In 2015, the IRS first included micro-captives, or small insurance companies which have elected under section 831(b) to exclude premiums from their income, on its annual dirty dozen list. At the end of 2015, Congress eliminated the use of micro-captives in estate planning but also expanded use of micro-captives by raising the threshold for tax exempt premiums for micro-captives from $1.2 million to $2.2 million, effective January 1, 2017.
For several years, the IRS has been examining hundreds of micro-captives as well as conducting promotor examinations of several captive managers. On November 2, 2016, the IRS took one more step in focusing on these transactions when it issued Notice 2016-66 which identified certain micro-captive transactions as transactions of interest. As a result, the IRS has added additional reporting and disclosure requirements for micro-captives which do not incur significant claims or which make loans to related entities, such as the insured. It appears the IRS is focused on finding taxpayers it has not already identified who have set up micro-captive structures.
Who Should Care?
- Micro-captives with insured losses and expenses which, over a five-year period, are less than 70% of the premiums earned (reduced by policyholder dividends)
- Micro-captives who loaned or transferred funds through some other means to the insured or any related parties
- Promoters who market micro-captive transactions
What Must I Do?
- Consult a tax advisor to determine whether you are required to file Form 8886, Reportable Transaction Disclosure Statement
- For promoters, determine whether you are in compliance with material advisor rules under section 6111 and 6112
When Must I Act?
- The deadline for filing Form 8886 if required for prior years is January 30, 2017
- Deadlines for filing Form 8886 for 2016 tax years will depend on annual income tax return deadlines
Why Should I Care?
- The minimum penalties for failure to file Form 8886 are $5,000 for individuals and $10,000 for entities per year
- Promoter penalties for failing to comply with the material advisor rules start at $50,000
The notice is available here: https://www.irs.gov/pub/irs-drop/n-16-66.pdf