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Captive-Related IRS Analysis: Everything but the Kitchen Sink

Kitchen Sink
August 26, 2015

By P. Bruce Wright, M. Kristan Rizzolo, and Graham R. Green
Sutherland Asbill & Brennan LLP

On August 14, 2015, the Internal Revenue Service (IRS) released Chief Counsel Advice (CCA) 201533011, in which the IRS determined that the excess loss insurance contracts at issue do not qualify as insurance for US federal income tax purposes. The CCA is the latest indication of the IRS's position on the ongoing issue of what is insurance and continues the IRS's reliance on the common sense insurance prong of the test for insurance to bolster its conclusions on the other prongs of the test.

The CCA addresses the tax treatment of excess loss insurance contracts issued by a captive insurance company to six brother-sister S corporations and one brother-sister C corporation. In a highly fact specific analysis, which included evidence of postissuance manipulation of the contracts by the parties, the IRS determined that the excess loss insurance contracts do not constitute insurance for tax purposes on the grounds that there was a lack of risk shifting and an absence of insurance in its commonly accepted sense. The CCA reflects the IRS's increasing penchant for citing a lack of insurance in its commonly accepted sense as a ground for disallowing insurance treatment of captive arrangements.

The ruling demonstrates that the IRS continues to scrutinize captive arrangements and, given the postissuance manipulation that is referred to in the facts of this case, such scrutiny may have been warranted here. However, the IRS's continued suggestion that the common sense prong of the insurance test is an "I know it when I see it test" is troubling for taxpayers and their advisers.

P. Bruce Wright and M. Kristan Rizzolo are partners in the tax department of Sutherland Asbill & Brennan LLP located in the New York and Washington, DC, offices, respectively. Graham R. Green is a Sutherland Asbill & Brennan LLP associate located in Washington, DC.

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