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Captive owners sue advisers after IRS imposes penalties

Posted On: Jul. 9, 2019 3:01 PM CST

Microcaptive lawsuit

The owners of an 831(b) captive that the Internal Revenue Service ruled did not qualify for various tax benefits is suing the lawyer who allegedly advised them to establish the microcaptive.

Benyamin and Orna Avrahami, who own a jewelry firm and various other businesses in Phoenix, last week sued Celia Clark, a former partner and now of counsel at Clark & Gentry PLLC in New York, alleging that Ms. Clark and her firm knew that the “captive insurance strategies” she recommended “did not provide insurance recognized under the Internal Revenue Code,” court papers say.

The Avrahamis relied on Ms. Clark for advice on “complex insurance and tax matters, including tax law and captive insurance,” according to the suit, which was filed in U.S. District Court in Phoenix and seeks class action status.

But the St. Kitts-based captive, Feedback Insurance Co. Ltd., and the transactions it was involved in failed to pass muster with the IRS, and the agency assessed the Avrahamis more than $1.5 million in back taxes and penalties.

In August 2017, the U.S. Tax Court ruled that Feedback charged unrealistic premiums and did not meet risk distribution requirements for captives, among other things. The court found that the captive paid few claims and the surplus was paid back to the Avrahamis in various ways.

In the latest suit, the Avrahamis seek unspecified damages from Ms. Clark and other defendants, including a local Phoenix law firm allegedly involved in establishing the captive. The Avrahamis allege the firms charged them $75,000 to set up the captive and $2,000 a quarter thereafter.

The lawyers should have known that the IRS would disallow the captive and “the organizational scheme that was designed by the defendants primarily to allow them to charge and collect, in multiple ways, fees and expenses across the entire structure, without any real intent to fund the captive insurance companies for real risk management and in a structure that supported actual insurance and reinsurance purposes,” the suit states.

According to the suit, Ms. Clark and her firm have since stopped offering captive insurance services.

831(b) captives, which are taxed on their investment income and not their underwriting income, have often been used by small and midsize firms that are too small to establish conventional captives, but many observers say they have also been used by wealthy individuals and others to avoid tax.

While the Avrahami ruling in 2017 was the first and most closely watched of various cases involving 831(b) captives, the U.S. Tax Court has since ruled against 831(b) owners, including a case involving Syzygy Insurance Co. earlier this year.

In addition, 831(b) captive owners sued Arthur J. Gallagher & Co.’s captive management unit, Artex Risk Solutions Inc., alleging the unit promoted the use of 831(b) captives that resulted in captive owners illegally reducing their taxes.