第三次美国税务法庭意见否认扣除风险汇总831(b)在Syzygy中的俘虏安排



<div _ngcontent-c14 =“”innerhtml =“

专属保险

JDA

高地坦克制造商,顾名思义,储存罐,在六个地点雇用约400名员工,总部设在宾夕法尼亚州。包括各个子公司,在各个地方经营的Highland Tank("HT&安培; A")2009年至2011年的收入在6000万美元范围内。作为一家S公司征税,该公司的总裁是与Van Vanenten结婚的Michael VanLenten。

通过他们不可挽回的信任,迈克尔和伊丽莎白拥有一个名为Bigbee Steel&amp;坦克公司,其他50%由约翰雅各布不可撤销的信托所有。其余的HT&amp; A公司由迈克尔,伊丽莎白和约翰以及他们各自的信托基金以相似的百分比拥有。所有信托都被视为雅各布或VanLenten的设保人信托。

HT&amp; A拥有众多地理位置多样化的地点,企业,众多员工和健康的收入,是替代风险部门中许多人认为是专属保险公司的理想人选。事实上,HT&amp; A有十几个商业政策,它通常支付超过100万美元的保险费,所以在那里应该有大量的优惠成本削减空间。

2008年,约翰雅各布开始探索与其保险经纪人Seubert&amp; amp;联合公司将约翰转介给位于加利福尼亚州欧文市的一家名为Alta Holdings LLC的公司,该公司由Greg Taylor拥有5%的少数股权,Greg Taylor将在这个故事中占据突出地位。在内部,泰勒向另一位Alta员工发送了一封电子邮件,称HT&amp; A公司可以支付每年50万至80万美元的年度保费。 "将 [sic] 屁股猜测"。

Alta的谈话持续了整个2008年,有时包括来自Alpern Rosenthal(现为BDO)公司的注册会计师Emanuel DiNatale,他定期向HT&amp; A提供有关税务事宜的建议。最终,在与Alta进行了多次讨论之后,DiNatale建议约翰雅各布继续俘虏,告诉约翰,从商业角度来看,俘虏似乎是有道理的,并且也符合美国国税局对专属保险公司的指导。

因此,Syzygy Insurance Company于2008年12月15日在特拉华州成立,并于当年12月31日从特拉华州获得了授权证书。 Syzygy由两家有限责任公司拥有,这些有限责任公司本身归Jacob和VanLenten信托所有。迈克尔·范兰滕为Syzygy担任总裁,约翰·雅各布是俘虏的秘书和财务主管。

虽然Alta的圈养计划有效,HT&amp; A并没有像大多数专属计划那样直接向Syzygy支付保费,而是HT&amp; A支付溢价给所谓的 "前置载体" 然后,前端运营商支付了Syzygy再保险保费的大致相同金额,以至于Syzygy最终获得了大部分HT&amp; A的溢价和风险。 2008年,2009年和2010年,前端运营商是美国风险协会保险公司(SPC)有限公司,2010年和2011年,它是Newport Re,Inc。

美国风险和Newport Re维持隔离的投资组合,其总政策限额为100万美元。这100万美元的保险范围分为第1层,其中索赔额高达250,000美元,第2层则涉及索赔额从250,000美元到100万美元。在HT&amp; A向美国风险或Newport Re支付溢价之后不久,这些公司将溢价分成49%的保费分配给第1层,而这49%的保费通过(被转让)给Syzygy。

HT&amp; A支付的另外51%的保费被分配给第2层,并且是所谓的第2层的一部分 "配额份额安排" 这似乎将风险与已经发给业主也有俘虏的企业的850多项保险政策相混淆。在保单期结束后约100天,美国风险或Newport Re将通过(转让)HT&amp; A支付给Syzygy的51%保费的余额减去其在850+其他保险中应付的任何损失的份额政策。

美国风险和Newport Re发布的所有保险单(显然是由Syzygy直接向HT&amp; A承保的单一保单)都是索赔制定的政策,这意味着无论何时保险单所涉及的索赔发生,索赔都有。在一定时间内报告,通常在保单期结束后的七天内报告,否则索赔将被没收。这些政策的有效期为12个月。在向HT&amp; A发布的所有政策中,美国风险和Newport Re收取2.5%的溢价 "前费" 这基本上是他们对交易的补偿。据推测,Alta因其对Syzygy的专属管理服务而获得单独补偿。

为了说明这一切是如何工作的,请考虑实际发生的事情

对于2009年,HT&amp; A支付了51万美元的保费,497,250美元(97.5%)支付了Syzygy。

2010年,HT&amp; A支付了545,000美元的保费,而511,268.26美元(93%)支付了Syzygy。 2010年是不同的,因为配额份额安排导致第2层损失20,106.74美元,这意味着Syzygy没有收到这个数额。

对于2011年,HT&amp; A支付了318,500美元的保费,310,537.50美元(97.5%)支付了Syzygy。

所有三年的底线是HT&amp; A支付了总计1373,500美元的保费,并且在Syzygy中支付了1,319.055.76美元(96%)

在HT&amp; A出现前一年,2007年,Alta聘请了Taylor-Walker&amp;来自犹他州的员工就保费分配提供建议,Taylor-Walker的精算师Randall Ross发表了各种评论。请注意,Alta的Greg Taylor与Taylor-Walker&amp;同事,他与他们分享一个名字只是巧合。

罗斯建议他预计第1层(0至250,000美元)的损失将超过保费的49%,而行业数据显示57%至78%。此外,49%和51%的分裂工作, 平均 索赔额必须超过500,000美元。罗斯还指出,如果这笔交易有意义 "附着点" (这里,意思是250,000美元的分界点)如果这个数字降到250,000美元以下或超出负债的超额限额增加到100万美元以上会更有意义。此后不久,罗斯还告诉阿尔塔,他估计70%的损失将发生在第1层(0美元至250,000美元),第2层只有30%(25万美元至100万美元)。

无论出于何种原因,Alta没有听从Ross的建议,并保持第1层49%的溢价和第2层51%的溢价。

约翰雅各布斯后来证实,他最初探索一家专属保险公司的意图是为了涵盖HT&amp; A对其产品的保修索赔。无论这个意图是什么,它从未被淘汰,因为HT&amp; A从未使用过它的专属安排。取而代之的是,HT&amp; A购买了一种典型的小额责任政策的鸡尾酒组合,这些政策为行政诉讼,破产优惠(即不收取债务人担保抵押品的全部金额),网络责任,商业免赔额的报销等事项提供保险。 – 购买保险,法律辩护,知识产权保护和执法,以及条件中的财产差异(一种财产损失形式)。

在这些政策中,有五项是超额保险政策,这意味着只有在超过相同商品的基本商业保险政策的政策限制时,才会产生政策责任,即索赔的责任和费用超过了商业政策的范围。上限。

阿尔塔的泰勒如何提出HT&amp; A政策的定价是不明智的。基本上,Alta向HT&amp; A提供了一份关于风险和现有政策的书面问卷,HT&amp; A将问卷与答案和各种文件一起归还。由此,泰勒选择了信息并创建了承保报告,然后将其发回给HT&amp; A。由于美国税务法庭后来发表评论:

然而,承销报告并没有详细说明泰勒先生的评级模型,计算或任何其他描述他如何达到保费的详细分析。该报告仅提供了有关预计损失,先前索赔以及有关HT&amp; D的信息的一般信息。 A的其他保险。承销报告中没有任何内容表明泰勒先生使用可比较的保费信息来定价保费。

为了协助定价和Syzygy的保险许可证申请,Ross(他将记住是Taylor-Walker的精算师)准备了一项可行性研究,但该可行性研究似乎主要关注Syzygy避免破产的能力而且它没有确定要收取的保费是精算合理的。此外,罗斯只使用了阿尔塔提供给他的信息,显然没有寻求任何独立的数据。

在保险业内,有一个称为 速率上线 这是通过采取保险单的保费金额除以保单的发生限额计算得出的。 HT&amp; A商业政策的平均在线费率为1.14%,而通过专属安排向HT&amp; A收取的平均在线费率约为6.1%⸺远高于五倍。

当Syzygy向特拉华州提交其保险公司许可证申请时,该州的自保险保险主管William White重点关注所收取的保费是否足以让Syzygy保持偿付能力,但不关心保费是否过高。

据推测,这些溢价基于泰勒估计有多少HT&amp; A声称Syzygy可能会支付的费用。可行性研究预测,从2008年到2012年,专属安排可能预计支付的保费总额中有56%的损失和损失费用,其中29%的损失来自第2层(250,000美元至1百万美元)。考虑到这些年份的保费实际损失率实际上总体上为1.5%,第2层为3%时,请记住56%和29%。

显然,事后看来,泰勒在他的承保预测中错失了很多。但这些百分比的可怕差异并非都是泰勒的错。相反,HT&amp; A在相关年份确实有相当多的主张,实际上他们的商业政策支付了免赔额,因为它们是如此多的主张。 "太多无法列出" 但是,即使他们被Syzygy政策所涵盖,他们也从未向Syzygy申请过这些免赔额。根据一项政策单独提出的一项索赔,专属安排可能对从未作出的56,012.58美元的免赔额承担责任,并且还有额外的$ 43,456.08免赔额,HT&amp; A本可以提出索赔。回想起来,这些数字会让泰勒的承保看起来好多了。

那么HT&amp; A为什么不对其俘虏安排提出索赔呢?天哪,你花了所有这些时间和金钱来分析和组建一个专属人员来支付索赔,然后你不提出索赔?约翰雅各布斯在证词中给出了表面上的原因:

John W. Jacob花了很多时间研究HT&amp; A的保险在发行年限内很重要。他作证说,由于时间管理方面的问题,他没有提出专属程序索赔,而且他们没有打到他的 "雷达屏幕"。约翰W.雅各布承认HT&amp; A没有针对他们的专属计划的理赔管理系统,但有 "不同的过程" 取决于其商业政策的主张。

现在,我们将把我称之为的东西放在一边 "我太忙了,不能处理它" 防守(这是 雅各 辩护并且可能根本没有,因为Alta设想的俘虏安排会起作用)并且稍后重新审视。让我们继续谈谈更多的事情,这就是Syzygy的资产投资方式。

从2008年开始的不起眼的不可撤销的信用证提供其最初的25万美元资本化,到2011年,Syzygy可以拥有超过150万美元的现金和等价物 – 当你不支付索赔时,很容易建立一个俘虏⸺和两个寿险保单价值603,184美元。

人寿保险政策的故事在这部剧中提供了一个有趣的情节,如果你愿意,也可以是悲剧。虽然Syzygy在其财务报表中列出了寿险保单,但Syzygy并未实际拥有这些保单。 Syzygy甚至不是这些人寿保险单的受益者,即使它付出了代价。而且他们是人寿保险的大政策:一人投保约翰雅各布的生命超过800万美元,另一人投保迈克尔范兰滕的生命超过730万美元。

事实上,尽管Syzygy的财务报表列出了人寿保险单,但它们实际上分别由Jacobs和VanLentens的不可撤销信托所有,而这些信托是这些政策的受益者。 Syzygy真正拥有的唯一权利是分裂美元安排下的权利,当雅各布和迈克尔继续获得奖励时,Syzygy有权获得它为政策支付的60万美元(,它只是得到了它的钱)或政策的死亡现金价值,以较大者为准。

否则,Syzygy没有资格获得一分钱,而雅各布和迈克尔还活着并且踢⸺Syzygy无法获得政策的现金价值甚至借用它们⸺除非政策被取消,然后Syzygy才会回来到那时,资金被留在了政策中。这里只需说这对一家保险公司来说是一项奇怪的投资,该保险公司可能在任何时候都需要其全部资产来支付索赔,但是有一些特别严重的损失发生了。我们稍后也会谈到这一点。

2011年,Alta告诉Syzygy,其溢价水平难以维持,需要减少超过20万美元才能更准确地反映HT&amp; A的索赔,因为约翰雅各布没有时间费心去做。从而:

John W. Jacob向Alta发送了一封电子邮件,解释说Syzygy正在改变经理人,因为除其他事项外,他对保费的减少感到不满。

在审判中,John W. Jacob作证说他对保费减少感到失望,因为有一个固定成本与专属经理相关,最有意义的是尽可能多地与专属经理人进行保险。

呃,是的 "渐进式,我要离开你了,因为你的保险费太低了,我可以通过State Farm得到更高的保费," 没人说过。

正如我在它发生之前多次预测的那样,遭遇亚瑟叔本华阶段的嘲笑和暴力反对之后才进入 "任何人都可以看到它即将到来" 在我们今天的阶段,美国国税局最终对风险集中的831(b)专属保险公司产生了浓厚的兴趣,并且这种强烈的兴趣最终落在了HT&amp; A对其支付给美国风险和Newport Re的保费的扣除上,并且迟早盘旋进入Syzygy。

归根结底,美国国税局确定,由于缺乏经济实质,专属安排无效,HT&amp; A对保费的支付不是保险支付,对专属保险的支付不是普通和必要的业务费用,Syzygy没有参与保险交易并不是用于税收目的的保险公司,因此Syzygy的831(b)选举无效,Syzygy收到的保费是应税收入。因此,基于所有这些,IRS不允许HT&amp; A的扣除并强加与准确性相关的处罚。

HT&amp; A方面的所有人(我将统称为所有人) "上访" 因为那是法院所称的,当我引用Ruwe法官时,会更容易理解美国税务局对美国税务法庭的判决和评估的上诉,并且在提出意见的法院的Ruwe法官面前进行了审判。我接下来会说。

但首先,请愿者的一点点旧脚射击。 2017年4月6日,法院发布了一项预审令,要求所有动议在2017年9月27日之前提交举证责任。无论出于何种原因,请愿人都没有提出动议,要求将负担转移到美国国税局,直到他们在2017年12月13日审判,迟到近四个月。也许就像约翰·雅各布在提交索赔时那样,他们太忙了,无法绕过它,但无论如何,法院否认这一动议是因为它违反了预审令。

引用第831(b)灾难, Avrahami诉专员,Ruwe法官指出,法院在决定特定的专属安排是否达到税收保险水平时,通常会考虑四个非排他性标准:

  1. 是否涉及可保风险;
  2. 损失的风险是否实际上转移到了俘虏;
  3. 被俘者是否在其保单持有人中分配风险;和
  4. 这种安排是否相当于普遍接受的意义上的保险。

Ruwe法官跳过了前两个标准(可保风险和风险转移),而是从风险分配问题开始。在这方面,法院采用了与法院基本相同的方法 Avrahami 法院确定风险是否已充分分配。

首先,法院审查了资金流动是否属于循环性质,并注意到HT&amp; A基本上向美国风险或Newport Re支付了资金,然后是大部分资金(较少的前端费用和一个小额索赔)第二层的一年,96%将被召回,进入Syzygy。鲁威法官确定,就像在 Avrahami虽然循环不完整,但它肯定似乎是一个循环的资金流。

其次,法院审查了保险单是否属于公平交易合同的性质。 Ruwe法官最初评论了HT&amp; A商业政策的平均在线费率差异,与专属安排的比率为6.14%,约为6.1%,并指出专属政策的价格高出五倍以上比商业政策。对于Ruwe法官来说,这引发了一种怀疑,即专属保险费被人为地夸大,以增加HT&amp; A的税收减免。

由于被捕政策中的各种条款(例如其中一些仅涵盖超额政策)通常意味着专属政策的实际成本应低于商业政策,因此这种怀疑得到了支持。此外,作为保险实践的问题,接下来是一个更可疑的观点,在政策到期后提出索赔仅七天的限制似乎对保单持有人比通常提供30至60的商业政策更不利。一天的时间。 (实际上,人们偶尔会遇到商业政策,在政策结束后只有七天的索赔期,但目前尚不清楚请愿人是否就此提出了任何证据。)

然而,最有说服力的一点不是这些事实,而是John Jacob将Alta解雇为Syzygy的俘虏经理,因为 – 正如他在电子邮件中所说的那样 – 他很不高兴Alta告诉他需要收取的保费。每年减少超过200,000美元。由于任何类似真正的公平交易的保单持有人都不希望他们的保费更高("亲爱的美国国际集团,你几乎没有向我收费,所以你被解雇了!"“没有人说过),这些事实严重影响了HT&amp; A试图夸大他们的保费以增加他们的税收减免,尽管Ruwe法官没有用这么多的话说出来,但整个安排看起来更像是一个避税所比任何像真正的俘虏结构。

第三,法院审查了保费价格是否经过精算确定, 是否采用了一些合理的精算方法来确定每项政策的保费应该是多少。尽管精算师罗斯和特拉华州的精算师都在考虑保费金额,但他们并没有这样做是为了定价,而是试图确定它们是否足以让Syzygy无法破产。所以他们的评论没有帮助。

这使得Alta的格雷格泰勒基本上是保费应该如何定价的唯一仲裁者,但泰勒并不是精算师,而是通过阅读泰勒通过使用OUIJA板和OUIJA板的组合开发他的定价模型的观点得到了这个想法。一个被蒙住眼睛的飞镖,也就是说,如果有人认为泰勒只是从天空中采摘数字,几乎没有反驳的事实。 Ruwe法官特别强调Taylor的电子邮件,他承认使用了 "将 [sic] 屁股猜测" 拿出保费。

但我要在这里离题一秒,并指出HT&amp; A的人无论出于何种原因都没有打电话给任何阿尔塔人作为审判的证人,试图解释其中的任何一个,并且得到的印象是HT&amp; A人们甚至都不愿意与阿尔塔人谈论如何保护案件。人们可以将其类比为试飞员,他在新飞机上起飞而不必费心去询问飞机工程师应该如何飞行以及在某些危急情况下该怎么做。

如果发生了这种情况,那么谁知道泰勒可能在定价问题上作证呢?泰勒所说的话可能对请愿者更有利而不仅仅是离开他的 "将 [sic] 屁股猜测" 那里的电子邮件没有任何关于他如何达到定价的反驳证词。这似乎是一个非常值得怀疑的诉讼策略,但它最终是否会产生任何不同是充其量的猜测。

一个更为技术性的问题是,阿尔塔显然忽略了精算师罗斯的建议,即第1层和第2层之间的溢价分配并非精算正确,而且更多的保费应该分配给第1层。这里我们再次看不到证词来自Alta的任何人都在解释为什么没有发生这种情况,但相反(更糟糕的是,更糟糕的是)John Jacob采取了立场来证明49%和51%的分配是在关注税收后果的情况下完成的,或者用他的话来说, "利用与税收相关的安全港"。这并不是纳税人想要看到的证据,其目的是说服美国税务法庭说出事情是出于保险原因而非出于税收原因。足枪战刷新。

无论如何,根据所有这些事实,Ruwe法官得出结论认为,保费定价并未精算开发。因为,如上所述,Ruwe法官还得出结论认为,资金流动是循环的,而且保费不是按公平原则制定的,因此法院认为没有风险分布存在,这已成定局。

最后一个 Avrahami 法院应考虑的标准是否 保险在普遍接受的意义上这是保险税案件中的一个术语。 Ruwe法官指出,由于他发现没有风险分布,请愿人已经失去了案件,但他仍然认为这个问题是他决定的另一个选择。

为了确定是否存在普遍接受的意义上的保险,法院指出有五个因素需要探讨:(1)俘虏的组织和运作方式,(2)俘虏是否资本充足,(3)政策是否合理是有效和有约束力的,(4)保费是否合理,以及(5)是否支付了索赔。

关于第一个因素,美国国税局认为Syzygy违反了特拉华州的各种保险条例,但Ruwe法官并未认为根据这一具体案件的事实特别相关。相关的是Syzygy是如何实际操作的,而且它并不漂亮。

Ruwe法官发现的最大问题在于如何处理索赔,因为HT&amp; A总共可以提交给美国Risk和Newport Re的索赔超过10万美元,但它并没有这么做。完全杀死这一点的是:

此外,John W. Jacob作证说HT&amp; A没有专属程序索赔的索赔程序,但确实有 "不同的过程" 他们的其他要求。可扣除的报销政策是HT&amp; amp;一个最昂贵的保险单,HT&amp; A在支付免赔额后未能提交索赔,表明该安排并不构成普遍接受的保险。我们关注的是HT&amp; amp; A关于承保问卷的声明,在2009年之前他们发生的免赔额是 "太多无法列出。" 请愿人关于John W. Jacob忙于提交索赔的论点并不能让我们相信这种安排是普遍接受的意义上的保险,因为HT&amp; amp; A曾声称他们没有为专属计划政策实施商业政策流程。

此外,对于提交给Syzygy的一项索赔,俘虏只是支付了索赔,而没有对索赔是否有效进行任何调查。想一想:您只需告诉您的保险公司您有索赔,而保险公司在没有任何调查或验证索赔的情况下付款。一直发生在真正的保险世界,而不是。

Ruwe法官也发现Syzygy的投资选择,用他的话来说, "令人不安"。 Ruwe法官特别谈到的是Syzygy购买的两种人寿保险单,但它们并不拥有,甚至不能借钱。因此,Ruwe法官评论说:

我们认为,普遍接受的保险公司不会将超过50%的资产投资于无法支付索赔的投资。

请愿人试图声称特拉华州保险公司董事史蒂夫金尼恩, "人寿保险政策没有问题。" 但Kinion自己在这个问题上的证词并不那么友好,Ruwe法官也不清楚Kinion甚至同时知道这些政策的存在。此外,Kinion作证说,每当特拉华州找到保险单时,俘虏无法获得现金价值,他的部门就会与俘虏联系并寻求改变安排。

在总结这一点时,鲁威法官说:

&gt;&gt;&gt;我们发现Syzygy的人寿保险投资的情况严重影响了Syzygy作为普通公认的保险公司。&lt;&lt;&lt;

法院接着讨论了HT&amp; A专属安排所涉及的保险单是否属于 "有效且有约束力" 政策。在这里,Ruwe法官担心这些政策从未及时发布给HT&amp; A,事实上在2009年和2010年,甚至在保险期限完全到期之前都没有发布政策。

为了在这一点上进行辩护,请愿者提交了迈克尔·安吉丽娜博士的专家证词,他证实了保险领域的后期政策发行很普遍,保险绑定人具有约束保险的法律效力。但根据Ruwe法官的说法,这只是到目前为止:

虽然请愿人的专家迈克尔·安吉丽娜博士作证说,延迟发行在保险业中很常见,但我们得出的结论是,即使是单一政策的及时发布也不会对普遍接受的保险安排造成压力。

但是最近发布的政策只是一个问题,更严重的问题是政策对政策所涵盖的HT&amp; A实体究竟是多么模糊,有时绑定者甚至与识别被保险人的政策相冲突。在2009年和2010年发布的可扣除的报销政策中发现了更多的邋 – – 但免赔额的报销政策仅在2010年存在。

也许是孤立的,每个错误本身并不是致命的,但总的来说,根据Ruwe法官的说法,它们很有说服力:

请愿者认为,无论含糊不清和相互矛盾的条款如何,各方的意图都在控制,因此政策具有约束力。的含义 "有效且有约束力" 对于联邦税收目的,还会考虑政策含糊不清和冲突的条款以及它们如何与交易精神相适应。显然,模糊和冲突的条款并不妨碍每项政策都是为了税收目的而保险,但是关联方交易受到了更严格的审查。 [Citation omitted.] 在关联方交易的背景下查看政策的延迟发布,含糊不清和相互冲突的条款会使我们得出结论,有效且有约束力的政策因素会影响请愿者。

下一个要考虑的项目是保险费的合理性,但法院仅在此指出,它已经认为保险费是不合理的,因此转为支付索赔,或者更确切地说是在第2层支付的单一索赔。 (仅限一年250,000美元至100万美元)。在这里,Ruwe法官注意到的是,虽然确实已经支付了索赔 "它的处理方式存在问题" 而且这笔索赔的支付意味着请愿者在这个问题上得到了一个空白点。但是,在大型计划中,这还不够,正如Ruwe法官得出的结论:

虽然Syzygy作为一家保险公司组织和监管,满足特拉华州的最低资本要求,并支付了索赔,但这些类似保险的特征并未克服该安排的其他缺陷。 Syzygy并不像保险公司那样经营。前线承运人收取不合理的保费和迟发的保单,条款相互矛盾,含糊不清。 * * * HT&amp; amp; A,Syzygy和前端运营商缺乏风险分配,并且在普遍接受的意义上不是保险。因此,该安排不是联邦所得税的保险,我们不需要处理专员的经济实质论据。

法院裁决的结果令人痛苦。至于Syzygy,由于它被确定为不是一个保险公司用于税收目的,它所做的831(b)选举被认为是无效的,它收到的保费将作为普通收入向公司征税。 。

至于HT&amp; A公司及其所有者,即Jacobs和VanLentens,他们不得扣除他们向美国风险和Newport Re支付的保费。在这里,请愿者通过说至少他们被用来赔偿HT&amp; A公司的损失而绝望地做了最后的喘息。 But Judge Ruwe wasn't buying that:

In the context of captive insurance there may be instances where noninsurance payments for indemnification protection might be appropriate and helpful to the development of the insured. But, at the bare minimum, for such payments to be considered appropriate and helpful, the indemnified party must intend to seek indemnification if a covered event occurs. Otherwise, there is no valid purpose for making such payments. In these cases HT &amp; A's failure to file claims that they thought were covered under the deductible reimbursement policies leads us to find that there was no intent to seek indemnification for covered losses. Accordingly, the payments are not deductible as ordinary and necessary expenses.

Thus it was that John Jacob's failure to make claims, because he was just too darned busy with other stuff, came back to take a second bite against petitioners. In a similar vein, the Court also denied an attempt to treat the payments made to Syzygy as something other than income, such as a loan or capital contribution. This was rejected as well:

While the revenue rulings suggest the possibility that an arrangement that purports to be an insurance contract may instead be characterized as a deposit arrangement, a loan, a contribution to capital, or otherwise, there is no evidence that any such recharacterization is appropriate.

This is a bad result in a captive case: Not only does the taxpayer lose the deduction for the company paying into the captive arrangement, but the taxpayer also has to pick up the income for what was paid to the captive, ., double taxation ⸺ and maybe even 三倍 taxation when one considers that the moneys coming out of Syzygy will again be taxed since it is taxed as a corporation and not as a passthrough.

But it could have been even worse as Judge Ruwe turned to whether the 20% accuracy-related penalty should be assessed. But here the savior was that John Jacob had relied upon the advice of DiNatale, the CPA, to go forward with the captive arrangement, and which the Court found to be good faith reliance such that the 20% penalty would not apply.

ANALYSIS

Syzygy opinion is the third in an increasingly long line of disasters for risk-pooled 831(b) captives, joining its predecessors AvrahamiReserve Mechanical in tax law infamy. Of the three opinions, however, Syzygy is the strangest opinion because Judge Ruwe enters his results based largely on the serious mistakes of the players involved, but never gets to the issue of whether the Alta Layer 1/Layer 2 quota-share design was either viable or flawed.

Certainly, there is the eyebrow-raising fact that Layer 2 only had one small-dollar claim made in three years against 850+ outstanding policies, but at best that would just be one piece of a puzzle that in the end could be no more than speculation. Which means that we will have to wait for another case to see if this sort of design can pass muster ⸺ I'm not holding my breath that it will, but that's just my own speculation.

The really weird thing is that HT&amp;A may not have needed to go into this type of captive arrangement at all, but seemed to have close enough to enough subsidiaries and risk units that HT&amp;A could simply have formed its own captive and internally distributed risk under the so-called multiple-entity safe harbor of Rev.Ruling 2002-90。 If HT&amp;A did not have sufficient subsidiaries to fall into that safe harbor, then some basic business planning could very likely have gotten them over the line. This would have saved Syzygy from any risk pooling at all, meaning that HT&amp;A could have avoided entirely the U.S. Risk and Newport Re quota-share deals and their attendant costs and liabilities.

It is always a curiosity to me when I see a captive in a risk pool when it didn't need to be there in first place, and I've yet to hear anything even modestly approaching a viable explanation for why risk-distribution through a risk-pool is somehow better for the captive arrangement than satisfying the tests as the captives of corporate America do, which is through multiple entity risk-distribution. With a risk pool, one is taking on the double risks of liability by big claims from parties unknown and the risk that if the risk pool blows up from a tax perspective as to any participant in the risk pool then it likely fails for tax purposes as to all participants. That practice is just bizarre to me, but I see it all the time in reviewing captives.

Another problem here is the arguably serious litigation error of not calling Greg Taylor as a witness to explain how he came up with his pricing models, since presumably anything he said would likely have been better than simply leaving his "将 [sic] ass guess" e-mail hanging. The impression thus lingers throughout the Opinion that Taylor was simply making up numbers as he went, which would make the case consistent with the pricing models in AvrahamiReserve Mechanical。 Whether that is right or wrong, we don't know — but those were the facts that Judge Ruwe had to deal with.

Which is to say that if you are going to try to defend one of these cases, you'd better have a thick pricing model in hand which shows how the premiums were calculated down to the last penny, and not just give the Tax Court a chart with a bunch of round numbers with little or no explanation as to how they were individually arrived at. Such were the facts of this case, and the outcome was quite predictable on this point.

Certainly, there was sloppiness to be found in Alta's management of the captive arrangement, such as relying on binders and not get the policies out in one case until after the policy year had passed. But this isn't an indictment of Alta so much as it is of the entire 831(b) risk-pooled captive sector in which it is endemic that captive managers often take far too long in issuing policies ⸺ it is the rare 831(b) risk-pooled captive that I review where the policies went out on time. Probably to nobody's surprise, this occurs much more where the folks running the captive management company are either tax or financial folks who don't understand the importance of timely policy issuance, and not experienced property/casualty personnel who do.

The problems with Alta issuing policies with conflicting terms and insureds, and issuing a deductibles policy for an underlying policy which didn't even exist in one year, are harder to overlook. Suffice it to say that nobody is perfect and mistakes are simply human, but chronic sloppiness at some point can have serious cumulative effects. But here it should be noted that Alta was effectively tried and convicted of sloppiness in abstentia, since the petitioners for whatever reason didn't call any of the Alta folks as witnesses, and we can do little more than guess at what their testimony might have been or whether it would have helped or hurt.

Yet, Alta's sloppiness pales in comparison to the error of John Jacob who administers his first fatal blow to his own captive arrangement by not bothering to make claims. If John Jacob had submitted the $100,000+ in claims, then the entire complexion of this case changes dramatically: The premiums don't look so random or unreasonable, the problems with the late-issued and sometimes conflicting policies don't appear so severe, and ⸺ by far most importantly ⸺ the entire arrangement doesn't smell so much like a tax shelter where the goal was to maximize deductions and minimize everything else.

Whether making the claims would have been the difference is, of course, just more speculation. But there is no doubt that it would then have been a much closer case, akin to the difference between sliding into third base on a close call, and face-planting in front of the shortstop and being tagged out between bases as what happened.

But this is another thing that is endemic to the 831(b) risk-pooled captive sector: Nearly all these cases have few or no claims being made. That was what happened in both AvrahamiReserve Mechanical, and before I even read a single word of this opinion I had the strong suspicion that similar circumstances would be found here as well. Where there are few or no claims, good luck in defending the arrangement in all but the rarest cases involving so-called low-frequency/high-severity risks such as earthquake or flood cover, etc., where the policy may literally go for decades without covering a single claim, and then suddenly and unexpectedly there are enormous claims which stress the insurance company to the very limits of its solvency.

The second and much more fatal blow that John Jacob made to his own captive arrangement was his admission that he terminated Alta because they wanted to decrease his premiums by $200,000+ per year, presumably to reflect that the actual claims made by the HT&amp;A companies wasn't coming close to those which had been predicted. This is about as close as one will ever find in a tax court case to an admission that the captive arrangement was not being used as anything like a 善意 risk management tool, but was rather just a naked tax shelter to try to cheat Uncle Sam out of some bucks.

A reality check: No captive arrangement, no matter how brilliantly designed, no matter how meticulously operated, is going to survive that kind of testimony. Judge Ruwe latched onto it immediately, and it was sure death for the Syzygy arrangement.

Another factor that Judge Ruwe highlighted, which was a factor discussed at much greater depth by the courts in AvrahamiReserve Mechanical, was the utter lack of anything like an arm's length transaction between HT&amp;A and the captive arrangement. Here, we see again the model where the captive manager comes up with policies and pricing and submits that to the common owner of the underlying operating business and the captive for approval. Very simply, that model does not work and will never work。 Either there are serious and meaningful negotiations between the underlying operating business and the captive, such that the business is trying to get the most coverage for the least amount of money, and the captive is trying to get the least coverage for the most amount of premiums, or you don't have an arm's length transaction for tax purposes.

Having the captive manager do it all and the common owner agree to it is simply a giant nothingburger, not even worth the paper that it is wasted on it, but again that seems to be the standard (bad) practice with 831(b) risk-pooled captives. This is a classic example of the captive management herd not being right and collectively running over the cliff together.

Speaking of bad practices, we now come to the idea of having life insurance inside a captive insurance company. The goal, of course, is to finally accomplish that Valhalla of life insurance planning that Congress does not ordinarily permit, which is to purchase life insurance with pre-tax dollars. The idea, which first arose in 2002 (I was around when it was first discussed), was that the business could take a deduction for making insurance payments to the captive, the captive would receive the payments without paying any income tax on them, and then the captive could use the money to purchase life insurance with what amounts to pre-tax dollars.

Starting around 2005, it got to be a popular deal to use 831(b) captives to purchase life insurance, driven in no small part by the large commissions being paid to the life insurance agents who helped to arrange the deal, and who typically got commissions somewhere around 40% of the first-year's premiums for universal life, and 80% of the first-year's premiums for whole life (if you want to known why life insurance agents are always trying to jam their clients into whole life, it is because their commissions are about double that for universal life, the latter almost always being better for the purchaser because the payments are much more flexible). To borrow the numbers from this case just as an example, if the policies were whole life policies, then the selling agent would get around 80% of the first-year premium of $300,000 — meaning a $240,000 commission. That's a nice hit for a few hours of work.

The problem was then, and still is now, is that for the very reasons that Judge Ruwe identifies, putting life insurance inside a captive doesn't make much sense because it is an inherently illiquid investment during the surrender period and thus the value of the policy is not available to pay claims. But it is even worse than that.

The tax problem of having the captive purchase life insurance is that the captive would be the owner of the life insurance policy, which on death would mean huge profits to the captive that would be taxed at the corporate income tax rate. Thus, as the Jacobs and VanLentens did here, the only way that doing such an arrangement makes any sense from a tax perspective is to do some sort of split-dollar arrangement (using "preferred LLC shares" was another method) such that the captive only got back what it paid for the life insurance in the first place.

But in doing so, from the perspective of the captive, the arrangement goes from not making any sense to then not even making any respectable nonsense. The effect is that the captive is investing in an asset that is completely tied up and unavailable until somebody dies, but in the end that captive doesn't show any profit for that risk. It is utterly absurd from the perspective of the captive, and Judge Ruwe took the time to carefully point that out.

As an aside, I have for years warned against using captives to purchase life insurance and have written numerous articles and given numerous lectures on the topic. These warnings also went through Schopenhauer's stages of ridicule, violent opposition and finally acceptance. For instance, New York attorney Celia Clark in 2009 published an 文章 in rebuttal to one of mine where she proclaimed life insurance to be a suitable investment for captive insurance companies; she later went on to be the primary architect of the Avrahami fiasco and closed up her captive shop entirely just a few days thereafter. A decade later, the results, as Maury Povich might say, are in: She was wrong.

But Celia Clark wasn't the only one pushing life insurance for captives, and literally dozens if not hundreds of life insurance agents and financial planners jumped into that game. Eventually around 2012, the life insurance companies themselves started to fear liability and many quit selling life insurance to captives altogether. Yet, there are probably not just a few of the cases currently docketed before the U.S. Tax Court that have life insurance as investments, and there is a good chance that these captive are all already DOA and are simply waiting to be told so.

The bottom line is that the Jacobs and VanLentens tried to misuse their captive to purchase life insurance with pre-tax dollars, but instead ended up buying the life insurance with -taxed dollars, and perhaps even 三倍-taxed dollars. That's quite a feat, congratulations.

When we get to the issue of penalties, we see that the Jacobs and VanLenten's barely escaped the 20% accuracy-related penalty only by the hair of their chinny chin chin because the CPA, DiNatale, had been involved in the discussions leading up to the captive and had blessed it from a tax standpoint before it was formed. Yet, this may be the place where Judge Ruwe errs in his opinion.

A captive arrangement can blow up in one of two ways or both, being either in the design and creation, or in its operation. Because Judge Ruwe never got to the issue of whether the Alta Layer 1/Layer 2 quota-share design was valid or defective, and because Syzygy was otherwise correctly formed and capitalized, this is the latter case where the captive arrangement failed in its operation since it was not actually run as an insurance company. But note that, at least from the facts recited by Judge Ruwe, DiNatale only gave advice on the design and formation of the captive, not how it was being operated. There is nothing in the facts stated in this opinion (which does not mean that such facts do not exist) which indicates that DiNatale gave any ongoing blessing during the years when the captive was not run as an insurance company.

Thus, if this ruling is appealed, it might be the IRS could make a good argument that the 20% accuracy-related penalties should have been imposed, because the Jacobs and VanLentens did not have anything upon which they could rely for each year as they filed their tax returns. But on this point, we'll have to see if the case is even appealed.

I'll conclude this article with the observation that we've now had three utterly disastrous cases for risk-pooled 831(b) captives: AvrahamiReserve Mechanical,和 Syzygy。 In each case, the tax law has grown increasingly worse for such captives. Indeed, the opinion by Judge Ruwe here is shorter and less detailed than those of the first two cases, which indicates that the U.S. Tax Court has largely decided that such captives are not normally going to past muster, and so is starting to give these challenges to IRS determinations increasingly short shrift. Anybody who thinks that the U.S. Tax Court is going to reverse direction anytime soon, short of a successful appeal by a taxpayer to a U.S. Court of Appeals somewhere, is simply deluding themselves.

We are now moving in a new phase for 831(b) risk-pooled captive: Denouement。 In this phrase, it can be expected that the U.S. Tax Court will routinely deny the deductions paid to such a captive and the only real fight will be on penalties. This will also be a phrase characterized by negligence suits and class actions (as I have previously written, there is already one class action going on and I've credibly heard that others are in the works). The epilogues for the captive managers and other professionals involved are increasingly likely to be played out in the U.S. Bankruptcy Court as it did with the 412(i) Plan and 419A(f)(6) promoters. It's not a pretty picture.

But it is a picture ⸺ and this is critically important to understand ⸺ that so far is strictly limited to risk-pooled 831(b) captives and has a very good chance of staying that way. Of the 600+ captive insurance cases that are rumored to be currently pending before the U.S Tax Court, all but a small handful are cases involving risk-pooled 831(b) captives. These tax court opinions will have relatively little impact if at all on the large corporate captives, and non-risk-pooled 831(b) captives (although the anticipated Caylor Land decision may be the outlier there, as it was a non-risk-pooled 831(b) captive but seemed to have no shortage of really bad facts). In other words, captive insurance arrangements can be quite safe from a tax standpoint, and very beneficial as a risk management and insurance cost-savings structure, so long as one avoids risk-pooled 831(b) captives and gets into the arrangement for the correct non-tax reasons.

I've only been giving that advice for over a decade now.

CITE AS

Syzygy Ins. Co. v. CIR, T.C. Memo. 2019-34 (April 10, 2019). Full opinion at https://captiveinsurancecompanies.com/2019-syzygy-captive-insurance.php

RELATED ARTICLES

“>

Highland Tank manufactures, as its name suggests, storage tanks and employs about 400 folks at six locations with its headquarters in Pennsylvania. Including its various subsidiaries, operating in various places, the Highland Tank ("HT&A") had revenues in the $60 million range for 2009 through 2011. Taxed as an S-corporation, the company's president is Michael VanLenten who is married to Elizabeth VanLenten.

Through their irrevocable trust, Michael and Elizabeth own 50% of one of the Highland companies, called Bigbee Steel & Tank Co., with the other 50% being owned by the irrevocable trust of John Jacob. The rest of the HT&A companies were owned in similar percentages by variously Michael and Elizabeth and John and their respective trusts. All the trusts were treated as grantor trusts to either a Jacob or a VanLenten.

With so many geographically diverse locations, businesses, numerous employees, and healthy revenues, HT&A was what many in the alternative risk sector would consider to be an ideal candidate for a captive insurance company. As it was, HT&A had about a dozen commercial policies to which it was generally paying over $1 million for coverage, so there should have been substantial room for premium cost-cutting in there somewhere.

In 2008, John Jacob began exploring the idea of a captive with its insurance broker, Seubert & Associates, which referred John to a company called Alta Holdings LLC in Irvine, California, which was owned in 5% minority part by Greg Taylor, who will feature prominently in this tale. Internally, Taylor sent an email to another Alta employee stating that the HT&A companies could pay $500,000 to $800,000 in annual premiums as a "will [sic] ass guess".

The Alta conversations lasted throughout 2008, and at times included Emanuel DiNatale, a CPA from the firm of Alpern Rosenthal (now BDO) who regularly advised HT&A about tax matters. Ultimately, after various discussions with Alta, DiNatale advised John Jacob to go forward with a captive, telling John that a captive seemed to make sense from a business perspective and also comply with the IRS guidance for captive insurance companies.

Thus it was that Syzygy Insurance Company was formed in Delaware on December 15, 2008, and received its certificate of authority from Delaware on December 31 of that year. Syzygy was owned by two LLCs which were themselves owned by the Jacob and VanLenten trusts. Michael VanLenten served Syzygy as its president, and John Jacob was the captive's secretary and treasurer.

The way Alta's captive program worked, HT&A did not pay premiums directly to Syzygy as in most captive programs, but instead HT&A paid its premiums to what is known as a "fronting carrier" and the fronting carrier then paid Syzygy reinsurance premiums for roughly the same amount such that Syzygy ended up with the bulk of HT&A's premium and risks. For 2008, 2009 and 2010, the fronting carrier was U.S. Risk Associates Insurance Company (SPC), Ltd., and for 2010 and 2011 its was Newport Re, Inc.

U.S. Risk and Newport Re maintained segregated portfolios which had aggregate policy limits of $1 million. This $1 million of coverage was divided into Layer 1 which covered claims up to $250,000 and Layer 2 which covered claims from $250,000 to $1 million. Soon after HT&A paid its premiums to either U.S. Risk or Newport Re, those companies divided the premium such that 49% of the premiums were allocated to Layer 1, and this 49% of premiums passed (was ceded) to Syzygy.

The other 51% of premiums paid by HT&A was allocated to Layer 2, and was part of a so-called "quota share arrangement" that appeared to mix the risk with over 850 insurance policies that had been issued to businesses whose owners also had captives. About 100 days after the policy period ended, either U.S. Risk or Newport Re would then pass (cede) the balance of the 51% of premiums paid by HT&A to Syzygy, less its share of any losses due on the 850+ other insurance policies.

All the insurance policies issued by U.S. Risk and Newport Re (and apparently a single policy directly underwritten by Syzygy to HT&A) were claims-made policies, which means that regardless of when a claim covered by an insurance policy occurred, the claim had to be reported within a certain period of time, usually within seven days of the end of the policy period, or else the claim was forfeited. The policies were all for a term of 12 months. On all of their policies issued to HT&A, U.S. Risk and Newport Re charged 2.5% of the premium as a "fronting fee" which basically was their compensation for the deal. Presumably, Alta was compensated separately for its captive management services for Syzygy.

To show how all this worked, consider what actually happened:

For 2009, HT&A paid $510,000 in premiums, and $497,250 (97.5%) wound up back in Syzygy.

For 2010, HT&A paid $545,000 in premiums, and $511,268.26 (93%) wound up back in Syzygy. The year 2010 was different because the quota-share arrangement caused a loss in Layer 2 of $20,106.74 meaning that Syzygy didn't receive that amount.

For 2011, HT&A paid $318,500 in premiums, and $310,537.50 (97.5%) wound up back in Syzygy.

The bottom line for all three years was that HT&A paid $1,373,500 in total premiums, and $1,319.055.76 (96%) wound up back in Syzygy

A year before HT&A came along, in 2007, Alta hired Taylor-Walker & Associates from Utah to advise on the premium allocation, and actuary Randall Ross of Taylor-Walker made various comments. Note that Alta's Greg Taylor is not related to Taylor-Walker & Associates, and it is merely coincidental that he shares a name with them.

Ross advised that he expected the Layer 1 ($0 to $250,000) losses to exceed 49% of the premiums and that 57% to 78% was suggested by industry data. Also, for the 49% and 51% split to work, the 平均 claim size would have to exceed $500,000. Ross also noted that the deal would make sense if the "attachment point" (here, meaning the demarcation point of $250,000) would make more sense either if that number was lowered below $250,000 or the excess limit of liability was increased beyond $1 million. Soon thereafter, Ross also advised Alta that he estimated that 70% of the losses would occur in Layer 1 ($0 to $250,000) and only 30% in Layer 2 ($250,000 to $1 million).

For whatever reason, Alta did not heed Ross's suggestions and maintained the split of 49% premiums for Layer 1 and 51% for Layer 2.

John Jacobs would later testify that his original intent in exploring a captive insurance company was to cover HT&A's exposure to warranty claims against its products. Whatever that intent, it never panned out since HT&A never used its captive arrangement for that purpose. Instead, HT&A bought a cocktail mix of typically small-liability policies which insured against such things as administrative actions, bankruptcy preferences (i.e., not collecting the full amount on a debtor's secured collateral), cyber liability, reimbursement of deductibles on its commercially-purchased insurance, legal defense, intellectual property defense and enforcement, and property difference in conditions (a form of property loss).

Of these policies, five were excess-coverage policies, which meant that there was policy liability only if the policy limits of the underlying commercial insurance policy for the same thing was exceeded, i.e., the liability and expenses of a claim ran over the commercial policy's upper limit.

How Alta's Taylor came up with the pricing for HT&A's policies is murky. Basically, Alta gave HT&A a written questionnaire about risks and existing policies, and HT&A returned the questionnaire with the answers and various documents. From that, Taylor selected information and created an underwriting report which was then given back to HT&A. As the U.S. Tax Court was later to comment:

However, the underwriting report does not detail Mr. Taylor's rating model, calculations, or any other detailed analysis describing how he arrived at the premiums. The report provided only general information about projected losses, previous claims, and information about HT & A's other insurance. There is nothing in the underwriting report that suggests that Mr. Taylor used comparable premium information to price the premiums.

To assist with both the pricing and Syzygy's insurance license application, Ross (who it will be remember is the actuary from Taylor-Walker) prepared a feasibility study, but that feasibility study seemed to mostly focus on Syzygy's ability to avoid insolvency and it did not determine that the premiums to be charged were actuarially reasonable. Further, Ross used only the information that Alta provided to him and apparently did not seek any independent data.

Within the insurance industry, there is a term known as rate-on-line which is calculated by taking an insurance policy's premium amount and dividing that by the occurrence limit of the policy. The average rate-on-line charged to HT&A for its commercial policies was 1.14%, while the average rate-on-line charged to HT&A through the captive arrangement was around 6.1% ⸺ well more than five times higher.

When Syzygy submitted its insurance company license application to Delaware, that state's Director for Captive Insurance, William White, focused on whether the premiums to be charged were adequate enough for Syzygy to remain solvent, but was unconcerned with whether the premiums were too high.

The premiums were, presumably, based on Taylor's estimate of how many of HT&A's claims that Syzygy could expect to pay. The feasibility study projected that from 2008 to 2012, the captive arrangement could expect overall losses and loss expenses of 56% of the premiums paid in, with 29% of those losses coming in Layer 2 ($250,000 to $1 millon). Keep 56% and 29% in mind as you consider that the actual loss ratio against premiums for those years actually turned out to be 1.5% overall and 3% in Layer 2.

Obviously, with the benefit of hindsight, Taylor had missed badly in his underwriting projections. But the terrible disparity in these percentages was not all Taylor's fault. To the contrary, HT&A did have quite a few claims during the relevant years and in fact paid deductibles on their commercial policies for so many claims that they were "too numerous to list" but then never made claims to Syzygy for those deductibles even though they were covered by a Syzygy policy. Under one claim on one policy alone, the captive arrangement was potentially liable for a $56,012.58 deductible that was never made, and there were an additional $43,456.08 in deductibles for which HT&A could have made claims. These numbers would have made Taylor's underwriting look a lot better in retrospect.

So why didn't HT&A make a claim against its captive arrangement? Gosh, you spend all this time and money in analyzing and forming a captive for the very purpose of paying claims, and then you don't make a claim? The ostensible reasons were given in testimony by John Jacobs:

John W. Jacob spent significant time working on HT & A's insurance matters during the years in issue. He testified that he did not file captive program claims because of time management issues and that they did not hit his "radar screen". John W. Jacob acknowledged that HT & A did not have a claims management system in place for their captive program but had "different processes" in place depending on the claim for their commercial policies.

For now, we'll set aside what I will call the "I was too busy to deal with it" defense (which was Jacob's defense and probably not at all as Alta had envisioned the captive arrangement would work) and revisit that later. Let's go on to something juicier, which was how Syzygy's assets were invested.

From its humble beginnings in 2008 with an irrevocable letter of credit providing its initial $250,000 capitalization, by 2011 Syzygy could boast cash and equivalents in excess of $1.5 million ⸺ it's sure easy to build a captive when you ain't payin' claims ⸺ and two life insurance policies worth $603,184.

The story of the life insurance policies provide an interesting subplot in this drama, or tragedy if you prefer. While Syzygy listed the life insurance policies on its financial statements, Syzygy didn't actually own those policies. Nor was Syzygy even a beneficiary of those life insurance policies even though it paid for them. And they were big life insurance policies: One insured John Jacob's life for over $8 million and the other insured Michael VanLenten's life for over $7.3 million.

In fact, although Syzygy's financial statements listed the life insurance policies, they were actually owned by the irrevocable trusts for the Jacobs and VanLentens respectively, and those trusts were the beneficiaries of the policies. The only thing that Syzygy really had were rights under a split-dollar arrangement whereby when Jacob and Michael went on to their rewards Syzygy was entitled to either the $600,000 that it had paid for the policies (., it simply got its money back) or the policy's cash value at death, whichever was greater.

Otherwise, Syzygy wasn't entitled to a penny while Jacob and Michael were still alive and kicking ⸺ Syzygy couldn't access the cash value of the policies or even borrow against them ⸺ unless the policies were cancelled and then Syzygy would just get back whatever moneys were left in the policies by that time. Suffice it here to say that it was a strange investment for an insurance company that might at any time have needed the entirety of its assets to pay claims had some especially severe losses come to pass. We'll come to this later as well.

In 2011, Alta advised Syzygy that its premium levels were untenable and needed to be decreased by more than $200,000 to more closely reflect HT&A's claims, which will be recalled were zero because John Jacob didn't have the time to bother with making claims.从而:

John W. Jacob sent an email to Alta explaining that Syzygy was changing managers because, among other things, he was displeased with the decrease in premiums.

At trial John W. Jacob testified the he was disappointed in the premium decrease because there were fixed costs associated with a captive manager and it makes the most sense to have as much coverage as possible with the captive manager.

Uh, yeah. "Progressive, I'm leaving you because your premiums are just too darned low, and I can get higher premiums with State Farm," said nobody ever.

As I repeatedly predicted long before it happened, suffering the Arthur Schopenhauer stages of ridicule and violent opposition before getting to the "anybody could see it was coming" stage where we are today, the IRS eventually took a keen interest in risk-pooled 831(b) captive insurance companies, and that keen interest eventually landed on HT&A's deductions for its premiums paid to U.S. Risk and Newport Re and sooner or later circled into Syzygy.

Ultimately, the IRS determined that the captive arrangement was invalid for lack of economic substance, the payments made by HT&A for premiums were not payments for insurance, the payments to the captive were not ordinary and necessary business expenses, Syzygy did not engage in insurance transactions and was not an insurance company for tax purposes, and thus Syzygy's 831(b) election was invalid and the premiums that Syzygy received were taxable income. Thus, based on all that, the IRS disallowed HT&A's deductions and imposed accuracy-related penalties.

Everybody on the HT&A side (all of whom I will collectively refer to as "petitioners" because that is what the Court calls them and it will be easier to understand when I get to quoting Judge Ruwe) appealed the IRS's determinations and assessments to the U.S. Tax Court, and a trial was held before Judge Ruwe of that court who gave the Opinion that I shall next relate.

But first, a little bit of good old foot-shooting by petitioners. On April 6, 2017, the Court issued a pretrial order that required all motions to shift the burden of proof to be filed by September 27, 2017. For whatever reason, petitioners didn't get around to filing their motion to shift the burden to the IRS until they were at trial on December 13, 2017, nearly four months late. Maybe like John Jacob in filing claims, they were just too busy to get around to it, but at any rate the court denied that motion because it violated the pretrial order.

Citing to the first 831(b) disaster, Avrahami v. Commissioner, Judge Ruwe observed that the courts have usually looked to four non-exclusive criteria in deciding whether a particular captive arrangement rises to the level of insurance for tax purposes:

  1. Whether insurable risk is involved;
  2. Whether the risk of loss has actually shifted to the captive;
  3. Whether the captive distributes its risk among its policyholders;和
  4. Whether the arrangement amounts to insurance in the commonly-accepted sense.

Judge Ruwe skipped over the first two criteria (insurable risk and risk-shifting) and instead started with the issue of risk-distribution. Here, the Court adopted basically the same methodology as the Avrahami court for determining whether risk had been adequately distributed.

First, the Court looked at whether the flow of funds was circular in nature, and noted that HT&A basically paid money into either U.S. Risk or Newport Re, and then the vast bulk of the money (less fronting fees and one minor claim in one year for Layer 2), that being 96% it will be recalled, made its way into Syzygy. Judge Ruwe determined that, just as in Avrahami, although the loop was not complete, it certainly appeared to be a circular flow of funds.

Second, the Court looked at whether the insurance polices were in the nature of arm's length contracts. Judge Ruwe initially commented on the disparity in the average rate-on-line for HT&A's commercial policies, which was 1.14% against those of the captive arrangement which were about 6.1% and noted that the captive policies were priced more than five times higher than commercial policies. For Judge Ruwe, this created a suspicion that the captive premiums were being artificially inflated so as to increase HT&A's tax deductions.

This suspicion was bolstered by the fact that various terms in the captive policies, such as that some of them covered only excess policies, should normally have meant that the captive policies should actually have cost less than the commercial policies. Further, and as a matter of insurance practice what follows is a more dubious point, the limit of only seven days to file a claim after the expiration of the policy seemed more disadvantageous to the policyholder than commercial policies which typically provide for a 30 to 60 day period. (Actually, one does occasionally run across commercial policies with only a seven days' claims period after the end of the policy but it is unclear whether the petitioners presented any evidence on that point.)

The most telling point, however, was neither of these facts but rather that John Jacob fired Alta as Syzygy's captive manager because — as he stated in his e-mail — he was displeased that Alta had told him that the premiums charged needed to be decreased by over $200,000 annually. Since no policyholder in anything like a true arm's length transaction would ever want their premiums to be higher ("Dear AIG, you are not charging me nearly enough, so you're fired!", said nobody ever), these facts weighed heavily towards HT&A trying to inflate their premiums to increase their tax deductions and, although Judge Ruwe didn't say it in so many words, made the entire arrangement look much more like a tax shelter than anything like a real captive struture.

Third, the Court looked at whether the premium prices had been actuarially determined, , whether some sound actuarial method had been employed to determine what the premium for each policy should be. Although both actuary Ross and the Delaware actuaries looked at the premium amounts, they were not doing so for pricing purposes but were trying to determine if they were adequate to keep Syzygy from becoming insolvent. So their review didn't help.

That left Alta's Greg Taylor as essentially the sole arbiter of how the premiums should be price, but Taylor was not an actuary and one gets the idea from reading the opinion that Taylor was developing his pricing models through some combination of using both a OUIJA board and a dartboard while blindfolded, which is to say that if one argued that Taylor was simply plucking numbers from the sky there would be almost no facts in rebuttal. Judge Ruwe put particular emphasis on Taylor's email where he admitted using a "will [sic] ass guess" to come up with premiums.

But I'm going to digress here for a second and point out that the HT&A folks for whatever reason didn't call any of the Alta folks as witnesses at trial to attempt to explain any of this, and one gets the impression that the HT&A folks didn't even bother to confer much with the Alta folks about how to defend the case. One can analogize this to a test pilot who takes off in a new aircraft without bothering to ask the aircraft engineers how it was supposed to fly and what to do in certain critical circumstances.

If that is what happened, then who knows what Taylor might have testified to on the issue of pricing ⸺ whatever Taylor would have said would probably have been more favorable to the petitioners than just leaving his "will [sic] ass guess" e-mail out there hanging with no rebuttal testimony about how he did arrive at pricing. Seems like a highly questionable litigation strategy, but whether it would have made any difference in the end is at best speculation.

A more technical problem was that Alta apparently ignored actuary Ross's suggestion that the premium split between Layer 1 and Layer 2 wasn't actuarially correct and that more of the premiums should have been allocated to Layer 1. Here again, we don't see testimony from anybody from Alta explaining why this didn't happen, but instead (and worse, much worse) John Jacob took the stand to testify that the 49% and 51% allocation was done with an eye towards the tax ramifications, or in his words, "to take advantage of a tax-related safe harbor". This is not exactly the testimony that a taxpayer wants to see in a case where the goal is to convince the U.S. Tax Court that things were done for insurance reasons and not tax reasons. Foot-Shoot-Reload.

At any rate, based on all these facts, Judge Ruwe concluded that the premium pricing had not been actuarially developed. Because, as set forth above, Judge Ruwe had also concluded that the flow of funds was circular and the premiums were not developed at arm's length, it was thus a foregone conclusion that the Court found that no risk-distribution was present.

The last of the Avrahami criteria to be considered by the Court was whether insurance in the commonly accepted sense, that being a term-of-art in insurance tax cases, was present. Judge Ruwe noted that because he had found an absence of risk-distribution, the petitioners had already lost the case, but he would consider the issue anyway as an alternative ground for his decision.

To determine whether insurance in the commonly accepted sense was present, the Court noted that there are five factors to be explored: (1) how the captive was organized and operated, (2) whether the captive was adequately capitalized, (3) whether policies were valid and binding, (4) whether the premiums were reasonable, and (5) whether claims were paid.

On the first factor, the IRS argued that Syzygy violated various of the Delaware insurance regulations, but Judge Ruwe did not consider that to be particularly relevant under the facts of this specific case. What was relevant was how Syzygy was actually operated, and it wasn't pretty.

The biggest problem that Judge Ruwe found was in how claims were handled insofar as HT&A had numerous claims exceeding $100,000 in the aggregate that it could have submitted to U.S. Risk and Newport Re, but it didn't bother to do so. What totally killed this point was that:

Additionally John W. Jacob testified that HT & A had no claims process for the captive program claims but did have "different processes" for their other claims. The deductible reimbursement policy was one of HT & A's most expensive insurance policies, and HT & A's failure to submit claims after paying deductibles is indicative of the arrangement's not constituting insurance in the commonly accepted sense. Our concern is bolstered by HT & A's statement on the underwriting questionnaire that before 2009 their incurred deductibles were "too numerous to list." Petitioners' contention that John W. Jacob was too busy to submit claims does not lead us to believe the arrangement was insurance in the commonly accepted sense because HT & A had claims processes for commercial policies that they did not implement for the captive program policies.

Moreover, for the one claim that was presented to Syzygy, the captive simply paid the claim without making any investigation as to whether the claim was valid. Think about that for a second: You simply tell your insurance company that you had a claim, and the insurance company pays it without the slightest investigation or verification of the claim. Happens in the real insurance world all the time, not.

Judge Ruwe also found Syzygy's investment choices to be, in his word, "troubling". What Judge Ruwe was specifically talking about were the two life insurance policies which Syzygy had purchased but which it didn't own, and couldn't even borrow against. Thus, Judge Ruwe commented:

We do not think that an insurance company in the commonly accepted sense would invest more than 50% of its assets in an investment that it could not access to pay claims.

The petitioners tried to claim that Steve Kinion, the Delaware Director of Captive Insurance, "had no issues with the life insurance policies." But Kinion's own testimony on the subject was not as friendly, and it was not clear to Judge Ruwe that Kinion even contemporaneously knew of the existence of the policies. Moreover, Kinion testified that whenever Delaware found insurance policies where the cash value could not be accessed by the captive, his department would contact the captive and seek to change the arrangement.

In summarizing this point, Judge Ruwe stated:

>>>We find that the circumstances surrounding Syzygy's life insurance investments weigh heavily against Syzygy's being an insurance company in the commonly accepted sense.<<<

The Court then moved on whether the insurance policies involved in the HT&A captive arrangement were "valid and binding" policies. Here, Judge Ruwe was concerned about that the fact that the policies were never timely issued to HT&A, and in fact for the years 2009 and 2010 the policies were not even issued until the coverage period had completely expired.

To defend on this point, petitioners presented the expert testimony of Dr. Michael Angelina, who testified to the effect that late policy issuances are common in the insurance world, and that the insurance binders had the legal effect of binding coverage. But this only went so far according to Judge Ruwe:

Although petitioners' expert Dr. Michael Angelina testified that late issuances are common in the insurance industry, we conclude that the failure to timely issue even a single policy weighs against the arrangement being insurance in the commonly accepted sense.

But the late-issued policies were only one problem, and a more serious problem is that the policies were ambiguous as to exactly which HT&A entity was covered by the policy, and sometimes the binders even conflicted with the policies in identifying the insured. More sloppiness was found in a deductible reimbursement policy issued for the years 2009 and 2010 — but the policy for which the deductibles were being reimbursed only existed in 2010.

Maybe in isolation, each error was not by itself fatal, but in the aggregate they were quite telling according to Judge Ruwe:

Petitioners contend that regardless of the ambiguities and conflicting terms, the intent of the parties is controlling and the policies are therefore binding. The meaning of "valid and binding" for Federal tax purposes also looks at policy ambiguities and conflicting terms and how they fit in with the spirit of a transaction. Obviously, ambiguous and conflicting terms do not prevent every policy from being insurance for tax purposes but related-party transactions are given heightened scrutiny. [Citation omitted.] Viewing the policies' late issuances, ambiguities, and conflicting terms in the context of a related-party transaction leads us to conclude that the valid and binding policies factor weighs against petitioners.

The next item to be considered was the reasonableness of premiums, but the Court merely noted here that it had already held that the premiums were unreasonable and thus moved on to the payment of claims, or rather the payment single claim that was paid in Layer 2 (the $250,000 to $1 million layer) in one year only. Here, Judge Ruwe noted little more than that the claim had indeed been paid although "there are problems with the way that it was handled" and that the payment of this claim meant that petitioners got a brownie point on that issue. But it was not nearly enough in the big scheme of things, as Judge Ruwe concluded that:

Although Syzygy was organized and regulated as an insurance company, met Delaware's minimum capitalization requirements, and paid a claim, these insurance-like traits do not overcome the arrangement's other failings. Syzygy was not operated like an insurance company. The fronting carriers charged unreasonable premiums and late-issued policies with conflicting and ambiguous terms. * * * The arrangement among HT & A, Syzygy, and the fronting carriers lacked risk distribution and was not insurance in the commonly accepted sense. Thus, the arrangement is not insurance for Federal income tax purposes and we need not address the Commissioner's economic substance arguments.

The result of the Court's ruling was painful. As to Syzygy, since it was determined not to be an insurance company for tax purposes, the 831(b) election that it had made was deemed to be invalid and the premiums that it received were to be taxed to the company as ordinary income instead.

As to the HT&A companies and their owners, i.e., the Jacobs and VanLentens, they were not allowed to deduct the premium payments they made to U.S. Risk and Newport Re. Here, the petitioners made a desperate last gasp at keeping their deductions by saying that at the very least they were used to indemnify the HT&A companies for losses. But Judge Ruwe wasn't buying that:

In the context of captive insurance there may be instances where noninsurance payments for indemnification protection might be appropriate and helpful to the development of the insured. But, at the bare minimum, for such payments to be considered appropriate and helpful, the indemnified party must intend to seek indemnification if a covered event occurs. Otherwise, there is no valid purpose for making such payments. In these cases HT & A's failure to file claims that they thought were covered under the deductible reimbursement policies leads us to find that there was no intent to seek indemnification for covered losses. Accordingly, the payments are not deductible as ordinary and necessary expenses.

Thus it was that John Jacob's failure to make claims, because he was just too darned busy with other stuff, came back to take a second bite against petitioners. In a similar vein, the Court also denied an attempt to treat the payments made to Syzygy as something other than income, such as a loan or capital contribution. This was rejected as well:

While the revenue rulings suggest the possibility that an arrangement that purports to be an insurance contract may instead be characterized as a deposit arrangement, a loan, a contribution to capital, or otherwise, there is no evidence that any such recharacterization is appropriate.

This is a bad result in a captive case: Not only does the taxpayer lose the deduction for the company paying into the captive arrangement, but the taxpayer also has to pick up the income for what was paid to the captive, ., double taxation ⸺ and maybe even 三倍 taxation when one considers that the moneys coming out of Syzygy will again be taxed since it is taxed as a corporation and not as a passthrough.

But it could have been even worse as Judge Ruwe turned to whether the 20% accuracy-related penalty should be assessed. But here the savior was that John Jacob had relied upon the advice of DiNatale, the CPA, to go forward with the captive arrangement, and which the Court found to be good faith reliance such that the 20% penalty would not apply.

ANALYSIS

Syzygy opinion is the third in an increasingly long line of disasters for risk-pooled 831(b) captives, joining its predecessors AvrahamiReserve Mechanical in tax law infamy. Of the three opinions, however, Syzygy is the strangest opinion because Judge Ruwe enters his results based largely on the serious mistakes of the players involved, but never gets to the issue of whether the Alta Layer 1/Layer 2 quota-share design was either viable or flawed.

Certainly, there is the eyebrow-raising fact that Layer 2 only had one small-dollar claim made in three years against 850+ outstanding policies, but at best that would just be one piece of a puzzle that in the end could be no more than speculation. Which means that we will have to wait for another case to see if this sort of design can pass muster ⸺ I'm not holding my breath that it will, but that's just my own speculation.

The really weird thing is that HT&A may not have needed to go into this type of captive arrangement at all, but seemed to have close enough to enough subsidiaries and risk units that HT&A could simply have formed its own captive and internally distributed risk under the so-called multiple-entity safe harbor of Rev.Ruling 2002-90. If HT&A did not have sufficient subsidiaries to fall into that safe harbor, then some basic business planning could very likely have gotten them over the line. This would have saved Syzygy from any risk pooling at all, meaning that HT&A could have avoided entirely the U.S. Risk and Newport Re quota-share deals and their attendant costs and liabilities.

It is always a curiosity to me when I see a captive in a risk pool when it didn't need to be there in first place, and I've yet to hear anything even modestly approaching a viable explanation for why risk-distribution through a risk-pool is somehow better for the captive arrangement than satisfying the tests as the captives of corporate America do, which is through multiple entity risk-distribution. With a risk pool, one is taking on the double risks of liability by big claims from parties unknown and the risk that if the risk pool blows up from a tax perspective as to any participant in the risk pool then it likely fails for tax purposes as to all participants. That practice is just bizarre to me, but I see it all the time in reviewing captives.

Another problem here is the arguably serious litigation error of not calling Greg Taylor as a witness to explain how he came up with his pricing models, since presumably anything he said would likely have been better than simply leaving his "will [sic] ass guess" e-mail hanging. The impression thus lingers throughout the Opinion that Taylor was simply making up numbers as he went, which would make the case consistent with the pricing models in AvrahamiReserve Mechanical。 Whether that is right or wrong, we don't know — but those were the facts that Judge Ruwe had to deal with.

Which is to say that if you are going to try to defend one of these cases, you'd better have a thick pricing model in hand which shows how the premiums were calculated down to the last penny, and not just give the Tax Court a chart with a bunch of round numbers with little or no explanation as to how they were individually arrived at. Such were the facts of this case, and the outcome was quite predictable on this point.

Certainly, there was sloppiness to be found in Alta's management of the captive arrangement, such as relying on binders and not get the policies out in one case until after the policy year had passed. But this isn't an indictment of Alta so much as it is of the entire 831(b) risk-pooled captive sector in which it is endemic that captive managers often take far too long in issuing policies ⸺ it is the rare 831(b) risk-pooled captive that I review where the policies went out on time. Probably to nobody's surprise, this occurs much more where the folks running the captive management company are either tax or financial folks who don't understand the importance of timely policy issuance, and not experienced property/casualty personnel who do.

The problems with Alta issuing policies with conflicting terms and insureds, and issuing a deductibles policy for an underlying policy which didn't even exist in one year, are harder to overlook. Suffice it to say that nobody is perfect and mistakes are simply human, but chronic sloppiness at some point can have serious cumulative effects. But here it should be noted that Alta was effectively tried and convicted of sloppiness in abstentia, since the petitioners for whatever reason didn't call any of the Alta folks as witnesses, and we can do little more than guess at what their testimony might have been or whether it would have helped or hurt.

Yet, Alta's sloppiness pales in comparison to the error of John Jacob who administers his first fatal blow to his own captive arrangement by not bothering to make claims. If John Jacob had submitted the $100,000+ in claims, then the entire complexion of this case changes dramatically: The premiums don't look so random or unreasonable, the problems with the late-issued and sometimes conflicting policies don't appear so severe, and ⸺ by far most importantly ⸺ the entire arrangement doesn't smell so much like a tax shelter where the goal was to maximize deductions and minimize everything else.

Whether making the claims would have been the difference is, of course, just more speculation. But there is no doubt that it would then have been a much closer case, akin to the difference between sliding into third base on a close call, and face-planting in front of the shortstop and being tagged out between bases as what happened.

But this is another thing that is endemic to the 831(b) risk-pooled captive sector: Nearly all these cases have few or no claims being made. That was what happened in both AvrahamiReserve Mechanical, and before I even read a single word of this opinion I had the strong suspicion that similar circumstances would be found here as well. Where there are few or no claims, good luck in defending the arrangement in all but the rarest cases involving so-called low-frequency/high-severity risks such as earthquake or flood cover, etc., where the policy may literally go for decades without covering a single claim, and then suddenly and unexpectedly there are enormous claims which stress the insurance company to the very limits of its solvency.

The second and much more fatal blow that John Jacob made to his own captive arrangement was his admission that he terminated Alta because they wanted to decrease his premiums by $200,000+ per year, presumably to reflect that the actual claims made by the HT&A companies wasn't coming close to those which had been predicted. This is about as close as one will ever find in a tax court case to an admission that the captive arrangement was not being used as anything like a 善意 risk management tool, but was rather just a naked tax shelter to try to cheat Uncle Sam out of some bucks.

A reality check: No captive arrangement, no matter how brilliantly designed, no matter how meticulously operated, is going to survive that kind of testimony. Judge Ruwe latched onto it immediately, and it was sure death for the Syzygy arrangement.

Another factor that Judge Ruwe highlighted, which was a factor discussed at much greater depth by the courts in AvrahamiReserve Mechanical, was the utter lack of anything like an arm's length transaction between HT&A and the captive arrangement. Here, we see again the model where the captive manager comes up with policies and pricing and submits that to the common owner of the underlying operating business and the captive for approval. Very simply, that model does not work and will never work。 Either there are serious and meaningful negotiations between the underlying operating business and the captive, such that the business is trying to get the most coverage for the least amount of money, and the captive is trying to get the least coverage for the most amount of premiums, or you don't have an arm's length transaction for tax purposes.

Having the captive manager do it all and the common owner agree to it is simply a giant nothingburger, not even worth the paper that it is wasted on it, but again that seems to be the standard (bad) practice with 831(b) risk-pooled captives. This is a classic example of the captive management herd not being right and collectively running over the cliff together.

Speaking of bad practices, we now come to the idea of having life insurance inside a captive insurance company. The goal, of course, is to finally accomplish that Valhalla of life insurance planning that Congress does not ordinarily permit, which is to purchase life insurance with pre-tax dollars. The idea, which first arose in 2002 (I was around when it was first discussed), was that the business could take a deduction for making insurance payments to the captive, the captive would receive the payments without paying any income tax on them, and then the captive could use the money to purchase life insurance with what amounts to pre-tax dollars.

Starting around 2005, it got to be a popular deal to use 831(b) captives to purchase life insurance, driven in no small part by the large commissions being paid to the life insurance agents who helped to arrange the deal, and who typically got commissions somewhere around 40% of the first-year's premiums for universal life, and 80% of the first-year's premiums for whole life (if you want to known why life insurance agents are always trying to jam their clients into whole life, it is because their commissions are about double that for universal life, the latter almost always being better for the purchaser because the payments are much more flexible). To borrow the numbers from this case just as an example, if the policies were whole life policies, then the selling agent would get around 80% of the first-year premium of $300,000 — meaning a $240,000 commission. That's a nice hit for a few hours of work.

The problem was then, and still is now, is that for the very reasons that Judge Ruwe identifies, putting life insurance inside a captive doesn't make much sense because it is an inherently illiquid investment during the surrender period and thus the value of the policy is not available to pay claims. But it is even worse than that.

The tax problem of having the captive purchase life insurance is that the captive would be the owner of the life insurance policy, which on death would mean huge profits to the captive that would be taxed at the corporate income tax rate. Thus, as the Jacobs and VanLentens did here, the only way that doing such an arrangement makes any sense from a tax perspective is to do some sort of split-dollar arrangement (using "preferred LLC shares" was another method) such that the captive only got back what it paid for the life insurance in the first place.

But in doing so, from the perspective of the captive, the arrangement goes from not making any sense to then not even making any respectable nonsense. The effect is that the captive is investing in an asset that is completely tied up and unavailable until somebody dies, but in the end that captive doesn't show any profit for that risk. It is utterly absurd from the perspective of the captive, and Judge Ruwe took the time to carefully point that out.

As an aside, I have for years warned against using captives to purchase life insurance and have written numerous articles and given numerous lectures on the topic. These warnings also went through Schopenhauer's stages of ridicule, violent opposition and finally acceptance. For instance, New York attorney Celia Clark in 2009 published an article in rebuttal to one of mine where she proclaimed life insurance to be a suitable investment for captive insurance companies; she later went on to be the primary architect of the Avrahami fiasco and closed up her captive shop entirely just a few days thereafter. A decade later, the results, as Maury Povich might say, are in: She was wrong.

But Celia Clark wasn't the only one pushing life insurance for captives, and literally dozens if not hundreds of life insurance agents and financial planners jumped into that game. Eventually around 2012, the life insurance companies themselves started to fear liability and many quit selling life insurance to captives altogether. Yet, there are probably not just a few of the cases currently docketed before the U.S. Tax Court that have life insurance as investments, and there is a good chance that these captive are all already DOA and are simply waiting to be told so.

The bottom line is that the Jacobs and VanLentens tried to misuse their captive to purchase life insurance with pre-tax dollars, but instead ended up buying the life insurance with -taxed dollars, and perhaps even 三倍-taxed dollars. That's quite a feat, congratulations.

When we get to the issue of penalties, we see that the Jacobs and VanLenten's barely escaped the 20% accuracy-related penalty only by the hair of their chinny chin chin because the CPA, DiNatale, had been involved in the discussions leading up to the captive and had blessed it from a tax standpoint before it was formed. Yet, this may be the place where Judge Ruwe errs in his opinion.

A captive arrangement can blow up in one of two ways or both, being either in the design and creation, or in its operation. Because Judge Ruwe never got to the issue of whether the Alta Layer 1/Layer 2 quota-share design was valid or defective, and because Syzygy was otherwise correctly formed and capitalized, this is the latter case where the captive arrangement failed in its operation since it was not actually run as an insurance company. But note that, at least from the facts recited by Judge Ruwe, DiNatale only gave advice on the design and formation of the captive, not how it was being operated. There is nothing in the facts stated in this opinion (which does not mean that such facts do not exist) which indicates that DiNatale gave any ongoing blessing during the years when the captive was not run as an insurance company.

Thus, if this ruling is appealed, it might be the IRS could make a good argument that the 20% accuracy-related penalties should have been imposed, because the Jacobs and VanLentens did not have anything upon which they could rely for each year as they filed their tax returns. But on this point, we'll have to see if the case is even appealed.

I'll conclude this article with the observation that we've now had three utterly disastrous cases for risk-pooled 831(b) captives: AvrahamiReserve Mechanical,和 Syzygy。 In each case, the tax law has grown increasingly worse for such captives. Indeed, the opinion by Judge Ruwe here is shorter and less detailed than those of the first two cases, which indicates that the U.S. Tax Court has largely decided that such captives are not normally going to past muster, and so is starting to give these challenges to IRS determinations increasingly short shrift. Anybody who thinks that the U.S. Tax Court is going to reverse direction anytime soon, short of a successful appeal by a taxpayer to a U.S. Court of Appeals somewhere, is simply deluding themselves.

We are now moving in a new phase for 831(b) risk-pooled captive: Denouement。 In this phrase, it can be expected that the U.S. Tax Court will routinely deny the deductions paid to such a captive and the only real fight will be on penalties. This will also be a phrase characterized by negligence suits and class actions (as I have previously written, there is already one class action going on and I've credibly heard that others are in the works). The epilogues for the captive managers and other professionals involved are increasingly likely to be played out in the U.S. Bankruptcy Court as it did with the 412(i) Plan and 419A(f)(6) promoters. It's not a pretty picture.

But it is a picture ⸺ and this is critically important to understand ⸺ that so far is strictly limited to risk-pooled 831(b) captives and has a very good chance of staying that way. Of the 600+ captive insurance cases that are rumored to be currently pending before the U.S Tax Court, all but a small handful are cases involving risk-pooled 831(b) captives. These tax court opinions will have relatively little impact if at all on the large corporate captives, and non-risk-pooled 831(b) captives (although the anticipated Caylor Land decision may be the outlier there, as it was a non-risk-pooled 831(b) captive but seemed to have no shortage of really bad facts). In other words, captive insurance arrangements can be quite safe from a tax standpoint, and very beneficial as a risk management and insurance cost-savings structure, so long as one avoids risk-pooled 831(b) captives and gets into the arrangement for the correct non-tax reasons.

I've only been giving that advice for over a decade now.

CITE AS

Syzygy Ins. Co. v. CIR, T.C. Memo. 2019-34 (April 10, 2019). Full opinion at https://captiveinsurancecompanies.com/2019-syzygy-captive-insurance.php

RELATED ARTICLES