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Micro-captive Insurance Company Found to Be a Scam

By Tom Ochsenschlager, J.D. CPA

In May, the U.S. Court of Appeals for the Tenth Circuit agreed with the IRS argument that micro-captive insurance transactions lacked economic substance and accordingly, the premiums paid to that entity were not deductible.

A micro insurance company is roughly defined as an insurance company with $2.45 million or less of gross premiums that can elect to be taxed only on its investment income and can exclude from its income the insurance premiums it receives while the insured entity can deduct the premiums.

The Court decision in Reserve Mechanical Corporation v. Commissioner (No. 81-9011 10th Cir. May 13, 2022) determined that Reserve Mechanical had established what it claimed was an insurance company but that the facts did not support that it was an insurance company. Although the “insurance” company did insure some unrelated entities, those premiums were relatively minimal and virtually all the insured risk was related to Reserve Mechanical. Additionally, due to the common ownership of Reserve Mechanical and the insurance company, the premiums paid were not attributable to an “arm’s length” transaction – a rough definition of “captive insurance company.”

Accordingly, the Court decided that the premiums paid lacked economic substance and were not deductible and that a 20% penalty applied to Reserve Mechanical.

Abusive micro-captive insurance arrangements made the list of the IRS’ 2022 “Dirty Dozen” transactions because of their potential for tax evasion.

IRS wraps up 2022 "Dirty Dozen" scams list; agency urges taxpayers to watch out for tax avoidance strategies | Internal Revenue Service

Taxpayer Loses in Micro-captive Case - Baker Tilly


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