Analysis Of The IRS's Big Win Against Risk-Pooled Small Captives In Reserve Mechanical https://ift.tt/2KmgrCG I previously wrote about the decision of the U.S. Tax Court in Reserve Mechanical v. Comm'r in my article Capstone's PoolRe Fails To Provide Risk Distribution In Reserve Mechanical Captive Insurance Case. That article simply summarized the opinion of Judge Kerrigan; this article analyzes the issues in that case and the lessons to be learned therefrom. Judge Kerrigan ruled that Reserve Mechanical lost on two grounds. First, Reserve Mechanical was attempting to satisfy the tax law requirement of risk distribution by participating in a risk pool (PoolRe as operated by the captive manager Capstone Associated), but PoolRe was not itself an insurance company for tax purposes and therefore provided no (or de minimis) risk distribution for Reserve Mechanical. Second, Reserve Mechanical was operated in a way such that it was not engaged in the business of insurance "in the commonly accepted sense". Each of these grounds will be explored at length below, as well as the issue of Reserve Mechanical's 953(d) election being invalidated and the consequences as to tax liability. So, what did we learn from Reserve Mechanical? I'll get to that in a moment, but first I want to point out that an argument can be made that we didn't actually learn anything new from the Reserve Mechanical opinion, but rather that opinion simply confirmed what we knew from other captive cases, not the least being Avrahami, i.e., Reserve Mechanical was simply the Avrahami train wreck, redux. But in a way, that tells us something also, which is that Avrahami was not a one-off or an outlier, but indeed does state the law as viewed by the U.S. Tax Court. Readers should also note two very important words, being "arm's length", which permeate both the Avrahami and the Reserve Mechanical opinion, as well as other recent captive insurance opinions involving large corporate captives. In general, captives for large corporations win their cases because they are able to prove that the operating business/captive relationship was an arm's length transaction, but smallish 501(c)(15) and 831(b) lose their cases for the very reason that they cannot establish an arm's length transaction. So look carefully for the two words arm's length in the discussion that follows. THE RISK POOL A risk pool is essentially just an insurance company that is owned and/or controlled by the captive manager. To obtain risk distribution, captive managers will first have the operating business of the client purchase some number of policies from and pay premiums directly to their captive (a/k/a "direct write" insurance), and then second the operating business will purchase other policies from and pay premiums to the risk pool. These latter premiums then make their way to the captive by way of reinsurance contracts between the risk pool and the captive. The net effect is that all of the premiums for a give year end up in the captive. Business via Forbes - Entrepreneurs https://ift.tt/dTEDZf June 25, 2018 at 10:17AM
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