On March 10, 2021, Judge Holmes of the U.S. Tax Court released her opinion in the matter of Caylor Land & Development, Inc. v. Comm'r which involved a captive insurance company which had made an election under § 831(b) of the Internal Revenue Code. What makes this case particularly interesting is that the captive arrangement here did not base its attempt to satisfy risk distribution for tax purposes by participating in a risk pool ― as have all the other so-called "microcaptive" cases leading to opinions previously announced by the U.S. Tax Court ― but instead attempted to meet the risk distribution requirement by spreading its risk out over numerous entities that were affiliated with the owner of the captive.
This is a big difference ― actually, a humongous difference ― with all the previous opinion to involve microcaptives, for the reason that the opinion in Caylor Land may potentially extend in its application to far more types of captives than where the IRS has so-far limited its own focus, which is to risk-pooled 831(b) captives. Many captives thought to be very safe from a tax perspective may require introspection and reevaluation, such as the typical farmer co-operatives that Senator Grassley has protected and promoted. I'll tell you just why after we go through the opinion in this case.
This case involves primarily a company by the name of Robert Caylor Construction Company, known as "Caylor Construction" that was formed by Bob Caylor in 1958, and then later was purchased by his son, Rob Caylor, who had built his own successful company called Caylor Land & Development Company, known as "Caylor Land". There were many other Caylor companies and trusts, but the biggest moneymaker was Caylor Construction, which paid millions in "consulting fees" to the other Caylor entities ― and were often the biggest percentage of those other entities' revenues. In other words, the money flow sprouted with Caylor Construction on the ground floor, and then made its way upwards where it was sprinkled liberally on the other Caylor entities.
The Caylor entities obtain quality insurance coverage against a wide variety of risks as recommended by their long-term insurance broker, and for the years 2005 through 2014, their insurance premiums paid were around $55,000 or so a year. Nonetheless, every year the Caylor entities had an average of about $50,000 in losses that was not covered by their existing insurance, and so Rob started looking into the idea of a captive insurance company. This lead Rob, his father, and his CPA to a lunch presentation on captive insurance given by Tribeca, a captive insurance management company that would ultimately be seen by some as one of the most prolific captive insurance tax shelter shops (Tribeca was later acquired by Artex Risk Solutions, Inc., an Arthur J. Gallagher & Co. subsidiary that is itself now suffering with IRS problems both of its own and Tribeca's making), and also as one of the sloppiest. That’s not a good combination if you think about it.
Rob's CPA thought that Tribeca's presentation of the benefits of captive insurance sounded "too good to be true" (ultimately, it was) and Rob himself sought additional guidance from one of his tax and business attorneys who, although barely knowledgeable in the area, made some inquiries and told Rob to the effect that it could work if "established correctly and operated correctly", but without opining on whether Tribeca could or would do either. Notably, although Rob was purportedly looking for an insurance solution, he didn't consult about the captive with his own longtime insurance broker.
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Rob thereafter engaged Tribeca to form a captive insurance company to be called Consolidated, and started working on the standard questionnaire that Tribeca had sent to him. Tribeca prepared a feasibility study showing that Rob's creation of a captive under his circ*mstances were reasonable, and soon Consolidated was incorporated and licensed as an insurance company in that international financial megacenter known as Anguilla (where the local Insurance Commissioner also runs the local bait & tackle shop ⸺ well, not really, at least as far as I know, but you get the picture). Consolidated made the 953(d) election to be treated as a U.S. corporation for all purposes, and then also made an election to be taxed as an 831(b) captive which limited its premiums to $1.2 million per year, but those premiums were not subject to income taxes).
Consolidated made these elections on December 21, 2007, and the same day Caylor Construction paid Consolidated its first $1.2 million in premiums, allowing Caylor Construction to deduct those on its 2007 tax return. Judge Holmes would later find comment:
"This was at least a bit odd, since Caylor Construction had not yet completed any underwriting questionnaires, and perhaps even odder because Consolidated had not yet underwritten or issued any policies to any of the Caylor entities. The record shows, and we find, that Caylor Construction did eventually fill out an underwriting questionnaire for 2007 by the end of May 2008. And Caylor Construction did eventually get policies that covered itself and several other Caylor entities . . .. But what really made this first year remarkable was that the 2007 policies that Consolidated finally got around to issuing in 2008 were 'claims-made' policies, which means that any claim had to be reported during the applicable policy period (or an extended reporting period of no more than 60 days). So when Caylor Construction paid $1.2 million at the end of 2007 to Consolidated—the same amount it would be paying during the years at issue for a year’s worth of coverage—in reality it was receiving at most 10 days of coverage and possibly none at all."
In 2008, the various Caylor entities paid their own premiums to Consolidated, but ⸺ as with 2007 ⸺ the 2008 underwriting process did not even begin until after the 2008 coverage period had already ended. Just like what happens with real commercial insurance, not. And all this time, the Caylor entities were paying in the aggregate about what they paid before in insurance, about the $55,000 per year.
In 2009, there were some readjustments of the Caylor entities covered, but once again Tribeca didn't get around to actually drafting the 2009 policies until 2010, and in fact the signed 2009 policies were not delivered by Consolidated to the Caylor entities until December of 2010, which was almost a year after the policies' coverage had terminated. Keep in mind that in the real world of insurance, policies are usually drafted and delivered before the coverage begins (or at least there is a binder), so here the policies were actually two years late.
Moreover, of the policies that were drafted, Consolidated only underwrote policies for three entities: Caylor Construction, Caylor Land, and another Caylor company called RCMC. While other Caylor entities were "additional insureds" under the policies, they were not underwritten directly to those other entities.
The year 2010 was pretty much like 2009, insofar as the coverage acceptance forms were not delivered until November of that year, the declaration pages were issued in January, 2011, after the 2010 coverage had expired, Consolidated didn't get around to actually issuing the policies until April 2011.
About as interesting in all these years was how the money flowed between the Caylor entities, which is that the company making by far the most money was Caylor Construction, and it then sloshed around funds to the other Caylor entities by so-called "consulting" payments, which they then used in substantial part to pay their insurance premiums to Consolidated. There doesn't appear to have been any actual written consulting agreements in place, but rather Rob simply caused money to be slushed around between the Caylor entities as they needed money at a given time. But if one were to strip away all these consulting arrangements, then in terms of cash flow the appearance is indelible that Consolidated was really only insuring on policyholder, being Caylor Construction (and maybe Caylor Land to a lesser extent).
In the long run, that is, between 2007 and 2010, the Caylor entities paid Consolidated a total of $4.8 million in premiums. So, based on even just a common-sensical understand of underwriting and actuarial analysis, the amount of money in claims that Consolidated paid would naturally be somewhere in this ballpark, right? Wrong. During those years, Consolidated paid out on only four claims for a whopping aggregate total of $43,000 in premiums.
But even these four claims were fishy. A claim in 2009 for $13,000 was for legal fees that Caylor Construction used to collect a debt. It is difficult to identify exactly which insurance policy would cover such a thing, and even Tribeca ⸺ hardly the most critical of captive managers ⸺ requested that Caylor Construction provide additional documentation for that claim. Instead, Consolidated simply overruled Tribeca's request and ordered that the claim be paid. This happened later with a $10,000 payment, and notably both claims were paid before Consolidated had even issued the policies which allegedly covered the claims.
If by now you have come to the conclusion that Consolidated wasn't anything like a real insurance company, but rather was just a hinky and poorly-run vehicle to generate big deductions for the Caylor entities, then you would be in good company with the IRS which eventually came to about that same conclusion. Ultimately, the IRS challenged whether Consolidated qualified as an insurance company for tax purposes, whether the "consulting" payments from Caylor Construction to Caylor Land were deductible, and finally the IRS asserted both accuracy-related and substantial understatement penalties. Judge Holmes held a trial, and then issued the opinion that I shall next relate.
The court first took up the issue of whether the consulting contracts paid by Caylor Construction to Caylor Land were deductible, and Judge Holmes noted that the payments made for such consulting contracts can be deductible by the business paying them if, among other things, those are properly documented and exactly what consulting was performed was properly recorded. Which is exactly why they failed here:
"The testimony and exhibits we have in the record cause us to find it more likely than not that this 'consulting' consisted of conversations that Rob and his dad had over breakfast. Neither one could say what this consulting concerned, what subjects they discussed, or the amount of time they spent talking business instead of the ordinary subjects fathers and sons talk about. For a father and son to have a warm and loving relationship that helps sustain and grow the family business is admirable. But it’s not deductible."
So much for that. Moving right along, Judge Holmes then considered whether the premiums paid by the Caylor entities to Consolidated were deductible. The general rule where the insurer and the insureds are related is that premiums paid for self-insurance are not deductible, but deductions are allowed for certain types of insurance arrangements, including captive insurance. Noting that the line between nondeductible self-insurance and deductible insurance is "blurry", Judge Holmes noted that line is typically clarified by looking at four criteria:
(1) Risk-shifting;
(2) Risk-distribution;
(3) Insurance risk; and
(4) Whether the arrangement appears to be insurance within certainly "commonly accepted notions of insurance."
Examining the requirement of risk-distribution first, Judge Holmes noted that in the three previous U.S. Tax Court cases involving microcaptive insurance companies, the taxpayers had attempted to meet risk-distribution by using "insurance pools" (what are known in the captive industry as "risk pools") whereby numerous diverse policyholders purchase insurance from the pool such that their risk is mixed ("pooled") sufficiently that the risks were distributed by the time the premiums made their way back to the policyholders' by way of reinsurance agreements between the risk pool and the captive ⸺ and in each of those three cases, the risk pool "wasn't actually insurance" and so risk distribution was never met.
Consolidated did not attempt to meet risk distribution by way of a risk pool. Instead, Consolidated attempted to go the route used by nearly all the much larger corporate captives, which is to meet risk-distribution by insuring a sufficient number of affiliated entities. The IRS "safe harbor" example gives a dozen as the minimum number of brother-sister affiliates of the captive, with no insured affiliate having less than 5% or no more than 15% of the total risks insured by the captive. See Rev.Rul. 2002-90.
This is where the opinion gets the most interesting. According to Judge Holmes: "The question is not solely about the number of brother-sister entities insured, but the number of independent risk exposures." [Emphasis in original]
Whoa! Hold on! The IRS guidance in Rev.Ruling 2002-90 doesn't even mention "risk exposures". Under that guidance, you count up the number of affiliates that are being insured, look at their insured risks as a percentage of the captive's risks as a whole, and if you have at least a dozen entities and their risks are within the 5% to 15% range for the captive as a whole, then you should be safely anchored within the calm waters of 2002-90.
What happened is that the Earth did not stop turning after the IRS issued Rev.Ruling 2002-90, but after that guidance was issued the U.S. Tax Court, and some U.S. Circuit Courts of Appeal in reviewing U.S. Tax Court decisions, started looking past the IRS's (now outdated) mechanical rules and began applying an analysis that looks as the risk exposures that Judge Holmes has focused upon here.
The IRS called as its expert witness Dr. David Babbel who opined that Consolidated really only had 34 risk exposures (12 for administrative action, 11 for loss of key contacts, 10 for cyber liability, and 1 for extended warranty), and 34 was not sufficient for risk distribution. Moreover, nearly all the risks derived directly or indirectly from a single insured, being Caylor Construction.
Looking at Consolidated's argument that it fell within Rev.Ruling 2002-90, Judge Holmes noted that this wouldn't save the captive arrangement here even if a mechanical application of that test was made, since the insurance underwritten for two of the Caylor entities each constituted 30% (or 60% together) of Consolidated's risk, well above the 15% limit, and seven of the Caylor entities fell below the 5% threshold in their risk that Consolidated was taking on.
The court then addressed whether the 34 risk exposures that Consolidated was insuring was sufficient for risk distribution. Judge Holmes made clear that it was not:
"[W]e stated in Avrahami that independent risk exposure is the key. But this is called the law of large numbers—not small numbers or some numbers. Our caselaw demonstrates how very large these numbers must be. In Harper Group, the captive insured 7,500 customers covering more than 30,000 different shipments and 6,722 special cargo policies. This meant more than 260,000 air shipments; 18,000 air flights; and 40,000 shipments on more than 3,000 ocean voyages were covered. In Rent-A-Center, the captive insured three types of risks—workers’ compensation, automobile, and general liability. It insured 14,000 employees; 7,000 vehicles; and 2,600 stores. And in R.V.I. Guaranty, the insurance company insured one type of risk, the residual value of assets. But even there, the insurance company issued 951 policies covering 714 different insured parties with more than 754,000 passenger vehicles; more than 2,000 individual real-estate properties; and more than 1.3 million commercial-equipment assets." [Citations omitted, emphasis in original]
The court noted that there is no precise number of risk exposures that must be met to satisfy the tax law requirement of risk distribution. But whatever type of number that might be, Judge Holmes found that Consolidated's risks "are at least a couple orders of magnitude smaller than the captives in cases where we’ve found sufficient distribution of risk."
Moreover, at the end of the day Consolidated was effectively only underwriting the risks of a single insured, being Caylor Construction, or perhaps two if you throw in Caylor Land, as the rest of the Caylor entities only had potential risks that arose from Caylor Construction. To the extent the rest of the Caylor entities had their own risks that were independent from Caylor Construction, these risks were almost nominal. Or, as Dr. Babbel had put it, "it was like having a bunch of mice on one side and an 800-pound gorilla on the other with no way for Consolidated to balance the risk that Caylor Construction carried compared to other entities."
For its part, Tribeca had attempted to calculate the premiums paid by the Caylor entities to Consolidated based on the revenues of each of the Caylor entities, but this likewise overlooked that nearly all the money for the Caylor entities originated with Caylor Construction and then was slushed out to the other entities by way of the aforementioned consulting contracts. By like token, if something bad the financially happened to Caylor Construction, the other Caylor entities would themselves be in a severe pinch too.
Judge Holmes also though it important that the Caylor entities were largely restricted to a single industry in a single location, being the Tucson real-estate market, and thus there was no geographic or industry diversity that might have favored risk distribution. Thus, the court concluded that Consolidated's risks were not sufficiently distributed to meet the tax law test for insurance, and thus the policies that Consolidated underwrote for the Caylor entities was not insurance.
The court then moved on to consider whether Consolidated's policies amounted to insurance in the "common accepted sense". The factors to be considered here include: (1) Was the captive properly formed and operated as an insurance company? (2) Was the captive adequately capitalized? (3) Were the policies real, i.e., valid and binding? (4) Were the premiums negotiated at arm's length and were reasonable? (5) Were claims paid? and (6) Was there a legitimate reason for the buying these policies from the captive?
Nancy Harman was an experienced insurance underwriter who had worked for Tribeca as a captive manager from 2006 to 2009. She testified that Tribeca's process of pricing insurance policies was "very different" (her words) from that of anywhere else she had worked. What made the pricing so unusual was that Consolidated and Tribeca figured out in advance how much premium Consolidated wanted to receive from each of the Caylor entities, and then backed into the premium amount, i.e., identified risks and developed policies to try to reach a set amount of premium, instead of identifying the risks and developing the policies and only afterwards setting the appropriate premiums (which is how it works in the real insurance world).
Dr. Babbell likewise testified that he "had never seen a real insurance company issue policies after the period being insured" (and neither has your humble writer), but such appeared to be the standard operating procedure for Consolidated and Tribeca. That this happened not once, but four years in a row made those facts seem surreal. Thus, looking at the realities of the Consolidated's underwriting of the Caylor entities, Judge Holmes noted that, "[t]he realities do not help Consolidated here," and pointed to the testimony of Ms. Harman and Dr. Babbell that Consoidated operation was abnormal.
But operation was not the only thing about Consolidated that was abnormal, since its claims handling procedure was also well outside the industry norm. Noting that "[i]t's common enough for an insurance company to ask for more information from its client when it receives a claim", the court pointed to the fact that Rob Caylor simply ignored Tribeca's quite reasonable request for more information about the claims made to Consolidated, and instead just ordered Consolidated to pay the claims regardless.
The bottom line is that the way Consolidated was operated and handled claims, the court found that Consolidated did not actually operate like an insurance company.
We now come to "the most glaring evidence that it wasn't an insurance company" as the court examined the policies issued by Consolidated. The obvious problem here is that Tribeca didn't bother to prepare the policies until well after (sometimes nearly a year after), the policy term had ended. Thus, the Caylor entities paid premiums to Consolidated without knowing at the time what those premiums were for, such as what policies would be issued or what the policies would cover. To make this even more bizarre, two claims were paid on policies that had not by that time even been issued. Thus, as Judge Holmes commented:
"Writing and delivering 'claims made' insurance policies after the claim period is, we find, abnormal and is to any reasonable observer just plain silly. A policy written after the claims period is being written after there is no longer a risk of loss, which defeats the whole purpose of insurance. * * * We find ⸺ in strong terms ⸺ that this was not normal behavior." [Emphasis in original, internal citation omitted]
Moving on to whether the premiums charged by Consolidated were reasonable, the court indicated that there were two issues with the premiums. The first issue was that Consolidated charged and received a total of $1.2 million in premiums, which just happens to be the maximum premium amount that an insurance company can receive and not exceed the 831(b) limit. That amount of premiums has to be contrasted, however, with Rob Caylor's testimony that in the decade prior to forming Consolidated, the Caylor entities had averaged only about $50,000 in uncovered claims, or an aggregate of $500,000 in such claims over that decade. Thus, "[w]hile we don’t think that any premium over $50,000 per year would be per se unreasonable, a premium that is so much higher ⸺ $1,150,000 higher to be specific ⸺ looks unreasonable and thus likely to be for something other than 'insurance' as that term is commonly understood." Here, the court also noted that the Caylors never bothered to consult their longtime insurance adviser about what either the policies that they were receiving from Tribeca or whether other commercial policies were available, and at what price, that could have been used to supplement their existing policies.
The second issue involved how Consolidated calculated the premiums that it charged to the Caylor entities. In the real insurance world, this would involve taking Consolidated's loss history, similar industry-wide loss data, etc., and crunching them through a modeling program to generate a price. That is not what happened here, or anything like it. Instead, Tribeca took the amount of premium that the Caylor entities wanted to pay, $1.2 million per year, and then started backing in the risks and the policies to try to reach that amount, i.e., what one would do for a tax shelter disguised as a captive. As Judge Holmes remarked:
"The calculations of the premiums also made little sense. Gotzinger, in calculating the premiums, started in a normal place ⸺ the ISO (Insurance Services Office) base rate. But the calculations soon took a detour to crazy town. Several adjustments were made to these base rates which had the effect of raising the premiums for each policy ⸺ which makes sense only as an effort to increase the total premium to the desired $1.2 million."
Tribeca claimed that it made adjustments called "captive risk factor" adjustments for the purpose of allowing the captive to build financial strength, however, these adjustments increased the premiums not by a little but by 300%. Moreover, as Judge Holmes noted, "[t]his factor is completely unknown in the conventional insurance industry." One witness, an actuary named Roberta Garland, stated that as far as she was aware Tribeca was the only insurance manager who used this factor and that the premiums ultimately derived were unreasonable. Dr. Babbel called the use of these factors "economically futile" and "contrary to common insurance practice."
The bottom line to all of this was that the court found that Consolidated was not operated like an insurance company, which finally brings us to the issue of penalties. Here, the Caylors argued that penalties should not apply because they relied upon the professional advice of their CPA and business law attorney. However, the record indicated that their CPA did not give them any advice (other than telling Rob Caylor that the arrangement seemed "too good to be true") and simply prepared their returns, and their business law attorney told them no more than that a captive arrangement can work only if "established correctly and operated correctly" ⸺ and Consolidated was never operated correctly or even close to it. A similar analysis also applied to the consulting payments that were determined to be non-deductible. Thus, Judge Holmes began her final paragraph with: "Penalties apply across the board."
ANALYSIS
Crazy town, indeed. Consolidated was operated so poorly that Judge Holmes could have merely set out the record facts and then given a three-word opinion: Dead On Arrival. Whether the facts of this case were worst than those of the three previous 831(b) disasters in Avrahami, Reserve Mechanical or Syzygy, I will leave others to debate, but on these facts the captive arrangement had a precisely-calculated 0.000% chance of being determined valid.
One might ask why, if the facts were so bad, did the Caylors even incur the litigation expense of taking it to trial? I am not privy to the answer to that question, but if I had to guess it would be that the IRS denied all the Caylors' deductions and slammed them with penalties anyway, such that they could not possibly be any worse off by going to trial and hoping to at least avoid the penalties. The litigants in Avrahami were, for instance, able to avoid the penalties in that case based on their reliance upon their tax professionals, but they had better facts and it will be recalled that the court there (also with Judge Holmes) essentially gave them a break on penalties because it was the first such case to come before the U.S. Tax Court and they couldn't know in advance how the court would treat some of these issues. By contrast, the Caylors knew what was likely to happen precisely because of the three prior cases, and it wasn't good.
What we see with Consolidated is pretty much the same stuff that we say in the previous cases, i.e., risks being pulled from the thin blue sky, premiums amounts backed in to match the amounts of the deductions desired, claims handling procedures that varied from the non-existent to the bizarre, etc., and there is little point in rehashing those particular issues again, especially because there is a new issue that is worth deep consideration: The risk exposures issue.
The problem of risk exposers seems to come up only in the context of so-called unrelated-party captives. By way of comparison, assume that ten otherwise unrelated farmers in the midwest form an insurance cooperative to insure against crop loss due to hail damage. Each farmer pays a $10,000 premium for an aggregate premium of $100,000. In the event that any farmer's parcel suffers losses due to hail, they will get paid out to the extent of their losses subject to an aggregate maximum of $100,000. Being from Oklahoma, I know quite a bit about hail damage and it is a lot like tornados in that it is freakish: Hail can destroy one acre and leave the acre next to it completely untouched, the point being that it is highly unlikely in a given year that a couple of farmers will sustain hail damages to policy limits, so these arrangements make great economic and insurance sense. In that case, although there is only 10 potential risk exposures, there is little doubt that risk distribution is met and that the arrangement is one of insurance such as that the $10,000 premium should be deductible by each farmer.
When a related-party is involved, however, 10 risk exposers isn't going to cut it — not even get close. This is the situation of the Caylor entities and Consolidated, where the same owner (Rob Caylor) owned both Consolidated and its brother-sister affiliates in the Caylor entities, i.e., they are all related by common ownership. The 34 risk exposures in this case were, according to Judge Holmes, "at least a couple orders of magnitude smaller than the captives in cases where we’ve found sufficient distribution of risk."
How many risk exposures must be present to satisfy risk distribution? Judge Holmes refused to say, and instead channeled the concurring opinion by Justice Stewart in Jacobellis v. State of Ohio, 378 U.S. 184 (1964), which involved a question about whether a particular movie was p*rnographic: "I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it ...." That is precisely the approach taken by Judge Holmes insofar as there is some number of risk exposures that would rise to the level of risk distribution, but whatever that undefined number might be, the situation involving Consolidated didn't even get close.
Suffice it to say that this is no way to run a railroad. If the IRS is going to challenge related-party captives based on risk exposures, then the IRS should strive to give some guidance on the issue. Judge Holmes implicitly suggested as much by way of stating that it is not the U.S. Tax Court's job to set a firm line, but rather the U.S. Tax Court can only rule on whether or not sufficient risk distribution is present: "There is no precise number of independent risks that must exist for risk to be sufficiently distributed to meet this element — we’re not a legislature or regulator, and that’s not the way common-law concepts become clearer over time."
Reading between the lines, and looking at comparisons of the number of risk exposures in the Harper Group, Rent-A-Center, and R.V.I. Guaranty cases, it seems that the "order of magnitude" required for risk exposures to meeting risk distribution is at the very least measured in the thousands if not the tens-of-thousands of risk exposures. If that is true, then small related-party captives will never get close to having a sufficient number of risk exposures and even middle-sized captives are going to be at risk of having insufficient risk exposures.
So here is the bottom line: Unless there is a reversal of the U.S. Tax Court by the U.S. Court of Appeals, such as the Reserve Mechanical decision that is now pending before the 10th Circuit, this issue of risk exposures is perhaps the final stake that kills small related-party captive insurance companies. Not that these captives did not face insurmountable hurdles in the first place, since it was almost impossible for small captives to either satisfy the requirement of an arm's length transaction or to price premiums at a level that would allow the captive arrangement to be economical against the relatively high maintenance expenses of the captive and yet still be reasonable for tax law purposes. But now there is an additional requirement of risk exposures that small captives can probably never meet. How far this extends beyond the related-party captives remains to be seen, but it could potentially be very troubling for them as well, at least until there is additional guidance either from the IRS or the U.S. Tax Court.
In other words, small related-party captives are now completely finished unless the U.S. Tax Court is reversed. If we had not reached it before, we've finally hit that point where Don Meredith starts singing "turn out the lights, the party is over." There simply is no way for a small related-party captive to satisfy all the criteria that is now required under the rulings of the U.S. Tax Court — if someone thinks there is, then it is either a very unique situation or that person is engaged in deep self-delusion, most likely the latter.
The party being over, it is now time for small related-party captives to start winding up if they have not started that process already (and quite a few such captives — well into the hundreds — have been wound up in the last couple of years). Those who have captives that are either under audit or are docketed before the U.S. Tax Court had better start about cutting their losses and moving on, because their chances of winning now have been reduced to nearly zero and probably the only thing at issue is whether the worst penalties can be avoided based on a reliance defense. But, as this case demonstrates, the reliance defense isn't anything like automatic even if tax professionals were involved with the captive arrangement and merely having a CPA file tax returns is not enough.
Maybe Reserve Mechanical will change things at the U.S. Circuit Court of Appeals level, but the party is clearly over at the U.S. Tax Court level. Turn out the lights.
CITE AS
Caylor Land & Development, Inc. v. Comm'r, T.C.Memo 2021-30 (3/10/2021). Full document at http://captiveinsurancecompanies.com/cases/caylor/Caylor_210310.pdf
