction of the IRS Appeals may also be eligible, but those with pending docketed years under Counsel’s jurisdiction are not eligible.” The offer does not apply to captives in the Tax Court system.
How many taxpayers with legitimate structures will succumb to the coercion? That remains to be seen. No doubt, many captive owners will be richly rewarded for deciding to “Hold ‘Em.”