The U.S. Tax Court today issued an opinion finding that amounts paid by the taxpayers to a captive insurance company in 2009 and 2010 were not insurance premiums for federal income tax purposes and were not deductible.
The case is: Avrahami v. Commissioner, 149 T.C. No. 7 (August 21, 2017). Read the 105-page opinion [PDF 370 KB]
The Tax Court summarized today’s opinion as follows: The taxpayers (husband and wife) owned three shopping centers and “three thriving jewelry stores” in Arizona. In 2006, the taxpayers spent a little more than $150,000 insuring them. In 2009, this insurance bill was more than $1.1 million and then in 2010, more than $1.3 million. The court’s opinion states that the taxpayers were paying the overwhelming share of these bills to a new insurance company that was wholly owned by the wife.
No claims were made on any of the insurance policies until the IRS began audits of the taxpayers’ returns and of the returns of their various entities. The insurance company had accumulated a surplus of more than $3.8 million by the end of 2010—$1.7 million of which ended up back in the taxpayers’ bank account as loans and loan repayments.
The taxpayers claimed deductions under section 162 on their 2009 and 2010 tax returns for amounts paid by their passthrough entities to the captive insurance company and to an off-shore company that reinsured a portion of its risk with the captive insurance company.
The IRS denied the deductions and determined that the insurance company’s elections under section 831(b) to be treated as a small insurance company and under section 953(d) to be taxed as a domestic corporation were invalid because the amounts paid did not qualify as insurance premiums for federal income tax purposes. The IRS also determined that amounts transferred out of the insurance company were distributions to the taxpayers—not loans—and that the taxpayers were liable for accuracy-related penalties under section 6662(a).
The Tax Court’s opinion, generally upholding the deficiency determination, concludes that:
© 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.