Tax alert: Avoid penalties. Report participation in micro-captive transaction by May 1
The IRS recently designated certain captive insurance arrangements, defined as ‘micro-captivetransactions, as a transaction of interest in Notice 2016-66. This designation means that the IRSbelieves that these transactions have the potential for abuse. All taxpayers participating in a microcaptivetransaction are required to provide this information by May 1, 2017, or could face penalties ofup to $50,000 per year. This includes the insurance company, the insured, and any other taxpayerwhose tax return reflects the tax consequences of a micro-captive transaction.
What is a micro-captive transaction?
A micro-captive transaction includes an arrangement where an organization enters into an insurancecontract with an insurance company that meets each of the following requirements:
- The organization, an owner of the organization, or a related party of either directly or indirectlyowns at least 20% of the insurance company.
As a result of the 20% related ownership test, a widely-held insurance company is lesslikely to be involved in a micro-captive transaction.
- The insurance company has made an 831(b) election only to be taxed on its investment income.
This election only applies to insurance companies that receive premiums of $1.2 million orless ($2.2 million for 2017 or later years).
- Over a five-year period ending with the tax year, either (1) the insurance losses and claimsadministration expenses incurred by the insurance company are less than 70% of the premiumsearned or (2) the insurance company has directly or indirectly entered into guarantees, loans or other transfers of capital with the insured, an owner of the organization, or any other related party.
Filing requirements & penalties
Any taxpayer that has participated in a micro-captive transaction must file Form 8886 to reportthat participation by May 1, 2017 (this due date was originally January 30, 2017, but wassubsequently extended to May 1 by Notice 2017-08.) This includes the insurance company, theorganization insured by the insurance company, and any other taxpayer whose tax returnreflects the tax consequences of a micro-captive transaction. Form 8886 is required to be filedfor each year in which a taxpayer participated in a micro-captive transaction to the extent thatthe statute of limitations was not closed for that tax year as of November 1, 2016.
These requirements may lead to multiple taxpayers having a Form 8886 filing requirement withrespect to the same micro-captive transaction. Each of those taxpayers may also have aseparate filing requirement for multiple years if the micro-captive transaction has metrequirements above with respect to more than one tax year. Reporting may still be requiredeven if a micro-captive transaction existed in a previous tax year but no longer exists today.
The failure to file Form 8886 by the deadline will result in a penalty equal to 75% of the taxbenefit generated by the micro-captive transaction, up to $50,000 ($10,000 in the case of anindividual taxpayer). The penalty for a failure to report applies even if the micro-captivetransaction is ultimately not considered to be abusive.
Many state and local jurisdictions have similar filing requirements and associated penalties.
The reporting deadline of May 1, 2017, is a very short deadline, and there are substantialpenalties for the failure to timely report. Therefore, it is recommended that all taxpayers thathave ever participated in a captive insurance arrangement review that arrangement todetermine if it meets the definition of a micro-captive transaction for any year open under theapplicable statute of limitations.
If you believe that you have participated in a micro-captive transaction or you would like to learn more about them, please contact your Plante Moran engagement team or read Notice 2016-66 and Notice 2017-08 for more information.
If you have any questions regarding this alert, please your Plante Moran client services representative.
The information provided in this alert is only a general summary and is being distributed with the understanding that Plante Moran, isnot rendering legal, tax, accounting, or other professional advice, position, or opinions on specific facts or matters and, accordingly, assumesno liability whatsoever in connection with its use.