On November 1, 2016, the IRS issued Notice 2016-66 (Notice), designating a new “transaction of interest” (TOI) relating to certain captive insurance companies that make elections under Section 831(b) to be taxed only on taxable investment income (micro-captives). This designation expands the number of TOIs that must be disclosed by taxpayers under Treas. Reg. Section 1.6011-4 and by material advisors under Treas. Reg. Section 301.6111-3.
Section 1 describes the types of transactions involving micro-captives that the IRS believes to be abusive. The Notice acknowledges that not all micro-captives involve tax avoidance, but the IRS has identified specific transactions that it believes have a potential for tax avoidance or evasion.
Section 2 of the notice expressly states that a transaction described in Section 2 is identified as a TOI “regardless of whether the transaction has the characteristics described in Section 1.”
Any transaction that is the same as, or substantially similar to the following criteria, which closely tracks the Notice, is a TOI:
The Computation Period is the most recent five tax years of the Captive or the period of the Captive’s existence if it has been in existence for less than five tax years. If the Captive has been in existence for less than five tax years and is a successor to one or more Captives created or availed of in connection with a transaction described in the Notice, tax years of the predecessor entities are treated as tax years of the Captive. For purposes of defining the Computation Period, a short tax year is treated as a tax year.
An arrangement under which a Captive provides insurance for employee compensation or benefits and for which the Employee Benefits Security Administration of the US Department of Labor has issued a Prohibited Transaction Exemption is not treated as an arrangement identified as a TOI under Notice 2016-66.
Participants: A taxpayer “participating” in a micro-captive TOI on or after November 2, 2006,must disclose the transaction as described in Treas. Reg. Section 1.6011-4. Each of the taxpayer parties described in Section 2 of the Notice as A, Insured, Captive or the intermediary fronting insurance company participates in the micro-captive TOI if the taxpayer’s return reflects a tax consequence or a tax strategy of the transaction. A taxpayer who fails to properly disclose the transaction under Treas. Reg. Section 1.6011-4 may be subject to the Section 6707A penalty of 75% of the reported tax benefits, with a maximum of $50,000 for entities/$10,000 for individuals and a minimum of $10,000 for entities/$5,000 for individuals. In addition, the IRS may impose other penalties on participants in these transactions, including the accuracy-related penalty under Section 6662 or Section 6662A.
The Notice requires each participant to disclose information as to when and how the taxpayer became aware of the transaction. Captive must provide additional information in its disclosure, including the authority under which Captive is chartered, types of coverage provided, how premiums were determined (including the name and contact number of any actuary or underwriter who assisted in the determinations of such premiums), a description of claims and a description of assets.
Past-year(s) participation: A taxpayer who has participated in a micro-captive TOI on or after November 2, 2006, and during a year for which the tax return has already been filed but for which the statute of limitation for assessment remains open as of November 1, 2016, must disclose that participation by submitting a properly completed Form 8886, Reportable Transaction Disclosure Statement, to the IRS Office of Tax Shelter Analysis (OTSA) (address in Form 8886 instructions) by January 30, 2017. See Treas. Reg. Section 1.6011-4(e)(2).
If a taxpayer participates in micro-captive TOI in a year for which the return has not yet been filed but is due prior to January 30, 2017, the disclosure statement will be considered timely if filed with the OTSA by January 30, 2017.
Current-year participation: A taxpayer who is currently participating in this TOI must disclose the transaction by attaching a properly completed Form 8886, Reportable Transaction Disclosure Statement, to its federal income tax returns for the current tax year and each future tax year in which the taxpayer participates. A copy of the Form 8886 must be sent to OTSA at the same time that the transaction is disclosed for the first time.
Material advisors: A material advisor who has made or makes a tax statement on or after November 2, 2006, with respect to a micro-captive TOI entered on or after November 2, 2006, has both disclosure and list maintenance obligations under Section 6111and Section 6112. See Treas. Reg. Section 1.6011-4(h) and Section 301.6111-3(i) and Section 301.6112-1(g). Persons required to disclose these transactions under Section 6111 who fail do so may be subject to the penalty under Section 6707(a). Persons required to maintain lists of advisees under Section 6112 who fail to provide such lists when requested by the IRS, may be subject to the penalty under Section 6708(a).
Generally, a material advisor is any person who provides material aid, assistance or advice with respect to organizing, managing, promoting, selling, implementing, insuring or carrying out any reportable transaction and who, in the case of the micro-captive TOI, directly or indirectly derives gross income in excess of $25,000 (or $10,000, if substantially all the benefits of the transaction are provided to natural persons).