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Healthmark Case Changes Brother-Sister Captive Tax Treatment

Tax Court Decision
April 06, 2015

By P. Bruce Wright, M. Kristan Rizzolo, and Saren Goldner
Sutherland Asbill & Brennan LLP

The treatment of insurance transactions between brother-sister companies has been addressed in several contexts. In the seminal case, Humana Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989), the court indicated that insurance transactions between subsidiaries of Humana Inc. and a sister captive insurer involved risk shifting because the transactions moved the effects of any losses from the subsidiaries’ balance sheets to the captive’s balance sheet. In the case, there was a significant number of operating subsidiaries involved.

In 2002, the Internal Revenue Service (IRS) published Rev. Rul. 2002-90, 2002-2 C.B. 985, which served as a safe harbor in Humana situations. It dealt with a situation in which 12 subsidiaries, no one of which accounted for more than 14 percent nor less than 5 percent of the risk. The ruling followed the holding in the Humana case.

Three years later, in Rev. Rul. 2005-40, 2005-2 C.B. 4, the IRS ruled that brother-sister insurance arrangements involving insureds that were single-member limited liability companies (LLCs) failed to qualify as insurance for tax purposes because they lacked risk shifting. In reaching that conclusion, the IRS, in essence, looked through the single-member LLCs for purposes of determining the insured under the insurance arrangements. Thus, the parent, rather than the LLCs, was treated as the insured, and the Humana analysis was inapplicable. This ruling was important even after the Rent-A-Center v. Commissioner, 142 T.C. 1 (2014), and Securitas v. Commissioner, T.C. Memo. 2014-225, cases because both relied on the presence of subsidiaries that would be recognized for federal tax purposes.

In Healthmark Group Ltd., Gregory Lentz, a Partner Other than Tax Matters Partner, Docket No. 8269-14, the IRS had apparently disregarded eight subsidiaries formed as single-member LLCs in concluding that a deduction for premium paid to a sister captive was not deductible. On March 27, 2015, a decision was entered in Tax Court apparently stipulating an entry of judgment pursuant to which all such deductions were allowed. 

Thus, after 10 years, it may be that the IRS is moving away from its position in 2005-40, which on its face appears to be inconsistent with this recent stipulated decision.

Mr. Wright and Ms. Rizzolo are partners and Ms. Goldner is counsel in the tax department of Sutherland Asbill & Brennan LLP. Mr. Wright and Ms. Goldner are located in New York and Ms. Rizzolo in Washington, D.C.

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