January 17, 2017
Filing Deadline Approaching for Small Captive Insurance Companies
IRS Notice 2017-08 Extends Filing Deadline for New Tax Reporting of “Transaction of Interest” Pursuant to Notice 2016-66 for Small Captive Insurance Companies
The IRS issued Notice 2016-66 on November 1, 2016, identifying certain transactions relating to small captive insurance companies as "transactions of interest." As a result of this designation, taxpayers and material advisors who participate in these transactions, or a transaction that is the "same as or substantially similar to" these transactions, now have a disclosure obligation to file Forms 8886 and 8918 with the IRS. The notice originally required these initial forms to be filed before January 30, 2017. However, the deadline was extended by an additional 90 days until May 1, 2017, by Notice 2017-08, issued on December 29, 2016.
A "transaction of interest" is a transaction identified by the IRS as having the potential for tax avoidance or evasion. Section 6011 of the Internal Revenue Code mandates that taxpayers who participate in certain "reportable transactions" must provide notice of participation to the IRS. A reportable transaction by definition includes "listed transactions," "confidential transactions," "transactions with contractual protection," "loss transactions," and "transactions of interest."
The text of the notice makes it clear that the IRS is concerned that certain §831(b) Captive Insurance Companies ("Captives") may have potential for tax avoidance or evasion. Prior to this notice, the IRS had identified these small or "micro" captives on its annual "Dirty Dozen" list of tax scams for the 2015 filing season. Under the Internal Revenue Code, small or "micro" captives can elect to exclude up to $1.2 million of insurance premium revenue from income ($2.2 million beginning in 2017) and only pay tax on investment income. Additionally, premiums paid to a captive by the insured company are deductible for tax purposes.
Most §831(b) captives will be subject to this new notice requirement. The notice will apply to any captive transaction if the following conditions are satisfied:
- An individual owning an interest in a business purchases insurance or reinsurance from an §831(b) captive insurance company.
- 20% or more of the voting power (or value) of the captive is owned directly or indirectly by any of the following:
- An individual owning an interest in the business who has purchased insurance from the captive;
- The business that has purchased insurance from the captive; or
- An individual or entity that is a related party to an owner or the business; and
- If one or both of the following apply:
- The sum of the liabilities incurred by the captive for insured losses and claim administration expenses during the computation period (the most recent five taxable years or the entire existence of the captive if less than five years) is less than 70% of the premiums earned by the captive during the computation period, minus any policyholder dividends paid by the captive during the computation period, which is the most recent five taxable years of the Captive.
- The captive has at any time during the computation period directly or indirectly made available a guarantee, loan, or other transfer of the captive’s capital to any owner, the or related party.
Basically, as a result of this notice, a disclosure filing is required for captives or any business that deducts premiums paid to a captive or the individual owner(s) of the business (if the business is a flow-through entity).
It is also important to note that the filing requirement applies to any taxpayer who has participated or is participating in an §831(b) captive transaction on or after November 2, 2006 (not 2016).
The disclosure information request will include, but is not limited to, the following:
- Detailed description of the transaction (all parties involved, tax structure, etc.);
- Types of coverage provided by Captive;
- How premiums are determined;
- Description of all claims paid by Captive;
- Description of assets held by Captive.
All participants in the transaction must report to the IRS all or part of the requested disclosure information but the Captive must provide the most detailed information. This means that multiple owners and multiple insureds will have reporting requirements in some cases. This could become quite a big project as each owner and insured must report the required disclosure information.
In the initial year of filing, Form 8886, Report Transaction Disclosure Statement, must be filed with the Office of Tax Shelter Analysis (OTSA) within 90 days of the date on which the transaction became a "transaction of interest." Due to the additional 90 days provided by Notice 2017-08, taxpayers' initial filing of Form 8886 and material advisors' filing of Form 8918 will now be due by May 1, 2017.
Thereafter, Form 8886 should be filed yearly with the taxpayer's timely filed tax return, should the taxpayer continue to participate in the captive program. Material advisors are required to file Form 8918, Material Advisor Disclosure Statement, and are also expected to maintain a list of all entities and/or individuals in which the advisor acted as a material advisor relating to a reportable transaction.
Even if the captive does not participate in any of the abuses listed by the notice, taxpayers and material advisers associated with these captives need to be aware of the mandatory filing obligation, as significant penalties could be assessed for late or unfiled forms. Failure to file may result in a penalty of 75% of the tax benefit ranging from $10,000 up to a maximum of $50,000 for businesses ($5,000 up to a $10,000 maximum for individuals). This penalty results from either not filing or not filing completely, correctly, or on time, and cannot be waived due to reasonable cause or good faith, so it is imperative that entities and individuals file the required forms in a timely manner.
Should you have any questions as to whether this reporting obligation is applicable to you or your business, please contact your Marcum tax professional.