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IRS again casts skeptical eye on microcaptive formations

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The Internal Revenue Service has previously indicated that it suspects 831(b) captives can be used for tax avoidance, but last November the agency signaled increased scrutiny of the vehicles with the issuance of Notice 2016-66 requiring years of information and data from owners.

In the 15-page notice, the IRS raised numerous questions about the structures and noted that 831(b) captives have “a potential for tax avoidance or evasion.” With a deadline extended to May 1, the IRS requires 831(b) owners and related parties to file a Form 8886, reportable transaction disclosure statement providing detailed information on the captives going back as far as 10 years.

The parameters of the tests on whether a captive owner should file the form are broad enough to include most 831(b) captive owners, experts say.

Among other things, the IRS requires the captive owners to provide details on: the jurisdiction where the captive is domiciled, the risks it insures, how the premiums were priced and contact information for the underwriter or actuary, descriptions of claims paid and information on how the captive’s assets are invested.

Once the IRS has reviewed the information, the notice says, it may do one of several things, including: remove 831(b) s from the transactions of interest category; designate them as a listed transaction, essentially labeling them tax avoidance schemes; or provide a new category of reportable transactions.

Meeting the requirements of the notice may be onerous, but it could have a beneficial outcome for owners if it provides clarity about 831(b)s to captive owners, said Charles J. Lavelle, senior partner at Bingham Greenebaum Doll L.L.P. in Louisville, Kentucky.

“In the notice, the IRS affirmatively says ‘this is a legitimate structure and we recognize tax payers can make this election,’ but they say that they don’t have enough information to decide which ones are abusive and which ones are not abusive,” he said.