In what may be a big step in the right direction, the IRS recently issued an important notice affecting certain captive insurance companies (“CICs”).
On November 1, 2016, the IRS issued Notice 2016-66 (the “Notice”). The Notice designates certain types of captive insurance companies (“CICs”), including those operated by most of our clients, as “transactions of interest”, and it obligates affected clients and certain other parties to disclose information about their CIC to the IRS by, generally, January 30, 2017. The vast majority of CICs taxed under 831(b) will be required to make the requisite disclosures.
The IRS has previously recognized on numerous occasions that CICs taxed under 831(b) are “a legitimate tax structure.” Consistent with that position, this Notice also acknowledges that CICs taxed under 831(b) are a “legitimate tax structure.” However, the Service indicates that it remains concerned about the potential for abuse. Per the Notice, the IRS can’t yet (despite years of audits) articulate a principled distinction between abusive arrangements and legitimate ones. It hopes to do so after processing the information obtained as a result of the Notice.
The notice requires the disclosure of information that CIC Services already has in its files and is already providing to regulators. Consequently, we will assist affected clients and their advisors in complying with the disclosure requirement. We will proactively notify those clients who we believe are required to disclose the information, but clients should consult with their captive attorney or tax advisor to be sure. Though the requirements will be quite burdensome on us, we hope to insulate our clients from most of the burden of preparing and submitting the necessary information.
While the issuance of this Notice may at first be perceived by some as “bad news”, there are reasons to believe that this notice is actually a large step in the right direction. For the first time (see Section 1 of the Notice), the IRS has formally described in detail the types of transactions that it believes might be abusive. We don’t believe any of our clients are implicated by the description.
Also, the IRS is now seeking to obtain the information needed to differentiate abusive arrangement from legitimate ones in a more focused and organized way (via the disclosure requirement imposed by the Notice). This could mean fewer, or at least less indiscriminate, audits of CICs in the future. That would be a welcome relief for the industry.
Once the IRS processes the information collected (which could still take months or even years), we can expect clearer guidance from the IRS. Such guidance should resolve uncertainty and will allow everyone to structure their CICs in demonstrably compliant ways going forward. The industry has been pleading for this guidance for years, and it seems that we are now one step closer to getting it.
Finally, it’s important to note that Notice 2016-66 simply imposes additional reporting requirements. Business owners should still act in their own best interest and the best interest of their businesses. For most business owners, the improved risk management afforded by Enterprise Risk Management with a Captive Insurance Company and the tax benefits provided for by Congress to encourage businesses to formally self-insure risks make owning a CIC one of the most logical choices a business owner can make.